In an effort to adjust to a new market reality shaped by the effects of the current coronavirus pandemic, companies are now considering, if not already taking steps to implement, changes to their compensation programs. In anticipation of these changes and the corresponding increase in shareholder concerns, Institutional Shareholder Services (“ISS”) and Glass Lewis (“GL”) both recently issued new policy guidance, indicating what types of changes they expect to see and how they intend to assess these changes. This client alert summarizes ISS and GL new guidance on compensation issues.
Institutional Shareholder Services
ISS acknowledges that companies may need to make changes to performance metrics, goals or targets in short-term compensation plans. ISS guidance encourages boards to provide contemporaneous disclosure to shareholders of their rationales for making such material changes to performance metrics, goals or targets used in compensation plans. While such contemporaneous disclosures to shareholders are not required and ISS guidance acknowledges that decisions by directors to make such adjustments to 2020 compensation programs will generally not be analyzed and addressed by shareholders until next year’s annual general meeting in 2021, ISS believes such disclosures will provide shareholders with greater insights into the board’s rationale and circumstances when the changes are made.
Regarding long-term compensation plans, ISS guidance notes that their benchmark voting policies generally are not supportive of changes to midstream or in-flight awards since they cover multi-year periods. Accordingly, ISS will assess such in-flight changes made to long-term awards on a case-by-case basis to determine if directors exercised appropriate discretion and provided adequate explanation to shareholders of the rationale for such changes. Structural changes to long-term compensation plans will continue to be evaluated under existing benchmark policy frameworks.
In addition to plan constraints, stock exchange listing requirements and other considerations applicable to the repricing of “out-of-the-money” option awards, the recent ISS guidance provides that directors’ actions that are undertaken without asking shareholders to approve or ratify such actions in a timely fashion will remain subject to scrutiny under the U.S. benchmark policy board accountability provisions (and equivalents in other market policies where relevant). Furthermore, if boards seek shareholder approval/ratification of repricing actions at 2020 meetings, ISS will apply its existing case-by-case policy approach for the relevant market. Under this policy for the U.S. market, ISS will generally recommend opposing any repricing that occurs within one year of a precipitous drop in the company's stock price. Among other factors, ISS will also continue to examine whether (1) the design is shareholder value neutral (a value-for-value exchange), (2) surrendered options are not added back to the plan reserve, (3) replacement awards do not vest immediately, and (4) executive officers and directors are excluded.
GL guidance notes that GL is already seeing a variety of approaches to changing compensation plans and anticipates a marked increase in shareholder concerns on repricing, dilution, burn rates, hurdle adjustments, changes to vesting periods, caps and cuts on incentives, and the quality of disclosure concerning the limits and exercise of board discretion.
Similar to ISS guidance, GL guidance emphasizes the importance of companies providing shareholders with effective disclosures and rationales for changes to compensation plans, specifically noting that this will be critical to GL’s exercise of discretion in making judgements about whether changes made as a result of this crisis are justified and address material shareholder concerns.
The reasonableness of proposed changes and outcomes will be assessed based on whether they are consistent and in proportion to the impact on shareholder interests and employees. GL guidance specifically notes that with respect to executive pay, boards will be expected to proactively seek changes that align with employee and shareholder experiences.
GL guidance also provides that when assessing the reasonableness of proposed changes and outcomes, more discretion will be afforded to companies that GL believes have a good track record on governance, performance and the use of board discretion prior to the pandemic.
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