Anyone looking for yet another headache likely to arise this proxy season, look no further: Institutional Shareholder Services has unveiled a new analytical model it will use to evaluate executive compensation.

In a white paper it published Dec. 19, ISS says it will now take a two-pronged approach to reviewing compensation packages. First will be a quantitative review that examines the CEO's pay and performance relative to other CEOs, and to his own company's shareholder returns for the last five years. Should that first phase raise any concerns, an in-depth qualitative assessment will follow where ISS will dispatch analysts to see whether any long-term disconnect between pay and performance has arisen.

“This year, a substantial majority of institutional respondents to ISS' 2011-12 policy survey confirmed two factors as very relevant to evaluating pay-for-performance alignment: pay relative to peers and pay increases that are inconsistent with the company's performance trend,” ISS said in its white paper.

The paper goes on to say that while Total Shareholder Return is a common metric investors use to judge executives' long-term performance, ISS does not recommend that TSR be the basis for structuring executive compensation. Rather, companies should fix executives' pay to the achievement of specific short- and long-term goals; should executives then hit those goals and create more value for the company, the thinking goals, TSR will increase as a matter of course.

The ISS paper also introduces three new metrics ISS will use when conducting its qualitative review, two of them relative (measuring the company's success against peers) and one absolute (evaluating success independently of other companies). The metrics are:

Relative Degree of Alignment. This measure compares the percentile ranks of a company's CEO pay and TSR performance, relative to an industry-and-size derived comparison group, over one- and three-year periods.

Multiple of Median. This measure expresses the prior year's CEO pay as a multiple of the median pay of its comparison group for the same period.

Pay-TSR Alignment. This absolute measure compares the trends of the CEO's annual pay and the value of an investment in the company over the prior five-year period.

 

                              Source: ISS.