A look at some of the boardroom issues currently on activist investors' minds
Public companies in the US have embraced the idea of ongoing engagement with their major shareholders only since the advent of say-on-pay votes at annual meetings, starting
in 2011, as mandated by the Dodd-Frank legislation. Given the impetus for them, it’s no surprise that most discussions between companies and investors have centered on executive pay policies and plans. More recently, however, engagement has begun to expand to include a broader menu of issues that are of interest to shareholders.
That isn’t to say that some investors weren’t asking questions or raising concerns long before say on pay, but it was done quietly and out of the media spotlight, says Chris Hayden, senior managing director of Georgeson. The issues most likely to be discussed in those more discreet times concerned shareholder rights, which currently include such topics as proxy access, written consent, special shareholder meetings and majority voting, he notes.
What Hayden finds most surprising this proxy season is the rise in shareholder inquiries about environmental, social and sustainability policies and practices. Until this year, investor calls were almost always about whether companies have the right board structure or governance practices, as well as compensation-related topics, he says.
‘Now very major institutions that my clients have been engaging with for years are saying, We sort of know your governance story and you’ve done a great job reaching out, but this year we’d like to talk about your environmental and sustainability policies,’ Hayden continues. ‘I used to think of that as coming from specialized investors focused on those issues.’
Most of these inquiries aren’t motivated by any specific burning concerns. ‘Where I’m seeing them is in far more general situations: firms that have not had any media-worthy or disclosable events but are still in industries that could be perceived as energy-intensive or pollutant producers,’ Hayden says.
The issues shareholders are increasingly raising relate to his clients’ environmental practices such as safety measures, how they address these concerns, and what their boards are looking at as far as such issues are concerned, as well as how companies are responding to changes in environmental regulations.
Director tenure
For David Bobker and Robert Lamm, advisory directors at Argyle, the highlight issue this year is director tenure. Bobker, who sees this as the continuation of a trend that began in 2014, cites a letter State Street very publicly sent to many portfolio companies last year expressing concern about board members who had served on the board for more than eight or nine years on average and about those with significant tenure who are serving on key committees, specifically the compensation committee.
Theresa Molloy, director at Prudential Financial, agrees there is heightened sensitivity – not only within the world of proxy advisers but also among investors – to board refreshment and how long members have served on a board. Within the past year, she says, State Street has created a framework for assessing board tenure and ISS has said it is now using nine years as a benchmark against which to assess director tenure.
‘These are frameworks and guidelines, not necessarily bright-line tests,’ Molloy says. ‘But investors want to understand not only the qualifications of the board but also how long it has worked collaboratively, and they want to ensure there’s independence.’
Although investors generally agree there needs to be a careful review of director tenure, ‘it goes beyond just applying a simple baseline number to directors on the compensation committee,’ says Bobker. ‘Their concerns are over what we call the potential toxic director syndrome’, where directors who serve as the finance expert on the audit committee of a company about which financial concerns have been raised also serve the same function on the audit committees of other companies. The main concern is the accountability of directors – especially those on the compensation committee – to shareholders, which want to ensure the board is providing adequate oversight to management, Bobker explains.
A related issue shareholders are raising is directors’ suitability for their role. Lamm sees this as ‘an after-effect of the shareholder proposal to separate the roles of chair and CEO at JPMorgan’. While the second anniversary of that event is approaching, it continues to resonate ‘because that’s the first time, at least in my memory, that two members of a major company’s board left the board because of shareholder concerns as to their competence to serve on a particular committee.’
The JPMorgan committee in question was the risk committee, created as a result of Dodd-Frank, whose failure to prevent the London Whale debacle cost JPMorgan more than $6 billion in trading losses. ‘That was a watershed moment,’ says Lamm.
The nominating and governance committee will likely be next to come under closer shareholder scrutiny, ‘because that’s the committee that deals with director succession, director diversity, director replacement, age limits – the whole nine yards,’ Lamm adds. ‘You see things like expanded discussions of director skill sets. Some companies are including in their proxy statements a much more robust director skills matrix.’
Prudential includes a director skills matrix in its proxy ‘because investors want to see not only the skills of the individual board members but also, holistically, the view of the [entire] board and how the skills and experience of all the board members are really complementary,’ says Molloy. ‘That’s critically important and we do that in the skills matrix so that investors can just look at it and get a very quick view. And then they can also do a deep dive into each board member by looking at the specific biography associated with each individual.’
Board self-assessment
Another issue shareholders are interested in is the process companies use to do annual board self-assessments. The Council of Institutional Investors (CII), in a report on companies’ disclosure of their boards’ evaluation processes published in September, says most US companies provide minimal information on this in their proxies, while such disclosure is much more common in Canada, the UK, mainland Europe and Australia. Amy Borrus, CII’s deputy director, says the hope is that as international owners’ shares become more important to US companies, those companies may start to do a better job of disclosing such information.
It’s perhaps no coincidence that a greater number of companies are taking shareholder engagement more seriously just as a practical framework to guide shareholder engagement has been developed and is being promoted by the Shareholder-Director Exchange (SDX), founded last summer by the law firm Cadwalader Wickersham & Taft, Teneo and Tapestry Networks. SDX comprises representatives from the world’s leading institutional investment firms such as Vanguard, BlackRock, State Street Global Advisors and CalSTRS, which collectively manage more than $10 trillion in assets. Last July the working group sent a letter to a wide range of chairs and lead directors of public firms encouraging them to participate in discussions with investors.
Although the SDX Protocol encourages engagement between directors and investors, most companies’ meetings or phone calls to discuss issues with interested shareholders don’t involve board members. ‘Engagement with directors and investors is typically sort of selective,’ says Hayden. ‘In most situations, you’re not going to see directors speaking to the top 100 investors. They might speak to the top five or six or 10 under a normal situation.’ When smaller investment firms, or those with relatively small stakes in a company, have a concern or question, they don’t expect to be able to speak with a director, he adds.
Hayden and others believe the person at the company who is most knowledgeable about the subject at hand should do the talking in meetings or phone calls with shareholders.
