ExecutiveLoyalty.org

Problematic Pay Practices - as identified by ISS

(based on its U.S. compensation policies, as updated 12/14/2017)


On at least an annual basis, those who make executive compensation decisions for public companies should check their practices against the guidelines published by ISS and other proxy advisory firms.  The table below reformats, but generally tracks, the U.S. Compensation Policy FAQs that ISS most recently updated on December 14, 2017. All references are to FAQ #48 unless another is noted. 


​When reviewing the table below, directors should first aim to determine whether their company has executive compensation structures that involve problematic practices.  The best companies avoid or eliminate such irritants to shareholders, unless there are solid business justifications for them.  For instance, the payment of tax gross-ups for golden parachute taxes is generally verboten. Nevertheless, tax gross-ups may be justifiable under some circumstances, such as when executive compensation is being restructured, to be more performance-based, in anticipation of a corporate sale.  Overall, boards should be careful to identify (and to justify) any problematic pay practices, because ISS and others will likely scrutinize them if incumbent directors do not.​



  Nature of

  Decision



  Problematic Practice
   RED FONT HIGHLIGHTS PRACTICES THAT ISS IDENTIFIES AS

   HAVING "SIGNIFICANT WEIGHT" THAT "WILL LIKELY RESULT IN

   ADVERSE VOTE RECOMMENDATIONS."

Employment ContractsEgregious contracts containing multi-year guarantees for –
  • salary increases,
  • non-performance based bonuses, or
  • equity compensation.

See also: 409A Diagnostic Checklist for Employment Agreements

New CEO's PayOverly generous new-hire package [evidenced by] --
  • excessive “make whole” provisions without sufficient rationale, or
  • any of the problematic pay practices listed in this policy.
Bonus Payments
  • Abnormally large 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.
  • Multi-year guaranteed awards that are not at-risk due to rigorous performance conditions. [FAQ #49]
  • Investors do not expect boards to reward executives when performance goals are not achieved, whether by lowering or waiving goals (a problematic pay practice) or granting other awards to compensate for the absent incentive payouts. [FAQ #52]

Retention Awards

  • Companies that grant special retention awards of cash or equity to executives when regular incentive plan goals are not met should provide clear and compelling rationale in their proxy disclosure. [FAQ #52]
  • Such awards should be conservative and should be an isolated/non-routine occurrence. [FAQ #52]
  • The awards should also include performance conditions and limitations on termination-related vesting, as these will strengthen alignment of pay and performance going forward and avoid "pay for failure" scenarios if the executive is not retained.   [FAQ #52]
Pension/SERPEgregious payout [potential from]:
  • 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.
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.
Severance and Other Change in Control (CIC) BenefitsExcessive due to –
  • CIC cash payments exceeding 3 times base salary plus target/average/most recent bonus.
  • New or materially amended arrangements that provide for CIC 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.
  • A "Good Reason" severance definition that is triggered by company bankruptcy or other actions indicative of performance failures.
  • Liberal CIC definition in individual contracts or equity plans which could result in payments to executives without an actual CIC occurring. 
  • The automatic full vesting of equity awards upon a CIC (i.e. single trigger) is viewed as a poor practice. Vesting acceleration should require both a CIC and qualifying involuntary termination event (i.e. double-trigger). [FAQ #63]
  • ISS considers windfall potentials when evaluating equity award treatment upon a CIC. Factors considered include, but are not limited to: . . . [continued in FAQ #63]
Tax ReimbursementsExcessive 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)
Stock AwardsDividends or dividend equivalents paid on unvested performance shares or units.
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).
Stock plans with a liberal CIC definition (e.g. low % or occurrence before CIC closing) coupled with single trigger vesting upon the CIC "are likely to receive a negative recommendation" (FAQ #63).

Internal Pay DisparityExcessive differential between CEO total pay and that of next highest-paid named executive officer (NEO).

Director Compensation (Excessive)

[New FAQ 67 in 2017]

  •  A policy for 2018 has been implemented by which ISS may issue adverse vote recommendations for those board members responsible for approving/setting NED pay when there is a recurring pattern of excessive NED pay magnitude without a compelling rationale.
  • Negative recommendations will be triggered only where a pattern of excessive NED pay is identified in two or more consecutive years.
  • Although NED pay magnitude may vary by company size and industry, when analyzing it across the broader market, ISS identified cases of extreme outliers with little to no rationale provided in the proxy.
  • To determine outlier cases, ISS will compare individual non-employee director pay totals to the median of all non-employee directors at companies in the same index and industry. The purpose is to identify a pattern of extreme outliers, which historically has represented pay figures above the top 5% of all comparable directors. 
Hedging and Pledging[See FAQ #50 for links to relevant ISS policies]

Amendments

 [FAQs 55-58]

  • Agreements that are extended or new will face the highest scrutiny and weight in ISS' analysis.
  • Material amendments will be considered an opportunity for the board to fix problematic issues, but as part of the holistic analysis.
  • If a problematic pay practice is present in a separate plan or agreement, ISS may view the modification of an employment agreement as involving the opportunity to remove that problematic practice.
  • ​Automatically renewing/extending agreements (including agreements that do not specify any term) are not considered a best practice, and existence of a problematic practice in such a contract is a concern. However, if an "evergreen" employment agreement is not materially amended, its automatic extension will not on its own result in an adverse vote recommendation.
  • The policy relevant for "new or extended executive agreements" applies to any and all agreements or plans under which the executive whose contract is being entered into or modified is covered. In other words, ISS may view entering into a new executive agreement (or modifying an existing agreement) as also being a modification or extension of the executive's separate arrangement that contains a problematic provision. To avoid triggering the problematic pay practice policy, the new or modified agreement should include a removal of the executive's entitlement to the problematic pay practice under the separate agreement.


Note in particular:

FAQ 49. ADVERSE VOTE TRIGGERS.  Which problematic practices are most likely to result in an adverse recommendation?

The list below highlights the problematic practices that carry significant weight and will likely 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, potentially including any gross-up related to a secular trust or restricted stock vesting, and home loss buyouts;
  • New or extended executive 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).

FAQ 69 [New in 2017] PAY RATIO

  • For this first year of mandated disclosure, the CEO pay ratio will not have any policy implication (i.e., it will not impact vote recommendations). ISS will continue to assess the CEO pay ratio data as it becomes available . . .


See generally:annual proxy statement planning for a comprehensive discussion of issues to address when preparing executive compensation disclosures.