How can investors tell if CEOs of the companies they own are overpaid? The answer may get still more complicated as fund managers start to pore over proxy statements in preparation for the March/April annual meeting season.
Thats because Institutional Shareholder Services (ISS), the top adviser to investors for so-called say-on-pay votes, reformed its methodology late last year, replacing one key litmus test with three. ISS says the new rules should yield about the same number of "No" recommendations as the old ones: 11 percent of the Russell 3,000. But presumably the roster of excessive compensators may change.
When the Dodd-Frank law made say-on-pay mandatory (though not binding) for public corporations last year, Rockville, Marlyandbased ISS leapt from relative obscurity to near omnipresence. Influence bred controversy as numerous boards singled out as overpayers fought back, telling shareholders the companys analysis was overly simplistic. ISS says it rethought its criteria to be transparent and allow more consistent evaluation.
Under the old rules, ISS screened for companies that had lagging shareholder returns relative to their peer group, then checked to see if a CEOs pay had gone up in the previous year. If so, an offending company was at risk of misalignment, and ISS set aside its file for further qualitative scrutiny. The new way retains this standard but looks at the bosss remuneration going back three years for more balance. Peer groups will also be expanded in the interests of a broader market sample. Last year firms were compared with between eight and 12 competitors. This year it will be a minimum of 14.
ISS will add two new metrics as well. One measures CEO compensation relative to a peer group median regardless of share performance. If last years take-home was more than 2.33 times the benchmark, that is a danger sign. The other new yardstick looks at absolute alignment of pay-to-performance disregarding the peer group. The compensation package should rise and fall in line with total shareholder return over the past five years, ISS says.
The new multifaceted test should in fact be more fair, say compensation consultants who design the nitty-gritty of CEO packages and have been ISSs most vocal critics. These are changes for the better, says Ira Kay, a managing partner at compensation consultant Pay Governance. ISS is positively impacting the pay-for-performance dialogue in the boardroom.
But ISS say-on-pay calls will retain a fair bit of mystery. The company has not made clear how it will weight the three new criteria, for instance. What is plain is that ISSs decisions resonate beyond the 46 companies 1.5% of the investable market that received "No" votes on their executive compensation last year.
Shareholders at 157 more corporations delivered "Maybe" votes on say-on-pay verdicts, meaning less than 70 percent approval. A fair number of these could turn into flat rejections given that stock markets stagnated last year compared to double-digit returns in 2010, putting investors in a crankier mood. If a CEO package fails ISSs test under both the old and new criteria, maybe it is time for a thumbs down from shareholders.