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Corporate Governance:  Getting the Message
Shareholders have long passed resolutions.  Companies have long ignored them. Until now.
By Jennifer Levitz
The Wall Street Journal
Monday, October 9, 2006

John Chevedden had a nickname for Sempra Energy:  serial ignorer.

For four years beginning in 2001, Mr. Chevedden, a 60-year-old retiree from Redondo Beach, Calif., whose family owns Sempra stock, submitted shareholder resolutions calling for the big San Diego utility to elect its directors annually rather than every three years in staggered terms.  The votes passed with increasing majorities every year, garnering 67% of the votes cast in 2005.

Sempra ignored the nonbinding resolutions.  But in the 2005 voting, shareholders also withheld nearly 30% of their votes from the directors up for re-election -- a big proportion by corporate election standards.  And that seemed to wake the company up.

In May, Sempra management introduced a binding resolution for annual elections, which passed with 95% shareholder approval.  Its board of directors also voted to eliminate a poison pill anti-takeover provision of its bylaws that shareholders had voted against in other nonbinding resolutions in 2004 and 2005.

Dennis Arriola, Sempra's vice president of investor relations, says, "There wasn't a straw that broke the camel's back.  But after looking at trends and talking to shareholders, the board made the decision that this was the right thing for shareholders."

Persistence Pays Off

After decades of frustration, shareholder activists like Mr. Chevedden are beginning to see more company boards take popular resolutions seriously.  In the 12 months following the 2005 proxy season, companies adopted 64, or 53%, of the 121 shareholder resolutions that gained majority support, according to the Council of Institutional Investors, a Washington-based organization that represents pension funds.  That's up substantially from an adoption rate of 8.2% back in 2000.

Companies see "which way the wind is blowing," says Elise Walton, director of corporate governance practices at Mercer Delta Consulting, a New York firm that advises boards.  "There's always the hope that [resolutions] will go away.  That has worked in the past," she says.  But now, she adds, "the folks writing the resolutions...have more momentum."

One reason companies are bending is the surge in shareholder resolutions.  In 1971, shareholders proposed just five such resolutions.  In 1991, they submitted 350.  So far this year, there are nearly 600.

Another reason is the persistence of activists like Mr. Chevedden, who keep introducing the same resolution until the message sinks in.  He says annual elections for directors are common sense:  "Why should they go three years without getting a grade?  It's like having employees go three years without having a review."

Directors who skirt shareholders' requests can often expect to see the contentious issue return -- bigger -- the next year.  And losing repeated votes makes managements look vulnerable.

But some companies are acting on shareholder requests because of something else shareholders are doing:  refusing to cast votes for directors.

Protest Tactic

Once a rare occurrence, large withholding of shareholder votes has become increasingly common in the post-Enron era.  More investors are now using the protest tactic to address issues ranging from executive pay to the structure of the board, says Patrick McGurn, an executive vice president of Institutional Shareholder Services, a Rockville, Md., firm that advises institutional investors.

"Anything approaching 30%, 40%, or 50% [of withholds] was unheard of nine years ago;  it's fairly commonplace today." says Mr. McGurn.  This year, Institutional Shareholder Services told shareholders at 26% of the companies it tracks to withhold votes.

Resolutions are typically nonbinding.  Shareholders can submit binding resolutions in some states, but usually choose the nonbinding route since management often wages protracted legal battles to stop binding resolutions from reaching the ballot.

At Home Depot Inc., shareholders recently withheld at least 30% of their votes from 10 of the 11 directors up for re-election in June, including Chairman and Chief Executive Bob Nardelli.

The vote was widely tied to anger over executive pay.  The Atlanta-based retailer has awarded more than $115 million in compensation to Mr. Nardelli since he took the helm in 2000, while the company's shares have declined 12% under him.

The shareholder protest seemed to inspire action from the company.  In August, Home Depot announced that its board had amended the company's bylaws concerning director elections.  Starting next May, incumbent directors who aren't elected by a majority of votes cast must offer their resignation to the board -- which then decides whether to take action.

In an Aug. 28 statement, Mr. Nardelli said the board's decision came after 56% of voting shareholders had approved a majority-vote standard at the company's annual meeting in May.  "By adopting a majority-vote standard," he said, "the board of directors is reinforcing our company's commitment to shareholder engagement and director accountability."

In May, shareholders voiced their displeasure at UnitedHealth Group Inc., where the CEO William McGuire and other officers are under scrutiny for possibly backdating stock options.  Analysis of option awards has shown that some executives benefited from extraordinary timing, getting grants dated at times when share prices hit lows.  More than 28% of the votes for two outside directors -- both members of the compensation committee -- who were up for re-election were withheld.  Shareholders withheld 4% of the votes for Dr. McGuire and another.  The four directors were re-elected to the board, however.

In a May statement, Dr. McGuire said the votes showed the "seriousness with which we are continuing our efforts to advance corporate governance and compensation issues."

One of the most famous cases of vote withholding came at Federated Department Stores Inc. in 2004.  After the board failed to adopt five winning resolutions calling for a repeal of staggered board terms, shareholders withheld the majority of their votes for four board members whose terms were up.  One director failed to get support from 61% of votes cast.

When Federated bought out May Department Stores Co. in 2005, the company sponsored a binding resolution -- which won shareholder support -- to do away with staggered board elections.

Majority Rules

At most companies, withheld votes don't mean that a director loses a seat.  Since most director elections are uncontested, a director can garner just one "yes" vote and still win.

But in one of the main issues of the 2006 proxy season, more companies voluntarily adopted rules that require directors to get more "yes" votes than withheld votes among votes cast in annual board elections.  This essentially turns a withheld vote into a "no" vote.  Under these new rules, the failure can trigger resignation requirements or involve the whole board.

Pfizer Inc., for instance, last year adopted a policy requiring board members who fail to garner a majority of "yes" votes to formally offer to resign.  The pharmaceutical company's board has 90 days to decide whether or not to accept the resignation.  Versions of "majority vote" rules have also been adopted at chip maker Intel Corp. and telecom-equipment company Motorola Inc.

Faced with scrutiny after a wave of corporate scandals, some companies "want to be out in front in terms of being regarded as progressive on corporate governance and responsive to shareholders," says Shirley Westcott, managing director of policy at Proxy Governance Inc., a proxy advisory company in Vienna, Va.

As of last month, 208 publicly traded companies had adopted some form of majority-vote policy, with 146 of those policies put in place since Jan. 1, 2005, according to the Council of Institutional Investors.

Such policies, say shareholder advisers, have prompted boards to respond more quickly to nonbinding resolutions these days.  "Companies don't adopt these winning recommendations at their own peril," says Ann Yerger, executive director of the Council of Institutional Investors.

But as boards start to respond more quickly, says Ms. Walton at Mercer Delta Consulting, the "hardest thing" for them is to determine "which shareholders to listen to and which shareholders are trying to make a fast buck," by pressuring the company to approve the sale of assets or other measures the stock owners believe will drive up stock in the short term.  "Those are not the shareholders directors feel as obliged to," she says.

Baker-Hughes Inc., a Houston-based oil-services company, finally listened to shareholder Harold Mathis.

Mr. Mathis, a Richmond, Texas, real-estate investor who owns 810 Baker-Hughes shares, submitted four resolutions starting in 2000 asking the company to force its board to be judged annually in elections.  Each year, Mr. Mathis's proposal got stronger majority support, rising to 90% in 2004.

"As long as it was improving, I was not about to stop," says the 66-year-old Mr. Mathis.

Baker-Hughes saw that he wasn't going away.  So in 2005, when Mr. Mathis submitted his proposal again, he was asked by the management to withdraw it, he says.  It turned out, he recalls, that the board, citing continued shareholder support for Mr. Mathis's resolutions, had decided to back a binding resolution of its own on the same issue.

Mr. Mathis says he's pleased that his suggestion is now policy at the company.  "That was a big break there," he says.

Gary Flaharty, director of investor relations at Baker-Hughes says, "We listened to our shareholders and responded."

--Ms. Levitz is a staff reporter in The Wall Street Journal's Boston bureau.

Write to Jennifer Levitz at