On Oct. 15, 2020, Institutional Shareholder Services (ISS) released preliminary FAQs on its approach to analyzing executive pay decisions relating to the COVID-19 pandemic. The FAQs, shaped by feedback from direct discussions with investors as well as ISS’ annual policy survey, provide general guidance regarding how ISS U.S. benchmark research may approach COVID-19-related pay decisions in the context of ISS’ pay-for-performance qualitative evaluation. The impact of the pandemic on a company’s operations will be a key consideration in upcoming qualitative evaluations. However, ISS cautions that the responses in the FAQs should not be construed as a guarantee as to how ISS will evaluate any given situation.

ISS typically publishes its final FAQs in December of each year, but given the severity of economic disruptions resulting from the ongoing pandemic, it released this preliminary series to provide investors, companies and their advisors with more time to consider the issues summarized below.

Summary of ISS Guidance and Key Takeaways

Temporary Salary Reductions

Companies should consider the impact of temporary salary reductions on an executive’s total compensation and whether there is a corresponding decrease in target incentive payout opportunities.

Temporary salary reductions will be given mitigating weight to the extent they decrease an executive’s total compensation. As base salaries typically account for a small portion of total pay for top executives, a salary reduction that represents a correspondingly small portion of an executive’s total pay will be given less weight than a reduction that represents a larger portion of his or her total pay. In addition, the action will be more meaningful if target incentive payout opportunities are also decreased to reflect the reduced salary.

Changes to Bonus/Annual Incentive Programs

Companies planning to implement certain changes to bonus/annual incentive plans as a result of the pandemic should ensure that disclosures relating to such changes are robust and clear and that underlying rationales are reasonable.

ISS expects that many companies will make adjustments to annual incentive programs, which may include changes to metrics, performance targets and measurement periods. Those companies most severely impacted by the pandemic may suspend their programs altogether and instead opt to make one-time discretionary payments. Other companies may implement a combination of these approaches. While ISS would consider these actions problematic under normal circumstances, it may view such actions as a reasonable response to the extraordinary circumstances of the current economic downturn so long as the justification and rationale for the changes are clearly disclosed and the resulting payouts appear reasonable.

ISS will continue to evaluate incentive programs on a case-by-case basis, but additional disclosures will be necessary to allow investors to evaluate COVID-19-related changes to annual incentive programs or discretionary awards. Key disclosure items include (but are not limited to):

• The specific challenges incurred as a result of the pandemic and how those challenges rendered the original program design obsolete or the original performance targets impossible to achieve, as well as an explanation of how changes are not reflective of poor management performance.
• For companies making midyear changes rather than one-time discretionary awards, an explanation as to why that approach (rather than the alternative) was taken and how such actions further investors’ interests.
• For one-time discretionary awards, which should still carry performance-based considerations, disclosure of the underlying criteria, even if not based on the original metrics or targets. Generic descriptions (such as “strong leadership during challenging times”) are likely to be insufficient.
• A discussion of how resulting payouts appropriately reflect both executive and company annual performance. This disclosure should clarify (or estimate) how the resulting payouts compare with what would have been paid under the original program design. ISS notes that above-target payouts under changed programs will be closely scrutinized.
• Companies that have designed the following year’s (2021) annual incentive program are encouraged to disclose information about positive changes, which may carry mitigating weight in ISS’ qualitative evaluation.

In the context of ISS’ analysis of incentive plan goal rigor, lower performance expectations that reflect external factors (such as operational impacts due to the pandemic) may be a reasonable explanation for setting lower goals. Even so, a lower performance target should be accompanied by disclosure as to how the board considered corresponding payout opportunities, especially if such payout opportunities are not proportionately reduced.

Changes to Equity/Long-Term Incentive Programs

Companies should consider the nature and scope of contemplated changes to equity/long-term incentive programs as well as the stage of the applicable award cycle. Companies should also ensure that accompanying disclosures are sufficiently detailed to allow investors to make meaningful evaluations of proposed changes.

COVID-19-related changes to equity/long-term incentive cycles that are currently in progress (e.g., fiscal years 2018-2020 or fiscal years 2019-2021) will generally be viewed negatively, especially for companies that exhibit a quantitative pay-for-performance misalignment. Based on investor feedback, ISS notes that these programs should be designed to smooth performance over a long-term period and should not be altered after the beginning of the cycle based on a short-term market shock.

ISS notes that investors generally do not expect to see drastic changes in the long-term incentive program for award cycles beginning in 2020 unless the underlying business strategy has fundamentally changed. More modest alterations to the program, such as moving to relative or qualitative metrics in the event of unclear long-term financial forecasts, may be viewed as reasonable. However, more drastic changes, such as shifts to predominantly time-vesting equity or short-term measurement periods, would continue to be viewed negatively. Companies should clearly explain any changes to the program to allow investors to evaluate the compensation committee’s actions and rationale.

COVID-19-Related Retention and One-Time Awards

ISS will review any proposed executive retention and other one-time awards very closely. Such awards should be appropriately structured, and related disclosures should be sufficiently detailed, addressing the specific underlying justifications for such retention or award.

Well-structured executive retention and other one-time awards to address concerns resulting from the pandemic may be appropriate in limited circumstances. With respect to structure, awards should be reasonable in size and isolated in practice. The award vesting schedule should be long term, and vesting conditions should be both strongly performance-based and clearly linked to the underlying concern the award aims to address. Awards should also contain shareholder-friendly safeguards to avoid windfalls, including limitations on termination-related vesting.

Companies granting one-time awards should clearly disclose the rationale for the award (including size and structure) and describe how the award furthers investors’ interests. Boilerplate rationale regarding “retention concerns” will not be viewed as sufficient.

Companies granting one-time awards in the year (or the following year) in which incentives are forfeited will be expected to explain the specific issues prompting the decision to grant the awards and how the awards further investors’ interests. Companies that indicate that one-time awards were granted in consideration of forfeited incentives, fairness considerations, lowered realizable pay or other similar rationales will also need to explain how such awards do not merely function to preserve executive pay at current or near-current levels.

ISS’ Responsiveness Policy

ISS’ responsiveness policy reviews three factors when a company receives less than 70% on a say-on-pay proposal: (1) disclosure of the board’s shareholder engagement efforts, (2) disclosure of specific feedback from dissenting investors and (3) any actions or changes made to pay programs and practices to address investors’ concerns. ISS expectations regarding the first two factors will remain the same. However, if a company is unable to implement the changes contemplated by the third factor due to the pandemic, the proxy statement should disclose specifically how the pandemic has impeded the company’s ability to address shareholders’ concerns. If program changes are delayed or do not fully address shareholder feedback, the company should disclose a longer-term plan describing how it intends to address investor concerns.

ISS’ Equity Plan Scorecard, Problematic Pay Practices and Option Repricing Policies

ISS does not plan to make any COVID-19-related changes to the Equity Plan Scorecard (EPSC), problematic pay practices (PPP) or option repricing policies. However, for the 2021 policy year, the passing scores for certain EPSC models will change. The passing scores for the S&P 500 EPSC model and the Russell 3000 EPSC will increase to 57 and 55 points, respectively. For all other EPSC models, the passing score will remain at 53 points.

ISS’ PPP policies, which generally flag problematic contractual provisions in executive agreements, will not change.

ISS’ U.S. policies on option repricing programs will not change. These policies employ a case-by-case approach but generally oppose repricing that occurs within one year of a precipitous drop in a company’s stock price. If boards undertake repricing actions without seeking prior shareholder approval, the directors’ actions will remain subject to review under the U.S. policies on board accountability.