2011 US Compensation Policy

Frequently Asked Questions

Display allUpdated: August 24, 2011

Standard Research Report – Compensation Related

Determining Peer Companies

  1. How are peer companies determined?

    ISS' selected peer group generally contains a minimum of eight and maximum of 12 companies, comprised of companies within the same six-digit Global Industry Classification Standard (GICS) with revenue ranging between 0.5- to 2.0-times the company’s revenue. If there are insufficient companies within the six-digit GICS, peer companies would be supplemented from the four-digit GICS or even the two-digit GICS, using the same size parameters. For Financial companies, size is measured by assets rather than revenue; for companies with very high or very low revenues or assets (making it difficult to create a peer group on that basis), market cap is used as the size measure. In cases of some very large companies, peer companies may be compiled using a standard index such as the Dow 30 or S&P 500 Index.

  2. What are GICS codes?

    The Global Industry Classification Standard (GICS) was developed by Standard & Poor's and MSCI in response to the financial community's need for a reliable, complete (global) standard industry classification system. GICS codes correspond to various business or industrial activities, such as Oil & Gas Drilling or Wireless Telecommunication Services. GICS is based upon a classification of economic sectors, which is further subdivided into a hierarchy of industry groups, industries and sub-industries. The GICS methodology is widely accepted as the industry analysis framework for investment research, portfolio management, and asset allocation.

  3. Where is the list of peer companies disclosed?

    The list of peer companies is disclosed under the Components of Pay section and it can be found under either the Management Say on Pay proposal or Compensation Profile (for companies that do not have a Management Say on Pay proposal on their ballot).

  4. Is the same list of peer companies used for a company's allowable cap on an equity plan proposal?

    No, the list of eight to 12 peer companies shown in the executive compensation section is not the same peer group used in determining a company's allowable cap calculation on an equity plan proposal. The peer group used for benchmarking executive pay is based on a combination of industry and size (such as revenue/assets or market cap); the peer group used for creating the allowable cap calculations for stock-based compensation is based on industry, with adjustments for market cap size.

  5. Who can I contact if I disagree with the GICS classification?

    ISS does not classify companies into the GICS codes. Please contact Standard & Poor's at 1-800-523-4534 if you believe that a company has been misclassified.

  6. How are the peer medians calculated for the Components of Pay table?

    The median is separately calculated for each component of pay and for the total annual compensation (TC). Please note: peer median total compensation will not equal the sum of all the peer median pay components, because the values are calculated separately for each pay component, while the median TC reflects the median of TC of the peer group constituents.

    Please note that calculation of Total Compensation may be different from the Total under the Summary Compensation Table in the proxy statement, mainly due to treatment of option valuation.

Listing Named Executive Officers (NEOs)

  1. How many named executive officers' total compensation data are shown in the Compensation Profile section?

    The executive compensation section will generally reflect the same number of named executive officer's total compensation as disclosed in a company's proxy statement. However, if six or more named executive officers' total compensation has been disclosed, only five will be represented in the section, based on the highest total compensation. Former or terminated executives within the past fiscal year will be excluded from the table.  However, executives who are terminated after the end of the last fiscal year will be included, as they were executives within the past complete fiscal year.

  2. A company's CEO has resigned and there is a new CEO in place. Which CEO is shown in the report?

    Our report displays the CEO in office on the last day of the fiscal year.

Components of Pay Section

  1. How is Total Compensation calculated?

    Total Compensation = Base Salary + Bonus + Non-equity Incentive Plan Compensation + Stock Awards*+ Option Awards**(based on full grant date values, as calculated by Equilar for research reports published through June 17, 2011 and by ISS for reports published after that date) + Change in Pension Value and Nonqualified Deferred Compensation Earnings + All Other Compensation. The calculation will generally match the Summary Compensation Table with the exception of the stock option value, described further below.

    *Stock Awards - Grant date value as reported in the Grants of Plan-Based Awards Table for any stock awards, including time-vested awards and performance shares, valued at target per revised SEC rules. If the grant date value is not reported, the number of target units/shares multiplied by the closing stock price on the grant date will be calculated. The stock awards value should generally match for both the Summary Compensation Table and Grants of Plan-Based Awards Table.

    **Option Awards - Grant date present value of options using Black-Scholes Option Pricing Model, as calculated by Equilar with respect to research reports published through June 17, 2011, and by ISS for reports published after that date.

  2. What is Equilar's Black-Scholes methodology?

    Item

    Source

    Comments

    C

    Option Value

    Calculated

    N/A

    S

    Stock Price

    Proxy

    N/A

    E

    Exercise Price

    Proxy

    N/A

    s

    Volatility

    SunGard

    Historical three-year stock price volatility measured on a daily basis from the date of grant. If a company has not been publicly traded for at least three years, Equilar measures volatility from the IPO date through grant date.

    q

    Dividend Yield

    SunGard

    Cumulative dividends for the 12 months prior to the option grant date divided by stock price (adjusted for stock splits over the period).

    r

    Risk Free Rate

    SunGard

    U.S. Government Bond Yield on the date of grant corresponding to the term of the option. For example, if the option has a 10-year term, the risk free rate is the 10-year U.S. Government Bond Yield on the date of grant.

    t

    Term/Expected Life

    Proxy

    Full term of the option.

    e

    Base of Natural Logarithm

    N/A

    N/A

    ln

    Natural Logarithm

    N/A

    N/A

    N(x)

    Cumulative Normal Distribution Function

    N/A

    N/A

  3. What is ISS' Black-Scholes methodology?

    Variable

    Item

    Source

    Comments

    C

    Option Value

    Calculated

     

    S

    Stock Price

    Proxy

     

    E

    Exercise Price

    Proxy

     

    s

    Volatility

    XpressFeed

    Historical three-year stock price volatility measured on a daily basis from the date of grant. If a company has not been publicly traded for at least three years, ISS measures volatility from the IPO date through grant date.

    q

    Dividend Yield

    XpressFeed

    Average dividend yield over five years. If a company has not been publicly traded for at least five years, ISS averages dividend yield from the IPO date and the grant date of option. Dividend yield is based on each dividend divided by the closing stock price on the last business day before the dividend date. The calculation excludes the payouts of special dividend

    r

    Risk Free Rate

    Dept of Treasury website

    U.S. Government Bond Yield on the date of grant corresponding to the term of the option. For example, if the option has a 10-year term, the risk free rate is the 10-year U.S. Government Bond Yield on the date of grant.

    t

    Term/Expected Life

    Proxy

    Full term of the option.

    e

    Base of Natural Logarithm

    N/A

    N/A

    Ln

    Natural Logarithm

    N/A

    N/A

    N(x)

    Cumulative Normal Distribution Function

    N/A

    N/A

  4. What is the Pay vs. TSR chart?

    The Pay versus Performance chart shows indexed total shareholder return ("TSR"), based on a $100 investment at a company at the end of the first year over a five year period, compared to the CEO's total compensation (calculated as stated above) for each corresponding year.  Pay information prior to 2007 is based on previous SEC disclosure requirements. This comparison is provided for informational purposes but is generally considered in ISS' Pay for Performance analysis, as applicable.

  5. Why is some data missing from the Pay for Performance section?

    ISS is providing pay and indexed total shareholder return as available, for companies in the Russell 3000 index. If the company was not a part of the Russell 3000 index historically, the compensation data for that year will be indicated as zero.

  6. How is the present value of all accumulated pensions calculated?

    This figure represents the summation of the present value of the benefits for all pension plans, both qualified and non-qualified, disclosed in the Pension Benefit table of the proxy statement.

  7. How is the value of Non-Qualified Deferred Compensation calculated?

    This figure is calculated by multiplying the disclosed number of shares in the Beneficial Ownership Table and the stock price on the last day of the fiscal year as disclosed in the Company Snapshot under the Financial Profile section. Stock options that are exercisable within the next 60 days are included, as disclosed by the company. Starting in September 2011, stock options that are exercisable within the next 60 days will be excluded in the calculation and the footnote will be updated appropriately.

  8. How is the value of CEO Stock Owned Calculated?

    This figure is calculated by multiplying the disclosed number of shares in the Beneficial Ownership Table and the stock price on the last day of the fiscal year as disclosed in the Company Snapshot under the Financial Profile section. Stock options that are exercisable within the next 60 days are included, as disclosed by the company. Starting in September 2011, stock options that are exercisable within the next 60 days will be excluded in the calculation and the footnote will be updated appropriately.

  9. How is potential severance calculated?

    The values for an involuntary termination without cause and a change in control related termination are provided as disclosed under the relevant termination scenario in the Change in Control Table and/or narrative.

Financial Data: Total Shareholder Return and Revenue

  1. Where does ISS obtain a company's 1-year fiscal total shareholder return, 3-year fiscal total shareholder return and revenue?

    ISS obtains all financial data in the Compensation Profile from Standard & Poor's Research Insight.

  2. How does Research Insight calculate 1-Year fiscal Total Shareholder Return (TSR)?

    The three-year total shareholder return is the annualized rate of return reflecting price appreciation plus reinvestment of monthly dividends and the compounding effect of dividends paid on reinvested dividends over a three-year period.

  3. How does Research Insight calculate company net income (loss)?

    Net income or loss is reported by a company after expenses and losses have been subtracted from all revenues and gains for the fiscal period including extraordinary items and discontinued operations.

  4. Why is the CEO pay as percent of a company's revenue showing NA?

    If a company's revenue is zero, the CEO pay as percent of a company's revenue will be NA.

  5. Why is the CEO pay as percent of company's net income showing NA?

    If a company's net income is zero or negative, the CEO pay as percent of a company's net income will be NA.

Management Say on Pay Evaluation

  1. What is ISS's Executive Compensation Evaluation policy?

    The Executive Compensation Evaluation policy consists of three sections: Pay for Performance, Problematic Pay Practices, and Board Communication and Responsiveness. Recommendations issued under the Executive Compensation Evaluation policy may apply to any or all of the following ballot items, depending on the pay issue (as detailed in the policy): Election of Directors (primarily compensation committee members), Advisory Votes on Compensation (MSOP), and/or Equity Plan proposals.

  2. If a company has an MSOP resolution on the ballot, will ISS also apply compensation-related recommendations to members of the compensation committee who are up for election?

    In general, if a company has an MSOP resolution on the ballot, any compensation-related recommendations will be applied to that proposal; however, if egregious practices are identified, or if a company previously received a negative recommendation on an MSOP resolution related to an issue that is still on-going, ISS may also recommend WITHHOLD/AGAINST votes with respect to compensation committee members.

  3. If one or more directors received a negative recommendation in the prior year due to ISS' concerns over compensation practices will it have a bearing on the following year's recommendation?

    If one or more directors received less than 50 percent of shareholders’ support (regardless whether it is a compensation issue), ISS may recommend that shareholders withhold from the entire board with the exception of new nominees if the company fails to take adequate action to respond or remediate the issues raised in the previous report. If one or more directors received a high level of dissent (30 percent to 49.5 percent), the company should discuss any action or consideration taken to address the concern. A high level of dissent indicates an overall dissatisfaction and the board/committee should be responsive to shareholders’ concerns. A lack of discussion or consideration, coupled with existing borderline concerns may have a bearing on the following year's recommendation.

Pay for Performance Evaluation

  1. ISS has recommended withholds on a company’s compensation committee or recommended against a company’s management say on pay or equity plan proposal on the basis of a CEO pay for performance disconnect. What prospective actions can the company take to address the concerns?

    The pay for performance evaluation is a case-by-case analysis, and the commitment should be tailored according to the underlying issues identified in the pay for performance disconnect. As an example, if the primary source of pay increase is due to time-vested equity awards, a remedy could be for the company to commit to making a substantial portion of equity awards to named executive officers performance-based. A substantial portion of performance-based awards would be at least 50 percent of the shares awarded to each of the named executive officers. Please note that this is 50 percent of the shares awarded rather than 50 percent of the value of the awards. Performance-based equity awards are earned or paid out based on the achievement of pre-established, measurable performance targets.

    The company should disclose the details of the performance criteria (e.g., return on equity) and the hurdle rates (e.g., 15 percent) associated with the performance awards at the time they are made. From this disclosure, shareholders will know the minimum level of performance required for any equity grants to be earned. Performance-based equity awards do not include standard time-based stock options or performance-accelerated grants. Instead, performance-based equity awards are performance-contingent grants, where the individual will not receive the equity grant if target performance is not achieved. Premium-priced options with an exercise price at least 25 percent higher than the fair market stock price on the date of grant may be considered performance-based. The 25 percent premium should serve as a guideline rather than a bright line test. A 25 percent premium may not be rigorous for a company trading at $1.00. If option vesting is contingent on the stock reaching a specified price, the price condition should be maintained for at least 30 consecutive trading days before vesting.

    As another example, if the primary source of pay increase is due to a discretionary bonus, an appropriate commitment could be to award only performance-based bonuses in the future. In order for shareholders to assess the rigor of the performance-based bonus program, the company needs to disclose the performance measures and goals. Complete and transparent disclosure is critical. The company needs to disclose the following:

    1. the measures(s) used (and rationale for the selections);
    2. the goal(s) that were set for each metric and the target (and, if relevant, threshold and maximum) payout level(s) set for each NEO;
    3. the reason that each goal was determined to be appropriate for incentive pay purposes (including the expected difficulty of attaining each goal);
    4. the actual results achieved with respect to each goal; and
    5. the resulting award (or award portion) paid to the NEO with respect to each goal.

     The actual results and the resulting award need not be disclosed until the performance cycle is complete.

    The renewed pay for performance commitment must be made in a public filing, such as a Form 8-K or DEFA 14A. Based on the additional disclosure of a renewed commitment, ISS may recommend a vote FOR the compensation committee members up for annual election and/or vote FOR the management say on pay or equity plan proposal, if there is one on the ballot. However, ISS is not likely to recommend a vote FOR the compensation committee members and/or vote FOR the management say on pay or equity plan proposal if ISS believes the company has not provided compelling and sufficient evidence of a renewed commitment and transparent additional disclosure of executive compensation. Further, if there are significant base salary increases in the current or following year that may be questionable in light of the company’s lagging stock performance, the pay for performance commitment may be nullified. It is important to note that a pay for performance commitment does not preclude ISS from conducting its Pay-for-Performance analysis at the company’s future annual meetings.

  2. A company makes equity grants near the beginning of each year based on an evaluation of the company and/or the executive’s performance in the immediately preceding year. Such grant information will appear in the following year’s proxy statement. Will ISS take into account the timing of these early equity grants made in the current fiscal year and make adjustments to the top executives’ total compensation when conducting its pay-for-performance evaluation?

    Such timing issue can be problematic for investors evaluating the relationship between performance and pay. The value of equity grants generally represents a significant proportion of top executives’ pay; if the grants are made subsequent to the “performance” year, disclosures in the Grants of Plan-Based Awards Table may distort the pay-for-performance link.

    Some investors believe that equity awards can incentivize and retain executives for past and future performance; therefore, adjustments for such timing issues may not be relevant. Nevertheless, ISS may consider the timing of equity awards made early in the fiscal year if complete disclosure and discussion is made in the proxy statement. In order to ensure that pay-for-performance alignment is perceived, the company should discuss the specific pre-established performance measures and goals that resulted in equity awards made early in a fiscal year. A general reference to last year’s performance is not considered sufficient and meaningful to shareholders. If the company makes equity grants early in each year, based on the prior year’s specific performance achievement, shareholders should not be required to search for the information in Form 4s and compute the adjusted total compensation for the top executives in order to make a year-over-year comparison. Instead, companies should provide information about grants made in relation to the most recently completed fiscal year in the proxy statement for the shareholder meeting that follows that fiscal year (aligned with other compensation reported for that year). Many companies provide an alternate summary compensation table that takes into account of the recent equity awards made in the current fiscal year. The number of options or stock awards with the relevant exercise price or grant price should be disclosed in the proxy statement. The term of the options should be provided as well. In order for ISS to compute the adjusted total compensation and include it for purposes of our narrative discussion and analysis, companies need to make transparent and complete disclosure in the proxy statement; ISS will not search for the companies’ Form 4 filings to make such adjustments but will rely on the specific grant disclosures found in the proxy statement.

  3. If the CEO was a recent internal promotion, does the Pay -for - Performance policy apply?

    No. The pay-for-performance policy is applicable only when the CEO has been in that position for two full fiscal years.

Problematic Pay Practices/Commitments on Problematic Pay Practice

  1. What is ISS's 2011 Problematic Pay Practices evaluation?

    Pay elements that are not directly based on performance are generally evaluated on a CASE-BY-CASE basis considering the context of a company's overall pay program and demonstrated pay-for-performance philosophy.  The list below highlights the problematic practices that carry significant weight in this overall consideration and may result in adverse vote recommendations:

    • Repricing or replacing of underwater stock options/SARS without prior shareholder approval (including cash buyouts and voluntary surrender of underwater options);
    • Excessive perquisites or tax gross-ups, including any gross-up related to a secular trust or restricted stock vesting;
    • New or extended agreements that provide for:
      • CIC payments exceeding 3 times base salary and average/target/most recent bonus;
      • CIC severance payments without involuntary job loss or substantial diminution of duties ("single"  or "modified single" triggers);
      • CIC payments with excise tax gross-ups (including "modified" gross-ups).
  2. Under the new policy, would an agreement which is automatically extended (e.g., an evergreen feature) but is not modified warrant a withhold or against vote recommendation if it contains a problematic pay practice)?

    Automatically renewing/extending agreements (including agreements that do not specify any term) are not considered a best practice, and a problematic practice in such a contract is a concern. However, if an evergreen agreement is not materially amended in manner contrary to shareholder interests, it will be evaluated on a holistic basis, considering a company’s other compensation practices along with features in the existing agreement.

  3. The policy lists the most problematic practices. What is the full list of pay practices that are considered problematic and may result in a withhold or against recommendation, on a case-by-case basis?

    Based on input from client surveys and roundtables, ISS has identified certain adverse practices that are contrary to a performance-based pay philosophy, which are highlighted in the list below.

    • Egregious employment contracts:
      • Contracts containing multi-year guarantees for salary increases, non-performance based bonuses, or equity compensation.
    • New CEO with overly generous new-hire package:
      • Excessive “make whole” provisions without sufficient rationale;
      • Any of the problematic pay practices listed in this policy.
    • Abnormally large bonus payouts without justifiable performance linkage or proper disclosure:
      • Includes performance metrics that are changed, canceled, or replaced during the performance period without adequate explanation of the action and the link to performance
    • Egregious pension/SERP (supplemental executive retirement plan) payouts:
      • Inclusion of additional years of service not worked that result in significant benefits provided in new arrangements
      • Inclusion of performance-based equity or other long-term awards in the pension calculation
    • Excessive Perquisites:
      • Perquisites for former and/or retired executives, such as lifetime benefits, car allowances, personal use of corporate aircraft, or other inappropriate arrangements
      • Extraordinary relocation benefits (including home buyouts)
      • Excessive amounts of perquisites compensation
    • Excessive severance and/or change in control provisions:
      • Change in control cash payments exceeding 3 times base salary plus target/average/last paid bonus;
      • New or materially amended arrangements that provide for change-in-control payments without loss of job or substantial diminution of job duties (single-triggered or modified single-triggered, where an executive may voluntarily leave for any reason and still receive the change-in-control severance package);
      • New or materially amended employment or severance agreements that provide for an excise tax gross-up. Modified gross-ups would be treated in the same manner as full gross-ups;
      • Excessive payments upon an executive's termination in connection with performance failure;
      • Liberal change in control definition in individual contracts or equity plans which could result in payments to executives without an actual change in control occurring
    • Tax Reimbursements: Excessive reimbursement of income taxes on executive perquisites or other payments (e.g., related to personal use of corporate aircraft, executive life insurance, bonus, restricted stock vesting, secular trusts, etc; see also excise tax gross-ups above)
    • Dividends or dividend equivalents paid on unvested performance shares or units.
    • Executives using company stock in hedging activities, such as “cashless” collars, forward sales, equity swaps, or other similar arrangements.
    • Internal pay disparity: Excessive differential between CEO total pay and that of next highest-paid named executive officer (NEO)
    • Repricing or replacing of underwater stock options/stock appreciation rights without prior shareholder approval (including cash buyouts, option exchanges, and certain voluntary surrender of underwater options where shares surrendered may subsequently be re-granted).
    • Other pay practices that may be deemed problematic in a given circumstance but are not covered in the above categories.
  4. Does the presence of single trigger vesting acceleration in an equity plan result in an automatic AGAINST vote for the plan, the say on pay vote, the entire compensation committee, or the full board?

    There are no “automatic” negative recommendations under ISS policy. We will consider all relevant aspects included with the company’s ultimate disclosure. With regard to equity-based compensation, ISS policy encourages “double trigger” vesting of awards after a CIC (considered best practice).

    In the absence of double-triggered vesting, the current preferred practice is for the board to have flexibility to determine the best outcome for shareholders (e.g., to arrange for outstanding grants to be assumed, converted, or substituted), rather than the plan providing for automatic accelerated vesting upon a CIC.

    Equity plans or arrangements that include a liberal CIC definition (such as a very low buyout threshold or a CIC occurring upon shareholder approval of a transaction, rather than its consummation), coupled with a provision for automatic full vesting upon a CIC, are more likely to receive a negative recommendation.

  5. While guaranteed multi-year incentive awards remain problematic, is providing a guaranteed opportunity for what ISS considers a performance-based vehicle acceptable?

    While guaranteeing any executive pay elements (outside of salary and standard benefits) is not considered best practice, the fact that the payout of such an award would ultimately depend on performance attainment (provided, as noted, that no payout would occur if performance is below a specified standard, and that the performance hurdles appear reasonably robust), would mitigate concerns about the guaranteed award size.

  6. Are material amendments other than extensions of existing contracts a trigger for analysis with respect to problematic existing contract provisions?

    ISS is concerned with the perpetuation of problematic practices, thus, agreements that are extended or new will face the highest scrutiny and weight in the analysis. Material amendments will still be considered an opportunity for the board to fix problematic issues, but as part of the holistic analysis.

  7. In 2009, in response to an ISS vote recommendation, a company adopted a policy prohibiting payments of tax gross-ups made on life insurance premiums in new or amended agreements. Certain officers were grandfathered at that time, and they continue to receive such payments. Is that policy, which ISS approved, to no longer be honored by ISS?

    All factors are weighed in the holistic analysis; including existing agreements, commitments, and continuing practices of the company. However, unless the existing contracts are extended, they do not rise to the level of the most problematic practices.

  8. Will commitments entered into in the last fiscal year (in 2010 or prior), before ISS announced its policy for the 2011 Proxy Season, be "grandfathered"?

    Commitments not to enact problematic features in future agreements will no longer mitigate the enacting of problematic pay practices in new or amended agreements during the prior fiscal year.

  9. If a company put excise tax gross-ups in new agreements in the last fiscal year, what action can they take to prevent an against recommendation from ISS?

    A company can remove that provision from the new agreements.

Frequency of Advisory Vote on Executive Compensation

  1. In the event that a company’s board decides not to adopt the say on pay vote frequency supported by a plurality of the votes cast, what are the implications in terms of ISS’ voting recommendations at subsequent meetings?

    This policy has not been determined. The policy will be decided after review of the first year of voting results and after consultation with ISS's clients, and will be included in the policy updates for 2012.

Advisory Vote on Golden Parachutes

  1. Under what circumstances would a say-on-pay vote be combined with a golden parachute proposal on a proxy?

    The Golden parachute vote is considered part of the MSOP vote if the company’s shareholder meeting proxy (with the MSOP item) includes a prescribed “Golden Parachute Table” in the CD&A. If that is the case, the information provided in the Golden Parachute Table would carry more weight in our overall MSOP recommendation – it does not matter whether that is a regular annual meeting or a meeting where shareholders are also voting on a CIC transaction.

  2. What does this mean: "In the case of a substantial gross-up from pre-existing/grandfathered contract: the element that triggered the gross-up (i.e., option mega-grants at low point in stock price, unusual or outsized payments in cash or equity made or negotiated prior to the merger)"

    ISS policy for the past few years has focused on new or amended agreements, and thus a disclosed estimated gross-up payment does not have any immediate implications. However, an outsized disclosed gross-up figure would result in a closer look at the individual situation and what figures might have contributed to the substantial payment. This will be evaluated on a case-by-case basis, and if there is significant concern there may be a recommendation against.

  3. 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.

Equity Related

Option Repricing/Exchange Proposals

  1. With the market rebound, fewer companies are seeking shareholder approval for option exchange programs. If a company were to consider such a program, can you provide additional guidance besides the standard shareholder friendly features, such as value-for-value exchange, exclusion of named executive officers and directors, resetting vesting schedules?

    Option exchange creates a gulf between the interests of shareholders and management, since shareholders cannot reprice their stock. Option exchange should be the last resort for management to use as a tool to re-incentivize employees. Only deep underwater options should be eligible for the program rather than somewhat underwater options, especially if the company’s stock is volatile. Using a company’s 52-week high as the threshold exercise price may be reasonable in a depressed economy, but it may not be rational in a market rebound. A company’s 52-week high may be its current stock price which may suggest that these options are marginally underwater. As a rule of thumb, the threshold exercise price for eligible options should be the higher of the 52-week high or 50 percent above the current stock price. That way, only deep underwater options are eligible for the program. However, this rule of thumb should not be considered in isolation, as there are several other factors, such as the timing of the request and whether the company has experienced a sustained stock price decline that is beyond management’s control among others. Further, a company’s current stock price can be a consideration as well. A premium of 50 percent for a company trading at $1 may be a low threshold if the company’s stock price is particularly volatile.

    A company should discuss the various levels of employees (management versus non-management) who will be eligible participants in the program. Some companies have broad-based option programs whereas others tend to grant to management at the Vice President level. Absent such disclosure, institutional investors may assume that equity grants are generally awarded to management.

  2. Cost of Equity Plans
  3. How does ISS look at the practice of buying shares on the open market to fund employees' equity grants?

    The practice of repurchasing shares on the open market in order to avoid dilution from employees’ equity grants may be beneficial to shareholders if this represents a good use of the company’s cash.   However, there is still a cost to the company, and we would still capture that cost by our SVT calculation. In an efficient market, the buyback should then have a positive impact on the company’s stock price despite the reduction in outstanding shares. Therefore, it should have a neutral effect on market valuation. In addition, when a buyback is executed, a company immediately receives higher EPS and other share denominated accounting performance metrics, which in turn may lead to higher allowable cap. Adjustments to reduce the voting power dilution may be made if the share repurchase is implemented to offset dilution from stock-based compensation and if such repurchase is made within the past two years.

  4. What is the policy on stock in lieu of cash plans?

    ISS includes all stock in lieu of cash plans in evaluating the total costs of equity plans. ISS believes that cash or stock payments are considered as compensation to the employees and therefore should be considered in evaluating equity proposals. The total cost of equity-based compensation to directors is also generally considered under the compensation model.  However, some stock-based plans do provide directors to take all or a portion of their cash compensation in the form of stock. If such plan provides for a clear dollar-for-dollar stock exchange of the cash compensation, ISS will view the stock in lieu of cash as value neutral for SVT purposes. Any other non-value neutral form of exchange which may include a premium for deferring cash compensation for stock is considered by ISS to cause transfer of shareholder’s equity which should still be measured.

  5. Burn Rate Policy
  6. How does ISS calculate the burn rate and annual stock price volatility?

    The annual burn rate is calculated as follows:

    Annual Burn rate = (# of options granted + # of full value shares awarded * Multiplier) / Weighted Average common shares outstanding)

    Stock Volatility is based on the 200-day volatility as of the company's quarterly data download, then annualized:

    Stock Volatility = Standard Deviation of 200 ln (Pt / Pt-1), where Pt is the closing stock price on day t and Pt-1 is the closing stock price on t-1.

    Annualized stock volatility = Stock Volatility X Square Root of 250.

  7. A company went public two and a half years ago. However, the 10-K discloses three years of historical grant information. Does the burn rate policy apply?

    The burn rate policy applies to companies that have been publicly traded for three complete fiscal years.

  8. What action may a company take if it fails to meet the three-year average burn rate policy?

    A company may commit to a prospective gross three-year average burn rate, which excludes stock options with a reload feature granted prior to 2005, equal to the higher of two percent of the company's common shares outstanding or the mean plus one standard deviation of its GICS peer group. A company's burn rate may exceed the peer group average in the first year, provided the prospective three-year average burn rate remains below the commitment level. The company would need to publicly notify shareholders of its commitment via, e.g., a form 8-K, DEFA14A, or in the summary plan description of the stock plan proposal in the DEF14A. The company would also be required to disclose in its future proxy statements the status of the commitment during the applicable period.

    Sample Disclosure:

    "The Company commits that, with respect to the number of shares subject to awards granted over the next three fiscal years [period of time], we will maintain an average annual burn rate over that period that does not exceed [x%] of weighted common shares outstanding.   For purposes of calculating the number of shares granted in a particular year, all awards will first be converted into option-share equivalents. In this case, each share that is subject to awards other than options will count as equivalent to [current multiplier] option shares."

    Making a commitment does not guarantee a vote change if ISS believes there are concerning flaws that remain in the company's equity plan design.  Also, when the plan potentially propagates an egregious compensation practice that was identified, a recommendation AGAINST the plan may persist. Note that when a prior burn-rate commitment was modified or has been violated mid-stream, it may warrant a vote AGAINST the plan absent justifiable reasons, or in some cases, may result in a recommendation AGAINST the compensation committee members.

  9. What multiplier is used to evaluate whether the company has fulfilled its burn rate commitment?

    Most companies, as part of their burn rate commitment, "lock in" the current year's multiplier to reduce uncertainty. If the multiplier is thus specified in the commitment, ISS will use that multiplier. If a company did not lock in the multiplier as part of their burn rate commitment, then ISS uses the multiplier that applies to them in the year we are analyzing them to see if they fulfilled their burn rate commitment.

  10. Which burn rate policy applies to a company whose GICS classification or Index Membership has been recently changed?

    Presumably, the new classification or index membership will reflect the appropriate operational and revenue size and thus the burn rates that are reasonable for the compensation structure of similar companies under the new classification will apply.  In very limited cases, ISS may consider a modified burn-rate commitment.

  11. Does the burn rate policy apply to a company that has been recently acquired?

    Yes. For companies that have been acquired, we would generally use the three-year average burn rate data for the acquirer.  For companies that have merged in a merger of equals, we would generally average the three-year average burn rate for both companies.

  12. If a company assumes an acquired company’s stock options in connection with a merger, will ISS exclude these stock options in the three-year average burn rate calculation?

    If the company discloses in the option activity table of the 10-K the number of assumed options in connection with the merger, ISS will not include assumed options for that year. However, if the company does not separate the number of assumed options and number of options granted, the assumed options will be included. This exclusion does not apply to new (inducement, recruitment, retention) equity awards granted following an acquisition, as these have the effect of depleting the available share reserves for compensation purposes.

  13. Liberal Share Recycling
  14. What is the liberal share recycling policy?

    Plans that have liberal share recycling provisions, i.e., where shares granted and exercised can, under certain circumstances, be added back to the plan reserve for future grants, will receive a more costly valuation in that all shares will be evaluated in the ISS model as full-value awards.

  15. Under what circumstances are shares considered “recycled”?

    For purposes of ISS’s liberal share recycling policy, recycled shares may include, but are not limited to, the following:

    • Shares tendered as payment for an option exercise;
    • Shares withheld from exercised shares for taxes;
    • Shares added back that have been repurchased by the company using stock option exercise proceeds;
    • Stock-settled SARs where only the actual shares delivered with respect to the award are counted against the plan reserve.
  16. Are SARs settled in cash considered “recycled”?

    In cases where a plan allows SARs to be settled in either cash or stock, ISS will assume all to be stock-settled.  If the plan also provides that only the net shares delivered with respect to the award will be counted against the plan reserve, the liberal share recycling policy will be triggered.

  17. What happens if a company provides a limit on the number of shares that it can recycle?

    If there is an articulated limit on full value awards and it is explicit that liberal recycling is only allowed on full value awards, then ISS will apply the limit accordingly as stated.  However, if liberal recycling is also permitted on other forms of awards (i.e. options), then ISS will consider that the recycling feature effectively nullifies the stated limit under the plan because of the additional cost attributed to the potential of recycling other types of awards. 

     
  18. Repricing
  19. Does ISS consider the cancellation and regrant of stock options/SARs as repricing?  What about the cancellation of stock options/SARs for cash payments?

    Yes, ISS considers the above two scenarios as repricing and will recommend an AGAINST vote on the equity plan if the company allows such arrangement without shareholder approval.

  20. What progressive action may a company take if it fails to meet the repricing provision policy in equity plans?

    Companies may eliminate the provision which allows the board or the administrator discretion to implement any form of repricing without seeking prior shareholder approval.  Alternatively, such statements can also be explicitly superseded by a statement clarifying that any transaction allowing for an economic value exchange by optionees will require further shareholder approval.

    Sample Language:

    "Except in connection with a corporate transaction involving the Company (including, without limitation, any stock dividend, distribution (whether in the form of cash, Common Shares, other securities or other property), stock split, extraordinary cash dividend, recapitalization, change in control, reorganization, merger, consolidation, split-up, spin-off, combination, repurchase or exchange of Common Shares or other securities, or similar transaction(s)), the company may not, without obtaining stockholder approval: (a) amend the terms of outstanding Options or SARs to reduce the exercise price of such outstanding Options or SARs; (b) cancel outstanding Options or SARs in exchange for Options or SARs with an exercise price that is less than the exercise price of the original Options or SARs; or (c) cancel outstanding Options or SARs with an exercise price above the current stock price in exchange for cash or other securities.”

  21. Liberal Definition of Change in Control
  22. What is the policy on liberal change in control definitions found in equity plans?

    ISS may recommend a vote AGAINST an equity plan if it could permit accelerated vesting of equity awards based upon a liberal change in control definition (e.g., a trigger linked to shareholder approval of a transaction, rather than its consummation, or an unapproved change in less than a substantial proportion of the board, or acquisition of a low percentage of outstanding common stock, such as 15 percent).

  23. What progressive action may a company take if its equity plans contain liberal change in control definitions?

    A company may qualify the problematic change in control definition to be preconditioned on determinate events that effectively constitute a change in control event, such as "consummation of a transaction" or "constructive loss of employment (double-triggered CIC)."

    Sample language:   “Change in Control shall be deemed to have occurred…upon the consummation of a merger or consolidation of the Company with any other corporation.”

    For an existing plan that is being amended, as opposed to a new plan, it is acceptable to specify that the CIC definition is effective for grants made after the plan amendment date.

    Examples:

    http://www.sec.gov/Archives/edgar/data/729237/000072923710000012/exhibit1011.htm

    http://www.sec.gov/Archives/edgar/data/1324948/000114420410046664/v195238_ex10-1.htm

  24. Fungible Plans
  25. How does ISS evaluate flexible share plans or fungible share pools?

    Under a flexible share plan, each full-value award counts more than one share and each option counts as one share of the plan reserve. ISS evaluates the total costs of the plan by analyzing a flexible share plan under two scenarios: (1) all new shares request as full value awards (2) all new shares request as stock options. Under the first scenario, ISS adjusts the number reserved according to the ratio provided in the plan document. ISS will support a flexible share plan as long as both scenarios generate total costs below the allowable cap. ISS presents the more costly scenario in our proxy analysis.

  26. 162(M) Plans
  27. A post-IPO company submits an equity plan that has problematic issues (e.g. repricing provisions) for approval by public shareholders for the first time, solely for 162(m) purposes.The company will not be adding shares to the plan or in any way changing any provision in the plan. Will ISS review the plan?

    While ISS generally recommends support for 162(m) plans, our ultimate recommendation is based on evaluation of all aspects of the plan, in order to ensure that any adverse provisions would not have a more detrimental potential impact on shareholders than a potential loss of tax deductions related to named executive officer grants. 

  28. Stock Option Overhang Carve-Out
  29. When will ISS apply the stock option overhang carve-out policy?

    Companies with sustained positive stock performance and high overhang cost attributable to in-the-money options outstanding in excess of six years may receive a carve-out of these options from overhang as long as the dilution attributable to the new share request is reasonable and the company exhibits sound compensation practices. A company needs to demonstrate that these in-the-money options outstanding in excess of six years have been continuously in-the-money after they were vested. The fact that employees had the opportunity to exercise these options but chose not to exercise them may reflect the confidence they have in the company’s future prospects. Presenting in-the-money options in excess of six years is not sufficient information for ISS to determine whether these options were continuously in-the-money after they were vested. Companies are advised to provide the individual tranches of option grants with grant dates, option exercise prices and vesting schedules so that ISS can analyze the portion of in-the-money options to potentially carve out from the overhang.

  30. In the stock option overhang carve-out policy, what does ISS consider to be sustained positive stock performance?

    ISS generally looks for positive 5-year total shareholder return (TSR) as well as positive year over year performance for the past five fiscal years at the time of the analysis. Exceptions may be made if stock performance was negative for the first two years and then strongly positive for the remaining three years, but vested grants that have been underwater for a substantial time during the 5-year period will not be eligible for the carve-out. These options should be deeply in the money for the periods where the company’s stock performance was only high for the latest three years. A comparison of the company’s five-year TSR against its four-digit GICS group can be helpful.

  31. Is ISS making any exceptions to the sustained positive stock performance criteria in light of the financial debacle experienced by almost all companies in 2009?

    ISS recognizes that companies are affected by the global recession and would take that into consideration of the company’s stock performance during this tumultuous period. Strong performing companies have experienced significant market rebound and should reflect that the stock price decline is temporary.

  32. Can ISS provide an example of a company providing such disclosure in order for ISS to carve out continuously in-the-money options outstanding in excess of six years?

    Please see Myriad Genetics’ DEFA 14A filed Oct. 28, 2009, Air Products and Chemicals' 8K filed Jan. 5, 2010,  NVR's DEF 14A filed March 19, 2010.

  33. What does ISS look for with respect to the distribution of awards to executives vs. other employees (concentration ratio) in the stock option overhang carve-out policy?

    ISS will calculate the concentration ratio in the past fiscal year, defined as total equity grants to the top five executives divided by total equity grants to employees and directors. Concentration ratios greater than 50 percent to named executive officers may be concerning.

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.