20 November 2019 – need2know
With ISS and Glass Lewis, two of the most influential Proxy Advisers disclosed updates of their Voting Policies regarding Continental Europe for the upcoming season 2020. As expected with focus on board matters as well as executive remuneration (say on pay).
Overview on the changes to the ISS Voting Policy
ISS released its update for EMEA (Europe, Middle East and Africa), Proxy Voting Guidelines Updates for 2020, applicable for shareholders’ meetings on or after February 1, 2020.
The important changes at a glance:
Director terms – from 2021 onwards terms reduced to max four years
The legal limit according to sec 87 para 7 of the Austrian Stock Corporation Act is a five years term. This term corresponds to the current market practice in Austria.
For shareholders’ meetings on or after 01 February 2021 ISS will generally recommend to vote against the (re)election of any director when the term exceeds four years, if an adequate explanation for non-compliance has not been provided.
Further reduction to be expected. ISS may consider moving to maximum board terms of less than four years in the future, as expressed by ISS directors should be accountable to shareholders on a more regular basis.
According to the rationale given by ISS directors are generally elected for terms of one to four years, with annual elections considered best practice. Board terms of more than four years have become exceptional and considered outdated. According to ISS many institutional investors favour standard board terms of less than four years or even annual elections. Thus it is to be expected that ISS will consider further limitations of the board terms in the future.
Board leadership – expectation of an independent board chair
Given the importance of board leadership, ISS may consider that the chair of the board at widely held companies should be an independent non-executive director according to ISS‘ classification. This is qualified as suggestion, but, however, will not cause negative vote recommendations by ISS if a board chair is not independent.
“Widely-held companies” is determined based on the membership in a major index and/or the number of ISS clients holding the securities.
The suggestion shall highlight the importance of board leadership given the dominant role of an independent board chair in many European markets. Furthermore, this addition shall sensitize the market that investors‘ expectations may rise and Board Chair Independence may become an ISS policy in the future.
Board composition – gender diversity
With respect to gender diversity ISS will in general recommend to vote against the chair of the nomination committee (or other directors on a case-by-case basis) when there are no female directors on the board of a widely-held company.
Due to the fact that many jurisdictions (e.g. Austria, Germany, France, etc.) already implemented a “gender quota” for supervisory boards such domestic legal requirements will prevail.
As a new element ISS implemented recommendations regarding the compensation committee/the board on the use of discretion to determine payments to ensure that rewards properly reflect business performance:
- In cases discretion is used to determine payments, a clear explanation of its reasons should be given, which are expected to be clearly justified by the financial results and the underlying performance of the company.
- The compensation committee should disclose how it has taken into account any relevant environmental, social, and governance (ESG) matters when determining remuneration outcomes. Such factors may include (but are not limited to): workplace fatalities and injuries, significant environmental incidents, large or serial fines or sanctions from regulatory bodies and/or significant adverse legal judgments or settlements.
- In the rare cases, where a compensation committee/board chooses to amend the targets for the annual bonus or the LTIP following the start of the performance period, ISS recommends a demonstration how the revised targets are in practice no less challenging than the targets which were originally set.
Compensation-related voting sanctions – Compensation committee responsiveness
Newly implemented with the policy update 2020 the failure to respond to significant shareholder dissent on remuneration-related proposals (as well as egregious remuneration practices, failure to follow market practice, by not submitting expected resolutions on executive compensation) will be enforced by an adverse vote recommendation (on a case-by case basis) on the
- (re)election of the chair of the remuneration committee or, where relevant, any other members of the remuneration committee;
- (re)election of the board chair;
- discharge of directors; or
- annual report and accounts (where applicable).
Glass Lewis – Overview on the 2020 changes
Glass Lewis published its Proxy Voting Guidelines for Continental Europe for the season 2020. The Remarkable changes that will be applicable for shareholders’ meetings as of 01 January 2020 include:
Executive board remuneration – Vote on remuneration policy
No one fits all approach. In general Glass Lewis highlights the given complexity of most companies’ remuneration programs, so that Glass Lewis applies a highly nuanced approach when analysing executive remuneration with review on both a qualitative basis and a quantitative basis, taking into consideration the context of industry, size, financial condition, historic pay-for-performance practices, ownership structure and any other relevant internal or external factors.
Also any significant changes or modifications, and associated rationale, made to a company’s remuneration structure or award levels, including base salaries, will be reviewed.
Disclosure with link to the company’s strategy. With respect to the mandatory vote on the remuneration policy in the season 2020 Glass Lewis requires that the remuneration policy should provide clear disclosure of an appropriate framework for managing executive remuneration and provide an explicit link to the company’s strategy, further set appropriate quantum limits along with structural safeguards to prevent excessive or inappropriate payments and particularly any reward for failure.
Troubled items list. The guidelines also contain a list of potentially troubling issues that might lead to a negative voting recommendation:
- Policy allows for high pay (as compared to the company’s benchmark) that is not subject to relevant and challenging performance targets over the period or has not otherwise been merited by outstanding company performance over the period;
- Overall remuneration structure or the balance between short- and long-term incentive plans is considered as not appropriate or not in shareholders’ best interests;
- Pay levels are benchmarked above median without sufficient justification;
- Performance targets are not sufficiently challenging, or not aligned with business strategy;
- Non-executive directors (i.e. supervisory board members) are eligible for cash and/or equity awards on similar terms as those granted to executives;
- Failure to sufficiently disclose the terms of the policy; and
- Substantial changes to the existing policy have been proposed and have not been adequately explained or justified, a negative vote against the policy may be recommended on this basis, if the changes mark a worsening of the overall structure.
Focus on pay for performance. Regarding the vote on the remuneration report Glass Lewis will pay particular attention to the alignment between performance and pay outcomes, and the committee’s level of disclosure regarding any application of discretion.
Poor disclosure and questionable adjustments. Negative voting recommendations in this context may be triggered by evidence of a pattern of poor pay-for-performance practices, unclear or questionable disclosure regarding the overall remuneration structure (e.g. limited information regarding benchmarking processes, limited rationale for bonus performance metrics and targets, etc.), questionable adjustments to certain aspects of policy implementation and/or outcomes (e.g. limited rationale for significant changes to performance targets or metrics, the pay out of guaranteed bonuses or sizeable retention grants, etc.) and/or other egregious remuneration practices.
List of problematic pay practices. Glass Lewis considers the following (non-exhaustive) list as indications of problematic pay practices triggering a negative vote against the remuneration report:
- Egregious or excessive bonuses, equity awards or severance payments, including golden handshakes and golden parachutes or guaranteed bonuses;
- Incentive plan targets set at performance levels well below actual past performance or strategic targets provided in guidance to shareholders, absent a compelling rationale for lowering the target;
- Lowered performance targets without justification;
- Incentive plans that pay out for performance below lower middle quartile peer performance levels;
- Lack of disclosure regarding performance metrics and targets;
- Performance targets not sufficiently challenging and/or providing for unreasonably high potential pay outs;
- Performance conditions do not adequately measure a company’s performance or align with strategy over the long term;
- Discretionary bonuses paid when short- or long-term incentive plans were not met;
- Executive pay that is high compared to the Company’s peers and is not correlated with outstanding company performance; and
- terms of a long-term incentive plan are inappropriate and a separate vote on the plan is not provided.
Measures against poor remuneration policies. In the case of a company that maintains poor remuneration policies year after year without any apparent steps to address the issues, Glass Lewis may also recommend a shareholders vote
- against the chair and/or other members of the remuneration committee;
- in addition, against the entire committee based on the practices or actions of its members, such as approving large one-off payments, the inappropriate use of discretion in determining variable remuneration, or sustained poor pay-for-performance practices.
Board responsiveness on items with 20% votes against
In case that at least 20% of minority shareholders vote contrary to the recommendation of the management, Glass Lewis will make a close examination of the underlying issues and an evaluation of whether or not a board response was warranted and, if so, whether the board responded appropriately following the vote.
If the board does not acknowledge and/or address such dissent appropriately this would be a contributing factor to recommend a vote against management’s recommendations in the future.
Further, Glass Lewis may, where appropriate, hold chairs and members of the relevant committees accountable via a recommendation against the relevant board ratification proposal(s) and/or their re-election where the response to shareholder concerns has fallen below a qualitative threshold.
Assessment of board responsiveness. The evaluation of board responsiveness involves the review of publicly available disclosures released following the date of the company’s last annual meeting with focus on:
- Board level – any changes in directorships, committee memberships, disclosure of related party transactions, meeting attendance, or other responsibilities;
- Revisions to the company’s articles of incorporation, bylaws or other governance documents;
- Press or news releases indicating changes in, or the adoption of, new company policies, business practices or special reports;
- Modifications made to the design and structure of the company’s remuneration program; and
- Modifications made to the company’s capital management powers such as issuance of shares authority or buyback programs.
Corporations should consider the voting policies of the proxy advisory firms in order to avoid negative voting recommendations, where such is achievable in the best interest of the company and its shareholders.
But in any case an ongoing company engagement with investors and the ability to quickly review and respond to proxy advisory firm recommendations is essential to counteract adverse ISS or Glass Lewis voting recommendations.
Authors: Christoph Nauer, Daniel Reiter
Questions? Please contact:
Capital Markets, Banking & Finance
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