Could Swedish-style nomination committees, with increased shareholder collaboration on director nomination and vetting, be a viable alternative to proxy access?
As debate rages in the US over shareholders’ ability to get more involved in the director election process and gain direct access to the proxy to nominate their own directors, it may be that the solution lies overseas. Swedish investors have the right to directly nominate and vet directors as part of the board nominating committee. While this does not constitute full proxy access, it is a very significant step toward it. Unlike proxy access, however, it has not attracted anywhere near the degree of vitriol seen in the US from supporters and opponents alike.
‘Stewardship is essential to the sound running of listed companies,’ observes Mark Goyder, founder of the UK-based think tank Tomorrow’s Company. ‘Left to themselves, neither boards nor investors will be able to do this well. The so-called discipline of the share price may work in the end, but markets are too often intoxicated by fashion, fear and greed.’
While stewardship may be essential, the polarizing tenor of the US proxy access debate underscores the difficulty in determining how it can best be executed. During late March, Tomorrow’s Company and activist fund Cevian Capital released the joint study ‘Tomorrow’s corporate governance: bridging the UK engagement gap through Swedish-style nomination committees’. This study, despite its European focus, offers its North American counterparts some food for thought. It examines the evolution of stewardship in Sweden and the important lessons other countries can learn from the Swedish experience. The report’s final suggestion is to include shareholders on the nominating committees of corporate boards; Harlan Zimmerman, senior partner at Cevian Capital, puts this in US-friendly terms, calling it ‘full proxy access’.
Experimental trials
Over the past 15 years or so, Swedish companies have experimented with various levels of shareholder involvement in the director nomination process. In the system’s current form, shareholder representatives, typically drawn from an issuer’s four or five largest investors, sit on the company’s nominating committee, which is generally overseen by the non-executive chairman. Together with the chairman, the committee proposes a slate of director nominees and explains to shareholders at the annual meeting what criteria were used in the selection process. In addition, the committee sets compensation levels for board members.
Goyder is quick to point out, however, that the committee’s job does not infringe on director authority. ‘This is not the shareholders running the company,’ he says. ‘In the early days there were occasions when the discussion became too strategic. Gradually, however, practices and the governance code changed to make it clear that the job is nominating the right people, not second-guessing the board.’
Theoretically, all investors may propose alternative candidates but, given the combined stake the top four or five shareholders typically represent, it is tempting to wonder whether shareholder dissent is just a formality.
Proponents of the Swedish model argue that the system contains sufficient checks and balances to protect minority interests. With the added responsibility comes increased accountability, especially in the event of failure. Aside from oversight by the board chairman, members of the nominating committee, for example, must be reappointed each year by investors. ‘If you are responsible for picking the board and the company goes down, it is going to come back to you,’ explains Zimmerman.
Balancing act
The report also credits the Swedish system with increasing investor confidence in directors and improving the alignment of interests between shareholders, boards and management. According to the study, a board appointment represents a mandate from the shareholders to govern the company; such a mandate, the study reasons, affords directors the job security to challenge management and act in the investors’ best interests. ‘In the US system the breakdown in the alignment usually happens between management and shareholders, with boards on the side of the management team that selected them,’ says Zimmerman. ‘In Sweden you really don’t see such confrontational arrangements.’
Benefits aside, the study is not blind to the system’s pitfalls, such as shareholders lacking the necessary skills to assemble a successful board or the required knowledge to structure compensation packages.
An interesting by-product of the Swedish model, Goyder says, is an increased collaboration between shareholders: ‘I recall talking to the CEO of a pension fund who said that when other issues came up with the company, it was much easier to contact the other investors. That is very significant because if you are going to take stewardship seriously, you need some mechanism that forces investors to start thinking cohesively.’
On the far horizon
As far as the practical application of investor-led nomination committees in the US goes, Zimmerman predicts that ‘it is a long way off’. One important lesson from Sweden’s experience that those in the US should keep in mind, he suggests, is that ‘if proxy access goes ahead, it is imperative not only that the power is exercised, but also that investors are made to exercise it in the best possible way.
‘There is a valid concern that your average fund manager or governance expert, as things stand, may not be the best person to decide who should be sitting on the board. These people will need to educate themselves, gain experience, bring in outside resources or pool what knowledge/resources they have.’
Despite Zimmerman’s assertions, some companies are looking for ways to formally involve shareholders in the director selection process. UnitedHealth, for example, has formed a non-board committee that includes shareholders and has tasked them with making non-binding recommendations for possible director candidates.
As it currently appears less than likely that the SEC will allow any real degree of proxy access, at least in the near future, a Swedish-style system or a less formal one such as that in operation at UnitedHealth may well be worth considering for companies that are searching for a workable solution.
