Director pay is increasingly in the crosshairs in the wake of shareholder lawsuits and proxy advisory firm criticism of outlier pay. Last year's ISS policy update included a reference to "excessive" non-employee director pay levels, noting that ISS would be identifying outliers based on companies in the same index and industry and would begin recommending against the directors responsible for setting pay after two consecutive years. In addition, a recent Willis Towers Watson survey found that with director pay up 3% in 2017, companies are increasingly implementing annual compensation limits (61% versus 55% in 2016) and evaluating director pay plans at least annually (49%).
2019 will be the first year in which companies are subject to the new ISS evaluation, and as this Pearl Meyer blog points out, there are a number of potential stumbling blocks:
Pay Compression. Several stakeholders have pointed out the fact that director pay is extremely compressed within industries, meaning that small changes have an outsized impact on pay ranking and could push a director into the "top 5% zone" unexpectedly. In addition, the industry or index selected will be critical to the evaluation results, since 95th percentile pay differs considerably depending on whether ISS uses two-digit or four-digit GICS codes. In addition, as Pearl Meyer notes, companies who belong to multiple indices will have varying results depending on which index ISS chooses.
Changes in Pay. As the Center plans to explain in our forthcoming comments to ISS on its 2019 policy survey, there are a number of factors that could cause fluctuation in director pay, such as unusual M&A activity resulting in higher board engagement or a special skill set for particular committee members that drives higher market pay. The Center believes that ISS should consider company rationales and pay history when evaluating "excessive" director pay, rather than rely exclusively on a quantitative, check-the-box approach.
As Pearl Meyer suggests, companies are wise to make a fresh evaluation of director pay compared to market, using multiple reference points and broader industry and index benchmarks in addition to peer groups. The article raises several issues that may result in high director pay, including the use of fixed equity grant guidelines that award a number of shares rather than a value, since changes in stock price could alter total compensation in a way that tips the scales of ISS's screens.