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21 Dec. 2011 | Comments (0)

Yesterday ISS published a white paper detailing its new methodology for the pay-for-performance test described in ISS’ 2012 proxy voting policies. ISS’ new approach to evaluating pay for performance alignment consists of two steps:   1. Quantitative Review: Intended to identify outlier companies that have demonstrated significant misalignment between CEO pay and company performance over time 2. Qualitative Review: Designed to identify causal or mitigating factors in a pay for performance disconnect for companies identified as outliers through the quantitative review A summary of ISS’ new approach is provided below. Quantitative Review ISS’ quantitative review of pay-for-performance alignment consists of three specific tests and includes both relative and absolute assessments. Each test evaluates CEO pay (as disclosed in the Summary Compensation Table, except that ISS will use a standard set of assumptions to value equity-based grants) and/or a company’s total shareholder return (TSR). 1. Relative Degree of Alignment (RDA): Compares the percentile ranks of a company’s CEO pay and its TSR performance relative to a peer group on a one- and three-year basis, with one-year weighted 40% and the three-year weighted 60% to emphasize the longer-term:
  • Company TSR is ranked vs. the peer group on an annualized basis over the one- and three-year periods ending with the company’s most recent fiscal-year end
  • CEO pay is ranked vs. the peer group on a one-year annual and three-year average basis
  • Combined rankings are calculated as follows:

*Combined Performance Rank = (1-Year Rank x 40%) + (3-Year Rank x 60%)

*Combined Pay Rank = (1-Year Rank x 40%) + (3-Year Rank x 60%)

  • RDA is the difference between the performance and pay. RDA values can range between -100 and +100, with -100 indicating high pay for low performance, and +100 indicating low pay for high performance

*RDA = Combined Performance Rank - Combined Pay Rank

  • Note that ISS has provided additional detail on its peer group selection approach, and for most companies will identify 14-24 peer companies as follows:

*Identify companies in the same 2-digit GICS category with revenues (assets for financial companies) from 0.45x to 2.1x and market capitalization from 0.2x to 5x the subject company

*Narrow this list by selecting companies in the same 6-digit GICS category, starting with companies that are closest in size, and then alternating larger and smaller companies to maintain the subject company near the peer group median. If this approach does not yield the minimum of 14 companies, the process is repeated using the 4-digit GICS and 2-digit GICS

2. Multiple of Median (MOM): Expresses most recent year’s CEO pay as a multiple of the peer group median pay for the same period
  • MOM = 1-Year CEO Pay ÷ Peer Group Median CEO Pay
3. Pay-TSR Alignment (PTA): Compares the trend in CEO annual pay and trend in TSR over a five-year period. Note the PTA is not designed to assess whether pay and performance go up and down together on a year-over-year basis. Rather, it is a measure of long-term directional alignment.
  • Linear regressions[1] for CEO pay and TSR over the prior five years are each calculated
  • Difference between the linear regressions are calculated to demonstrate the degree to which CEO pay has changed more or less rapidly than TSR
Based on the evaluation from these three tests, ISS will determine whether the company demonstrates a pay-performance disconnect, which will trigger a qualitative review. The table below shows the levels for each measure that indicated where a company would be considered an outlier (“Medium” concern) or a significant outlier (“High” concern). High concern for any individual factor will trigger an overall High concern level, and multiple Medium concern levels may also result in an overall High concern.
Measure Level that may trigger high concern in conjunction with other measures Level that triggers high concern by itself
Relative Degree of Alignment -30 ~25th percentile -50 ~10th percentile
Multiple of Median 2.33x ~92nd percentile 3.33x ~97th percentile
Pay-TSR Alignment -30% ~10th percentile -45% ~5th percentile
Qualitative Review In cases where a company’s pay-performance alignment appears to be weak, ISS will conduct a qualitative review to determine causal or mitigating factors, including:
  • Strength of performance-based compensation (e.g., ratio of performance-based pay to total pay, disclosure of performance goals)
  • Peer group benchmarking practices (e.g., peer company size and target pay positioning)
  • Results of financial/operational metrics (e.g., rigor of performance goals and evaluation of performance on non-incentive plan metrics)
  • Special circumstances (e.g., new CEO or unusual equity grant practices)
Additionally, ISS has provided updates on its Governance Risk Indicators (GRId) evaluation process for 2012. The updates are largely intended to capture ISS’ framework for evaluating Say-on-Pay proposals, including the new pay for performance test. Now that ISS has disclosed updates to its pay-for-performance methodology and GRId evaluation process, companies are well-advised to begin assessing their pay programs and performance vs. these new criteria early to understand the implications and to consider whether any changes to their pay programs are warranted. About the Guest Blogger [caption id="attachment_1703" align="alignleft" width="99" caption="Guest Blogger: Kristine Meyer, Clearbridge Compensation Group"]Guest Blogger: Kristine Meyer, Clearbridge Compensation Group[/caption] Kristine Meyer is a Senior Associate at ClearBridge Compensation Group, an independent executive compensation consulting firm based in New York City. Ms. Meyer’s areas of expertise include executive compensation strategy and design and financial performance measurement, working with both publicly-traded and privately-held companies in a variety of industries. She can be reached at

[1] Calculated as weighted least-squares regressions of Pay and TSR against independent (x) variable time
  • About the Author:Marcel Bucsescu

    Marcel Bucsescu

    Marcel Bucsescu is a Co-Program Director of The Conference Board Chief Legal Officers Council. Bucsescu has also served Executive Director of the Ira M. Millstein Center for Global Markets and Corpora…

    Full Bio | More from Marcel Bucsescu


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