Analysis of ISS’ QualityScore Updates

Holly J. Gregory and John P. Kelsh are partners and Rebecca Grapsas is counsel at Sidley Austin LLP. This post is based on a Sidley publication by Ms. Gregory, Mr. Kelsh, Ms. Grapsas, and Claire H. Holland. Related research from the Program on Corporate Governance includes What Matters in Corporate Governance? by Lucian Bebchuk, Alma Cohen and Allen Ferrell (discussed on the Forum here).

On October 30, 2017, Institutional Shareholder Services (ISS) announced new questions and other methodology updates to its ISS Governance QualityScore corporate governance scoring tool that will take effect on December 4, 2017. These and additional updates are reflected in the QualityScore technical document ISS published on November 14, 2017, available here. This post summarizes the QualityScore updates applicable to U.S. companies and reminds companies to verify their data against QualityScore’s methodology until Tuesday, November 28, 2017 at 8:00 p.m. (ET).

QualityScore assigns each company in the S&P 500 and Russell 3000 (as well as companies in several foreign indices) a numeric, decile-based score indicating its corporate governance risk relative to other companies in the applicable index or region. Scores range from “1” to “10,” with “1” indicating the highest level of governance quality and lowest level of governance risk. ISS analyzes a company’s corporate governance risk based on specified factors across four topical pillars: Audit & Risk Oversight, Board Structure, Compensation/Remuneration and Shareholder Rights.

New Factors Applicable to U.S. Companies

Effective December 4, 2017, ISS will evaluate U.S. companies based on 116 factors total, including 11 factors categorized under the Board Structure pillar that are new or newly applicable to U.S. companies:

  • What percentage of the board is independent based on an ISS global classification? (New Q378)
  • What percentage of the nominating committee is independent based on an ISS global classification? (New Q380)
  • What percentage of the compensation committee is independent based on an ISS global classification (New Q381)
  • What percentage of the audit committee is independent based on an ISS global classification? (New Q382)
  • What is the classification of the chairman of the nominating committee? (Q23)
  • What is the classification of the chairman of the compensation committee? (Q28)
  • What is the classification of the chairman of the audit committee? (Q34)
  • Are there Company executives on the nominating committee? (Q306)
  • Are there Company executives on the compensation committee? (Q27)
  • Are there Company executives on the audit committee? (Q33)
  • What percentage of the directors attended less than 75% of board and/or key committee meetings? (Q44) (Existing Question 45 already asks if any directors attended less than 75% of the aggregate board and applicable key committee meetings without a valid excuse.)

Director Independence Classifications

Existing QualityScore Questions 10, 19, 25 and 31 asking what percentage of the board and key committees are independent will continue to apply to U.S. companies, but they will now be qualified by “local market classification,” meaning that ISS will evaluate independence for those factors based on differing practices by market. ISS explained in the updated QualityScore technical document that the “ISS global classification” referenced in new Questions 378, 380, 381 and 382 is based on a “U.S. centric definition for determining independence” but provides more global comparability across markets. Unlike the global classification, the technical document notes that local market classification will take into account “local market nuances” (e.g., whether or not a company is a controlled company, if directors are elected by shareholders). ISS has advised us informally that the “local market classification” and the new “ISS global classification” will be identical for U.S. companies. Therefore, for U.S. companies, the answers to existing Questions 10, 19, 25 and 31 and new Questions 378, 380, 381 and 382 will be the same.

For new Question 378 asking what percentage of the board is independent based on an ISS global classification:

  • ISS will exclude “unclassified” directors (i.e., directors for which there is insufficient disclosure for ISS to make an independence determination) from the total number of directors, and will exclude “shareholder nominees” (not defined in the technical document) from both the total number of directors and the number of independent directors.
  • ISS stated that “a board lacking a majority of independent members will raise significant concerns.”

For new Questions 380, 381 and 382 asking what percentage of the key committees are independent based on an ISS global classification:

  • Key committees with less independent membership than recommended by local best practice will raise concerns about governance risk. ISS noted that best practice for U.S. companies dictates that the key committees be composed solely of independent directors.
  • ISS will consider the percentage of independent members on a key committee using the independence definitions in the ISS U.S. Categorization of Directors in ISS’ proxy voting guidelines. If no information is given with respect to the independence of committee members or no committee exists (or in the case of the nominating committee, if there is no clear nomination process), then ISS will deem the answer to the question as “not disclosed.”

Other Updates

Greater Global Comparability

To enable investors to compare the governance practices of companies in different regions, ISS published 21 “global core” factors that are uniform across all markets (other than Japan). The 21 global core factors, which are listed in ISS’ summary of the 2017 QualityScore methodology updates available here, represent an increase from just six uniform factors. Of the 21 global core factors, four are new questions (e.g., those relating to board and committee independence discussed above), one factor will be newly applicable to U.S. companies and 16 factors already apply to U.S. companies.

Gender Diversity

In the updated QualityScore technical document, ISS clarified when it will give maximum credit on the existing QualityScore factors relating to board gender diversity. Noting that the average board size is nine as of November 2017, ISS will give full credit for the question asking about the number of women on the board (Q304) when three or more women serve on the board. ISS will give maximum credit for the question asking about the proportion of women on the board (Q354) when at least 50% of board seats are held by women.

Minimum Vesting Periods

Though not specifically highlighted as a 2017 update, ISS amended the explanation to the existing Questions 131 and 132 about the minimum vesting periods mandated in the equity plan documents for executives’ stock options, SARs, restricted stock and stock awards.

  • The questions currently cover equity incentive plans “adopted/amended in the last three years.” Beginning in December 2017, ISS will consider all active equity incentive plans containing shares available for grant, not just plans from the previous three years.
  • ISS will only give credit for these questions if the minimum vesting restriction applies to at least 95% of all awards. No credit will be given in the case of additional carve-outs (e.g., grants for non-executive directors).
  • In the case of ratable vesting, the scored minimum vesting period will be based on the earliest possible vesting (e.g., in the case of 3-year ratable vesting with the first vesting occurring on the first anniversary of grant, the factor will be scored as “12 months”).

Removal of Non-Scored Factors

Three questions that previously applied to U.S. companies as non-scored factors will be removed and no longer apply for QualityScore purposes:

  • Does the poison pill have a TIDE provision? (Q81)
  • What is the degree of alignment between the company’s cumulative 3-year pay percentile rank, relative to peers, and its 3-year cumulative TSR rank, relative to peers? (Q226)
  • What is the degree of alignment between the company’s cumulative 1-year pay percentile rank, relative to peers, and its 1-year cumulative TSR rank, relative to peers? (Q227)

Lengthy Tenure

According to the Addendum to the updated QualityScore technical document, in February 2017 ISS updated the explanation for Question 13 asking what proportion of non-executive directors on the board has lengthy tenure. Specifically, ISS clarified that:

  • For U.S. companies, lengthy tenure is defined as nine or more years.
  • ISS will not deduct credit for this factor unless more than 1/3 of directors exceed the lengthy tenure definition.

Data Verification Period

ISS announced November 13-28 as the dates of its annual data verification period during which companies have the opportunity to verify their data against QualityScore’s methodology. Companies should verify their data prior to Tuesday, November 28, 2017 at 8:00 p.m. (ET), and reference public filings where appropriate when providing corrections. The data verification tool is free for companies and is accessible from the “Data Verification” tab at the following link: https://www.issgovernance.com/solutions/iss-analytics/qualityscore/. Companies that do not already have a login for the ISS Governance Analytics platform may request login information by sending an email to contactus@isscorporatesolutions.com. ISS has specified that data verification logins will only be issued to representatives of the subject company—not law firms, compensation consultants, proxy solicitors or others. Companies that anticipate filing a proxy statement in the near future should be aware that data verification is not available during the period between the filing of a proxy statement and the publication of ISS’ proxy voting recommendations for the annual meeting.

In reviewing these methodology changes and verifying data, companies should bear in mind that QualityScores are relative, and scores may be average or below average even if the company has adopted many best practices advocated by ISS. Directors and management should continue to ensure that a company’s governance structure is appropriate for that company and resist the temptation to make governance decisions for the purpose of increasing QualityScores.

Both comments and trackbacks are currently closed.
  • Subscribe or Follow

  • Supported By:

  • Program on Corporate Governance Advisory Board

  • Programs Faculty & Senior Fellows