A season of surprises

Every year it seems to be the same thing. People stand up and shout, ‘This was the busiest year ever.’ Well, 2008 isn’t any different, and with the proxy voting season almost behind us, we can safely say that this year was not only one of the busiest on record but also one of the most interesting and important.

In the face of some of the worst financial market turmoil in recent memory, companies and investors were predicting a particularly turbulent voting season. While there was certainly no shortage of high profile proxy fights, many battles did not achieve the predicted victories. In a number of cases, shareholder proposals did not secure the level of support most people thought they would.

In Risk & Governance Weekly, a newsletter issued by RiskMetrics Group, parent company for ISS Governance Services, Ted Allen and Reed Walton write, ‘Early on, it seemed that 2008 would be marked by frequent displays of shareholder discontent. Activist institutional investors, angered by the SEC’s decision in November to bar proxy access proposals, appeared ready to rally behind shareholder proposals seeking independent board chairs and advisory votes on executive pay. The SEC also frustrated activists by allowing many firms affected by the credit crisis to exclude most of their new proposals that sought compliance committees, mortgage risk reports and better CEO succession planning.’

Cutting them a break

Carol Bowie, head of RiskMetrics’ governance institute, explains, ‘While it appeared that investors were poised to express their deep dissatisfaction and anger in reaction to the credit crisis, many institutions and individuals chose to limit action in order to allow boards and management to focus on the job at hand.’ That job was to ensure the companies they represent are in the best possible position to weather the current financial storm.

Conditions are difficult enough as it is and some investors obviously felt it was more important for companies to address the immediate financial issues than to worry about governance-related matters. ‘This is not to say that the governance issues are not as important as they have ever been, but sophisticated investors were obviously making a short-term decision to stay action in some cases,’ Bowie says.

Perhaps one of the most surprising results of the year was in the arena of ‘say on pay.’ According to figures compiled by RiskMetrics Group, a total of 75 shareholder proposals were brought requesting a shareholder advisory vote on executive compensation (at the time of writing this article, some of these are still pending).

Many commentators expected an even greater number of say on pay proposals to be filed. But companies did a good job of communicating with shareholders behind the scenes and were able to reach agreement without the need for a formal proposal. While the expanded compensation disclosure rules launched last year were expected to encourage more say on pay proposals as shareholders were able to see the real size of management pay packages, it may have been that the opposite was the case.

As Pat McGurn, special counsel for ISS Governance Services, notes, ‘Simply put, the bear market mauled the 2008 proxy season. The collapse of Bear Stearns on the eve of the season let most of the air out of the shareholder activism balloon.’

For many companies, despite the wow factor of compensation deals, investors were happy just to get the information. After being given time to view the CD&A and communicate with management, they clearly decided that while they may not be happy with the payments, directors were generally doing a good job.

With this trend in mind, of the 66 say on pay proposals that had been voted on as of July, as analyzed by the American Federation of State County and Municipal Employees (AFSCME), a mere nine gained greater than 50 percent voter support. What is perhaps even more surprising is that 18 companies saw support for the proposal decrease from the previous year’s annual meeting.

The numbers make for compelling reading. AFSCME was by far the most prolific filer of say on pay proposals, having been behind 13. The Communications Workers of America filed seven, AFL-CIO five and shareholder activist John Chevedden also submitted five proposals. The most successful of the shareholder groups was the AFL-CIO, which achieved greater than 50 percent support on two occasions (and a third garnered 48.3 percent of the vote).

Reading between the lines

While there are still a number of voting results to come in, the filing trend is very significant. It is a common mantra for companies these days but understanding shareholders and the things they are likely to focus on is extremely important. Richard Ferlauto, director of pensions and benefits at AFSCME, explained during a Corporate Secretary event in May, ‘We have a very long list of companies for which we are targeting proposals. It is possible that a number of these will not make it to the proxy because through engagement with the company we can often achieve a desirable result.’

As Bowie comments despite the drop in say on pay support at a number of companies, ‘We did see a sharp increase in the number of withhold votes for reelection of members of compensation committees.’ This may be an important voting pattern. Just because a particular vote does not receive majority support does not mean it is a non-issue. Many investors may be choosing to withhold reelection votes rather than cast a ‘protest’ vote for a particular proposal.

This may be a signal of a strategic change in direction. Bowie points out that many of these proxy votes, while an important indicator of shareholder sentiment, are usually non-binding. ‘Even if a say on pay vote, for example, achieves a majority of support, this does not mean the company is obligated to change anything. It is a non-binding advisory vote.’ Election of directors, however, may be viewed as a much more powerful tool.

Flow-on effect of majority voting

The shift in voting patterns highlights the importance of majority voting. While many boards resist, it is becoming a common practice at US companies. But actual voting power is seen in the reaction to say on pay and other proposals this year. ‘Investors are being more strategic,’ says Bowie. They know that an effective withhold or ‘no’ campaign against a particular director, such as a compensation committee member, will likely have a more immediate effect than support for a non-binding vote.

Talking about voting trends is a useful exercise but sometimes the numbers tell the story best. Case in point: the 2008 say on pay results sidebar, a full list of say on pay voting results in order of level of voter support.

Despite some surprising results, the proxy season was not without its areas of success. Scott Fenn, managing director of policy at Proxy Governance, points to some high-profile votes concerning independent board chairmen. While proposals in this area were brought at fewer companies than in previous years, he notes, the overall level of support increased. He also feels that greater focus on risk management and strategic issues will lead to stronger governance performance.

There is no doubt that the 2008 proxy season threw out a lot of surprises in the number and type of proposals and also in the results of votes. Some of the most powerful names in business were not able to secure votes. Possibly the biggest fight of the year was the Rockefellers versus ExxonMobil. Even the powerful and famous family were unable to secure a majority of support. Theories abound as to why, but the simplest answer is performance. Exxon has been one of the most profitable US companies and it is very difficult to secure a vote against directors and management under circumstances like that.

There is one thing we can certainly count on for next year. As the credit crisis continues to play out and we develop a better understanding of the causes, it is possible that shareholders will make a strategic shift in voting practices toward risk management and performance metrics, and away from some of the ‘pure’ governance elements common to the past.