On December 13, 2024, Institutional Shareholder Services (ISS) issued updated Frequently Asked Questions (FAQ) related to its U.S. Executive Compensation Policies effective for shareholder meetings occurring on or after February 1, 2025. Notable updates are summarized below.
Increased Scrutiny of Performance-Based Compensation
The upcoming proxy season’s FAQ updates signal a growing emphasis on the disclosure of decisions related to performance-based incentives, including greater scrutiny of both the qualitative disclosure for companies that show a quantitative pay-for-performance misalignment and mid-cycle changes to in-progress performance awards.
Emphasis on Disclosure and Design of Performance-Based Equity Plans (Q. 34)
As previously suggested in ISS’ proposed benchmark policy changes for 2025, the updated FAQ provides that, beginning with the 2025 proxy season, ISS will place a greater focus on performance-vesting equity disclosure and design aspects, particularly for companies that exhibit a quantitative pay-for-performance misalignment. While ISS previously has been analyzing the disclosure and design of incentive programs as part of its qualitative review of the annual proxy statement, existing qualitative considerations around such programs going forward will be subject to greater scrutiny for companies with a quantitative pay-for-performance misalignment. The FAQ further provides a nonexhaustive list of typical considerations that would trigger a higher level of scrutiny:
- Nondisclosure of forward-looking goals. (Note: Retrospective disclosure of goals at the end of the performance period will carry less mitigating weight than in prior years.)
- Poor disclosure of closing-cycle vesting results.
- Poor disclosure of the rationale for metric changes, metric adjustments or program design.
- Unusually large pay opportunities, including maximum vesting opportunities.
- Non-rigorous goals that do not appear to strongly incentivize for outperformance.
- Overly complex performance equity structures.
As noted in the FAQ, multiple concerns with performance equity programs are likely to lead to an adverse vote recommendation.
Evaluation of Incentive Program Metrics (Q. 39)
As in previous years, ISS claims it does not favor total shareholder return (TSR) or any specific metric in executive incentive plans, believing the board and compensation committee are best suited to select metrics that drive long-term shareholder value. However, per the updates, ISS more specifically acknowledges that shareholders prefer an emphasis on objective metrics that increase transparency into pay decisions. The new FAQ provides a nonexhaustive list of factors ISS may consider when evaluating metrics under an incentive program:
- Whether the program emphasizes objective metrics that are linked to quantifiable goals, as opposed to highly subjective or discretionary metrics.
- The rationale for selecting metrics, including the linkage to company strategy and shareholder value.
- The rationale for atypical metrics or significant metric changes from the prior year.
- The clarity of disclosure around adjustments for non-Generally Accepted Accounting Principles (GAAP) metrics, including the impact on payouts.
In its 2024 Global Benchmark Policy Survey, ISS suggested a possible change in its approach to plans that predominantly consist of time-based awards. The new FAQ does not, however, provide for or further address such a change.
Mid-Cycle Changes to Incentive Programs (Q. 42)
The FAQ reiterates ISS’ stance against midstream changes to ongoing incentive programs — such as altering metrics, performance targets or measurement periods — but does not specify, as in previous years, that it would view negatively shifts to predominantly time-vesting incentives or short-term measurement periods. The FAQ further clarifies that companies should (i) provide a clear and compelling rationale in their disclosures relating to such actions and (ii) explain how any midcycle changes do not act to circumvent pay-for-performance outcomes.
Miscellaneous
Consideration of Clawback Policy as ‘Robust’ for Say on Pay (Q. 46)
Consistent with an off-cycle update from October 2024, the FAQ includes new Question 46, which addresses what is required for a clawback policy to be considered “robust” under the Executive Compensation Analysis section of the ISS research report. The FAQ provides that in order to receive credit for being “robust,” a company’s clawback policy must (i) extend beyond the minimum requirements of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (Dodd-Frank) and (ii) explicitly cover all time-vesting equity awards. ISS further clarifies that a clawback policy adhering only to minimum Dodd-Frank requirements will not be considered robust, as such requirements generally do not cover all time-vesting equity awards.
The updated FAQ is generally consistent with ISS’ approach to clawback policies in its review of equity compensation plan proposals, but does not directly align. ISS FAQs related to U.S. Equity Compensation Plans provide that no Equity Plan Scorecard (EPSC) points are allocated for a clawback policy that only adheres to the minimum Dodd-Frank requirements, indicating that ISS expects the clawback policy to authorize recovery of gains from “all or most equity-based compensation” for all named executive officers in order to gain full points in the EPSC analysis.
In light of the new FAQ, companies that maintain only a mandatory Dodd-Frank compliant policy may wish to consider adopting a discretionary clawback policy early in 2025. While mandatory clawback policies only require the recovery of incentive-based compensation erroneously received by Section 16 officers based on an accounting restatement (with a three-year look back period), regardless of whether such officers are at fault, discretionary clawback policies may cover (i) a broader population; (ii) additional types of compensation (e.g., time-based equity awards); (iii) instances of employee fault such as fraud or misconduct, reputational harm to the company, breach of fiduciary duties or violation of company policies; or (iv) other triggering events.
Companies that previously deemed their Dodd-Frank-compliant policies robust under former ISS guidelines — possibly because more than 50% of their CEOs’ equity awards were performance-based (earning additional ESPC points) — may now wish to adopt a discretionary policy to be considered as having a robust policy under the new U.S. Executive Compensation Policies FAQ.
Computation of Realizable Pay (Q. 24)
Consistent with an off-cycle update from October 2024, ISS has updated its calculation methodology of “realizable pay” for S&P 1500 CEOs, stating that the realizable pay chart will not be displayed for companies with two or more CEO changes within the three-year measurement period.
This memorandum is provided by Skadden, Arps, Slate, Meagher & Flom LLP and its affiliates for educational and informational purposes only and is not intended and should not be construed as legal advice. This memorandum is considered advertising under applicable state laws.
For further information, please contact:
Erica Schohn, Partner, Skadden
erica.schohn@skadden.com
