Directors face compromise with investors or being voted off the board.
Over the last decade, institutional shareholders have been fighting to gain more influence over Canadian issuers, and indications are that this year they have finally found enough leverage to get more of what they want. More boards are voluntarily shifting policies in line with governance proposals put forth by investors involved with the shareholder democracy movement and the Canadian Coalition for Good Governance (CCGG), a trend that could eventually give large, vocal shareholder groups broker-type influence over the boards of many companies.
‘There is definitely an interest from the shareholders to be able to exercise voting rights, make their views known and submit shareholder proposals as a means of encouraging change at corporations,’ says Andrew MacDougall, partner at Osler Hoskin & Harcourt. The big issue for boards is: how much change is appropriate for investors to encourage? While some in the corporate community have balked at adjusting policies in response to shareholder proposals, others say you really can’t fault investors for wanting to be more actively involved.
Over the last few years, ‘investors lost an awful lot of money, and they take that ownership responsibility more seriously these days,’ notes Glenn Keeling, a partner at Phoenix Advisory Partners. He says investors have been scrutinizing company performance and, ‘in many cases, shareholders believe they can run a company better than [the board] can – and in some cases it happens that they do.’ He recalls how struggling beverage maker Cott’s stock was revived after New York hedge fund Crescendo Partners bought an 8.7 percent stake in the company and pushed for management changes in 2008.
Hostility on the increase
Jay Hoffman, a partner at Miller Thomson in Toronto, says an increase in investor dissatisfaction with performance coupled with increased pressure for corporations to voluntarily adopt some governance measures has led to a significant increase in hostile proxy fights for control by activist firms, hedge funds and institutional shareholders. He points out that these battles are much more common in Canada now than in the past. You can expect to see more activist groups ‘requisitioning a meeting to replace the board or, more often, running a dissident slate at an annual meeting by filing a dissident circular to remove all or part of the board,’ he says.
Phoenix senior vice president Susy Monteiro agrees. ‘There is no hesitation now to stage a hostile takeover because it’s not viewed as corporate raiding anymore,’ she says. ‘There is even a format for setting up and preparing for a proxy fight. It’s more accepted now and, as a result, we’re seeing more volume than 10 years ago.’
Investors have also become more active because of a fundamental belief that the proxy system in Canada is broken. Shareholders have complained about unequal treatment, votes not being counted, and the right to attend shareholder meetings or to vote on many key measures being denied.
The shareholder democracy movement, which is supported by the Canadian Society of Corporate Secretaries (CSCS) and other groups, has been pushing for the adoption of several governance best practices to address some of these problems, including: appointment of an independent chair or lead director of the board; annual director elections with individual director-by-director votes; adoption of a majority voting policy by the board; and annual say-on-pay shareholder advisory votes.
A CCGG shareholder democracy study released in June shows there has been positive movement on all of these issues. According to the study, more than two thirds of boards that did not have an independent chair have appointed an independent lead director in 2011, up from 25 percent in 2003. The study also shows that since 2003, when no issuers adhered to many of these practices, more than 50 percent have adopted some of them voluntarily in the name of good governance.
Not all smooth running
Of course, the boards haven’t gone along with everything the movement has asked for. The adoption of say-on-pay votes hasn’t moved quickly, with only 80 firms voluntarily adopting the practice by the end of May 2011. And the study acknowledges that, ‘even though there has been a significant level of adoption of best practices in shareholder democracy since 2003, many leading Canadian firms have failed to accept the fundamental right of shareholders to be able to vote effectively for or against each individual director nominee.’
Independent of the shareholder democracy movement, the CCGG has also done a great deal to encourage the voluntary adoption of a lot of these governance practices by using the influence of many of the nation’s largest institutional shareholders. The coalition includes about 50 institutions that own significant stakes in nearly 85 percent of all publicly traded firms in Canada – a constituency no board of directors can ignore.
‘The CCGG represents the collective views of a large block of institutional equity and it has worked on a very organized program of articulating its views to encourage the development of best practices by getting corporations to align with the interests it has expressed rather than having to initiate a proxy battle or challenge,’ MacDougall says.
For better or worse, the success of shareholder democracy efforts has changed the relationship between a board and its shareholders. As shareholders put more pressure on companies to perform, the more likely it is that the executive team and directors will need to compromise on some issues. Specifically, the movement for annual votes to retain or remove individual directors and the implementation of individual director scoring have ratcheted up the heat on directors.
Directors who don’t receive 50 percent approval in elections are required to resign or petition the board to keep them on. Each director must now carefully consider how shareholders will react to company policies on director voting or face being voted off the board in the next proxy season. Boards are also likely to find more of their operating decisions challenged by investors in the future as scrutiny of company performance intensifies.
This puts directors under pressure to approve strategies that will improve company performance and stand up to investor criticism. It also means the board and the corporate secretary must create strategies that can effectively deal with the possibility of increased proxy battles or a hostile takeover. This may mean greater interaction between the corporate secretary and the investor relations division. Companies that are well prepared and proactive will stand a better chance of minimizing the influences of shareholder activism.
In this new environment, Hoffman says corporate strategy ‘must withstand investor scrutiny as well as scrutiny by the courts and securities regulators. There is a need for boards to understand their legal obligations in a contested situation. Canadian courts have recently reaffirmed that they will show deference to decisions of boards that exercise their business judgment in responding to shareholder activism.’
To strengthen corporate strategy, Hoffman says firms should ‘review and assess by-laws, management and board practices, composition of the board and board committees and their mandates and the corporation’s investor relations functions. Look for weaknesses and address them.’ He also says companies should ‘review and assess strategic and business plans, improve executive compensation practices, review social responsibility practices, and consider adopting voluntary policies such as say on pay, majority voting and no-slate voting.’
Experts agree the best way to get insight into which business strategies will pass investor scrutiny is to engage more effectively, so a review of shareholder engagement must be a top priority. Sylvia Groves, principal at GG Consulting, suggests corporate secretaries take the lead in developing a better shareholder engagement strategy that educates the board about who its underlying shareholders are and which issues they may find sensitive.
She suggests firms identify their 20 largest, most influential shareholders and then conduct research to find out what they stand for. ‘Institutional investors are getting better at putting what they don’t approve of on their websites,’ she points out.
An early start
Groves also emphasizes that directors must reach out and talk to their shareholders prior to proxy season to get an idea what key investors are thinking. ‘Being proactive is the key,’ she says. ‘Most firms will have an idea whether they have practices that some or lots of shareholders might not like, and the idea is to engage early and often so that when the vote comes down they might take your call.’
MacDougall suggests companies find ways to use their websites and the internet in their strategies to improve communication with shareholders. ‘Taking advantage of webcasts, blogs and other electronic communications to reach a broad group and provide a more personalized experience [for investors] is very exciting,’ he says.
Issuers shouldn’t be afraid to enlist help with the engagement process, either. Proxy advisory firms can help find out critical information about a company’s main shareholders and offer strategies to avoid proxy fights. Proxy solicitors can also reach out to shareholders that are likely supporters and encourage them to vote.
Keeling suggests enlisting a company like his before trouble surfaces, however, or even all year, ‘to minimize the number of voting surprises, educate you about what is happening with your investors and make the annual meeting a much less stressful event.’
As Monteiro says: ‘The worst thing you can do is have the first time you make a call to a significant shareholder be when you find yourself under attack.’
