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Institutional Shareholder Services (ISS) announced a number of important updates relating to its 2017 pay-for-performance evaluation for U.S. and Canadian companies. The headlines are:

• ISS will evaluate companies’ performance relative to peers on six financial metrics, and present the results in a standardized table in all companies’ proxy research reports. On a three-year basis, relative ROIC, ROA, ROE, revenue growth, EBITDA growth, and growth in cash flow from operations will be evaluated, along with TSR, with the weight on each metric varying by industry.
• ISS will use the relative financial metric results in its qualitative pay-for-performance analysis. For the 2017 proxy season, no changes are being made to the quantitative pay-for-performance tests, although ISS is leaving the door open for changes in 2018 and beyond.
• The ISS peer groups for Canadian companies will, for the first time, incorporate information from a company’s self-determined peer group. ISS has used this information for U.S. companies in recent years, generally yielding closer overlap between a company’s peer group and the ISS peer group.
• ISS’ peer submission window for U.S. and Canadian companies will run from November 28 to December 9. For most of your issuer clients, this is their opportunity to have ISS consider changes to the company’s self-selected compensation peer group in the ISS peer group construction process. Only companies that have made changes to their peer group for 2016 pay decisions need to participate.
• The existing Relative Degree of Alignment test will only apply to companies with two full fiscal years of TSR and pay data. This move reflects the spirit of this test, which is to measure the longterm alignment of a company’s CEO pay and TSR performance relative to peers.

More details on these announcements will likely be forthcoming from ISS through its annual compensation FAQs and other publications.

What you need to know about ISS’ new relative financial performance evaluation

Evaluating financial performance is not new for ISS; this update adds standardized relative analysis and presentation

For many years, ISS has presented financial performance data in proxy research reports, and that data has been available to ISS analysts to use in their qualitative assessment of a company’s pay-for-performance alignment. The evolutions that ISS are making this year include computing relative 3-year measures for each of the metrics, compared to the ISS selected peer group, comparing performance on these metrics with relative compensation levels, and presenting the results, including an overall weighted financial performance metric, in a new standardized table.

The weighted financial performance metric will measure relative financial performance against relative granted pay, and will generate a numeric result indicating the alignment between three-year financial metric performance and three-year granted pay.

Strong investors and issuer support led ISS to incorporate relative financial performance metric evaluation using six key financial indicators

Investors and issuers responding to this summer’s ISS policy survey voiced strong support for expanding the focus on performance beyond total shareholder returns. In response, in its proxy advisory reports for annual meetings on or after Feb. 1, 2017, of companies subject to ISS’s quantitative
pay-for-performance screens, ISS will display a company’s three-year performance not only on TSR but also on six financial metrics relative to its ISS peer group, using data from S&P Compustat: return on equity; return on assets; return on invested capital; revenue growth; growth in earnings before interest, taxes, depreciation, and amortization; and growth in cash flow from operations.

Existing quantitative pay-for-performance tests will not be affected for 2017; relative financial performance used in qualitative evaluation only

This new assessment will not be a component of ISS’s quantitative pay-for-performance screening for 2017, and the calculation and scoring of the three existing tests in the quantitative screening—Relative Degree of Alignment, Multiple of Median, and Pay-TSR Alignment, are not impacted by this change. However, ISS may use the relative financial performance information in its qualitative assessment of a company’s pay-for-performance alignment.

ISS Corporate Solutions’ online modeling capabilities for the relative financial performance evaluation will be available by mid-December

Online projections of the relative financial performance evaluation will be provided at no additional charge to companies with ExecComp subscriptions with ISS Corporate Solutions (ICS).

What does the relative financial performance evaluation mean for my compensation disclosure?

If CD&As have not traditionally emphasized the company’s financial performance, now may be the time to suggest considering it—not merely because of today’s announcement from ISS, but because shareholders increasingly seek to understand at a high level how a company’s compensation decisions relate to the company’s recent financial and market performance, even before they dive into details of the company’s incentive program design.

For subscribers to ICS ExecComp Suite or ExecComp Platinum, ICS includes a confidential reviews of drafts of the CD&A and executive compensation tables at no additional charge, to ensure that the company’s compensation narrative is as clear and useful for shareholders as possible. Contact us if you have questions about this service.

What you need to know about today’s peer group announcements

The peer group submission window is opening soon, using the ICS Governance Analytics platform

Because ISS must construct its peer groups before most companies’ 2017 proxy filings are available, U.S. and Canadian companies subject to ISS’ quantitative pay-for-performance screens that will hold shareholder meetings between Feb. 1, 2017, and Sept. 15, 2017, are welcome to submit the peer groups used in setting compensation for the most recently completed fiscal year prior to their upcoming shareholder meeting. (For companies with calendar fiscal years, this means the 2016 peer group—not the 2017 peer group.)

The window for submitting these peer groups to ISS is November 28 through December 9. This year, peer submissions will flow through ICS’ Governance Analytics platform. Only representatives of the company may log into the Governance Analytics platform and complete the peer submission process; if any of your clients need an account, please have them reach out to us at contactus@isscorporatesolutions.com. We will make sure you and they receive additional information on the submission process as the opening of the window nears.

Canadian companies’ peer groups will influence ISS peer group selection, and Canadian firms are eligible to participate in the peer submission window

ISS conducts a pay-for-performance evaluation, including quantitative pay-for-performance screens that rely on comparisons to an ISS-constructed peer group, for companies in the S&P/TSX Composite index and all companies that put a voluntary say-on-pay proposal on the ballot. For AGMs at these companies on or after Feb. 1, 2017, ISS will incorporate a Canadian company’s self-determined peer group into its process for constructing the company’s ISS peer group.

When ISS began doing this for U.S. companies in 2013, the level of agreement between companies’ own peer groups and their ISS-constructed peer groups increased substantially; this year, about 60 percent of U.S. companies saw at least half of their own peers in their ISS constructed peer group. Higher overlap should make some companies more comfortable with the ISS peer group construction process, although it has not had a material impact on the proportion of U.S. say-on-pay proposals that
ISS supports.

What you need to know about today’s quantitative pay-for-performance screening announcements

The existing Relative Degree of Alignment test, and the new relative financial performance evaluation, will only apply for companies with two full fiscal years of trading data

U.S. and Canadian companies subject to the ISS quantitative pay-for-performance screens have, up to now, been eligible to receive a score on the Relative Degree of Alignment test after one full fiscal year of trading as a public company. However, this test is designed to provide a lens into the long-term alignment of a company’s CEO pay and TSR performance relative to its ISS peer group. Accordingly, effective for shareholder meetings on or after Feb. 1, 2017, ISS will require two full years of trading data
and two years of CEO pay data before applying this test as part of its quantitative screening.

Similarly, the relative financial performance evaluation announced today will apply to companies with at least two full years of trading data and financial results as a public company.

Source: ISS Press Release 11-8-2016