On ISS and SERPs

We're getting close to proxy season for issuers of proxies under the purview of the Securities and Exchange Commission (SEC). And, especially since the passage of Dodd-Frank which gave us the new concept of the  (non-binding, but very important) Shareholder Say-On-Pay (SSOP), one of the most important names that we see is Institutional Shareholder Services (ISS).

In a nutshell, ISS provides a service to institutional shareholders of issuers. By performing their analysis of SSOP proposals, ISS gives its subscribers guidance related to how they should cast their SSOP votes. While I may not sound entirely favorable toward ISS and their opinions in this post, I do think this is a valuable service.

For those people who would like to understand ISS's standards and protocols, they have a fairly detailed website with new practices for 2013 as well as their comprehensive 2012 policies.

Now I quote directly from their comprehensive 2012 policies:

 Egregious pension/SERP (supplemental executive retirement plan) payouts:

§  Inclusion of additional years of service not worked that result in significant benefits provided in new arrangements

§  Inclusion of performance-based equity or other long-term awards in the pension calculation

I could be particularly troubled by what I see there, but it's not what gives me pause. Generally, granting of additional years of service for top executives is not a best practice. Similarly, inclusion of long-term awards in compensation for SERP purposes is not a best practice.

However, ISS appears (emphasis here on appears as compared to has) to have taken the position that having a SERP with a more generous formula than in a qualified plan also constitutes an egregious SERP. Often, they are correct. But, not always.

There is a reason, or at least there ought to be, that SERPs are designed as they are. Some companies, for example, tend to promote from within and their executives will likely be long-service employees who are motivated by retention devices rather than attraction devices. SERPs perform this function well. Freezing a SERP when the qualified defined benefit (DB) plan is frozen may be detrimental to shareholders as executives will no longer be bound by the retention device.

What should ISS do? While I have often said negative things about the Summary Compensation Table (SCT) in the proxy, perhaps the SEC had it somewhat correct when they designed it. While technical pension issues may make the pension data in the proxy less valuable than it otherwise might be, the pension accrual is part of annual compensation.

Now, suppose an executive receives lower direct cash compensation than his peer group (other companies), but receives more in deferred compensation through a SERP. Should this be problematic to shareholders? In my opinion, it should not be. In fact, since direct cash compensation is the proverbial bird in the hand while deferred compensation may not be paid if the company suffers particularly adverse business circumstances such as bankruptcy, the generous SERP in lieu of generous current cash may actually be more desirable. But, it's not viewed that way.

New methodologies allow reviewers of proxies to better make this analysis. I'm working on a paper that will explain this in more detail. Regular readers will see it here.