ISS Will Not Change Pay for Performance, Equity Plan Analysis in Aftermath of 162(m) Changes

January 26, 2018

In an interview on investor expectations following the repeal of the performance-based pay exception in Section 162(m) of the tax code, ISS's Head of U.S. Compensation Research, David Kokell, stated that "changes [to company pay programs] that generally reduce the transparent and objective pay-and-performance alignment between shareholders and executives will be viewed negatively when we evaluate compensation pay-for-performance."  He further stated ISS will not change its framework for analyzing pay-for-performance when reviewing equity plan proposals.  With respect to investors, he said that ISS does not anticipate investor expectations of company compensation and equity plan design to change and that "investors will be watching companies closely over the next several years to see how compensation programs evolve under the new regime."  The repeal in the recently adopted Tax Cuts and Jobs Act limits deductible compensation to $1 million annually for the CEO, CFO, and three other of the most highly compensated executives.  Previously, companies could deduct performance-based compensation above $1 million, provided certain procedural and design limitations were followed.  As Mr. Kokell stated, these limitations "helped paint the lines on the executive compensation field, defining what was in-bounds and out-of-bounds for executive compensation programs, and providing some transparency and investor control."  However, without the need to follow the steps to secure the now-repealed deduction, companies have potentially gained flexibility in design.  Mr. Kokell cautioned companies to use this flexibility carefully, citing Netflix's decision to raise its CEO's salary and decrease performance-based pay due to the tax code changes as an example of the elimination of at-risk pay that severs pay-for-performance.  "ISS will continue to closely scrutinize any decision that diminishes performance pay," Mr. Kokell noted, adding that such changes would "likely result in an adverse voting recommendation."  Mr. Kokell cautioned companies on using “positive discretion” to increase compensation, which is no longer expressly prohibited by 162(m) to achieve the deduction.  Mr. Kokell did admit, however, that some investors “have comfort with some level of discretion embedded in programs, as long as that discretion is applied judiciously and is well-explained."