Companies may face a number of unexpected obstacles, but better shareholder communication can put out fires
It seems that every passing year is marked as a watershed for investor rights. The 2007 proxy season was unique for many reasons, not least of which being it was the first year following bolstered compensation disclosure rules. Shareholder proposals soared in certain areas and serious advances were made in relation to a shareholders’ ability to directly influence the actions of directors.
Many people involved in corporate governance and compliance functions were hoping that 2007 would prove to be a peak in the shareholder activism cycle but it seems that the considerable success achieved by many activists has only served to embolden shareholder groups further. It appears as though 2008 will yet again prove to be the busiest proxy season on record.
With proxy season rapidly approaching, many corporate secretaries and general counsel are trying to assess what the hot button areas are likely to be. At first glance it would appear as though it is going to be more of the same, but there are a number of new proposals that are likely to emerge. Majority voting and various executive compensation-related issues will again be at the top of the list. Majority voting is well known to corporate secretaries, and following the ground-breaking year of compensation disclosure, pay proposals are to be expected. Most companies will be well prepared for these types of proposals and conversations.
Where companies need to spend some time preparing their strategy is in fields that have not attracted a lot of investor action in the past but which will feature heavily this year. Pat McGurn, EVP and special counsel for Institutional Shareholder Services, says the proxy voting advisor believes issues relating to product safety, which have been firmly in the general media headlines, will show up on ballots this year. Healthcare is also likely to feature far more prominently.
Another new area that will gain attention, as reported in this magazine (Trouble on the horizon, December 2007), is the emerging risk surrounding share buyback plans and executive 10b5-1 plans. Rich Ferlauto, director of pension and benefit policy at the American Federation of State, County and Municipal Employees (AFSCME), one of the most prominent shareholder rights activists in the US, says he has already identified a handful of companies that AFSCME will be talking to about share trading activity. He also says he will be taking a more serious look at populist issues like climate change.
Minimizing shareholder proposals
As always, the key to a relatively pain-free proxy season is communication. Gaining a strong understanding of your shareholder base and effective communication with them is usually sufficient to prevent costly and time-consuming resolutions making it to the ballot. It is more than likely that companies will continue to accommodate investor demands before they get to the ballot. ‘More than ever, public companies made concessions to minimize the number of shareholder proposals that made it onto the proxy ballot and to avoid proxy contests altogether,’ explains David Drake, president of Georgeson.
Speaking at the January Directors’ Forum, hosted by the University of San Diego, Ferlauto explained: ‘The SEC has effectively abdicated its role as shareholder advocate so activist groups are being forced to step in and take up the fight. The SEC’s failure to fulfill its role as mediator means there will be a significant increase in withhold and vote no campaigns.’ Despite this, he also stressed the need for improved communication on all sides to improve relations between shareholders and boards.
As McGurn explains, the top issues will be ‘much the same as last year: majority voting, say on pay and pay for performance.’ McGurn expects to see a large number of resolutions surrounding majority voting, but does not see many of them actually making it onto the ballot. ‘We have, in some ways, achieved a level of critical mass in this area and there are very few arguments companies can offer to refuse a majority vote standard,’ he says. ‘Many larger companies are already on board so you can expect to see this movement shift down the market cap ladder this year.’
According to the Shearman & Sterling report entitled ‘2007 trends in corporate governance of the largest US public companies’, 56 percent of the top 100 companies (as defined by market cap from the Fortune 500 list) require directors to be elected by a majority of votes cast. For the companies that still maintain a plurality vote standard, 21 percent require any director receiving more withhold votes than votes for to tender his or her resignation to the board.
But simply implementing a majority vote standard may not stave off attention from activist groups. It is likely that holdover periods will attract some comment this season. Of companies that have a majority vote standard, only 43 percent require resignations of directors who do not receive a majority but would otherwise continue to serve on the board under holdover provisions.
According to a review of 2007 governance practices from Georgeson, ‘Nearly 130 majority voting resolutions were submitted to issuers for consideration. However, less than 30 percent of those proposals actually made it to the ballot – only 37 came to a shareholder vote, as compared to 87 in 2006. Faced with widespread momentum and the fear that failing to adopt the voting mechanism would simply result in more opposition to the board, companies found it prudent to give in rather than fight.’
Pay issues still at forefront
The area attracting the most attention is probably executive compensation. Shareholders and the SEC have had 12 months to review the expanded disclosures from companies but rather than improving the situation, more information has allowed them to identify more areas of concern. The two most sensitive issues are ‘say on pay’ and pay for performance. According to Ferlauto, AFSCME is planning to bring around 100 ‘say on pay’ proposals during 2008. He feels the implementation at Aflac and Verizon means many other companies will find it hard not to comply. ISS is planning to file 150 to 200 pay-for-performance proposals.
This will probably come as no surprise to any corporate executive who has been involved in disclosure or shareholder communications this past year. The problem is that opinion varies considerably about what can safely be disclosed and also what action should be taken by shareholders. One area where all shareholder groups appear to be in agreement is in their treatment of tax gross-ups. They all favor a zero-tolerance policy. ‘Any way you cut it, gross-ups are an extremely inefficient way to compensate executives,’ says Ferlauto.
So what do companies need to do this year to appease shareholders? Provide hard facts and figures. Proxy advisers are looking for more specific information surrounding performance hurdles, when they take effect and what criteria are actually used. Many companies do not feel comfortable disclosing this information because they feel it may give competitors a competitive advantage.
Novel approach
One creative solution that seems to have been very well received is that of Pfizer. Also speaking at the San Diego Directors’ Forum, Peggy Foran, Pfizer’s corporate secretary, general counsel and SVP of corporate governance, described a meeting the company arranged between the board and its top 30 shareholders: ‘The communication that took place was extremely fruitful and the board was able to listen to and address shareholder concerns.’ She explains that many companies are nervous about conducting such meetings, mostly because of Regulation FD: ‘There are dozens of reasons you can find not to do it, but that is the wrong path. You must find reasons to do it and with a little preparation it is not difficult to avoid Reg FD issues.’
John Wilcox, head of corporate governance at TIAA-CREF, attended the Pfizer meeting. ‘We felt this was a huge success,’ he remarks about the event. ‘We were able to raise questions and felt our concerns were being listened to. Their directors engaged intelligently on the issues. It was reassuring to see that the board was informed and involved and was not attempting to be self-protecting. Even though we did not agree with everything – there was even disagreement between the shareholder groups – we all walked away happy.’
Foran believes this ‘was one of the best information gathering exercises Pfizer has ever conducted,’ and encourages her peers at other firms to conduct similar exercises.
One area likely to attract increasing attention is related party transactions. The Shearman & Sterling report finds proxy statements at the top 100 firms reveal that standard practices regarding the disclosure of related-person transactions have not yet emerged and that these companies have adopted varied approaches. Of the 71 companies that disclosed related-person transactions, 56 disclosed a related-person transaction involving a director or a former director, 55 disclosed a related-person transaction involving an officer or a former officer and nine disclosed a related-person transaction involving shareholders or beneficial owners.
A perennial favorite that is also tipped to feature heavily this proxy season is board composition. Director independence, staggered boards and the separation of the CEO/chairman role will see at least a few resolutions as some companies refuse to make concessions in these areas.
The Shearman & Sterling report finds a number of leading practices are emerging around board composition. Some of the most common include a requirement for the board to contain a ‘substantial’ or ‘significant’ majority of independent directors and no more than two current or former employees. Three companies require all board members to be independent with the exception of the CEO/chairman and two require at least 75 percent of independent directors.
As of June 15 2007, separate individuals served as chairman and CEO at 22 of the top 100 companies, a slight decrease from 24 in 2006 but a significant increase over 2003 and 2004. The presence of a lead independent or presiding director has often been suggested as an alternative to a requirement that an independent director serve as chairman of the board. Notwithstanding that the NYSE requirement to disclose the name or method of selection of the non-management director who presides over executive sessions has been in place for several years, no single approach has emerged. One trend that has emerged, however, is that more top 100 companies have disclosed that their lead or presiding directors, regardless of how they are selected, have been given responsibilities in addition to presiding over executive sessions.
Opposition groups may try surgery or sledgehammer
Again the overall theme seems to be communication. Jim Melican, chairman at Proxy Governance, stresses the need to understand the varying opinions of the entire shareholder base and their likely voting patterns. It is also, he explains, important to remember that not all advisory groups agree on all issues and many will take different approaches when it comes to expressing displeasure with board policies.
The two main alternatives are demonstrated by ISS and TIAA-CREF. Wilcox explains that if his pension fund is not happy with compensation polices, for example, but generally feels the members of the compensation committee are performing well in other board duties, it will take an engagement approach and specifically target individuals if need be. The ISS approach is to conduct a more broad-based withhold campaign against all members of the committee and perhaps the board as a whole.
Jim Hale, former EVP, general counsel and corporate secretary, and director at Target, Tennant and United Health, explains that he ‘prefers the more surgical approach of TIAA-CREF versus the sledgehammer type approach of ISS and some other groups.’ Both approaches are effective in certain circumstances and companies need to know which companies investors are listening to and what their strategies will be.
