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Corporate Governance & Disclosure Issues

Corporate Governance:

The main tenets of corporate governance revolve around what is best for the shareholders.  There are several principles involved, the most commonly discussed are the duty of loyalty, duty of fairness, and duty of care.  Each officer and director have duties imposed upon them by state law and, in some cases, by contract, bylaws, case decisions, etc.  Directors are held to a very high standard since they are the ones elected to the board to manage the company and elect officers to run the company on a day to day basis. Many times they rely upon the business judgment rule to defend their decisions and actions to show that any action had a legitimate business purpose, was an informed decision, and was fair to the corporation, its shareholders, etc.

There are also duties imposed on controlling shareholders, so just because someone is not elected to the board or as an officer, doesn’t mean they can do whatever they want.

Recent legislation such as the Sarbanes-Oxley Act of 2002 (SOX) or the Dodd-Frank Wall Street Reform Act (Dodd-Frank) have added or expanded corporate governance, as well as certain disclosure required.  These acts are meant to apply to publicly traded companies; however, they can have implications on even the smallest startup.  Founders need to understand that the shareholders and general public are the ones protected by many laws and you simply can’t start a corporation, make yourself majority shareholder, director, and sole officer and do anything you please.  In the early stages of a company, there may not be any other shareholders and the company may have not started doing business, so in practice, a founder may not have to worry as much about their actions, but they should still understand the principles of corporate governance so they don’t get themselves into hot water.

A) Overview & Implementation:  The Dodd-Frank Wall Street Reform and Consumer Protection Act contains numerous provisions which affect the governance of issuers. For example:

  • Section 951 requires advisory votes of shareholders about executive compensation and golden parachutes. This section also requires specific disclosure of golden parachutes in merger proxies. This section further requires institutional investment managers subject to Section 13(f) of the Securities Exchange Act to report at least annually how they voted on these advisory shareholder votes.
  • Section 952 requires disclosure about the role of, and potential conflicts involving, compensation consultants. This statute also requires the Commission to direct that the exchanges adopt listing standards that include certain enhanced independence requirements for members of issuers’ compensation committees. The Commission is also directed to establish competitively neutral independence factors for all who are retained to advise compensation committees.
  • Section 953 requires additional disclosure about certain compensation matters, including pay-for-performance and the ratio between the CEO’s total compensation and the median total compensation for all other company employees.
  • Section 954 requires the Commission to direct the exchanges to prohibit the listing of securities of issuers that have not developed and implemented compensation claw-back policies.
  • Section 955 requires additional disclosure about whether directors and employees are permitted to hedge any decrease in market value of the company’s stock.

SEC Implementation: The SEC is the governing body that they refer to in the legislation about what the “Commission” needs to do.  On January 25, 2011, the Commission adopted rules concerning shareholder approval of executive compensation and “golden parachute” compensation arrangements to implement Section 951 of the Dodd-Frank Act. (Release No. 33-9178 at

On March 30, 2011, the Commission proposed rules directing the national securities exchanges to adopt certain listing standards related to the compensation committee of a company’s board of directors as well as its compensation advisers, as required by Section 952 of the Dodd-Frank Act. (Release No. 33-9199 at

On October 18, 2010, the Commission proposed rules to implement the Section 951 provisions related to institutional investment managers. The rules would require institutional investment mangers to report their votes on executive compensation and “golden parachute” arrangements at least annually, unless the votes are otherwise required to be reported publicly by SEC rules.

Dodd-Frank also expanded some of the requirements of Sarbanes-Oxley and will likely continue to expand it through further rulemaking.  Sarbanes-Oxley’s (SOX) main issues were to increase quality and reliability of company disclosures, responsibilities of officers and directors, as well as auditors, and provide further accounting oversight.  SOX provides for accelerated filing of certain public disclosures, certification of financial statements, internal control disclosures, and audit committee financial expert requirements.  These two laws mostly apply to public companies, but they provide insight for and may end up being applied to private companies as well.

It is important for even private or startup companies to pay attention to these requirements since many VCs, angels, or other investors may require certain corporate governance standards be in place for the companies they fund.

B)  Executive Compensation Issues:  Executive Ratios & Comp Disclosure, Disclosure on Hedging Activities, Comp Claw-Back Policies, Officer Loans

Executive Compensation Ratios-  Public companies are required to produce certain disclosures about the executives compensation and comparison ratios of the CEO’s total pay to the pay of all other employees.

Loans-  It is good for a private company to prohibit loans from the company to officers or directors, or to have an independent compensation committee review the terms of those loans to be sure they are fair and being complied with.

Claw back-  These are procedures put in place that allow the company a way to essentially get back executive compensation that is determined to be excessive.

C)  Proxy & Disclosure Requirements– “Say on Pay”, “Say on Golden Parachute”

Dodd-Frank puts requirements that the company provide shareholders with some form of access to be able to communicate with the board of directors that they hold an interest in.  If that is not in place, the public company has to include disclosures in its proxy to explain why it doesn’t have those in place.  The company also has to implement ways for shareholders to have access to proxy materials sent by the company to add nominees to be elected to the board of directors.

Say On Pay & Say on Parachute-  Dodd-Frank puts requirements in that public companies give their investors the right to vote on executive compensation at least every 3 years.  The vote is not binding on the company and is only advisory, but should be taken into account by the board and compensation committee in reviewing executive compensation.  The disclosures deal with not only salary, but also things like retirement benefits or other so-called “golden parachute” payments.

D)  ISS:

This is the Institutional Shareholder Services 2012 policy guidance from their website at:

“2012 US Compensation Policy

 Frequently Asked Questions

Updated: January 25, 2012

Compensation — Pay for Performance

Please see the ISS white paper, Evaluating Pay for Performance Alignment, for an explanation of the methodology.

  1. For pay-for-performance alignment, how will ISS treat CEOs who have not been in the position for three years?         The quantitative methodology will analyze total CEO pay for each year in the analysis without regard to whether all years are the same or different CEOs. If that analysis indicates significant pay for performance misalignment, the ensuing qualitative analysis may take into account any relevant factors related to a change in CEO during the period. However, given an apparent disconnect between performance and CEO pay, shareholders would expect the new CEO’s pay package to be substantially performance-based (with clearly disclosed metrics and goals).For years when a company has more than one CEO, we will use only one CEO’s pay: the CEO who was in the position at the end of the fiscal year will generally be the one whose pay will be used. The base salary for a CEO serving less than one year will be annualized. If the company has co-CEOs, the higher total compensation figure will be used; note that the impact of co-CEO compensation costs may be addressed separately as part of ISS’ qualitative executive compensation evaluation, however.
  2. How are the one-year and three-year total shareholder returns (TSRs) calculated? How are “peaks and valleys” accounted for in the five-year analysis?Under the relative assessment, the one- and three-year TSRs represent annualized rates of return reflecting stock price appreciation over the period, plus the impact of reinvestment of dividends (and the compounding effect of dividends paid on reinvested dividends).Under the absolute assessment, indexed TSR represents the value of a hypothetical $100 investment in the company, assuming reinvestment of dividends. The investment starts on the day five years prior to the month-end closest to the company’s most recent fiscal year end, and is measured on the subsequent five anniversaries of that date. The Pay- TSR Alignment (PTA) measure (as outlined in the ISS Evaluation of Executive Compensation white paper) is designed to account for the possibility of “bumps” in the overall trend.The following table illustrates how indexed TSR would be calculated for a company with a fiscal year end of October 2, 2011, and how indexed TSR relates to annual total shareholder returns:

    Annual TSR

    Indexed TSR


















  3. What TSR time period will ISS use for the subject company and the peers in the Pay for Performance analysis?             What about the compensation period?TSRs for the subject company and all its peers are measured from the last day of the month closest to the subject company’s fiscal year end. For example, if the subject company’s fiscal year end is Dec 31, then the one-year and three-year TSRs for the subject company and its peers will be based on Dec 31. Compensation figures for all companies are as of the latest available date. The front page of the ISS report will show these closest month-end FYend TSRs for the company and its peer groups, which thus may differ from the reported fiscal year returns of the company and its peers.
  4. For companies with meetings early in 2012, whose peer CEO 2011 pay has not yet been released, what pay data does ISS use?          ISS uses the latest compensation data available for the peer companies, which may be from the previous year.
  5. Do you include the subject company in the derivation of the peer group median? When you say 14 companies minimum for peers, does the 14 include the subject company?              No, neither the CEO pay nor the TSR of the subject company is included in the median calculation. The subject company is also not included in the number of peer companies, which will generally be a minimum of 14.
  6. What impact might an adverse pay-for-performance recommendation have on equity plans proposals?        If a significant portion of the CEO’s misaligned pay is attributed to non-performance-based equity awards, and there is an equity plan on the ballot with the CEO as one of the participants, ISS may recommend a vote AGAINST the equity plan. Considerations in recommending AGAINST the equity plan may include, but are not limited to:
    • Magnitude of pay misalignment;
    • Contribution of non-performance-based equity grants to overall pay; and
    • The proportion of equity awards granted in the last three fiscal years concentrated at the named executive officer level.

    A concentration ratio for the top 5 that exceeds 25% would warrant additional scrutiny. We would look at both the CEO and the top 5 concentration ratios. If the CEO has less than 20% but the top five has 50% due to a new hire situation, it is unlikely that we would recommend against equity plan. We would also look at the past three years of concentration ratio with and without CEO. Is the concentration high due to the CEO or is there more/less equal distribution among the key exec? Is the LTI program similar for the CEO and the top 5? Are there performance features for the equity awards and is it the same for all top five?

  7. If a company has not been publicly traded for five fiscal years, does the quantitative Pay-for-Performance evaluation still apply?        What if the company has not been publicly traded for three fiscal years? Would such a company be used as a peer company for other companies?     If the company has not been publicly traded for five fiscal years, the relative assessment, specifically the relative one-year and three-year TSR pay and performance rank and the multiple of pay against the peer median, will still apply.If the company has not been publicly traded for three fiscal years, the one-year pay and performance ranking and the multiple of pay against the peer median will still apply.In both cases, the company’s limited life as a publicly traded company will be considered as part of any qualitative evaluation.

    Generally, only companies with three full years of data will be peer companies. In limited circumstances, a company with < 3 years of data may be used when the quantitative evaluation focuses on only one year.

  8. Will pay continue to be defined as summary compensation table pay or consider the current value of LTIs (potential realizable pay)?       It will continue to be defined as granted pay and pay opportunities, for a number of reasons but including: 1) that is the best reflection of the compensation committee’s oversight and decision-making, and 2) pay opportunities should be reflective of the company’s past performance — in particular, if the opportunity appears to be misaligned with that performance (in a negative way), shareholders expect those grant opportunities to be strongly performance-based.
  9. With the discount rate at its lowest, the calculated value of pension benefits has increased. Will ISS take this into account in their assessment of CEO pay?     Because ISS’ quantitative analysis has a long-term orientation, year-to-year pay anomalies are not expected to have a significant impact on the results. However, such anomalies may be considered in the qualitative evaluation conducted before a negative recommendation would be issued.
  10. Can only Russell 3000 companies be used as peer companies?      Will ISS use companies that an issuer considers as peers (specified in the proxy) to develop the ISS comparator group?If the subject company discloses the names of the companies that it uses as its peers, and these companies are public, ISS will collect the data on them even if they are not in the Russell 3000. If these companies fit ISS’ criteria for peers, then they may be used as ISS peers as of the next update of ISS peer groups.
  11. Will a company always be at the median of its peer group in terms of size?       The aim of the methodology is to produce a mix of larger and smaller peers than the subject company (ideally putting it at the median); however, as long as a company-s 6-digit GICS group peers meet the market cap and revenue/asset range criteria they may be selected. The premise is that any company within the size range may be expected to provide compensation opportunities at around the same level as any other company within the size range.
  12. When will a company’s peer group have more than 14 members?       Less than 14 members?    If more than 14 companies within the subject company’s 6-digit GICS group meet the applicable size criteria (market cap and revenue/assets), up to 24 of those companies may be selected for the peer group. If <14 companies in the subject company’s 6-digit GICS group meet the size criteria, peers that do meet the size criteria will be selected from the broader GICS groups until a minimum of 14 (or, in very limited cases, a minimum of 12) are identified.In a limited number of cases — when size and industry parameters are difficult to satisfy — ISS may use a minimum 12-member peer group for a company’s quantitative evaluation and may apply other criteria to construct a reasonable peer group.
  13. What are the size parameters for the P4P peer group selection?      In general, companies with market cap ranging from 0.2- to 5-times a subject company’s market cap and revenue (or assets in the case of financial companies) ranging from 0.5- to 2-times the subject company’s revenue/assets may be included as peers.
  14. Will there be greater linkage of GRId and P4P in formulating the MSOP vote recommendation?       GRId 2.0, which will be launched in late February, will include the factors evaluated in the new quantitative analysis, which will substantially increase its linkage to MSOP recommendations. As a data-driven product, GRId will not incorporate the qualitative analysis, so there will still be some cases where the GRId profile indicates a level of concern higher or lower than might be inferred from the MSOP recommendation.
  15. Will ISS continue to take into consideration prospective pay for performance commitments in future pay programs, as filed in Form 8-K or DEFA 14A?      With annual management say on pay proposals, commitments on strengthening the company’s pay for performance alignment in the future are not as relevant. ISS will take into consideration the company’s current pay programs as disclosed in the proxy statement, and any changes to existing awards that have called into question the company’s pay-for-performance philosophy (e.g., to add performance-based vesting conditions to such awards). Additional filing materials made after the publication of our report that indicate future changes planned for the pay program will have minimum impact on the vote recommendation.

Compensation — Management Say on Pay Responsiveness

  1. Should all companies, regardless of the vote result, highlight key actions?      Yes, shareholders can only benefit from understanding how the company is improving its compensation program.
  2. In considering company’s response to say-on-pay, how will ISS take into account company engagement with shareholders?         If a company engages with their investors and took certain actions that satisfy their shareholders, would that be sufficient?ISS will consider all aspect of the company’s response, including proxy disclosure of engagement with shareholders and decisions/actions flowing from that. The evaluation will also consider the nature of the issue(s) perceived to have caused high opposition and their impact going forward.
  3. When will a low or negative vote on Management Say on Pay roll over and affect the voting recommendation on the election of directors (assuming the company is having another MSOP vote in the current year).     Under ISS’ “Yellow Card/Red Card” approach, in general the compensation committee (and/or full board in rare cases) will be held accountable (i.e., receive negative recommendations) under two conditions: 1) if an issue is deemed sufficiently egregious to warrant that, even if MSOP is on the ballot; and 2) if ISS determines that the board has failed to respond adequately to issues that led to high opposition to the prior MSOP proposal.

Equity Plans

  1. Is the SVT analysis applied on all equity plans for recent IPO companies seeking initial 162(m) approval (and no new shares) just as it would be for established companies that are seeking more shares, or is it case by case for the new IPO companies?        The new policy is to apply a full analysis, including SVT, for all equity plans put up for shareholder approval, for any reason, for the first time following a company’s IPO.
  2. Are there any methodology changes for the stock plan model approach for 2012?            The volatility and dividend yield calculations are changing from 200-day to, respectively, three-year historical volatility and average dividend yield over five years. This change will start with the plans using the Dec 1st 2011 Quarterly Data Download- i.e. companies with March- May 2012 meetings. Prior methodology will apply to February 2012 meeting.

Note: The questions and answers in this FAQ page are intended to provide high-level guidance regarding the way in which ISS’ Global Research Department will generally analyze certain issues in the context of preparing proxy analysis and vote recommendations for U.S. companies. However, these responses should not be construed as a guarantee as to how ISS’ Global Research Department will apply its benchmark policy in any particular situation.”

E)  Committees

Although SOX applies this to public companies, it is best to implement board of director committees at some point in the company’s growth.  The main committees are audit, compensation, and nominating and corporate governance.

Compensation Committee Independence

SOX began with these issues and Dodd-Frank expands them, but basically the issue is to create a compensation committee that is completely independent and allow them to hire outside consultants to examine the compensation of management. 

D) Board of Directors:

SOX implemented a requirement that public companies appoint at least one member of the board who is a “financial expert” and that person generally heads the company’s audit committee.  In addition, there are requirements, mostly through listing standards with NYSE and NASDAQ regarding the independence of members of the board.  Often a startup will have the founders as the initial board members and officers, which is fine initially, however, it is best to start to bring in outside members who qualify as independent and a financial expert to head the audit committee as the company grows.

Dodd-Frank also puts disclosures regarding one individual serving dual roles as an officer and director and why those two positions are being filled by one.

Related Blog Posts:

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Legal Disclaimer: All answers and discussions in this article are meant to be general and educational in nature only and should not be relied upon as legal, business, or tax advice for your specific situation.  Most discussions refer to laws and regulations as applied to a California corporation and these can vary by location, as can other factors in certain situations within California, so it is always best to consult with a licensed local attorney with experience in these matters.  Use of, or any discussion as a result of these articles does not create an attorney-client relationship and is not governed by rules on confidentiality.