The ISS Pay for Performance Model

Abstract

Institutional Shareholder Services (ISS) announced a new approach to evaluating pay for performance in late 2011. This paper explains the new approach, highlights four significant weaknesses of the new approach and explains how ISS could substantially improve its Pay for Performance Model, now and in the future. Without making any change in the data it collects, ISS could improve its assessment of pay for performance by: (1) adopting more meaningful measures of the three basic dimensions of pay for performance – pay leverage, pay alignment and pay premium at industry average performance, (2) defining reasonable trade-offs between leverage, alignment and cost, (3) changing its peer group selection methodology so it’s selecting labor market peers, not companies that fall in the same sector but don’t compete for the same talent, and (4) giving examples of simple compensation programs that provide perfect pay for performance. In the future, ISS could provide more value to investors by using "mark to market" pay to calculate better measures of pay leverage and alignment and by using stock ownership and mark to market pay to calculate a more comprehensive measure of the CEO’s shareholder value incentive ("wealth leverage").

Keywords: corporate governance, ISS, Institutional Shareholder Services, executive compensation, management incentives, pay for performance, pay leverage, pay alignment

JEL Classification: G30, J33, J41, J44, M52