Proxy advisory firm Institutional Shareholder Services will be updating its methodologies used when issuing recommendations on companies' proposals beginning Feb. 1, 2012. Companies whose proxy meetings will take place on or after that date should pay attention to these changes in the ISS assessment.

Not surprisingly, the first change presented by the experts at ISS during a Wednesday Webinar was on the management say-on-pay proposal (MSOP). In 2012, ISS will focus their assessment on MSOP issues based on compensation committee members' responsiveness to issues raised by shareholders instead of scrutinizing board actions as it has done in the past. The proxy firm said it will also highlight the type of disclosures that shareholders will examine to determine if a company has sufficiently addressed shareholders' prior-year concerns.

For a company with less than a 70 percent support in the previous say-on-pay proposal, ISS will assess other criteria, including the company's response, frequency of the event, and the company's ownership structure, prior to issuing any recommendation. If previous support is less than 50 percent, a higher degree of committee responsiveness will be required to get a positive recommendation.

Carol Bowie, the firm's head of U.S. compensation research, said although ISS had not issued any recommendation when it comes to say-when-on-pay in the last proxy season, the 2012 update will see ISS adopting a policy to cast an against or withhold vote on the entire board of directors, except new nominees, if the board implements an advisory vote on executive pay on a less frequent schedule than what majority shareholders want.

On votes that only receive plurality instead of majority support, she said, “Moving forward, any annual frequency will get popular support from shareholders. Boards that ignore the demand will be held responsible. We will look at the board's rationale, the company's ownership structure and vote results, our analysis if a problematic pay practice exists historically, and the previous-year support level before issuing any recommendation.”

Another key highlight is ISS's new take on the pay-for performance screening process. Bowie said after considering many comments from clients, the firm found there has been increased interest in the quantitative components used by ISS to evaluate pay vs. performance alignment. “Two major changes in ISS thinking that will take place next year include more emphasis on long-term alignment and the use of the same peer group in the analysis,” said Bowie.

In refining the quantitative methodology to determine pay-for-performance under the executive compensation evaluation policy, ISS will conduct its analysis to satisfy alignment between the two subjects over a sustained period. When comparing the two in relative alignment, the firm will look at a company's total shareholder return rank (TSR) and the chief executive officer's total pay rank within a peer group measured over one- and three-year periods, and the multiple of the CEO's total compensation relative to the peer group median. She explained the peer group will consist of between 14 and 24 companies. They are selected using criteria such as market capitalization, revenue, and industry group in order for them to gain meaningful comparison to the company they are evaluating.

When it comes to absolute alignment, ISS will study the trend in CEO pay and company TSR over the last five years before issuing any recommendation. “The peer group is not to benchmark the CEO pay. We are trying to get an alignment on total shareholder return and CEO pay over the long-term period,” she said. She adds the firm will undertake further examination of the data if the initial screening shows that significant unsatisfactory misalignment has taken place over the period of study. 

Beginning next year, any performance-based compensation plan on the ballot for the first time under Section 162(m) that needs approval from shareholders will be given a full equity plan evaluation. Bowie said in general, the ISS recommendation will be in favor for proposal to approve or amend executive incentive bonus plans if it includes features to comply with the provisions of Section 162(m) for tax return purposes. “Our general approach is to support this proposal for tax return purposes unless it involves re-pricing of stock options without shareholder approval,” Bowie said.

On proxy access, ISS will refine the factors used in its evaluation process while broadening the policy to apply to management proposals. ISS pledges its support to proxy access, calling it an important shareholder right.

During the briefing session, ISS said it will not endorse any single set of specific parameters at this time since there is no uniform standard to abide by. Instead, ISS will look at the proposals based on company-specific factors and proposal-specific factors. The criteria include ownership thresholds proposed in the resolution, maximum proportion of directors' nomination that shareholders can make each year, and the method to decide which nominations should appear on the ballot.

“We really want our 2012 framework to be flexible,” said Patrick McGurn, special counsel at ISS. “A lot of ideas are being thrown around. For this season, let all sort of proposals come out. Let the creativity bloom.”

 Other key changes next year include:

Risk Oversight: Adding an explicit reference to risk oversight. Under extraordinary circumstances, ISS will vote against or withhold from individual directors, members of a committee, or the entire board due to failure in governance, fiduciary responsibilities, and egregious actions related to a director's service on boards, and others.

Unequal Voting Rights: Generally vote against proposals to create a new class of common stock.

Political Spending: Generally vote in favor of proposals requesting greater disclosure of a company's political contributions and trade association spending policies & activities.

Lobbying: Vote case-by-case on proposals requesting information on a company's lobbying activities

Fracking: From no existing policy to generally vote in favor of proposals requesting greater disclosure of a company's hydraulic fracturing operations

Workplace Safety: Vote case-by-case on requests for workplace safety reports, including reports on accident risk reduction efforts.

Meanwhile, Debra Sisti, the firm's head of Canadian research team, said the existing evaluation policy and method will remain unchanged in Canada for at least another year. She cited the lack of the required 5-year disclosure information on pay-for-performance, which is integral in the new quantitative approach, as the main reason for the delay. “To capitalize on the improvement, we will wait one more year until we have at least five-year disclosure information on pay-for-performance,” she said.

The ISS issued the proposal on its 2012 policy update back in October. The comment period ended in early November. More than 40 comments were received and studied by the proxy advisory firm prior to the briefing.