ISS: Exec Pay Controversy Just Getting Started

March 13, 2007 ( - Corporate governance and proxy voting service provider Institutional Shareholder Services (ISS) has a word of advice for those who think the excessive executive pay issue has run its course: Think again.

In a new report examining the corporate governance hot button issue of too-robust compensation packages for executives, ISS said new Securities and Exchange Commission (SEC)  compensation disclosure rules (See  SEC Approves Updated Executive Comp Disclosure Rules ) are certain to keep the matter high on investors’ agenda during the upcoming round of 2007 annual corporate meetings.

“Brace yourself for even higher levels of controversy over executive pay, including the exit packages known as severance and golden parachute agreements,” ISS asserted. “New executive compensation disclosure rules likely will result in new revelations and even more vigorous public debate.”

According to ISS, the new SEC disclosure rules will throw an even greater spotlight on severance and change-in-control. Before the new regulation, companies only had to say whether they had severance or change-in-control agreements for the five highest paid executives and for all executives as a group, and to describe the agreements in broad terms.

However, the new rules require companies to list all the agreements for named executive officers, to disclose the payment triggers and to give an estimated dollar value of potential payments and benefits and the specific factors used to determine them. Commented ISS: “Expect plenty of fodder this proxy season for “Holy Cow!” moments.”

In addition to the warning about more executive pay controversy, the ISS report also featured best practices recommendations for this controversial area.

ISS recommendations included:

  • Companies should enter into employment contracts under limited circumstances for a short time period; e.g., a three-year contract for new executive hires.
  • Severance provisions should avoid giving the appearance or the reality of "pay for failure." The severance formula should be reasonable; e.g., severance multiples should be 1X, 2X or 3X of salary and bonus. Long-term incentive awards should be excluded.
  • Change-in-control payments should be double-triggered. That means that the payments should be made only when both of the following conditions are met: a significant change in company ownership structure and loss of employment or a substantial change in job duties associated with the change in company ownership structure.

In terms of severance agreements, ISS said a severance multiplier of 2X appears common among large companies and that many institutional investors believe that the severance multiple should be one, two, or at most three times. Furthermore, the formula should use the target bonus or the average historical bonus and not other compensation such as long-term incentive pay.

ISS gave kudos to a handful of companies it said had adopted policies that limit severance to a multiple of 2.99 times salary and bonus and require shareholder approval of any severance agreement above that:

  • American Electric PowerCo. ;
  • Borders GroupInc.;
  • Cardinal HealthInc .;
  • The Coca-ColaCo .;
  • Electronic Data SystemsCorp .;
  • Hewlett-PackardCo .;
  • Starwood Hotels & Resorts WorldwideInc .;
  • Union PacificCorp.; and
  • Verizon CommunicationsInc .

Casting an eye toward the future, ISS saidthere are three factors that could work to improve severance and golden parachute practices in the U.S. 

  • Boards are working harder now to see the big picture. Until recently, some boards approved individual components of executive compensation in piecemeal fashion without fitting the jigsaw pieces together to see the whole picture.
  • "Say on pay" promises to become one of the hottest topics this proxy season. Advocates are keen to import shareholder advisory votes on pay plans to the U.S.
  • Many experts see better succession planning as the antidote to excessive executive compensation. The more eager (or desperate) a board is to bring in a stellar CEO from the outside, the more it is willing to offer up a candy store of incentives, ISS said.

"Severance and golden parachutes are the final acts that help define the legacy of departing executives, "ISS said in the report. "A flawed exit package will cement a bad legacy or cast a pall over an otherwise good one. But it's not true that bad practices are universal. …some companies embrace best practices. In the gathering storm of public debate over executive compensation, these models can serve as beacons. Call them best practices in practice."

The SEC ruleorganized executive compensation disclosure into three broad categories:

  • compensation over the last three years;
  • holdings of outstanding equity-related interests received as compensation that are the source of future gains; and
  • retirement plans, deferred compensation and other post-employment payments and benefits.

The rule refined previously required tabular disclosure and combine it with improved narrative disclosure to "elicit clearer and more complete disclosure of compensation of the principal executive officer, principal financial officer, the three other highest paid executive officers and the directors." 

The ISS report is  here .

U.S. Representative Barney Frank (D-Massachusetts),  Chairman of the House Financial Services Committee, recently introduced  legislation that would give shareholders a non-binding vote on how much top corporate executives should be paid (See Frank Introduces Executive Pay Bill ).

More general information about the issue is at a U.S. House Financial Services Committee  Web site .