Published on: August 20, 2021
Topics: Proxy Advisory Firms
Dear Mr. Goldstein:
The Center On Executive Compensation (“Center”) is pleased to submit its responses to and qualitative comments on Institutional Shareholder Services, Inc.’s (“ISS”) 2022 Policy Survey on behalf of its Subscribers.
As you know, the Center is a research and advocacy organization that seeks to provide a principles-based approach to executive compensation policy from the perspective of the senior human resource officers of leading companies. The Center is a division of HR Policy Association, which represents the chief human resource officers of nearly 400 large companies, and the Center’s nearly 150 subscribing companies are HR Policy members who represent a broad cross-section of industries. Because senior human resource officers play an important role in supporting the compensation committee, we believe that our Subscribers’ views are particularly helpful in better understanding how executive compensation plans are developed and executed, especially in the post-say on pay era. Consistent with the Center’s mission, our comments and survey responses reflect the input of our Subscribers and are primarily focused on ISS’s survey questions regarding executive compensation and related governance issues.
Our comments focus on the following survey questions: the use of non-financial ESG metrics in executive compensation (page 4), racial equity audits (page 5), and CEO pay quantum and midcycle changes to long-term incentives (page 6).
Use of Non-Financial ESG Metrics in Executive Compensation
Mainstream institutional investors have made it clear through public statements and proxy voting they expect boards to actively address environmental and social concerns including lowering emissions or reducing waste, mitigating likely climate change risks, and improving the diversity, equity, and inclusion within their workforces across all levels of employment.
Additionally, given this enhanced focus, the SEC is likely to require companies to provide more explicit disclosures on these topics. As disclosure has become more common, investors have or will soon encourage boards to show improved performance in these areas. It is therefore likely that companies will increasingly tie incentive payouts to performance against ESG goals.
However, as with financial metrics, boards remain best placed to determine which ESG metrics or milestones align best with the long-term growth strategy. As highlighted by a Center Subscriber, “[ESG] can be considered as part of an overall compensation decision process but companies should retain discretion on whether to include specific ESG metrics/weightings in their compensation plans and which metrics are most applicable.” Similarly, boards should have the flexibility to decide if ESG incentives are most appropriate in the short- or long-term incentive plans, as discussed by a Subscriber, “Generally speaking, ESG efforts tend to take years (vs months) suggesting they may be more appropriate in LTI plans. However, some efforts take the focus and attention of the entire company down to the supervisor level (e.g., diversity & inclusion). Since this level in the organization isn't generally covered by LTI plans, STI may be more appropriate.”
Racial Equity Audits
The HR Policy Association, the Center On Executive Compensation, and our Subscriber companies believe that equal opportunity, diversity, and inclusion are vital to broad-based economic health. As previously noted, diverse companies tend to provide healthier shareholder returns.
In the ongoing calls for racial justice, the Center and our Subscribers recognize that more must be done to ensure equal opportunity to find meaningful employment and to advance careers. The Center has engaged with Subscribers in a long-term effort to evaluate which strategies work to increase diversity, inclusion, and opportunity from top to bottom. Racial equity audits may be considered a useful tool among several options in addressing long-standing inequalities. Audits will need to account for different reporting capabilities, internal demographic data maintained by companies, and regional/national variability if any comparisons are to be reliable.
We believe that the use of racial equity audits should be determined on a case-by-case basis and consider other specific efforts the company is already taking to promote racial equity.
Longer-term Perspective on Pay Quantum and Midcycle Adjustments to Equity
Given investor preference for executive compensation plans to be explicitly tied to long-term growth in shareholder returns, we believe it would be relevant to include a longer-term perspective on evaluations of CEO pay quantum as compared to peers in addition to continuing to present the one-year multiple of median score. However, the longer-term evaluation of quantum pay presents some challenges, primarily if the ISS does not adjust previous years for realized pay. Therefore, we believe it is useful to provide both data points so that investors see both the annual and long-term perspective. The longer-term view would provide useful context, beneficially smoothing out volatility from economic impacts, rapid increases or decreases in share price, or from a CEO succession event.
It is now clear that COVID-19 will continue to impact the economy through 2021 and into 2022. Certain economic sectors will likely see waves of negative impacts as economies reopen and perhaps shut down again in response to emergent variants of the virus. The Center believes flexibility and resiliency will be hallmarks of corporate governance and executive compensation for the near future. Boards and management teams have had to ensure both operational flexibility and financial resiliency while ensuring the health and safety of employees and customers.
It is imperative that Compensation Committees have the flexibility to incentivize safety, stabilization, and growth. Even within sectors, companies have seen wide disparities on how the pandemic has impacted their customers, employees, and shareholders. Operational impacts will stretch into a second year and possibly longer. Given the lack of clarity in the future business environment caused by the lingering effects of the pandemic, Compensation Committees will find it increasingly challenging to set new short- or long-term performance targets. Rather, it appears increasingly likely that committees will need to take a holistic view of how the pandemic impacted the company and what steps management has taken to address the crisis. Reasonable, well explained modifications to long-term equity incentives may be an appropriate response in specific cases. We encourage ISS to incorporate this flexibility into executive compensation evaluations and related vote recommendations.
The Center On Executive Compensation appreciates the opportunity to submit its views on the 2022 policy process and welcomes the chance to provide the corporate perspective on ISS’s policies. Please do not hesitate to contact me at [email protected] if you have any questions about our comments or would like to discuss them further.
Vice President, Compensation Research and Practice
Center On Executive Compensation