On November 21, 2017, ISS released preliminary U.S. Compensation FAQs in anticipation of the final FAQs that normally come in mid-December. While unusual, it is a much appreciated gesture as some of these changes will have an important impact on year-end analysis and decisions. The heads-up came for two important topics: the quantitative pay-for-performance (PFP) test and the Equity Plan Scorecard (EPSC).
Quantitative PFP Test:
- Multiple of Median (MOM) Test: The new threshold for medium level of concern on the MOM test has gone from 2.33 to 2.0 for S&P 500 companies only. There is no change to threshold for high level of concern (currently at 3.33).
- Total Shareholder Return (TSR) Calculation: To reduce point-in-time fluctuations, ISS will average the beginning and ending stock price for the month closest to the fiscal year-end of a company. Stock splits and dividends occurring during such averaging periods will be factored into the TSR calculations. If a company’s fiscal year-end is on or after the 15th of the month, then that monthly stock price average will be used; otherwise, the monthly average of the prior month will be used.
- New Financial Performance Assessment (FPA): The relative FPA will be applied as a secondary measure after the traditional three screens (MOM, Relative Degree of Alignment, and Pay-TSR Alignment). While the FAQs do not provide specific guidance on how it will be applied, they suggest that if a company has a medium level of concern on the three primary screens but strong relative fundamental financial performance, the quantitative concern may be reduced to low. Conversely, if a company had a low level of concern on the primary screens but had relatively weak fundamental financial performance, the quantitative concern may be increased to medium. The FAQs also include a chart showing which metrics will be used based on GICS classification. However, no information is available about weighting or prioritization of these measures.
Pearl Meyer Commentary: While ISS has given us a glimpse into how the new quantitative PFP Test will operate in light of the FPA factor, we still have very little insight as to the impact that this new element will have on the quantitative test results. Unfortunately, the outcome may be even less transparency on a quantitative test that was formerly objectively driven.
Equity Plan Scorecard:
- “Passing” Points: The minimum points necessary to pass the EPSC model went from 53 to 55 for S&P 500 companies (all others remain at 53).
- Change-in-Control (CIC) Vesting Factor: This EPSC factor will only yield full or no points. Full points will be awarded when an equity plan contains both of the following provisions (absent these provisions, no points will be awarded):
- For performance-based awards, acceleration is limited to actual performance achieved, pro-rata of target based on the elapsed portion of the performance period (or a combination of both), or the performance awards are forfeited or terminated upon a CIC. If there are no performance-based awards, points for this factor will be based solely on the treatment of time-based awards.
- For time-based awards, acceleration upon a CIC cannot be automatic single-trigger or discretionary.
- Holding Requirement Factor: This factor is simplified to provide either full or no points. To receive full points, awards must be subject to a minimum 12-month holding period, or holding through the end of employment. A holding period of less than 12 months or only until stock ownership guidelines are met will result in no points.
- CEO Vesting Requirement Factor: This factor is also simplified to provide either full or no points. To receive full points, time-based options, time-based restricted stock, and performance-based equity compensation for the CEO must all have a vesting requirement of at least three years from the date of grant until all shares from the award vest.
- Discretion to Accelerate Factor: This factor is similarly simplified to provide either full or no points. Full credit will be awarded if the discretion to accelerate vesting is limited to cases of death and disability. If discretion extends to any other situations (e.g., CIC, retirement, other terminations), no points will be awarded.
Pearl Meyer Commentary: Other than the increased passing threshold, many of these factor simplifications are long overdue. In drafting equity plans, companies now have definitive language tools that should result in points (or not), rather than having to guess as to whether their plan provisions will garner some level of credit.
Stay tuned for more FAQs in December.
