The 2007 proxy season may best be remembered in the context of three major themes: shareholder say in executive compensation; majority voting and proxy access for shareholders in director elections; and the filing of a record number of social and environmental proposals, most of which deal with political contribution disclosure.
While most finance executives tend to remain on the sidelines of proxy processes, CFOs must be in the loop on major developments because the fallout can significantly impact company policies and performance over time.
The stock options backdating scandals that rocked companies during 2006, resulting in new SEC rules pertaining to executive compensation disclosure, played out in corporate boardrooms around the country throughout this year's proxy season. Yahoo Inc.'s CEO, who drew fire from shareholders over excessive compensation that was far out of sync with company performance, stepped down in June. Shareholders rebuked Yahoo directors responsible for approving such an overly generous pay package by withholding votes for their reelection.
"A significant theme for the 2007 proxy season will be the continuation of the 2006 movement toward majority voting for the election of directors," predicted Richard P. Swanson, securities attorney at Arnold and Porter, at the beginning of this year, a prognostication that proved correct as many companies adopted a requirement that all directors be elected by an affirmative majority of votes cast.
Proposals on a dozen social issues, including disclosure of corporate political donations and proposals relating to global warming, proliferated during this proxy season. Of the more than 350 social proposals that were filed this spring by shareholders, the largest number, 60 proposals, revolved around the adoption of disclosure and board oversight of some or all political spending, according to San Francisco-based As You Sow, an advisory group that works with corporations and shareholders in areas including corporate governance and the environment.
But while 2007 was an active year for shareholder resolutions, there were few full-blown proxy contests for control. "There were fewer than I expected," says Swanson. "The reason is that boards are being more responsible and acting peremptorily [to address shareholder concerns]."
"Say on pay" proposals, which would allow shareholders an annual nonbinding vote on executive pay, were submitted at more than 60 companies this year, according to proxy advisory services. These proposals approach the issue of excessive executive compensation in a way that may get results without seeking to impose pay limits, explains Michael Passoff, associate director of the Corporate Social Responsibility Program at As You Sow, and companies are responding to the call. In fact, proxy advisory services have recommended votes in favor of these proposals. "Shareholders in the United Kingdom have been allowed to cast advisory votes on executive compensation for several years," says Passoff. "Such a vote is not binding but gives shareholders a clear voice that provides feedback on how shareholders view management performance."
"The average support for say on pay is around 40 percent in shareholder votes, which is pretty high," says Roger McCormick, vice president, Proxy Research, Glass Lewis. "It received a majority vote at Blockbuster and Verizon, but at Verizon it just squeaked through with a bare majority. But remember, these are both nonbinding. The goal isn't for shareholders to have a vote up or down on compensation or in compensation program design or to set amounts, but instead to encourage companies to talk about performance goals and targets."
The more extreme forms of say on pay proposals, which are usually defeated at the annual meeting because management still controls a majority of the proxies, are those that call for incentives to kick in only when the firm performs significantly above its industry peers, according to Phillip Phan, professor of finance and management at Rensselaer Polytechnic Institute's Lally School of Management and Technology. "A good example is Yahoo. That proposal received a 35 percent yes vote. But even though it was defeated, such high proportions of support generally cause the board to rethink the issue and respond publicly at some future date. At that level, institutional shareholders generally get involved -- and they have a lot of clout and moral persuasion power to make boards sit up."
Regardless of the mechanics of specific say on pay proposals, it's clear that investors believe that more needs to be done to curb executive compensation abuses. Many CFOs agree that the SEC's new proxy requirements for compensation disclosure and transparency will do little to affect executive compensation, according to a recent survey conducted by Tatum LLC. Sixty-five percent of respondents say that the greater detail required will have no change on executive compensation.
"Although the compensation section is longer and more detailed, it has also become more confusing and difficult to interpret, causing many readers to skim over it or skip it altogether," says Cynthia Jamison, national director of CFO services for Tatum. "And the legal language around plan descriptions can be arduous to read through and provides minimum clarity about how the programs actually work in practicality."
The disclosures create confusion and the sense among shareholders that there are still problems that need to be addressed.
Congress is now involved in the say on pay debate and may soon require companies to give shareholders a say in executive compensation. Therefore, some companies are taking a wait-and-see approach before initiating further action.
Still, some firms are moving ahead now. This year, Aflac Incorporated's board of directors approved a resolution giving shareholders a nonbinding vote on executive compensation -- but not until 2009, which will be the first year that executive compensation tables in the proxy statement will contain three years of data that reflect the SEC's new disclosure rules. Shortly after Aflac made its move, several other big companies, including Verizon Communications and Motorola, announced that they would also file such proposals.
Aflac's plan arose in response to an institutional investor with holdings in the company, Boston Common Asset Management, which submitted a say on pay proposal late last year to be considered this proxy season. "It was something that we took very seriously early on," says Ken Janke, Aflac's senior vice president of investor relations. "We had an initial dialog with them, and we also consulted with people inside the company as well as from outside the company -- everyone from our legal counsel to our proxy solicitor -- just to get the various viewpoints. But our CEO is really the one who led the charge on this more than anyone else. It's his opinion that it wasn't a bad thing to do -- and, in fact, that it was a right thing to give shareholders an opportunity to express opinion on executive compensation."
Another reason for Aflac's proactive posture is that the company knew that it was dealing from a position of strength. "First of all, we knew that it was likely that the proposal would be defeated if it went before a group of shareholders, Janke says. We knew all along that our compensation at all levels throughout the company had been tied closely to performance. Compensation was consistent with what shareholders want."
The proposal, which didn't get on the ballot due to Aflac's willingness to involve shareholders in executive compensation decisions, would have been a first for the company. "In our history as a public company, which goes back to the mid-'50s, we've never had a shareholder proposal in our proxy statement," Janke says. "We've tried to be a good corporate citizen, not only locally where we're headquartered but also in the markets we serve -- the United States and Japan -- and we've earned a very good reputation."
Is Aflac's approach just enlightened self-interest? The company has received a lot of positive media attention as a result of its plan, and it may look like nothing more than good public relations on the surface to skeptics. "But it's always difficult to be the first one to step forward and take action," says Claudia Allen, an attorney with Neal, Gerber & Eisenberg. "Aflac deserves some credit."
In the 2006 and 2007 proxy seasons, majority voting in director elections, a requirement that all directors be elected by an affirmative majority of the votes cast rather than a plurality, has gone from a controversial activist-driven governance practice seldom adopted by public companies to a mainstream governance standard. "Majority voting represents a significant shift in the balance of power away from management and in favor of institutional shareholders," says Swanson.
A 2007 study by the Corporate Governance Practice Group of Neal, Gerber & Eisenberg reveals that over 52 percent of the companies in the S&P 500 have adopted a majority vote policy, bylaw, and/or charter provision, compared to under 20 percent of the companies in that index in 2006 that did so. Moreover, this year's study demonstrates that companies are increasingly adopting true, binding, majority vote bylaws -- and in some cases, charter provisions -- in contrast to one year ago, when companies were generally adopting nonbinding majority vote policies.
What's driving this trend? Companies want to be out in front of the issue to help shape changes in their best interest. "Some are doing this because they're presented with stockholder proposals that passed in previous years or have done so under the threat of binding proposals," says Allen, who was the author of the majority voting study. "They saw that it was coming, so they did it as part of a negotiated settlement with a proponent. And some did so intentionally peremptorily. Some companies have tried other formulations first to see if they would satisfy an activist, but they didn't. So there was an iterative approach."
Proxy access, a companion issue to majority voting that would allow shareholders in certain circumstances to nominate directors without going to the expense of filing their own proxy, was revived late last year when the United States Court of Appeals for the Second Circuit ruled in favor of a shareholder group's attempt to put a binding bylaw amendment proposal before AIG's stockholders that would allow large, long-term holders of AIG's stock access to management's proxy in subsequent years for purposes of nominating competing candidates. Historically, the SEC doesn't permit shareholders to nominate directors directly or to propose bylaws or charter amendments to permit them to do so. But the court found that AIG could not exclude the proposal from its proxy. As a result, other proxy access proposals came about this year.
Major players on the social and environmental front, including pension funds, foundations, religious institutional investors, socially responsible investment firms, labor unions, and special-interest nongovernmental organizations, such as the Sierra Club and People for the Ethical Treatment of Animals, filed over 350 resolutions this proxy season. Proposals addressing the disclosure of corporate political contributions represented the largest segment, followed by global warming, sustainability, labor standards, human rights, the environment, animal welfare, health, sexual orientation, charitable contributions, toxics, and tobacco, reports As You Sow.
While most social resolutions historically get only 4 to 7 percent of the vote, there were some high scores at more than ten big companies, according to Passoff. "Many social resolutions still get single-digit vote totals, but there have clearly been some major crossover issues during the past few years that now get mainstream support."
In the political donation arena, a proposal at Unisys Corp. passed with 51.1 percent of the vote, while votes on proposals at The McGraw-Hill Companies, Entergy Corp., and Citigroup Inc. scored in the 30 to 38 percent range.
Environmental issues accounted for the widest variety of issues and filers this year, according to Passoff. Global warming concerns comprise the majority of environmental proposals and encompass items on greenhouse gas emissions, climate science, carbon disclosure, and renewable energy. But while this proposal category represented the second largest area for social proposals, only two came in at 30 percent of the vote or above: A proposal at Boston Properties relating to energy efficiency weighed in at 32.5 percent, and an initiative at Exxon Mobil related to greenhouse gas emissions registered 31 percent.
Almost 40 shareholder proposals were filed by investors seeking disclosure of a company's social and environmental practices in the belief that they impact shareholder value, according to As You Sow. Such corporate "sustainability" reports are defined by the United Nations as "the ability to meet present needs without impairing the ability of future generations to meet their needs" and includes a statement on the economic, social, and environmental impacts of a company's operations.
Guidelines were developed for voluntary use by companies in issuing these reports, and more than 2,000 companies worldwide publish them. "There's more of an effort to talk about it [sustainability] in the context of corporate citizen reports by Fortune 500 companies," says Doug Bauer, senior vice president, Rockefeller Philanthropy Advisers, a firm that advises foundations in investment decisions. "Slowly, we're seeing companies derive positive benefits by paying attention to sustainability. DuPont has become a leader and made it core to the business. They see it as a profitability issue and a real business opportunity."
Sustainability proposals that received significant votes this proxy season involved Hasbro, Wendy's International, and MDU Resources Group, where votes ranged between about 33 and 45 percent.
In these three key social and environmental areas -- political donation disclosure, social/environmental issues, and sustainability -- only Unisys Corp.'s proposal on political contribution disclosure passed with a majority vote. But these proposals that attained large number of votes are important to watch. Proposals that score enough votes to meet requirements for resubmission next proxy season will likely be back on the ballot unless management takes actions that address the issue to shareholder satisfaction. And most shareholder resolutions that are passed are at least acknowledged by the board.
"Even if they do not adhere to the resolution in full, there is still the possibility that it will change management practice," says Phan. "The point is that if the board ignores the resolution, institutional shareholders will take note and the share price of the company will likely not do very well. Given this era of Internet blogging, Cramer on CNBC, and a generally high level of publicity now accorded to such things, even nonbinding resolutions can make change in the boardroom."
Companies with sound governance practices and processes that continue to create shareholder value aren't often likely to run afoul of shareholders. "There are no checklists or black-and-white rules for avoiding problems," Swanson warns. What is required is sound judgment and extensive effort to align management and shareholder interests.
Still, companies should take steps to minimize the likelihood of problems. Swanson recommends that senior management and boards insist upon greater tracking of the specific institutional character of a company's shareholder base. "By tracking Forms 13F, required to be filed by institutional investors managing more than $100 million, companies can identify who their shareholders actually are. It's also possible to construct a database of which institutional shareholders typically vote for or against specific shareholder proposals. You can therefore estimate, well in advance, what the likely support for different kinds of shareholder proposals may be and try to deal with the possibility of such proposals preemptively."
Leading companies that have faced shareholder pressure on major environmental and social issues have responded by showing their commitment to addressing activists' concerns. Wal-Mart, General Electric, and Chiquita, for example, have taken major steps to establish themselves as leaders in improving the environment by working with shareholder groups.
The best news for businesses in proxy voting not surprisingly resides with proposals put forth by management. Companies rarely lose in close shareholder votes on management-generated proposals. When Yair Listokin, an associate professor at Yale Law School, studied such proposals, he discovered that on hot-button issues with substantial shareholder opposition, management usually wins by a nose -- maybe just several percentage points -- but rarely loses by tiny margins. This is a result of the many advantages management enjoys, including the fact that companies can keep a running tally of shareholder votes as proxy cards come in and try to influence major shareholders who may not have voted yet, while shareholders, of course, cannot.
Listokin believes that as activists become increasingly aware of management's many advantages, they'll fight back. Companies could find themselves in the midst of the next round of big corporate scandals, he says.
Whether the trend toward more shareholder democracy is a good thing for investors and management is open to question. "Shareholder activism is unquestionably fueled by large pools of capital available to hedge funds, which often have relentless short-term orientation," says Swanson. "The interests of shareholders and management who favor longer-term, value-building strategies may suffer as a result. But there is no question that our legal and institutional structure has driven greater levels of shareholder activism and participation in corporate voting, and the changes are likely permanent."
Shareholder Insight: Action Steps for Passing Management Proposals1. Understand when it is the right time to push through an aggressive plan, such as a dilutive option authorization proposal. Stock price movement relative to peers is the most scrutinized metric investors use to gauge past success, but nearly as important are the general vision and growth outlook for the company as well as the credibility management has gained by limiting surprises and delivering predicted financial results. 2. Before researching the proxy voting tendencies of your shareholders, take a step back and analyze what drives your top investors. Aggressive plans might be more palatable to growth investors who are willing to pay for future expansion, but more risk-averse value investors might reject such a proposal if it is dilutive. 3. Make sure that your team understands specific shareholders' voting policies. A majority of investment firms publish their voting policies on their corporate Web sites or in various SEC documents. Through this research, you can determine whether a company always votes in line with proxy advisory firms such as Institutional Shareholder Services (ISS) or Glass Lewis regarding a specific plan -- whether it is always for or against management or instead takes each situation on a case-by-case basis. 4. Once you've identified many of your shareholders' voting policies, research the voting histories of those case-by-case voters. You should also understand whether the portfolio manager holds more power than the compliance officer and begin discussions with your best firm contact to assess what might move the needle to get their support. 5. Understand proxy advisors such as ISS and Glass Lewis and their voting practices. While you can pay a healthy price to access an advisor's database, which would help you develop a proposal that you know they will vote in favor of, this cost may be unnecessary if you do your homework. In addition to a plethora of public information regarding its previous voting history, ISS has a blog on its Web site that provides even more color behind the proxy advisor's voting tendencies. 6. Be prepared to respond to hostile/activist activity in response to a proxy, particularly if it is dilutive or overly advantageous for management (such as a lucrative executive compensation package). Aggressive hedge funds continue to play a major role within the investment community, and their impact on the proxy voting process is no exception. While most companies are aware of activist shareholders well in advance of the proxy's release, many mainstream hedge funds have become more active in their review of proxies. Furthermore, their potential for impact is exacerbated by practices such as empty voting, where larger firms will essentially "loan" them their voting rights to help them block management proposals. 7. All policies should be customized for the individual company. Take into account varying shareholder bases vs. peer companies, value creation histories, management credibility, etc., before laying out a plan similar to that of an industry peer. 8. Understand the nature of the voting mechanism itself, including how companies are now offering the "vote withheld" option. In many cases, a withheld vote can have the same effect as a vote against a proposal, as it limits the number of investors voting in favor of it. 9. Pay for a proxy solicitor when the situation is warranted. It never pays to do your own internal proxy work if you have a large retail component to your base. The time and effort that goes into the process of tracking down retail holders and gaining their proxy vote is extensive. 10. Build good relationships with your shareholders. Personal relationships and an investor's ability to understand management's long-term vision can go a long way toward gaining their trust, even in difficult times. Also, continued conversations and external perception work allows you to best gauge areas in the communication plan that need ongoing improvement. SOURCE: ASHTON PARTNERS |