RiskMetrics Introduces a New Governance-Risk Rating System That May Impact Executive Compensation Arrangements
05/25/2010RiskMetrics Group, formerly Institutional Shareholder Services (ISS), recently introduced a new tool for assessing governance-related risk at public companies. The new system, called Governance Risk Indicators (GRId) replaces the Corporate Governance Quotient (CGQ) previously used by RiskMetrics to assess corporate governance risk. A new feature of GRId is that its ratings are determined on an absolute basis according to “best practices,” as determined by RiskMetrics. Ratings using CGQ were determined on a relative basis compared to peer and general industry practices.
RiskMetrics will use GRId going forward to assess risk by rating answers to a variety of questions in four different categories: audit, board, shareholder rights and compensation. The new GRId system could result in a significant negative compensation risk assessment for executive compensation arrangements that previously were not problematic under RiskMetrics’s proxy voting policies. For example, severance provisions in a change of control agreement that have a single or modified single triggers and are more than one-year-old result in a negative rating under GRId. In contrast, these provisions under grandfathered arrangements were often disregarded by RiskMetrics when making recommendations on whether to approve an equity compensation plan under its proxy voting guidelines. Similarly, grandfathered excise tax gross-up provisions in change of control agreements that were disregarded under Risk Metrics proxy voting guidelines will not be grandfathered under GRId.
Negative ratings are assigned when public companies fail to disclose certain types of information, even if not required under federal securities laws (Item 402, Regulation S-K). For instance, failure to disclose annual bonuses, including performance measures, whether or not executives are subject to equity holding periods, and chief executive officer and director equity ownership guidelines, results in negative ratings under GRId.
GRId risk assessments are just beginning to be used, and it appears that many long-standing executive compensation practices will result in an unfavorable GRId grade. The extent to which a negative compensation rating will be a red flag for investors in practice remains to be seen. Companies should evaluate their compensation programs and executive compensation disclosures under the new GRId rating system and monitor changes in the market in response to GRId throughout the coming months.
