Proxy adviser, ISS, held its policy review meeting in Sydney on 1 March 2016. Hosted by Head of Research, Vas Kalesnikoff, the seminar covered a range of areas:
- Trends witnessed by ISS through 2015
- What was controversial for ISS in 2015
- Where remuneration is headed
- Board level observations
This article captures the significant matters discussed and alerts readers to particular issues to consider as we near the end of FY16.
Directors should recognize that much of ISS’ client base is foreign investors and that ISS sends its report to their clients 14 days before a company’s AGM. This means there is limited scope for engagement at that time.
Looking back – what ISS did and saw in 2015
Looking through the detail, the following should be noted:
- ISS increased its recommendations “against” remuneration resolutions by 28% over 2014.
- It recommended “against” 12 companies seeking an increase in the NED fee pool.
- Consistent with 2014, it recommended “against” 10% of remuneration report resolutions.
- Its recommendations against 55 Director elections was in line with 2014 (56). ISS will review the nomination closely if there are tenure or independence issues around 1/3 of the board directors.
- ISS identified an increasing number of additional Board Committees and questioned whether more committees are appropriate. This often results in an increase in director fees.
- There were 66 companies in the ASX 300 that did not have a majority of independent directors according to ISS standards.
- ISS expressed significant concern over the practice of voting on remuneration resolutions through a ‘show of hands’, particularly when the proxy voting was between 20% and 25%. ISS said they will closely scrutinise the 2016 remuneration reports of companies that had followed this practice in 2015.
It was stated that three companies with proxy voting greater than 25% resolved the vote on a show of hands, and five companies with voting between 20% and 25% did the same.
Some particular trends around remuneration issues that ISS identified included:
- The “US effect” where companies benchmark remuneration against the US on the basis of their activities, operations or location of executives. This may be appropriate for the company itself given its particular circumstances, but it raises the question of domestic companies including these companies in their Australian benchmarking.
ISS’ believes this can cause remuneration inflation based on flawed methods.
- STI targets: Vas Kalesnikoff explained that ISS considered the diminishing transparency around disclosure of STI targets to be a significant concern. While he acknowledged director concerns that disclosure of targets may provide guidance, Mr Kalesnikoff maintained even retrospective disclosure of STI outcomes against targets was limited. This will be a continuing focus of ISS in 2016.
- Financial v non-financial metrics: ISS identified a significant increase in the use of non-financial metrics over financial in the STI. A number of participants explained that it was the role of the board to determine the metrics that are most appropriate for the company in the context of its strategy and circumstances and that a view on the weighting of same may be overly simplistic.
- Retention payments: payments that are unhurdled but for a service period are increasing in frequency.
- LTI hurdles: Mr Kalesnikoff also noted there was a number of companies beginning to use non-financial hurdles for their LTI, and some not disclosing the nature of those hurdles.
Points of controversy in 2015
Vas Kalesnikoff explained the continuing controversy throughout 2015 concerning investors ‘blindly’ following the recommendations of proxy advisors. This was said to cause significant negative voting based on ‘wrong facts’. Quite a number of companies considered the facts on which ISS made its recommendations may have been incorrect.
Mr Kalsenikoff assured the participants that ISS recognizes the significance of its “against” recommendations and goes to great lengths to ensure its facts are correct.
Guerdon Associates suggested ISS share its analysts’ data with the company for fact-checking. ISS indicated that it is continuing to explore ways in which it can improve data verification.
It is a significant concern for companies and directors when the media focus on an ”against” recommendation of a proxy adviser that may have been made on the basis of incorrect data.
Looking forward – ISS’ focus in 2016
Vas Kalesnikoff advised that particular areas of ISS’ focus and consideration in 2016 will include the following issues.
- It will look to understand if companies are justifying pay increases on the basis of the ‘US effect’ (see above).
- ISS has reservations about companies using market capitalisation for their benchmarking noting this measure can be volatile. See for example, the materials sector.
- ISS will closely scrutinize the use of underlying performance measures and where one-off adjustments.
- Similarly, ISS expressed is concerned about a material shift by companies to the use of non-financial hurdles. It will be looking at such structures more closely.
- In particular, ISS will be focusing on STI outcomes of companies with significant impairments and poor 1 year TSR. It was noted by Guerdon Associates that STIs are typically based on backward looking metrics, whereas TSR is forward looking, and picked up by LTI measures. Guerdon Associates and others also suggested that impairments typically impact LTI vesting, which would be appropriate as impairments are made on assets acquired or developed before the beginning of the STI period in question.
- Vas Kalesnikoff said that ISS has identified an increasing gap between the LTI reported and that which is ultimately realised. He believed there is an inconsistency between allocation of LTI based on face value and fair value that is causing excessive remuneration for those using the fair value methodology. This was challenged by Guerdon Associates, investors and directors at the meeting. An example of this is covered in our article on LTI values (see HERE). Many companies disclose the value of the LTI using both methods.
- Mr Kalesnikoff also noted that ISS will be focused on the performance hurdles for LTI grants of those companies that have incurred significant losses. For example, companies in the bottom of commodities cycles will be measuring many metrics over the next three to four years off an unusually low base.
- Once-off grants of LTI that are outside of the remuneration structure will capture the attention of ISS.
- There was discussion around the treatment of LTI on a change of control. ISS considers there have been some instances where the treatment may be regarded as excessive and it expects a pro-rata vesting at the time of change. However, several were of the view that annual LTI grants are part of annual reward, and should be permitted to fully vest if performance criteria are otherwise met.
Other board issues
The following matters continue to be an area of focus for ISS.
- Overboarding: ISS will look closely at director elections when they consider an individual may be a director of too many companies.
- New committees: see the comments earlier
- Travel allowances: Mr Kalesnikoff expressed the view that there are inconsistent approaches to director travel where some companies pay allowances while others do not. It is not clear to us if this is an issue for ISS as companies will either pay a separate allowance or ensure they have recognised the extent of travel involved when determining the base fee level for directors.
Many directors are required to undertake significant travel to fully acquit their duties.
- Retirement and post-retirement benefits: these are reviewed by ISS to understand the appropriateness of the arrangements.
- Shareholding guidelines: ISS noted, without comment, that there is a significant difference in practice among companies.