Each year, Institutional Shareholder Services (ISS) seeks feedback from institutional investors, public companies (“issuers”) and the consulting and legal community on emerging corporate governance, executive compensation and other issues as part of its annual policy formulation process. Issuers and their advisors are collectively referred to as “non-investors” hereafter. Possibly reflecting concerns about the influence of ISS policies, 62% of Survey respondents were issuers, while only 27% of respondents were investors, generally large institutional shareholders.
The Survey was intended to provide feedback to ISS on a wide range of questions, including: non-GAAP performance metrics in incentive compensation programs, proxy access, overboarding and director independence for former executive officers, capital allocation and share buybacks, and certain other matters not covered in this Update.
Adjusted Performance Metrics in Incentive Compensation Programs
The Survey asked whether the use of adjusted or non-GAAP metrics in incentive compensation programs is acceptable.
Investors (81%) and non-investors (61%) agree that adjusted metrics are sometimes acceptable, depending on the nature and extent of the adjustment(s) and the degree to which disclosure of their purpose is transparent. Sixty-six percent of investors and one-half of non-investors (49%) believe that non-GAAP metrics are acceptable as long as performance goals and results are clearly disclosed and reconciled with GAAP metrics in the proxy statement, and the reasons for the adjustments are adequately explained. A sizeable minority of non-investors (42%) believe adjustments to GAAP metrics should be described and explained, but do not necessarily need to be fully reconciled to GAAP metrics.
The Survey also asked whether specific adjustments to GAAP metrics are appropriate. A majority of investors believe that it may be appropriate to adjust financial results for discontinued operations, non-recurring or extraordinary charges and foreign exchange volatility. However, a majority of investors also believe that adjustments for goodwill write-downs, litigation expenses and compensation expenses are not appropriate. Investors are evenly split as to whether adjustments for acquisition expenses may be appropriate.
A majority of non-investors (60%) also believe that adjusting financial results for compensation expenses is inappropriate, while majorities of non-investors believed that each of the other types of adjustments were appropriate. The following chart summarizes investor and non-investor responses.
|Non-GAAP Adjustment||% of Respondents Believing Adjustments Are Inappropriate|
|Expenses from lawsuits and related penalties||70%||42%|
|Goodwill write-downs or other impairments||58%||26%|
|Charges deemed non-recurring or extraordinary||43%||9%|
|Impact of foreign exchange volatility||40%||32%|
|Impact of discontinued operations||33%||14%|
Source: 2015-2016 ISS Global Policy Survey Summary of Results
Restrictions on Proxy Access
The Survey asked whether certain types of restrictions adopted by a company’s board in response to a majority-supported shareholder proposal on proxy access should be viewed as sufficiently problematic to “call into question the board’s responsiveness and potentially warrant ‘withhold’ or ‘against’ votes for directors.”
A great majority of investors believe that each of the restrictions on proxy access identified by ISS (and which are identified in the chart below) in the Survey should be viewed as sufficiently problematic to warrant negative votes on directors at companies that impose such restrictions.
In contrast, a vast majority of non-investors believe that negative votes on directors are not warranted for imposing all but two of the restrictions on proxy access that are identified in the chart below. A slight majority of non-investors (52%) believe that negative votes on directors could be warranted if the company established an ownership threshold greater than 5%, while 44% of non-investors believe that negative votes could be warranted for an ownership duration requirement in excess of three years.
The following chart summarizes investor and non-investor responses.
|Restriction on Proxy Access||% of Respondents Believing Restriction Warrants Negative Votes on Directors|
|An ownership threshold in excess of 5%||90%||52%|
|An ownership duration greater than 3 years||90%||44%|
|Information disclosures that are more extensive than those required of the company’s nominees, by the company, the SEC, or relevant exchanges||80%||39%|
|A cap on nominees set at less than 20% of the existing board||79%||25%|
|An aggregation limit of fewer than 20 shareholders||76%||23%|
|An ownership threshold in excess of 3%||72%||14%|
|Restrictions on compensation of access nominees by nominating shareholders||72%||26%|
|More restrictive advance notice requirements||70%||20%|
|Renomination restrictions in the event a proxy access nominee fails to receive a stipulated level of support or withdraws his/her nomination||68%||20%|
Source: 2015-2016 ISS Global Policy Survey Summary of Results
In the Survey, ISS asked what constitutes an acceptable number of directorships on public company boards for non-employee directors, directors who are active CEOs and other directors.
As shown in chart on the following page, no clear consensus exists among investors as to an appropriate limit on the number of directorships that should be held by non-employee directors and directors who are active CEOs. In contrast, a large plurality of non-investors believes that no limits should exist.
|Number of Directorships||Investors||Non-Investors|
|§ No limit||12%||41%|
|§ No more than 4 directorships||34%||19%|
|§ No more than 5 directorships||18%||7%|
|§ No more than 6 directorships||20%||25%|
|Directors who are Active CEOs|
|§ No limit||12%||35%|
|§ No more than 1 outside directorship||48%||20%|
|§ No more than 2 outside directorships||32%||37%|
Source: 2015-2016 ISS Global Policy Survey Summary of Results
ISS also asked whether a stricter standard on the number of directorships should apply to executive directors. Two-thirds of investors believe that a stricter standard on the number of directorships should apply to directors with “demanding full-time jobs,” such as CFOs and law firm partners. According to ISS, investor comments suggested that stricter limits should also apply to board chairmen, lead directors and audit committee members. Only 37% of non-investors agree that a stricter standard should apply to such directors.
Finally, ISS asked whether there should be any exceptions to its standard for excessive directorships for directors’ service on boards of non-operating companies or for services by investment holding company executives on boards of publicly traded companies in which the investment holding company has an interest. A majority of investors and non-investors believed that such exceptions should be made (58% and 74%, respectively).
Director Independence for Former Executives
Under current ISS policy, a former executive (other than a CEO) serving on the board of directors is considered to be a non-independent director for five years from the time the individual held an executive position at the company (“cooling off period”). After the cooling off period lapses, ISS will consider such a director to be independent. The policy applies to an individual who served on the board continuously for the period and to a director who reported to the company’s current CEO while the director was an employee of the company.
In the Survey, ISS solicited input on when the “cooling off period” should start for former executives. Almost a majority of investors (46%) believe that the cooling-off period should begin to run only after the individual retires from the board as well as from all executive posts. In contrast, two-thirds of non-investors (68%) believe that the cooling-off period should begin to run as soon as the individual retires from the executive position.
ISS also asked whether a cooling-off period should apply to an individual who is a former employee of a firm providing significant professional services to the company, such as the company’s auditor or outside counsel. The vast majority of investors (82%) believe that a cooling-off period should apply to such an individual, while non-investors were evenly split on the question.
Capital Allocation and Share Buybacks
The Survey asked a series of questions regarding capital allocation and share buybacks. Specifically, the Survey asked whether certain five-year historical financial metrics would be helpful in assessing capital allocation decisions, share buybacks and the efficiency of board stewardship.
A majority of investors believe that five-year historical data on share buybacks (96%), dividends (95%), capital expenditures (93%) and cash balances (85%) would be helpful in assessing capital allocation decisions. Similarly, the majority of investors believe that data on current year share buybacks as a percentage of the company’s market cap (95%) and cash balance (85%), as well as five-year cumulative buybacks as a percentage of the company’s market cap (97%) and cash balance (84%), would be helpful. According to ISS, investors indicated that they would also find data on R&D expenditures, ROE, ROIC, and ROA to be helpful, particularly the relationship between capital expenditures and ROA and the relationship between cash balances and ROE. ISS noted in its Survey Summary of Results that some investors also expressed an interest in information on executive compensation and how it is affected by share buybacks.
A majority of non-investors also believe that five-year historical data on share buybacks (80%), dividends (79%), capital expenditures (61%) and cash balances (62%) would be helpful in assessments. Two-thirds of non-investors believe that current year or five-year cumulative share buybacks as a percentage of market cap would be helpful, while almost half of non-investors believe the same with respect to the ratios of buybacks to cash balances. According to ISS, some issuers echoed investor views that additional metrics, such as R&D spending, non-capital investment, acquisitions and growth in operating income would also be useful in assessing capital allocation decisions.
Meridian comment. The Survey responses suggest that ISS might start to provide institutional shareholder clients historical data on a company’s capital allocation decisions for their independent review. We do not believe that a company’s capital allocation decision will impact ISS’s vote recommendations on director elections in 2016. However, this may be a precursor to ISS assessing whether a company’s Board of Directors has demonstrated effective stewardship over capital.
As we stated in our comment letter to ISS on the Survey, we believe that ISS is not in a position to substitute its judgment for that of a company’s Board of Directors to evaluate capital allocation decisions. Capital allocation decisions do not lend themselves to universal benchmarks or ratios; they depend greatly on a company’s unique circumstances and prevailing market dynamics. In our experience, Boards spend a significant amount of time carefully evaluating capital decisions, including share buybacks and dividend policies, and are cognizant of the potential effects that capital decisions may have on incentive plan goal setting. Given the complexities of these decisions, we believe that a company’s board is in the best position to decide the best use of corporate resources.
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The Client Update is prepared by Meridian Compensation Partners’ Technical Team led by Donald Kalfen. Questions regarding this Client Update or executive compensation technical issues may be directed to Donald Kalfen at 847-235-3605 or email@example.com.
This report is a publication of Meridian Compensation Partners, LLC, provides general information for reference purposes only, and should not be construed as legal or accounting advice or a legal or accounting opinion on any specific fact or circumstances. The information provided herein should be reviewed with appropriate advisers concerning your own situation and issues.