November 14, 2011
Previously published on November 9, 2011
Institutional Shareholder Services has released its 2012 Draft Policies, and, given its activist-centric approach to corporate governance, it is not surprising that the proposed approach to responding to management say-on-pay votes defies both logic and shareholder prerogative. ISS’ proposal provides that it will “recommend CASE-BY-CASE on Compensation Committee members . . . and the current MSOP proposal if the company’s prior say-on-pay proposal received significant opposition from votes cast, taking into account . . . [t]he level of opposition; [t]he company’s ownership structure . . .” and various other factors. The phrase “company’s ownership structure” is a euphemism for large, affiliated blocks of stock and stock held by management and other traditional insiders, and the reference is designed to neutralize their impact. The proposal goes on to request comments on whether “a support level of less than 70 percent warrants an explicit response from a company to address concerns -- i.e., including actions or an action plan? If not, what opposition level warrants an explicit response?” Consider these two concepts carefully. First, ISS indicates that it intends to treat shareholders differently based on their ownership levels. Just because a shareholder owns a large block of stock, its vote may be suspect. This suggests that the votes of a large PE firm that has just completed a first step IPO of a portfolio company do not deserve the same weight as the votes of other shareholders, despite the PE firm’s likely expertise. We do not consider this a fair perspective, and even if the shareholder is a traditional insider, we do not understand why its vote should count less than the votes of other shareholders. Second, the supermajority concept - a concept that ISS universally opposes in other contexts - is equally alarming. A company’s approach to compensation can be approved by a majority of its shareholders, yet, to get ISS’ recommendation, the company must demonstrate “outreach efforts to major institutional investors as well as concrete action that it has taken or will take to address the compensation issue(s) that resulted in significant opposition votes.” If a majority of the shareholders vote to approve a company’s compensation system, we believe that it is inappropriate for ISS to require that the company accommodate the minority as a precondition to receiving ISS’ positive recommendation. Any other approach diminishes the voting rights of the majority and devalues their economic interest. What level of votes does ISS consider “significant”? The Draft Policies do not make it clear, but the request for comments on the Draft Policies certainly suggests that 30 percent or more is enough. While we believe that any meaningful negative vote warrants careful attention by management, the compensation committee and the board of directors, and we always have encouraged clients to remain in close contact with their shareholders, we are hard-pressed to believe that 30 percent of the votes affirmatively cast is enough to warrant action that, in the absence of which, ISS will recommend against compensation committee members and a company’s next say-on-pay vote. Indeed, given the data provided by ISS in its 2011 post-season report that average support by shareholders where ISS recommended a negative vote for the say-on-pay proposal was 65 percent, we believe the ISS’ Draft Policies effectively require that companies that received a negative recommendation from ISS in 2011 address ISS’ own concerns and agenda, not necessarily the concerns of the actual shareholders who voted. We believe ISS’ latest Draft Policies interfere with its self-described role as an independent advisory firm and further the view that it relies on policies that lack clear analytical support. Increasingly, we worry that institutional investors may not be fulfilling their fiduciary duties if they follow ISS’ potentially ill-considered policies without conducting their own independent analysis.
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