Ready For A Red-Hot Proxy Season
By Joan Warner
Wednesday, December 20, 2006
If the 2006 proxy season felt dramatic, just wait until
spring. The folks with their fingers on the pulse of big
shareholder groups have already identified the top five
areas of activity this year: majority voting, executive
compensation, board declassification, poison pill
elimination and activist hedge funds.
Many boards grappled with one or more of these issues last
season, but that doesn't mean they've gone away. If
anything, shareholders feel empowered by their progress.
Proxy advisory firm Institutional Shareholder Services
recently polled the largest of its 1,720 clients on the
future of corporate governance. The 325 institutional
investors surveyed control some $20 trillion worth of
equities, or 62% of the total $32 trillion under management
by ISS clients. "Ninety-seven percent of the respondents
said that corporate governance was going to be more
important than it is today," reported John Connolly, the
firm's president and chief executive. Furthermore, he
added, a large majority said that within their own
organizations, corporate governance has moved from a
compliance activity to a business imperative.
What does this mean for boards, and how should directors be
spending their time in the runup to the 2007 voting season?
The consensus of Directorship's Agenda 2007 panel on proxy
issues was that communicating clearly and frequently with
shareholders is more important than ever. Investors who
don't hear about strategy, financial developments,
transactions and major market changes from corporate
leadership are going to draw their own conclusions. And
with various stakeholders eager to spin events to fit their
own agendas, those conclusions will often be negative. "As
we well know, nature abhors a vacuum," said Nancy Humphries,
president and CEO of the National Investor Relations
Institute. "Either you control the situation, or one of
your owners or the media is going to control it."
Directors aren't about to be asked to become instant
investor relations experts --although some companies bring
their IR leaders into the boardroom often. But arguably, in
today's climate, part of their fiduciary duty is pressing
management to engage early and often with shareholders on
key issues. That is a year-round job. "The annual meeting
process nowadays is kind of like being a professional
athlete. Even in the off-season you have to train," says
Warren de Wied, corporate partner at law firm Fried, Frank,
Harris, Shriver & Jacobson. "And if you're not training in
the off-season, you may not do very well in the regular
Clearly, shareholders have targeted the boardroom as the
place where they want to see change begin. It's telling
that two of the five hot issues for 2007 relate to board
composition and structure. Connolly expects 450 resolutions
on majority voting to come before U.S. companies this year,
up from 140 in 2006, 89 in 2005 and just 12 in 2004.
Corporate giants from
Wal-Mart Stores to
already embedded majority voting in their bylaws, and many
more large companies will likely follow.
Gavin Anderson, CEO of rating firm GovernanceMetrics
International (GMI), called the majority voting movement an
"unstoppable train." So far, only 150 out of 9,000 publicly
traded companies have adopted it. But Anderson predicts
that a majority will do so within three or four years.
Starting this season and continuing indefinitely, more and
more directors will be unseated because of shareholders'
views of their performance or because they are associated
with a problem within the company. And fewer
board-appointed directors will be elected in the first place
if there's dissatisfaction with the company's overall
strategic direction or share price.
Meanwhile, the movement toward board declassification has
gathered so much momentum that Connolly advised companies
not to waste their resources fighting it. Already, 53% of
publicly traded companies have declassified boards, and last
year saw 94 proposals. Academic studies by Harvard's Lucian
Bebchuk and others correlate staggered boards with lethargic
stock performance, and shareholders have taken notice.
Connolly thinks they have simply concluded that a classified
board has no benefits for them as owners.
Of all the issues that motivate investors to call for a
board shakeup, executive compensation is probably the most
explosive, and new disclosure regulations on pay packages --
for directors as well as managers -- will make the topic
even more prominent this year. A whole slew of formerly
private information will henceforth be public, and the
scandal over options backdating is ongoing. All the
panelists agreed that the scandal could be a catalyst for
action at a lot of companies.
Once again, clear communication with shareholders could go a
long way toward defusing potential crises. Once the
compensation committee makes its recommendations and the
full board decides on executive pay, says Humphries, "the
presses are going to run with hundreds of thousands if not
millions of copies of your proxy statement. I would suggest
to you that the board needs to know, if they don't already
know, very clearly what the process of communication is
going to be around those numbers. And that's got to be done
beforehand and not after."
Executive compensation that is not closely tied to
performance is one important issue that makes companies
vulnerable to activist hedge funds. And because more and
more companies are eliminating their poison pills, the kind
of major proxy fights seen last year -- Nelson Peltz's run
on Heinz for
instance, and Carl Icahn's on
could become more common. "We have favorable market
conditions for the type of investor who is seeking to make a
short-term profit by trying to get a company to restructure
or sell itself," says de Wied. "And what every director
needs to understand is, unless you have a controlling
stockholder or group, you are usually a target."
Connolly thinks even
General Motors could come under intense attack
from activist hedge funds or private equity investors this
year. "So, how you as a board of directors communicate with
those shareholders is, I think, going to be increasingly
important," he says.
Directors may also have to pay more attention to governance
ratings. Whether such ratings, including numbers like ISS's
Corporate Governance Quotient (CGQ) and GovernanceMetrics'
accountability score, correlate with financial performance
remains a matter of fierce debate. The important point for
companies is that many powerful investors believe the
correlation is real. Francis Coleman, executive vice
president of Christian Brothers Investment Services (CBIS),
which has more than $4 billion in assets under management
and promotes socially responsible policies in the companies
where it invests, says, "This is not something that we are
doing just to do it. There is a fundamental belief that
companies that address these issues are better plays and
better investments in the long term than companies that
aren't addressing them."
In fact, Coleman says, his organization's clout is growing
precisely because its concerns address economic
performance. (CBIS is a member of the Interfaith Center on
Corporate Responsibility, which includes some 275
faith-based organizations with over $110 billion in assets.
Talk about clout.) Whereas 10 years ago, companies in which
CBIS held several million shares barely acknowledged him, he
has a much easier time initiating dialog with management and
board leaders now. "I think one thing that is contributing
[to that influence] is our increased ability to make the
business case on some critical social issues," Coleman
says. "There are issues out there that are potential
long-term hidden bombs for companies. Environmental
liabilities, human rights issues -- no one wants a headline,
'Company Is Employing Children in a Factory.' That just
doesn't play well."
Of course, making a business case for good governance is
what activists of every stripe try to do. That's why
companies' CGQ and GovernanceMetrics ratings are so widely
watched. GMI's Anderson says that unlike ISS, his
organization produces governance ratings without advising
investors on how to vote their shares. But he says that
among the 3,800 companies his organization rates, the top
10% in terms of governance metrics had superior return on
equity and return on investment than average "and way
outperformed the bottom 10%."
He says that such numbers, which measure economic
performance rather than stock activity, are watched on an
ongoing basis -- not just by hot-money hedge funds or
long-term pension investors but by the vast universe of
mutual-fund managers and shareholders. "Remember, the proxy
is just dealing with two or three issues that happen to be
the hot-buttons this year," Anderson says. "But your
overall governance matters."
That huge, anonymous investor pool could get much more
visible in the future if the Securities and Exchange
Commission follows the New York Stock Exchange's
recommendation and eliminates broker-dealer discretion.
"The broker-dealer vote for the issuer community has been a
management-favored vote for years," says Connolly. When
individual investors vote their proxies, the balance could
change dramatically. Connolly envisions teachers'
organizations issuing voting policies that apply to all
teachers who own shares or mutual funds, or AARP instituting
guidelines of its own.
The central issues in the coming proxy season all point to
large-scale and lasting "democratization" of corporate
leadership. One result for companies will be a need to
spend more time separating mere gadflies from
well-intentioned shareholders. CBIS's Coleman says that
when companies engage with their critics, "you will be able
to discern who are the serious players in this arena and who
are not. It behooves you to begin a conversation with those
Better investor relations, the panel concluded, will go a
long way toward preventing disasters at this year's annual
meetings. Directors need not be humiliated by hostile
questions or irate lectures. They just have to make their
message heard outside the boardroom. "You've got to be out
there talking to your investors," says de Wied. "And you
have to talk to the proxy advisory firms, because they have