ISS’s Canadian Proxy Guidelines Now Include Pay-for-Performance Evaluation


On December 19, 2012, Institutional Shareholder Services (ISS) released its 2013 Canadian proxy voting guidelines for TSX-listed companies. The updated guidelines are effective for shareholders’ meetings held on or after February 1, 2013. These guidelines include ISS’s new pay-for-performance methodology to evaluate the alignment between executive compensation and company performance. The methodology will be applied to all S&P/TSX Composite Index Companies and all companies with say-on-pay proposals. On January 23, 2013, ISS added a Frequently Asked Questions (FAQs) section to its website to provide additional guidance on how it will apply the pay-for-performance methodology.

The evaluation of long-term pay-for-performance alignment is a two-step process: an initial quantitative assessment for all companies subject to the methodology, followed by an in-depth qualitative assessment if the quantitative assessment indicates a potential misalignment. In its FAQs, ISS explains that the test focuses on CEO compensation to determine pay-for-performance alignment because the CEO’s package sets the tone for executive compensation levels at most companies, and compensation committees and boards are generally most involved in decisions about the CEO’s pay.

Implications of Pay-for-Performance Misalignment

If ISS determines that there is a significant long-term misalignment between compensation and company performance, it will generally recommend voting against the company’s say-on-pay proposal (if the company has one) and/or voting against or withholding votes on compensation committee members (and in rare cases all members of the board). In addition, if a significant portion of the CEO’s compensation is linked to non-performance-based equity awards, ISS may recommend voting against an equity incentive plan proposal if the CEO is a plan participant.

Say-on-pay is not mandatory under Canadian law; however, during the 2012 proxy season, 99 Canadian issuers had voluntarily adopted say-on-pay. The possibility of ISS’s recommending against the re-election of compensation committee members may encourage more S&P/TSX Composite Index Companies to adopt say-on-pay so that any adverse ISS recommendation is directed toward the say-on-pay proposal and not the compensation committee members.

Quantitative Assessment

The quantitative assessment will consider the following: (i) the relative degree of alignment between the company’s total shareholder return rank and the CEO’s total compensation rank within an ISS-selected peer group over one-year and three-year periods; (ii) the CEO’s total compensation in the last reported fiscal year relative to the median total compensation of the peer group; and (iii) the difference between absolute CEO pay changes and absolute total shareholder return changes over the prior five fiscal years.

ISS will use the CEO’s total compensation as reflected in the summary compensation table of the proxy circular. ISS will select a peer group of between 11 and 24 companies for each company subject to the methodology. Peer groups will be based on the company’s industry, revenue and market value.

Qualitative Assessment

If a company receives an adverse score on the quantitative assessment, ISS will conduct an in-depth qualitative assessment based on the disclosure in the proxy circular before making its final recommendation. Factors that ISS will consider include the following:

  • The strength of the company’s performance-based compensation. ISS will review the ratio of performance-based to time-based equity awards and the overall ratio of performance-based compensation to total compensation. It will also assess the quality of the disclosure and the appropriateness of the performance metrics and goals. Because ISS will focus on the compensation committee’s most recent decisions, it is important that the proxy circular clearly describe the applicable performance metrics, why such metrics were chosen and how they fit into the long-term corporate objectives.
  • The company’s peer group benchmarking practices. ISS notes in its FAQs that some studies have identified benchmarking practices as a source of pay escalation that is not linked to performance. If a company uses benchmarks, it is required to disclose the composition of its peer group, how the peer group was selected and how compensation decisions were based on the benchmarking. ISS will closely review the disclosure on benchmarking to determine whether the company’s approach is a contributing factor to a pay-for-performance disconnect. For example, selecting a number of peers with a higher market cap may lead to pay escalation without regard to performance, because larger companies may provide higher levels of compensation.
  • Results of financial and operational metrics. ISS may consider absolute and relative trends in metrics, such as growth in revenue, profit, cash flow and return on equity.
  • Special circumstances. ISS may also consider exceptional circumstances such as the hiring of a new CEO or an unusual or special equity grant that may affect the quantitative assessment. If a company has hired a new CEO in the previous fiscal year, the proxy circular should clearly describe the decision-making process in setting the new CEO’s compensation package, as well as how the new CEO’s pay is linked to future company performance.




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