Frequently Asked Questions

Updated: December 20, 2012

Please see ISS’ “Evaluating Pay for Performance Alignment” white paper for an explanation of the quantitative methodology used in the first phase of this analysis, and a summary of the qualitative factors considered.

Methodology

  1. How does ISS’ initial quantitative pay for performance analysis affect the ultimate vote recommendation for Management Say on Pay proposals or election of compensation committee members (in the absence of management say on pay proposal)?

    The quantitative pay for performance analysis serves as an initial screen of the company’s pay for performance alignment. A high or medium concern from the quantitative screen results in an in-depth qualitative review of the company’s Compensation Discussion & Analysis to identify the probable causes of the misalignment and/or mitigating factors. Subsequent to the qualitative review of the company’s proxy statement, only 53% of the high concern companies resulted in negative vote recommendations during the 2012 proxy season, while 47% of the high concern companies received a favorable vote recommendation due to mitigating factors identified in the qualitative assessment.

  2. What are the factors that ISS considers in conducting the qualitative review of the pay for performance analysis?

    Here are key factors that ISS considers in conducting the qualitative review of the pay for performance analysis:

    Factors that are relevant to each analysis will be discussed in the report.

    • Ratio of performance- to time-based equity awards;
    • Overall ratio of performance-based compensation;
    • The completeness of disclosure and rigor of performance goals;
    • The company’s peer group benchmarking process (e.g., whether it includes the presence of outsized peers or above-median benchmarking);
    • Actual results of financial/operational metrics, such as growth in revenue, profit, cash flow, etc., both absolute and relative to peers;
    • Special circumstances related to, for example, a new CEO in the prior fiscal year or anomalous equity grant practices;
    • Realizable pay compared to grant pay; and
    • Any other factors deemed relevant.
  3. How does ISS use realizable pay in its analysis?

    ISS’ standard research report will show three-year realizable pay compared to the three-year granted pay for S&P 500 companies starting with Feb. 1, 2013 meeting dates. See question 7 below for ISS’ definition of realizable pay and how it will be calculated.

    Realizable pay will generally be discussed in cases where the company’s initial quantitative screen shows a high or medium concern. For S&P 500 companies, we may utilize the realizable pay chart to see if realizable pay is higher or lower than granted pay and further explore the underlying reasons. For example, is realizable pay lower than granted pay due to the lack of goal achievement in performance based awards, or simply due to a decline in stock price? Is realizable pay higher than granted pay due to above target payouts in performance based equity awards and, if so, are the underlying goals sufficiently rigorous, or is the difference due to increasing stock price?

    For all companies, ISS’ consideration of realized and/or realizable pay is to assist in determining whether the company demonstrates a strong commitment to a pay-for-performance philosophy. The fact that realizable pay is lower, or higher, than grant-date pay will not necessarily obviate other strong indications that a company’s compensation programs are not sufficiently tied to performance designed to enhance shareholder value over time. However, in the absence of such indications, realizable pay that demonstrates a pay-for-performance commitment will be a positive consideration.

  4. How is Realizable Pay for large cap companies computed?

    ISS’ goal is to calculate an estimated amount of “realizable pay” for the CEOs of S&P 500 companies. It will include the amounts actually paid or realized, or the current value of incentive grants made, during a specified measurement period*, as of the end of that measurement period.

    Realizable pay will include all non-incentive compensation amounts paid over the measurement period, plus the value of equity or long-term cash incentive awards made during the period and either earned or, if the award remains on-going, revalued at target level as of the end of the measurement period. The total realizable value for these grants and payments will thus be the sum of the following:

    *Generally three fiscal years, based on the company’s fiscal year. For realizable pay calculated as part of ISS’ 2013 analyses, this will generally consist of fiscal years 2010 through 2012.

    Note that ISS’ realizable pay amount will be based on a consistent approach, using information from company proxy disclosures. Since current SEC disclosure rules are designed to enumerate “grant-date” pay rather than realizable pay, these estimates will be based on ISS’ best efforts to determine necessary inputs to the calculation. In cases where, for example, it is not sufficiently clear whether an applicable award has been earned or forfeited during a measurement period, ISS will use the target award level granted.

    • Base Salary reported for all years in the measurement period;
    • Bonus reported for all years;
    • Short-term (typically annual) awards reported as Non-equity Incentive Plan Compensation for all years;
    • For all prospective long-term cash awards made during the measurement period, the earned value of the award (if earned during the same measurement period) or its target value in the case of on-going award cycles;
    • For all share-based awards made during the measurement period, the value (based on stock price as of the end of the measurement period) of awards made during the period (less any shares/units forfeited due to failure to meet performance criteria); or, if awards remain on-going, the target level of such awards;
    • For stock options granted during the measurement period, the net value realized with respect to such granted options which were also exercised during the period; for options granted but not exercised during the measurement period, ISS will re-calculate the option value, using the Black-Scholes option pricing model, as of the end of the measurement period;
    • Change in Pension Value and Nonqualified Deferred Compensation Earnings reported for all years; and
    • All Other Compensation reported for all years.
  5. Why doesn’t ISS use the intrinsic value (exercise price minus current market price) of stock options when calculating realizable pay?

    Top executives’ stock options typically expire after seven to 10 years, meaning that even if an option is underwater in the first few years after its grant, there is a substantial likelihood it will ultimately deliver some value to the holder prior to expiration. Shareholders recognize that in considering “realizable” pay as a pay-for-performance factor, it is important to include the economic value of underwater options (which will also reflect the impact of a lower stock price, if applicable).

  6. A company would like to disclose ongoing and/or completed performance-based equity awards for awards made in the past three years. What type of disclosure format would ISS suggest?

    Disclosure of ongoing or completed performance-based equity awards in a consistent manner would facilitate ISS’ calculation of realizable pay (which is based on a best efforts extraction of necessary information from proxy statements). If a company has awarded performance-based equity awards in the past three years, disclosure of the awards in the following table would be helpful:

    Grant Date Threshold Payout (#) Target Payout Maximum Payout Performance Period* Target/Actual Earned Date Actual Payout
    3/1/2009 100,000 150,000 200,000 1 year 6/1/2010 180,000
    3/1/2010 150,000 200,000 250,000 3 years 6/1/2012 Not determined yet

    *Performance period does not include time-vesting requirement.

  7. How will ISS calculate realizable pay when the CEO changes during the measurement period?

    In general, ISS will calculate the realizable amounts, as of the end of the measurement period, of the Summary Compensation Table pay reported for each CEO in office on the last day of each fiscal year in the measurement period.

  1. Will “pay” continue to be defined as summary compensation table pay or consider the current value of LTIs (potential realizable pay)?

    Total compensation calculated by ISS will continue to be defined as granted pay and pay opportunities, for a number of reasons but including that: 1) it is the best reflection of the compensation committee’s oversight and decision-making, and 2) pay opportunities should be reflective of the company’s past performance to some degree – in particular, if the opportunity appears to be misaligned with that performance (in a negative way), shareholders expect those grant opportunities to be strongly performance-based. Realized or potentially realizable pay will be considered as part of ISS’ qualitative evaluation of pay-for-performance alignment.

Determining Peer Companies

  1. How does ISS select constituents for the peer groups used in its Pay-for-Performance analysis?

    As of 2013, ISS’ methodology for selecting peers maintains its focus on identifying companies that are reasonably similar to the subject company in terms of industry profile, size, and market capitalization, taking into account a company’s self-selected peers to guide industry selections.

    ISS’ selected peer group generally contains a minimum of 14 and maximum of 24 companies based on the following factors:

    • the GICS industry classification of the target company
    • the GICS industry classifications of the company’s disclosed benchmarking peers
    • size constraints for both revenue (or assets for certain financial companies) and market value.

    Subject to the size constraints, and while choosing companies that push the subject company’s size closer to the median of the peer group, peers are selected from a potential peer universe in the following order:
    1. from the subject’s own 8-digit GICS group
    2. from the subject’s peers’ 8-digit GICS groups
    3. from the subject’s 6-digit GICS group
    4. from the subject’s peers’ 6-digit GICS groups
    5. from the subject’s 4-digit GICS group

    When choosing peers, priority is given to potential peers within the subject’s “first-degree” peer group (the companies that are either in the subject’s own peer group, or that have chosen the subject as a peer), and companies with numerous connections (by choosing as peer or being chosen as a peer) to these first-degree peers. All other considerations being equal, peers closer in size are preferred.

  2. What are some ways that the peer groups constructed via ISS methodology implemented for 2013 differ from ISS’ previous peer groups?

    The following table outlines some of the characteristics of the projected 2013 peer groups (based on most recent disclosure as of September 2012) relative to prior peer groups:

    New Methodology (as of 2013)

    Prior Methodology
    GICS Precision – 8-digit The average company has more than 80% of potential ISS peer selections based on the company’s 8-digit GICS or the 8-digit GICS groups of self-selected peers Approximately 40% of peers are based on the company’s 8-digit GICS group
    GICS Precision – 2 digit No potential peer groups have members based on 2-digit GICS 12% of peer groups have members based on 2-digit GICS
    Similarity with company’s selected peers 42% of companies have a potential ISS peer group that overlaps at least 50% of their own.On average, potential ISS peer groups contain 44% of the company’s self-selected peers. Approximately 20% of companies have an ISS peer group that overlaps at least 50% of their own.
    Size comparison Over 90% of potential ISS peer groups maintain the subject within 20% of the peer group median size 82% of peer groups maintain the subject company within 20% of the peer group median size
  3. Will a company’s self-selected peers always appear in the ISS peer group, if they meet ISS’ size constraints?

    No. While the new methodology does place a priority on the company’s own peer selections, there are a number of reasons why a company selected peer may not appear in the final ISS list, even if it meets the relevant size (revenue or assets and market capitalization) constraints. As noted above, the new methodology also places priority on other factors as it builds the peer group:

    • The company’s own 8-digit GICS category
    • Maintaining the subject company size at or near the median of its peer group
    • Maintaining the approximate distribution of GICS industry codes as reflected in the company’s self-selected peer group

    As a result, at times including a company’s self-selected peer may push the subject company away from the median, or lead to an overrepresentation of that industry within the final peer group. In these cases the company’s self-selected peer may not be included.  In addition, if a company’s self-selected peer is the only peer company in its 6- and 8-digit GICS category, it will receive a lower priority in the peer selection process.

  4. What are ISS’ size parameters for qualifying a potential peer?

    ISS applies two size constraints to qualify potential peers:

    1. Revenue (or assets for certain financial companies, as noted below)
    In general companies should fall in the range 0.4 to 2.5 times the company’s revenue (or assets). These ranges are expanded when the subject company’s revenue is larger than $10 billion or smaller than $200 million in revenue (assets). Companies smaller than $100 million in assets are treated as if they have $100 million in assets.
    2. Market capitalization (in millions)

    Companies are classified into market capitalization buckets as follows:

    Bucket

    Low end

    High end
    Micro

    0

    200
    Small

    200

    1,000
    Mid

    1,000

    10,000
    Large

    10,000

    No cap

    While ISS may choose peers that fall outside a subject company’s market cap bucket if necessary to reach a minimum peer group size, none may have a market cap of less than 0.25 times the low end or more than 4 times the high end of the subject’s market capitalization bucket.

  5. Which industry groups will be useful assets for size comparisons? What happens when a company has potential peers in both asset-based and revenue-based industry groups?

    ISS will use balance sheet assets (rather than revenue) to measure the size of companies in the following 8-digit GICS groups.

    • 40101010 Commercial Banks
    • 40101015 Regional Banks
    • 40102010 Thrifts + mortgage
    • 40202010 Consumer Finance
    • 40201020 Other diversified

    Both subject and potential peer must be in the asset-based GICS groups listed above in order to be compared on the basis of assets.  In cases where a subject company is in one of the asset-based GICS groups and a potential peer is not, revenues will be used for size comparisons. This principle applies to the size comparisons made to qualify a peer for potential inclusion as a peer, to the size rankings made to maintain the subject company near the median size of the peer group, and to the size prioritization of peers.

  6. When will a company’s peer group have more than 14 members?

    In general, the closer the industry match, the larger the subject size of the peer group: for direct matches to the company’s own 8-digit GICS, as many as 24 peers may be chosen. For matches of the company’s peers’ 8-digit GICS, as many as 18 peers may be chosen, falling to a maximum of 14 peers when choosing from the company’s 4-digit GICS. More peers, however, may be selected in order to bring the target company’s size closer to the median of its peers.

  7. If the standard methodology fails to yield the minimum number of acceptable peers, what peer group will be used? How will ISS create peer groups for very large “super-mega” companies for 2013?

    In general, ISS will supplement the peer group generated by the standard methodology in such cases.  For larger “super-megacap” companies, ISS will use the standard methodology to identify as many peers as possible for these very large companies. In cases where this does not provide a sufficient number of peers, ISS will supplement these peer groups according to the principles above.

    In exceptional cases, the ISS peer group may contain a minimum of 12 constituents.

  8. How does ISS treat foreign-domiciled or privately-held company peers?

    ISS uses these peers for the purpose of identifying relevant GICS industry groups, if relevant industry data is readily available. Foreign-domiciled companies that file Def14A, 10-Qs, and 10-Ks may be included as ISS selected peers. Privately-held or other foreign-domiciled companies that do not make such filings are not included as ISS selected peers.

  9. If a company used multiple peer benchmarking groups, which group will ISS use as an input to the process? What does ISS do if a company does not employ a peer group for benchmarking?

    ISS uses the company peer group that is used for CEO pay benchmarking purposes. If there is no peer group employed, the peer methodology will draw peers from the company’s own 8-, 6- and 4-digit GICS groups, subject to ISS’ size constraints.

  10. Does ISS apply additional judgment in the process of building peer groups?

    ISS may adjust any peer groups that appear to have inappropriate constituents at the time of our analysis.  The basic principles of the methodology will still apply: peers should come from similar industries and be of similar size, and company peers should be prioritized where possible.

  11. Wihat impact will peer group methodology changes have on the pay-for-performance quantitative screen?

    ISS’ preliminary back-testing indicates that more than 80 percent of companies would experience a change of less than 15 points (up or down) in their Relative Degree of Alignment (RDA) measure under the new methodology, compared to the current peer methodology. Similarly, 80 percent of companies would experience a change of less than 0.2 in their Multiple of Median (MOM) measures under the new methodology. Accordingly, for the overwhelming majority (>95%) of companies, the quantitative screen concern levels would not be affected by the new peer groups.

    In addition, the overall distribution of these RDA and MOM measures under the new methodology does not deviate significantly from the current distribution of these scores.

  12. When will ISS reconstruct peer groups?

    Company peer groups will be reconstructed during July and August, after the Russell 3000 index is updated in July.  Expectation is that any revisions to company peer groups, which are not anticipated to be significant, will be in place for research in process as of September 1 (generally affecting companies that have filed DEF14As after mid August).  A subsequent peer group construction will occur in December and early January, effective for meetings as of February 1.

  13. In December 2012, ISS provided companies an opportunity to communicate any changes made to their benchmarking peer groups following their 2012 proxy disclosures. Will companies with later fiscal year-ends that did not know at that time what changes they were making to peer groups used with respect to fiscal 2012 compensation decisions also have an opportunity to communicate changes?

    Yes, ISS will provide a similar opportunity after proxy season, prior to reconstruction of its peer groups per above, for companies with later meetings.

  14. Can only Russell 3000 companies be used as peer companies?  Will ISS use companies that an issuer considers as peers (specified in the proxy) to develop the ISS comparator group?

    If a Russell company discloses the names of the companies that it uses as its peers, and these companies are public, ISS will collect the data on them even if they are not in the Russell 3000.  If these companies fit ISS’ criteria for peers, then they may be used as ISS peers as of the next update of ISS peer groups.

Problematic Pay Practices

  1. Why does ISS consider now hedging and pledging of company stock under its policy framework for the election of directors, rather than under the problematic pay practices policy?

    In considering new policy related to the significant pledging of company stock, ISS obtained market feedback from our policy survey, roundtables, comment letters, and other means. While shares that are used by executives or directors who engage in hedging or pledging transactions often have been acquired via compensation programs, many investors expressed the view that the board is specifically responsible for setting policies related to risks to shareholder value. Since both hedging and pledging raise such risks, ISS decided to move this aspect of the policy to the appropriate section, election of directors, where it will be evaluated under the Egregious Actions framework.

  2. How does ISS view hedging or significant pledging of company stock by an executive or director?

    Hedging is a strategy to offset or reduce the risk of price fluctuations for an asset or equity. Stock-based compensation or open market purchases of company stock should serve to align executives’ or directors’ interests with shareholders. Therefore, hedging of company stock through covered call, collar or other derivative transactions sever the ultimate alignment with shareholders’ interests. Any amount of hedging will be considered a problematic practice warranting a negative vote recommendation against appropriate board members. Please see the 2013 U.S. Proxy Voting Policies and Procedures FAQ for more insight on ISS policy in this regard.

Advisory Vote on Golden Parachutes (SOGP)

  1. An event has technically triggered a change in control according to the company’s formal definition; however the company continues to exist and there is minimal impact on board turnover or management structure.  How would ISS apply its SOGP policy in this regard?

    In cases where ISS concludes that a bona-fide change in control event has not occurred (e.g., the company’s equity remains outstanding and the board is not significantly affected) ISS views that severance payments or automatic acceleration of outstanding equity awards should not occur. If ISS’ policy framework is not applicable due to unusual circumstances, recommendations will generally be made on a case-by-case basis, taking into consideration whether the outcome is beneficial to shareholders.

  2. How would ISS determine that the performance measures would not have been achieved in the absence of the decision to accelerate the performance based awards? If a truncated performance period is used, then how would ISS know whether the performance measures would not have been achieved had no CIC transaction occurred?

    Best practice is pro rata vesting based on current achievement. If it is impossible to measure performance under pre-determined performance criteria the board should justify paying an award as if target or highest performance goals were met.

  3. How does ISS determine whether specified golden parachute payouts are “excessive”?

    In evaluating disclosed payouts related to a change in control with respect to the SOGP proposal, ISS may consider a variety of factors, including the value of the payout on an absolute basis (e.g., relative to an executive’s annual compensation) or one or total payouts relative to the transaction’s equity value.  There are no bright line thresholds for these considerations, since they are made in conjunction with other factors in ISS’ review.

  4. How will ISS consider existing problematic change-in-control severance features in its SOGP evaluation?

    Beginning in 2013, ISS will consider existing (as opposed to new in the last year) problematic features such as excise tax gross-up provisions and single and modified single payout triggers in determining a vote recommendation on SOGP proposals. In general, legacy excise tax gross-up provisions will be considered in the context of the amount of actual tax gross-ups reported as part of the company’s SOGP disclosure.  Legacy single/modified single triggers also may be considered in the context of the total change-in-control payout and whether they result in unjustifiable payouts in the absence of an executive’s termination without cause in connection with the change in control.

Note: The questions and answers in this FAQ page are intended to provide high-level guidance regarding the way in which ISS’ Global Research Department will generally analyze certain issues in the context of preparing proxy analysis and vote recommendations for U.S. companies. However, these responses should not be construed as a guarantee as to how ISS’ Global Research Department will apply its benchmark policy in any particular situation.

Start typing and press Enter to search