ISS updates CGQ ratings

By: Cydney Posner

ISS has just announced updates to its U.S. Corporate Governance Quotient (CGQ) ratings model. This year, the CGQ ratings model will incorporate indicators related to majority voting, financial restatements, options backdating and director-withhold recommendations. In addition, two ratings criteria, board structure and Chairman/CEO separation, will now allow “in progress” credit where companies have taken intermediate steps to modify their corporate governance structures (e.g., where there is a governance structure in place to counterbalance the Chairman-CEO or where a company with a classified board has passed a proposal to declassify the board, but directors are not yet elected annually). The CGQ indicator related to option expensing will be removed since expensing is now required under accounting rules.
With regard to majority voting standards, ISS’ policy has been to “generally vote FOR reasonably crafted shareholders proposals calling for directors to be elected with an affirmative majority of votes cast and/or the elimination of the plurality standard for electing directors (including binding resolutions requesting that the board amend the company’s bylaws), provided the proposal includes a carve-out for a plurality voting standard when there are more director nominees than board seats (e.g. contested elections).”  The new CGQ rating will create several categories of responses consistent with this policy: a) majority vote standard with plurality for contested elections and a director resignation policy, b) majority vote standard with plurality for contested elections, c) plurality vote standard with director resignation policy, d) plurality standard or e) majority vote standard with no carve-out for contested elections. 

The financial restatement rating will indicate those companies that have had to make a material restatement to year-end financial results during the past 24 months for any prior period, taking into account whether a company has disclosed remedial action to address the underlying reason for the restatement.

The options backdating rating will indicate those companies that, during the past 24 months, have had a material restatement to year-end financial results for any period and/or that have been subject to an enforcement action as a result of options backdating. ISS contends that it "is generally agreed that options backdating is a result of fraudulent behavior by management and could signal a lack of effective oversight by the board."  Hopefully, the quoted language suggests that ISS intends to apply demerits only to true intentional "backdating" and not to "misdating" or similar inadvertence or sloppiness. 

Finally, ISS intends to identify those companies one or more directors of which have been the subject of an ISS withhold voting recommendation for either the most recent annual meeting or the next annual meeting. There are several categories of responses, reflecting whether the directors that were subject to the withhold recommendation serve on key committees or whether the entire board was the subject of the withhold recommendation. The rating also takes into account whether the company has disclosed steps taken to address the issue underlying the withhold recommendation. ISS contends that withhold recommendations may signal problems, such as pay-for-performance problems or general underperformance, that the model may not otherwise capture.