Institutional Shareholder Services (“ISS”) released its policy updates and voting guidelines for shareholder meetings beginning in 2022. Unsurprisingly, much of the focus continues to be on responding to investor views on climate and diversity initiatives and certain governance considerations such as unequal voting structures. Below, we outline the key changes to ISS’ voting guidelines that companies should consider as they begin to prepare for the upcoming proxy season.
Management and Shareholder Proposals on Say on Climate
This year, ISS codified the framework developed over the last year relating to Say on Climate proposals. Both management and shareholder proposals will be evaluated on a case-by-case basis. In order to increase transparency, ISS has set out non-exhaustive lists of criteria for evaluating both shareholder and management proposals, many of which are focused on the robustness of the company’s disclosure and the availability of metrics or targets.
In 2021, there were two management Say on Climate proposals at U.S. companies, which were likely the result of negotiated withdrawals of shareholder proposals or other stakeholder pressures. These proposals were not approved by shareholders. Given the escalating investor focus on climate and climate-related issues, we expect the number of management proposals to increase in the years ahead, in part due to continued external pressures and negotiations. Companies that propose a management Say on Climate vote (whether as part of negotiations for withdrawal or a shareholder proposal or otherwise) will need to be mindful that these votes are unlikely to be viewed as check-the-box exercises and will come with increased scrutiny by ISS and investors (as well as other stakeholders), expectations for change based on voting results, and potential reputational impact.
Companies that receive a Say on Climate shareholder proposal will also be evaluated on many of the same measures. The rate of these proposals is likely to increase: frequent proponent As You Sow stated it would send letters to “hundreds more” companies and submit related shareholder proposals. In addition, many companies also receive shareholder proposals on climate or climate-related reports, which ISS will evaluate under the same rubric as Say on Climate proposals. These proposals have already received significant and sometimes majority support, and with ISS’ recommendations, support levels are likely to increase.
In addition to weighing in on proposals, ISS also intends to hold directors accountable for climate change matters. For the 2022 proxy season, driven by strong investor support, ISS intends to focus on the 167 companies currently identified on the Climate Action 100+ Focus Group list as significant GHG emitters. At these companies, ISS will recommend withhold/against votes for responsible directors when “minimum” steps are not taken to understand, assess and mitigate the risks associated with climate change. These steps include detailed disclosure of climate-related risks (such as according to the framework established by the Task Force on Climate-related Financial Disclosures (TCFD)) focused on board governance measures; corporate strategy; risk management analyses; and metrics and targets.
This significant change in policy signals a new willingness to hold individual directors accountable for business and strategic decisions. While ISS is no stranger to targeting individual directors at companies with what it views as shareholder-unfriendly governance practices, there had not otherwise been a policy that seeks to hold directors personally accountable on the environmental, social or policy decisions of a company.
We recommend that companies carefully review their climate and environmental disclosures and thoughtfully engage with shareholders on these issues. A careful messaging strategy will likely be worth the effort in engaging with shareholders and negotiating withdrawals for climate-related proposals and retaining high levels of director support.
Identified “high emitters” (and other companies that will undoubtedly become the focus in subsequent years) should evaluate the feasibility of implementing the steps outlined by ISS and ensure that their disclosure adequately addresses key climate and environmental risks and the company’s strategy for addressing them.
Moving Towards Board Diversity and Racial Equity Audits
ISS continued its expansion of board diversity requirements. In 2023 all public companies will be at risk of withhold/against votes for the nominating committee chair (or other directors on a case-by-case basis) if there are no women on the board.
In addition for 2022, the one-year grace period to include a racially or ethnically diverse member on the board of a Russell 3000 or S&P 1500 company will have expired, and ISS will recommend a vote against/withhold for the chair of the nominating committee (or other directors on a case-by-case basis) at non-compliant companies. Although this policy remains limited to Russell 3000 or S&P 1500 companies, ISS may expand the policy to all companies in future years in line with ISS’ expansion of its gender diversity policy.
Both of these policies overlap with other, often more onerous, recent legislative and regulatory advancements. As such, companies headquartered in California that are in compliance with California’s state law and companies that have satisfied NASDAQ’s board diversity rule, will have already satisfied the conditions necessary to avoid being impacted by ISS’ policy update.
In the face of increasing requests that companies oversee an independent racial equity audit (even though none of these proposals passed during the 2021 proxy season), ISS will focus on six factors for determining voting recommendations. These factors include whether the company has an established process for addressing racial inequities, whether the company issued a public statement relating to racial justice, whether the company engaged with impacted communities and if it is the subject of any recent related controversy. Many companies have significantly increased their efforts on this front over the last few years – as always, broad stakeholder engagement will be critical for staying on top of, and responding to, any issues that may arise.
Who’s in Control?
There is renewed momentum among institutional shareholders opposing multi-class capital structures. ISS’ policy, beginning in 2023, will recommend withhold/against votes for incumbent directors of all multi-class companies that lack a sunset provision of less than seven years from the date of the IPO (irrespective of when they became public). This change will result in directors at a number of iconic companies, which have regularly outperformed peers and the market for decades (as documented through empirical studies, including ISS’ own studies), being subject to withhold/against votes. The impact will be negligible at most of these companies in view of the fact that the high vote shares represent a majority of the voting power and are held by founders and others that do not adhere to ISS recommendations. Moreover, the directors at these companies include many of the most respected directors in the country who have guided their companies to extraordinary successes. Nonetheless, there are some dual and multi-class companies that reserve a minority of board seats for election exclusively by the low vote shares. It will be advisable for these companies to re-examine their standards and policies for the election of these so-called “low-vote share directors” on the board, including any obligations of such low-vote directors to resign if they fail to receive a majority of the votes cast and the flexibility of the board to reject these resignations. At the end of the day, this ISS policy runs contrary to the corporate law principle that a director has no duty to pursue an objective that would be futile – which is the case at all these companies where the high vote shareholders have no interest in exploring whether they would provide their requisite approval for a reclassification transaction to collapse the dual or multi class structure. The economic incentive to pursue a reclassification transaction always exists for high vote holders (see here). The ISS policy is not going to change that calculus and, ironically, may only have the effect of weakening the hand of the independent directors negotiating on the part of the low vote holders in the event of any future reclassification transaction negotiations.
Companies that have proposals to increase the authorized shares of capital stock should note that ISS made changes to its policy that reflect the need for capital at companies that faced challenges. ISS recognized that its policy of limiting companies in the bottom 10% of TSRs to a cap on the increase in share capital ISS affected companies that suffered financial or operational setbacks and had limited options for raising capital, which were further constrained by ISS’ policy. However, when ISS giveth, it also taketh away: ISS tightened its policy by expanding its review of the use of capital beyond three years to include longer-term non-shareholder approved poison pills, differentiating between general and specific use authorizations of capital, and clarifying the hierarchy of factors that are considered.
Regarding compensation plans, ISS will replace the current volatility-based adjusted burn rate calculation with a “Value-Adjusted Burn Rate” calculation which it expects will more accurately measure the value of recently granted equity awards.