Companies have more to worry about than just the "seven deadly sins" of executive compensation, according to a recent epistle by John Roe, who heads up ISS Analytics. Brushing past the "mortal sins" of unresponsive compensation committees, unjustified special awards, "aspirational" peer groups, duplicative or poorly disclosed metrics, softball targets and executive agreement irritants, Mr. Roe warns companies to also consider the "seven venial sins" below:
1. Too much focus on TSR. In a somewhat maddening role reversal (and, arguably, a touch of revisionist history), the article pushes back hard against company use of TSR as an incentive plan metric, claiming that ISS never endorsed company use of the metric and that there are in fact myriad concerns relating to the use of TSR in incentive plans. These include such strangely familiar arguments as the fact that TSR lacks line of sight to management, is a point in time measurement that does not reflect long-term performance, and may be less meaningful than financial goals selected by a company's board. Newer criticisms include the idea that TSR is too levered a measure in a bull market and that TSR rewards executives twice for the same shareholder wealth creation. If companies use TSR, the article proposes, incorporating it as a modifier rather than discrete metric may be preferable, parroting where the market is already heading. This criticism is particularly ironic given that ISS is seeking to incorporate the use of Economic Value Added (EVA) into its pay for performance analysis.
2. Too many metrics. Citing studies showing that 90% of the S&P 1500 includes eight or fewer metrics in their short-term plans, Mr. Roe suggests that any company employing more than eight annual plan metrics should be scrutinized. The median number of long-term incentive metrics is three; only 10% of companies use six or more metrics in the long-term plan.
3. Letting management and consultants drive the ship. Mr. Roe advises "firm and effective boardroom oversight" over compensation consultants, warning companies not to allow consultants or even members of management to explain company compensation programs when members of the compensation committee are present in the room. Allowing that management does play a "vital role" in the executive compensation process, the article nevertheless emphasizes that directors are expected to be able to articulate pay program strategy and general mechanics in shareholder meetings without relying on a third party.
4. Confusing retentive pay with incentive pay. Simply stated, ISS disapproves of "rescuing" any part of a performance award that has not paid out or providing supplemental awards to "make up" for lost incentive pay, arguing that these constitute special awards (which are a deadly sin as pointed out above).
5. Not enough focus on NEO and director pay. ISS may be telegraphing here its intention to move on to the low-hanging fruit of director and NEO pay, given that CEO pay best practices are largely well settled and accepted among investors and not likely to radically change. Areas of scrutiny include "excessive" director pay, NEO turnover and severance paid to retiring NEOs.
6. "Snowflake Syndrome." Perhaps striking back at one of the most frequent criticisms lodged against ISS, that it seeks to evaluate all companies using the same one-size-fits-all methodology, the article casts doubt on how deep the differences really go when it comes to executive pay plan design, noting that banks and rating agencies seem perfectly able to develop projections on every company.
7. It's not just about ISS anymore. The final venial sin, Mr. Roe explains, is the sin of assuming that because a company addresses the requirements of ISS and Glass Lewis, it has also addressed the concerns of its biggest shareholders. Admitting that institutional investors have their own views on pay, many of which have been informed by in-house expertise from former compensation consultants and practitioners, Mr. Roe concludes that shareholder engagement is the key to making sure that incentive plans and disclosure are in line with investor expectations - a view the Center certainly shares.