Changes to the Global Industry Classification Standard (“GICS”) structure announced late last year 2017 to better reflect modern communication activities are set to take effect at the end of September 2018. These changes, which represent the biggest reclassification of companies in the history of GISC, will affect numerous Internet and e-commerce companies, including Google, Netflix, and Facebook. For technology companies, the changes may prompt a reassessment of their compensation peer group, as well as their understanding of how their executive compensation program will be evaluated by Institutional Shareholder Services (“ISS”), the major proxy advisory firm. This Thoughtful Pay Alert describes the pending changes and provides our initial observations on their potential implications in the months ahead.
Background
The Global Industry Classification Standard (“GICS”) structure is an industry taxonomy developed in 1999 by S&P Dow Jones Indices and MSCI, Inc. for use by the global financial community. The GICS structure currently consists of 11 sectors, 24 industry groups, 68 industries, and 157 sub-industries into which Standard & Poor’s has categorized all major public companies. The GICS structure is used as a basis for Standard & Poor’s and MSCI’s financial market indexes in which each company is assigned to a sub-industry, and to a corresponding industry, industry group, and sector, according to the definition of its principal business activity.
In addition, the major proxy advisory firms, particularly Institutional Shareholder Services, Inc. (“ISS), use the GICS structure in their modeling analytics when formulating their voting recommendations on matters to be submitted for shareholder action at a company’s annual meeting of shareholders.
Changes to the GICS Structure
On November 17, 2017, S&P Dow Jones and MSCI announced revisions to the GICS structure “to reflect the evolution in the mode in which people communicate and access entertainment content and other information.” Citing this evolution as a result of the integration between telecommunications, media, and internet companies, the proposed revisions are as follows:
- The “Telecommunication Services” sector will be broadened and renamed the “Communication Services” sector;
- Media companies will move from the “Consumer Discretionary” sector to the “Communication Services” sector;
- Internet services companies will move from the “Information Technology” sector to the “Communication Services” sector; and
- E-commerce companies will move from the “Information Technology” sector to the “Consumer Discretionary” sector.
These changes are to be effective on September 28, 2018.
Implications for ISS Analyses
ISS uses the GICS structure classifications to construct compensation peer groups that are used in formulating its voting recommendations on compensation-related proposals submitted for shareholder action at companies’ annual meeting of shareholders, including the “Say-on-Pay” and employee stock plan proposals.
Although it is difficult to predict how the pending reclassifications will affect the analysis of a given company’s specific situation, we envision that changes could occur in these areas of ISS focus:
- Summary of a company’s total shareholder return performance (on a one-, three-, and five-year basis) relative to companies with similar GICS classifications;
- Construction of peer groups for purposes of pay benchmarking and relative “pay-for-performance” comparisons;
- Review of the relative alignment of the compensation of a company’s CEO as part of its quantitative screen for evaluating an executive compensation program in connection with formulating Say-on-Pay proposal voting recommendations;
- Review of the compensation arrangements for the non-employee members of a company’s Board of Directors relative to the competitive market for purposes of identifying “excessive compensation” practices;
- Review of new or amended employee stock plans to determine the shareholder value transfer and gross burn rate relative to companies with similar GICS classifications; and
- Calculation of a company’s “QualityScore,” which considers specific corporate governance and executive compensation-related policies and practices relative to GICS-based industry norms.
Initial Observations
While some of the changes that will result from the GISC structure reclassification will be nominal (for example, grouping internet software and other software companies together), other changes may have significant ramifications for how companies will be evaluated for comparative purposes (for example, moving internet retail companies from the “Information Technology” sector to the “Consumer Discretionary” sector). The most prominent technology companies affected by the changes, along with their new proposed classifications, are listed on Exhibit A to this article.
