ISS releases COVID case study
10/08/2020
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In response to COVID-19, companies might adjust 2020 performance goals, delay remuneration decisions or change the mix of equity awards by making more full-value grants. In recent months, proxy advisors Institutional Shareholder Services (“ISS”) and Glass Lewis have published guidance with respect to these and other governance issues (summarized HERE and HERE). The ISS guidance indicated that adjustments to annual incentive goals should be accompanied by contemporaneous disclosure to shareholders indicating the rationale for making such changes, but did not  disclose any specific details on how ISS Research would evaluate such adjustments as disclosed in the remuneration disclosures.

The consulting arm of ISS has released the first of four case studies setting forth a framework for the adjustment of annual incentive goals and reductions to CEO annual incentive awards in light of COVID-19.

Over the course of the next few weeks, the following case studies will be published by ICS to provide issuers “context and insight on potential adjustments that can be made to annual incentive goals in light of the COVID-19 pandemic”:

1. Adjust full-year goals with commensurate reduction to CEO STI opportunity

2. Eliminate full-year goals and establish second half goals with 50 percent reduction to CEO STI opportunity

3. Replace absolute financial goals with relative financial goals with no reduction to CEO STI opportunity

4. Replace absolute financial goals with relative TSR goals with no reduction to CEO STI opportunity

But be careful as you consider these case studies. These cases studies were prepared by ISS Corporate Solutions (“ICS”) and not ISS Global Research (“ISS”). The latter publishes proxy advice. The former sells data and consulting on the premise that they have knowledge of ISS’ methods. To fend off regulators concerned with a conflict of interest, ICS are at pains to say that their advice, and this case study, should not be considered as any indicator as to how the ISS Global Research Department, which is separate from ICS, will evaluate company remuneration design decisions when preparing voting recommendations for investors.

A brief summary of the case study is below.

Facts: Before the pandemic, a midcap retail company’s remuneration committee approved fiscal year 2020 goals and adopted Earnings before Interest, Taxes, Depreciation and Amortization (“EBITDA”) as the only metric to determine awards under its CEO’s annual incentive program.

Response to COVID-19: The onset of COVID-19 forced the company to close all of its retail locations and rendered the performance goals unattainable. In order to keep its CEO motivated, the remuneration committee revised the EBITDA targets by adjusting the projected growth rate downward and the volatility assumptions upward. In addition, the remuneration committee reduced the CEO’s award opportunity by 25 percent consistent with pay-for-performance principles and reflective of the reduction in the EBITDA targets.

Benefits: ISS indicates that this response motivates the CEO to obtain full-year operating results by reference to clear metrics, while still aligning performance with shareholder interests. In addition, ISS notes that prospectively adjusting the metrics makes it less likely that the remuneration committee will need to exercise year-end discretion to calculate the payout of awards.

Drawbacks: The case study points out the challenges in adjusting the underlying assumptions that result in a lower EBITDA target in light of the uncertainty around COVID-19. Moreover, ISS suggests that this proactive approach may draw shareholder criticism for revising goals to be more easily attainable, especially if the economy stabilizes sooner than forecasted.

ISS makes clear that the above case study is intended to highlight relevant considerations, but does not reflect any specific recommendation from ISS.

As well they might. Depending on how it is done, many Australian companies will encounter hurdles in obtaining proxy adviser and investor support if they change the goal posts during a performance period and even more so if they subsequently apply discretion. Some, such as ACSI, will take a very dim view of any incentives being paid at all if a company received government assistance (e.g. Jobkeeper payments) and/or benefited from a capital raising, and/or ceased dividends during the period.

It would be very interesting indeed if issuers copied the case study example and received or alternatively did not receive ISS and investor support.

Read the case study in its entirety HERE.

© Guerdon Associates 2021
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