Advisory votes on compensation are more than half a decade old in the U.S., and the trends are clear:

• The vast majority of companies provide for annual votes.
• “Pay for performance” assessments underlie most investor voting.
• Each year the overall support level averages more than 90 percent, while about only about 2 percent of companies fail to receive majority support for their pay programs.
• Another 5 to 10 percent pass with what is deemed mediocre backing – below 70 or 80 percent support per proxy advisor policies (ISS and Glass Lewis, respectively) and in the eyes of many investors. This result triggers expectation that the compensation committee will demonstrate a substantive level of responsiveness to the relatively low vote.
• Increasingly important, low support for say on pay can be a red flag to activist investors who closely monitor shareholder dissatisfaction at potential targets.

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Women corporate directors globally are showing greater proportional gains on occupying key board committees than on boards overall, according to a new analysis by leading governance and ESG data and analytics provider Institutional Shareholder Services.

Between Jan. 1, 2014, and Jan. 1, 2016, the proportion of women directorships at companies across major markets and indices in Europe, the U.S., Australia, and Canada grew by 5.5 percentage points compared with 6.9 points for those on audit committees. Growth evidenced in the proportion of women on audit committees during that period included double digit gains at companies in Italy and France, 7.2 percentage points at U.K. companies, and 6 percentage points at Swiss companies. Meanwhile, the proportion of women on other key committees, including those addressing remuneration and nomination, similarly outpaced gains at the overall board levels, albeit less prominently, at 6.5 and 5.9 points, respectively.

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ISS’ latest update of the structure and composition of boards and individual director attributes at Standard & Poor’s U.S. “Super 1,500” companies (i.e., companies in the S&P 500, MidCap 400, and SmallCap 600 indices) found a number of new and continuing trends in board practices and director attributes at these key index companies.
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Do more titles equal higher pay? It is well-documented that U.S. CEOs’ compensation, when compared to that of the average worker, has ballooned in recent decades. Past studies of the drivers of CEO pay at public companies have largely focused on firm size, number of employees, revenues, and TSR (total shareholder return) among other factors. A recent analysis examines whether and, if so, how board structure may impact CEO compensation. Specifically, the analysis tests whether a combined CEO/chairman role correlates to higher pay, and if a particular board leadership structure has a statistically significant relationship with CEO compensation. The analysis focuses on S&P 500 companies whose board structure remained relatively constant over a recent three-year period, to provide a consistent view of the trends.

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US Executive Pay Overview

1. Which named executive officers’ total compensation data are shown in the Executive Pay Overview section?

The executive compensation section will generally reflect the same number of named executive officer’s total compensation as disclosed in a company’s proxy statement. However, if more than five named executive officers’ total compensation has been disclosed, only five will be represented in the section. The order will be CEO, then the second, third, fourth and fifth highest paid executive by total compensation. Current executives will be selected first, followed by terminated executives (except that a terminated CEO whose total pay is within the top five will be included, since he/she was an within the past complete fiscal year).

2. A company’s CEO has resigned and there is a new CEO in place. Which CEO is shown in the report?

Our report generally displays the CEO in office on the last day of the fiscal year; however, the longer tenured CEO may be displayed in some cases where the transition occurs very late in the year.

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ISS is providing answers to frequently asked questions with regard to select policies and topics of interest for 2015:

Proxy Access Proposals

1. How will ISS recommend on proxy access proposals?

Drawing on the U.S. Securities and Exchange Commission’s (SEC) decades-long effort to draft a market-wide rule allowing investors to place director nominees on corporate ballots, and reflecting feedback from a broad range of institutional investors and their portfolio companies, ISS is updating its policy on proxy access to generally align with the SEC’s formulation.

Old Recommendation: ISS supports proxy access as an important shareholder right, one that is complementary to other best-practice corporate governance features. However, in the absence of a uniform standard, proposals to enact proxy access may vary widely; as such, ISS is not setting forth specific parameters at this time and will take a case-by-case approach when evaluating these proposals.

Vote case-by-case on proposals to enact proxy access, taking into account, among other factors:

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General Questions

1. What is the basis for ISS’ new scorecard approach for evaluating equity compensation proposals?

The new policy will allow more nuanced consideration of equity incentive programs, which are critical for motivating and aligning the interests of key employees with shareholders, but which also fuel the lion’s share of executive pay and may be costly without providing superior benefits to shareholders. While most plan proposals pass, they tend to get broader and deeper opposition than, for example, say-on-pay proposals (e.g., only 60% of Russell 3000 equity plan proposals garnered support of 90% or more of votes cast in 2014 proxy season, versus almost 80% of say-on-pay proposals that received that support level). The voting patterns indicate that most investors aren’t fully satisfied with many plans.

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1. How does the new approach differ from the previous approach?

Under the previous approach, ISS generally recommended for independent chair shareholder proposals unless the company satisfied all the criteria listed in the policy. Under the new approach, any single factor that may have previously resulted in a “For” or “Against” recommendation may be mitigated by other positive or negative aspects, respectively. Thus, a holistic review of all of the factors related to company’s board leadership structure, governance practices, and performance will be conducted under the new approach.

For example, under ISS’ previous approach, if the lead director of the company did not meet each one of the duties listed under the policy, ISS would have recommended For, regardless of the company’s board independence, performance, or otherwise good governance practices.

Under the new approach, in the example listed above, the company’s performance and other governance factors could mitigate concerns about the less-than-robust lead director role. Conversely, a robust lead director role may not mitigate concerns raised by other factors.

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ISS recently issued updated guidelines for several of its benchmark global voting policies, which will be effective for analyses of publicly traded companies with shareholder meetings on or after Feb. 1, 2015. For the 10^th year running, ISS gathered broad input from institutional investors, corporate issuers, and other market constituents worldwide as a key part of its policy development process. The 2015 updates reflect the time and effort of hundreds of investors, issuers, corporate directors, and other market participants who provided input through a variety of channels, including ISS’ annual policy survey, topical and regional roundtables, and direct engagements with staff.

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Calls for independent board chairs were the most prevalent type of shareholder proposal offered for consideration at U.S. companies’ annual meetings in 2014. As of June 30, 62 of these proposals have come to a shareholder vote, up from 55 resolutions over the same time period in 2013. Notably, the number of proposals calling for independent board chairs has more than doubled over the past five years. Under the current policy formulation, ISS recommended against 32 of these 62 proposals in 2014. In line with results from recent seasons, independent chair proposals received average support of 31.2 percent of votes cast at 2014 meetings. Only four of these proposals received the support of a majority of votes cast.

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As issues around cost transparency and best practices in equity-based compensation have evolved in recent years, ISS proposes updates to its Equity Plans policy in order to provide for a more nuanced consideration of equity plan proposals. As an alternative to applying a series of standalone tests (focused on cost and certain egregious practices) to determine when a proposal warrants an “Against” recommendation, the proposed approach will incorporate a model that takes into account multiple factors, both positive and negative, related to plan features and historical grant practices.

Feedback from clients and corporate issuers in recent years, beginning with the 2011-2012 ISS policy cycle, indicates strong support for the proposed approach, which incorporates the following key goals:

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Though the global financial crisis of 2008 prompted a seismic shift in attitudes toward executive pay on the part of lawmakers, the public, investors, and other stakeholders, average compensation levels continue to rise or have returned to where they were before the crisis.

Mindful of the outcry over particular elements of pay packages, companies began scaling back bonus awards as well as payments related to “golden parachutes” and other forms of exit pay following the crisis.

Indeed, such components of executives’ total annual compensation declined in fiscal 2009 with some elements, including those dealing with exit pay, continuing to decline modestly into fiscal 2010.

But that has been more than offset through increases in other pay elements, most notably awards tied to company stock. The result is a 37 percent surge in total annual compensation paid to C-suite officers from fiscal 2008 to 2010 with stock awards now constituting more than half of the total pay pie.

As such, this post explores how the executive pay package mix and overall total annual compensation levels have changed since fiscal 2008 and the role played by stock-based awards in fueling the spike in total executive pay.

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Escalating CEO pay packages in the last few decades have stirred much debate, culminating in mandated advisory shareholder votes on executive compensation under the Dodd-Frank Act of 2010. The first year of widespread “say-on-pay” votes in the U.S. suggests that investors are taking a conservative approach – about 40 proposals at Russell 3000 index companies received less than majority support from votes cast for and against, and fewer than 200 received support from less than 70 percent. The advent of say on pay in the U.S. has highlighted pay-for-performance as the most significant factor driving investors’ voting decisions on the issue, however.

Doubts about the strength of pay and performance alignment arise from perceptions of “agency problem” conflicts of interest, weak board oversight and aggressive pay benchmarking; from demonstrated abuses such as options backdating; and most recently, from concern that pay practices at some firms likely contributed to the financial meltdown that triggered the latest economic and market malaise.  Further, while executive pay has increased at a fairly rapid pace since the 1980s, investor portfolios have experienced multiple market swings – booms and busts that often appear disconnected from individual executives’ impact — adding to skepticism about long-term pay and performance alignment.

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Top Governance Issues

Executive compensation continues to be an American issue for a second straight year. Only for North America, a majority of both investor (60 percent) and issuer respondents (61 percent) cite the perennial issue of executive compensation as one of the top three governance topics for the coming year, similar to last year’s survey results.

On a global basis, investor respondents focused on board independence. Across every region, board independence was identified among the three most important governance topics by approximately 40 percent of investor respondents.

Issuers focus on risk oversight in North America and Europe. For issuers, the second most commonly cited topic in North America was risk oversight. In Europe, risk oversight was commonly cited along with board competence.

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RiskMetrics Group recently released updates to its 2009 proxy voting policies, after an extensive process that included outreach to and input from hundreds of institutional investors and corporate issuers. RiskMetrics’ policies will be applied to all companies with shareholder meeting dates on or after February 1, 2009.

This year’s policy revisions reflect the unprecedented market turmoil that has sparked investor and regulatory focus on executive compensation practices, board accountability and oversight, and the quality of financial reporting. Accordingly, the three main areas of focus for the 2009 policy updates are executive pay, board structure, and audit practices.

Both issuer and investor respondents to RiskMetrics’s annual policy survey demonstrated little tolerance for outsized pay packages, with 70 percent of investors and 85 percent of issuers specifying pay relative to performance as “very important” in evaluating executive compensation practices. Thus, RiskMetrics’ policy guidelines on executive compensation have been expanded to examine practices that divorce pay from performance, such as tax gross-ups on severance payments and executive perks, and provisions that pay severance for voluntary departures following a takeover.

RiskMetrics has also harmonized assessment of company performance across several North American policies. As of 2009, corporate performance will initially be assessed using a relative, rather than absolute, measure of total shareholder return over 1- and 3-year periods. This assessment will result in greater scrutiny under several policies, including pay-for-performance evaluations, independent chair shareholder proposals, and director elections. Regarding the latter, the policy update addresses cases where lagging company performance is coupled with a governance structure that discourages director accountability and may lead to board and management entrenchment.

Additionally, RiskMetrics has updated its accounting policy guidelines to specify ongoing material weaknesses in Section 404 disclosures and misapplication of GAAP as triggers for in-depth analysis of a company’s accounting practices, and to recommend against audit committee members in the case of an adverse opinion from auditors.

Internationally, RiskMetrics revised its share buyback policy to reflect client feedback and regulatory developments in Europe. RiskMetrics’ policy on discharge of directors resolutions, common in several markets, will now accommodate recommendations designed to provide a “yellow card” warning to directors who may not be fulfilling their fiduciary duties. Director independence best practices in several European markets have also been incorporated into the 2009 policies. In Canada, RiskMetrics is introducing a Poor Pay Practices Policy to reflect the additional disclosure that is now available in that market.

The 2009 policy updates are accessible through RiskMetrics’ online Policy Gateway, which also contains FAQs and other informational resources to provide all market participants with a good understanding of how RiskMetrics formulates and applies its corporate governance policies. In addition to its own policies, the corporate governance policies and philosophies of leading market participants are also available via RiskMetrics’ Policy Exchange platform.

Enhanced proxy pay disclosures, which the SEC believed would assist shareholders trying to assess the efficacy of executive compensation at their portfolio companies, have mainly underscored the elaborate and opaque nature of most pay programs. A new paper from RiskMetrics Group entitled Explorations in Executive Compensation aims to guide shareholders through the maze of terminology and complex processes being detailed in proxy statements and -– importantly -– proposes two innovative techniques that may help both investors and directors clarify disconnects between executives’ pay and shareowners’ interests.

You can view the paper, along with interactive tools that illustrate these techniques, at www.riskmetrics.com/compensation. RMG is seeking a range of feedback to help refine the paper and the potential tools.

The first proposed technique focuses on peer group benchmarking -– long suspected of contributing to spiraling pay levels that cannot be linked to consistently superior returns. Academic literature has demonstrated the importance of benchmarking in the pay process (e.g., see Faulkender and Yang’s, “Inside the Black Box: The Role and Composition of Compensation Peer Groups.” Working Paper). But RMG may be the first to create a model to consistently measure the quality of a company’s peer group in terms of its homogeneity (relative to size and industry factors) as well as the company’s rank within the peer group relative to the benchmarks it targets – identifying where a company that is the smallest in the group targets pay at the seemingly innocuous median level, for example. Do such distortions contribute to pay inflation? The data are revealing.

The second technique brings a financial markets perspective to evaluating how a CEO’s pay package is or isn’t aligned, in terms of risk, with that of shareholders. Understanding that alignment -– or misalignment -– can identify companies where incentives may be motivating a top executive to pursue strategies (e.g., high- or low-risk) that don’t fit with a shareowner’s investment goals or even the board’s declared business strategy.

RMG’s project is ambitious in scope and intent — to help bring clarity to the often thorny and always complex issue of executive pay. But it epitomizes our objective of producing thought provoking research that creates constructive dialogue on the important corporate governance issues facing investors and corporations. The goal is to create a shared language and measures that market participants can use to create, evaluate, and communicate about executive pay systems. The project is offered in the spirit of RMG’s commitment to bringing transparency, expertise and access to all financial market participants, and a vital part of the project is the feedback we get from all market participants. We invite your comments at www.riskmetrics.com/compensation.