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For those unaware, Institutional Shareholder Services (“ISS”) announced updates to its 2019 benchmark proxy voting guidelines on November 19, 2018. This is the last step of their annual process wherein they review policies, solicit thoughts and input from various constituencies, and ultimately conclude any changes to be made ahead of the start of the subsequent proxy season. We have reviewed the changes and summarized the most influential ones below for the benefit of our clients. Please feel free to reach out to the NFPCC team with any thoughts or questions on the policy updates and how they may impact your corporate governance practices.

Board Gender Diversity

Given the level of focus on board gender diversity in the marketplace, as well as its inclusion in the proposed policy updates published by ISS in October, it is not a surprise to see that ISS has adopted a formal policy on the topic. Historically, ISS had maintained a vague principle stating that a board “should be sufficiently diverse to ensure consideration of a wide range of perspectives.” It was on this basis that ISS, while it noted where public issuers did not have gender diversity, did not use a lack of gender diversity as a factor in its vote recommendations on any matters. Per the new policy taking effect February 1, 2020, ISS may issue adverse vote recommendations for nominating committee chairs on boards that lack gender diversity. ISS will generally recommend an “against” vote at companies where boards have no female representation.

NFPCC notes a few key elements of this policy change that were noted in ISS’ marketing material accompanying the announced changes:

  • The new policy will apply to companies in the Russell 3000 and S&P 1500 indices;
  • ISS is providing a one-year grace period to allow boards the opportunity to recruit qualified female directors should they so choose;
  • “Against“ vote recommendations may be directed to other directors responsible for the nomination process (example: companies with no formal nominating committee); and
  • In the event a company does not have female representation on its board, it may provide a “compelling” rationale for such circumstance to gain a temporary pass from ISS.

Overall, NFPCC sees this policy adoption as in-line with trending dialogue in the market. We anticipate gender-related topics to see increasing levels of focus going forward, and encourage clients to ensure effective disclosure in the proxy that lay out the rationale for their corporate governance practices and the factors considered when determining its board representatives.

Adoption of Economic Value Added Metrics for Quantitative Pay-for-Performance Screen
Another proposed change disclosed in October, ISS will be phasing-in key economic value added (“EVA”) metrics developed by EVA Dimensions LLC into the Financial Performance Assessment (“FPA”) element of its quantitative review process. The phase-in follows ISS’ recent acquisition of EVA Dimensions LLC and is likely intended to encourage public issuers to consider engaging EVA Dimensions on a consulting basis to create value from the acquisition for ISS. For 2019 proxy season research reports, ISS will continue to use GAAP financial metrics within its FPA element of the quantitative review as factors for decision-making, but will also include EVA metrics for informational purposes. ISS states it will continue to explore the potential future use of EVA metrics within the FPA, but is unclear in what capacity (replacing GAAP metrics, supplementing GAAP metrics, etc.).

Some key elements to be mindful of with respect to this policy change:

  • The adoption of EVA metrics runs counter to investor and public issuer preferences, evidenced by the results of ISS’s recent policy questionnaire that was circulated to its market; and
  • NFPCC understands there are many concerns with EVA metrics and the methodology they employ: few companies currently use EVA formally in incentives, the calculation is complicated enough to earn a “black box” tag, EVA not very applicable in certain industries to name a few. Given ISS’ historical approach of effecting policy changes that serve its self-interest, NFPCC believes ISS will factor EVA metrics performance in future pay-for-performance assessments, further complicating the system.

Board Meeting Attendance
While not a new policy per se, ISS is establishing more definition around its historical case-by-case approach to assessing a director’s poor meeting attendance. In the event there is chronic poor attendance without reasonable justification, ISS will generally vote against appropriate members of the nominating/governance committees or the full board in addition to voting against the director(s) with poor attendance. ISS defines chronic poor attendance as three or more consecutive years of poor attendance without reasonable explanation. The policy approach may also be applied in cases where there is a long-term pattern of absence, such as poor attendance in the previous year or three out of four previous years.

The policy will apply as follows:

  • Three years of poor attendance = recommend withhold from the chair of the appropriate committee;
  • Four years of poor attendance = recommend withhold from the full appropriate committee;
  • Five years of poor attendance = recommend withhold from all board nominees.

Given current expectations of director meeting attendance in the market, NFPCC does not believe this new policy will have a material impact on director elections. However, it does demonstrate ISS’s intent to exert influence in other areas it has not been historically associated.

Director Performance Evaluation
Another modification to a director-focused policy, ISS is making changes to a policy that is intended to identify companies with long-term underperformance relative to their respective industries as well as a significant number of board entrenchment features. Sustained poor performance may now be identified by one, three or five-year total shareholder returns that are in the bottom half of a company’s four-digit GICS code group. This differs from historical ISS practice that only evaluated one-year and three-year TSR outcomes.

This policy change is projected to benefit corporate issuers, as ISS claims the move of the five-year performance criteria to the initial screening process will reduce the number of companies that undergo scrutiny under the policy.

Please feel free to reach out to the NFPCC team with any questions on the policy updates and how they may impact your corporate governance practices.

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