Heads-Up for the Compensation Committee: ISS Issues FAQs on COVID-19-Related Pay Decisions – Provides Roadmap for CD&A Disclosures

As the 2021 proxy season approaches, compensation committees are actively assessing the unique challenges they face in making short- and long-term executive compensation decisions amidst the ongoing pandemic. Institutional Shareholder Service (ISS) has released frequently asked questions (FAQs) on how ISS will approach COVID-19-related pay decisions in the context of ISS’ qualitative pay-for-performance evaluation in the upcoming proxy season. These FAQs have been issued ahead of the ISS’ regular annual update, which is expected to be published in December. According to ISS, the FAQs have been shaped by feedback from direct discussions with investors in various roundtables as well as the annual policy survey. Among other things, the FAQs provide guidance as to what disclosures ISS will be looking for in proxy statements. The new FAQs can be found here. Key takeaways from the FAQs are as follows:

  • COVID-related Changes to Bonus / Annual Incentive Programs and Discretionary Awards.
    • For companies severely impacted by the pandemic, ISS may view adjustments made to annual incentive plans, which may have been problematic in normal circumstances, to be a reasonable response so long as the justifications and rationale are clearly disclosed, and the resulting outcomes appear reasonable. 
    • ISS identifies a non-exclusive list of key disclosure items that would help investors evaluate COVID-related changes to the annual incentive program, including: (i) specific challenges faced as a result of the pandemic and how those challenges rendered the company’s original program design obsolete or performance targets impossible to achieve, including addressing how changes are not reflective of poor management performance; (ii) if applicable, an explanation of why mid-year changes versus one-time discretionary awards were selected as the appropriate approach and how such actions further investors’ interests; (iii) tailored (non-generic) descriptions for performance-based considerations for one-time discretionary awards (e.g., “strong leadership during challenging times” would be insufficient); and (iv) a discussion of how the resulting payouts appropriately reflect both executive and company annual performance, including an estimate of how the resulting payouts compare with what would have been paid under the original program design. ISS also encouraged companies to disclose positive changes they have made for their 2021 annual incentive program, which could mitigate ISS’ qualitative evaluation for 2020.
  • Financial or Operational Target Changes Below Prior Year Performance Levels. According to ISS, investors have indicated that lower performance expectations that reflect external factors (such as operational impacts due to the pandemic) may be a reasonable explanation for lowering financial or operational targets below the prior year’s performance levels. However, ISS states that a lower performance target should be accompanied by disclosure as to how the compensation committee considered corresponding payout opportunities, particularly if such payout opportunities are not commensurately reduced.
  • In-Flight Equity / Long-term Incentive Cycles.
    • ISS states that changes to in progress long-term incentive cycles would be generally viewed negatively, particularly for companies that exhibit a quantitative pay-for-performance misalignment.
    • For award cycles beginning in 2020, ISS notes that investors generally do not expect to see drastic changes to long-term incentive programs unless the underlying business strategy has fundamentally changed. ISS advises that companies should clearly explain any changes to the program to allow investors to evaluate the compensation committee’s actions and rationale.
  • COVID-related Retention or Other One-Time Awards.
    • As with one-time awards granted outside the context of the pandemic, companies that grant one-time awards to address concerns resulting from the pandemic, which may include executive retention, should clearly disclose the rationale behind the award (including magnitude and structure), as well as describe how the award furthers investors’ interests. ISS indicates that boilerplate language regarding “retention concerns” would not be viewed as sufficient rationale and that awards should be reasonable in magnitude and an isolated practice.
    • Companies that grant one-time awards in the year (or following year) in which incentives are forfeited, will be expected to explain the specific issues driving such decision and how the awards further investors’ interests. ISS notes that companies that indicate that one-time awards were granted in consideration of forfeited incentives, for fairness considerations or lower realizable pay will need to explain how such awards do not merely insulate executives from lower pay.
  • Temporary Salary Reduction. Since base salaries typically make up a small portion of total pay for top executives, ISS will give temporary salary reductions for executives mitigating weight only to the extent they decrease total pay. ISS will consider temporary salary reductions more meaningful if targeted incentive payout opportunities are decreased to reflect the reduced salary.
  • Update to ISS Responsiveness Policy. ISS’ responsiveness policy reviews three factors when a company receives less than 70 percent support on a say-on-pay proposal: (1) the disclosure of the board’s shareholder engagement efforts; (2) the disclosure of the specific feedback received from dissenting investors; and (3) any actions or changes made to pay programs and practices to address investors’ concerns. ISS advises that if a company is unable to implement changes due to the pandemic, the proxy statement should disclose specifically how the pandemic impeded the company’s ability to address shareholders’ concerns. ISS’ guidance further states that if pay program changes are delayed, or do not necessarily fully address shareholder feedback, the company should disclose a longer-term plan on how it intends to address investors’ concerns.