What the proxies tally: A rising tide of activism.
By James Melican

Proxy rePort directors & boards T he 2007 and 2008 proxy seasons have been char- acterized by a rising tide of shareholder activism, spurred on both by a concerted effort to require boards to dialogue with shareholders on execu- tive compensation issues and by the increasing willingness of hedge funds and other activist investors to mount board challenges. The 2008 season is, as this article is written, still in its early stages. But even before the spring meetings peter out, it is evident that the weakening economy, the collapse in the housing market, the subprime mortgage debacle, and the tidal wave of credit-related losses at major financial insti- tutions have combined to stiffen the resolve of a number of prominent shareholders to hold directors responsible — not just for what they regard as flawed executive compensation policies, but also for failure to rein in the excessively risky bets made by company management. “Say on Pay” In 2007 we saw a vastly increased number of shareholder res- olutions seeking an advisory, nonbinding vote on executive compensation. Some 50 of these were voted on (others were withdrawn for various reasons). Of that number, eight re- ceived a majority of the votes cast; in total, the average level of support was 42%. Aflac warded off a shareholder resolution by being the first to announce that it would seek such an advisory vote. A handful of other companies — all but one of which were among the eight companies where the resolution got a majority vote last year — have since announced that they will also implement the advisory vote mechanism. They are (as of this writing) Verizon Communications, Par Pharmaceuticals, Blockbuster, and RiskMetrics (a newly public company that acquired and has since integrated what was formerly known as Institutional Shareholder Services, or ISS). The major distinction between last year and this is that, in 2007, the “say on pay” concept was generally regarded as an initiative of AFSCME (the American Federation of State, County and Municipal Employees). By contrast, this year other shareholders that are widely thought of as more centrist and less confrontational are also actively promoting the advi- sory vote concept. For example, TIAA-CREF is the proponent of such a shareholder resolution at PepsiCo and Johnson & Johnson. It is hoping that, if several large and highly regarded companies were to opt for the advisory vote, others, including those whose compensation policies might be less transparent What the proxies tally: A rising tide of activism The voting both last year and this year shows a stiffening resolve by shareholders to press boards on several fronts, including executive pay, corporate performance, board representation, and investor confidence. By James Melican and Shirley Westcott James P. Melican is chairman of PROXY Governance Inc., a leading corporate governance and proxy advisory firm (www.proxygovernance. com). Prior to joining the firm, he was executive vice president of Inter- national Paper Co., where he had responsibility for the company’s legal, corporate secretary, and investor relations functions, as well as several other administrative and operating units. He has served as a director of two publicly traded companies. Shirley Westcott is managing director of policy at PROXY Governance. She is responsible for overseeing the development of the firm’s U.S. and global proxy voting guidelines and overall approach to corporate governance issues. She previously was chief policy advisor of Institutional Shareholder Services Inc. Continued on page 50 Proxy rePort 50 directors & boards or more suspect, will feel constrained to follow suit. The proponents insist that they are not trying to microman- age board compensation policies; rather, they are attempting to encourage dialogue between the board’s compensation com- mittee and shareholder representatives on the one issue on which they feel company management has an inherent conflict of interest. They also contend that the existence of an advisory vote may tend to stiffen the backbone of board members con- fronted by excessive compensation demands from an overly aggressive or greedy CEO. They point out that an advisory vote on compensation is now standard practice in the United Kingdom, Australia, Sweden, and the Netherlands (where it is binding). In addition to AFSCME and TIAA-CREF, other traditionally active shareholders such as the AFL-CIO and CalPERS are supporting the shareholder resolutions, as are proxy advisory firms RiskMetrics (formerly ISS) and Glass Lewis. The Council of Institutional Investors (CII) has also been strongly supportive. Those opposed to an advisory vote also cover a wide spec- trum, ranging from some trade unions such as the United Brotherhood of Carpenters (UBC), to large institutional in- vestors such as Barclay’s Global Investors (BGI) and organi- zations that represent business interests, notably the Business Roundtable and the U.S. Chamber of Commerce. At this point at least, virtually all the corporations that have received such a resolution are opposing it. While the opponents’ reasons vary widely, a common argu- ment is that, even with the SEC’s enhanced executive com- pensation disclosure regulations, shareholders cannot have the same level of understanding as do board members sitting on the compensation committee of the various needs and objectives of the corporation, which could vary significantly from year-to-year, or even, in unusual circumstances, with- in the year. They would contend that the details of how the CEO’s compensation package is structured should be left to the compensation committee to decide, with the caveat that, if the shareholders don’t like the result, they have the option of withholding their vote from compensation committee members who are up for election. They argue that in an era when, particularly among the larger companies, some form of majority voting has generally been adopted, withholding votes from a director is an immediate and much more potent message than an advisory vote. What the proxies tally Continued from page 8 In addition to campaigns on a number of longstanding social issues — ranging from corporate political contributions to sustain- ability reporting — social issue shareholder proponents have focused this year on topics that are prominent in the presidential election campaigns or newspaper headlines. These include: • Subprime mortgage lending: proposals asking companies to disclose mortgage lend- ing practices and risks or to establish board compliance committees to oversee these risks. • Climate change: proposals asking for dis- closure of climate-related risks and opportu- nities or for the establishment of quantitative emissions reductions goals. • Healthcare reform: proposals to adopt universal healthcare principles or to disclose board conflicts or political contributions related to healthcare issues. • Product safety and supply chain issues: proposals to manufacturers and retailers regarding food safety and security, use of lead-based paint and other toxics substances in toys, use of nanotechnology in cosmetics and other products, and use of PVC-based products and packaging. • Human rights in Sudan, China, and Burma: proposals regarding the development, review, or adoption of human rights policies. S o c i a l s h a r e h o l d e r p r o p o n e n t s a r e encountering a changing playing field in 2008. On the one hand, the SEC is proving to be a tougher hurdle on some social issues, increasingly allowing companies to omit pro- posals from proxy statements on “ordinary business” or other grounds. Recently, for instance, New York City sued Apache Corp. over the company’s exclusion of a proposal asking the company to bar discrimination based on sexual orientation. The company omitted the proposal from its proxy after get- ting “no action” support from the SEC staff on “ordinary business” grounds, even though an identical proposal had survived an SEC challenge in 2007. Some observers suggest that the litigation could have important impli- cations for the future of SEC rulings on the exclusion of social issue proposals, similar to the Cracker Barrel legal case in 1992. At the same time, however, proponents appear to have gained ground in the level of voting support for many social proposals, where a few proposals have won majority support, and have been more successful in negotiating settlement agreements with com- panies leading to proposal withdrawals. An example of this trend is the headway that a prominent group of shareholders called the Investor Network on Climate Risk (INCR) has made on climate-related issues. The INCR consists of 60 institutional investors with $5 trillion of assets under management. Support for climate-related proposals has doubled in recent years, rising from an average support level of 11% in 2005 to 22% in 2007. M o r e i m p o r t a n t l y, c o m p a n i e s h a v e increasingly taken the actions requested by proponents. A recent example was an April 9 announcement that shareholders would with- draw a climate proposal at Ford Motor Co. after the company announced that it would become the first automaker to spell out how it plans to reach a goal of reducing greenhouse gas emissions from its new vehicles by 30% by 2020. — Scott Fenn Scott Fenn is managing director of policy of PROXY Governance Inc. He can be contacted at fenns@proxygovernance.com. On the social responsibility front Proxy rePort annual report 2008 51 PROXY Governance, for its part, takes a case-by-case ap- proach to shareholder say-on-pay resolutions. We have gener- ally recommended against them, except at companies where there have been longstanding pay issues, i.e., the compensation being paid to the company executives is not at all commen- surate with the financial performance of the company, or is substantially above the compensation being paid at peer com- panies. These are often instances where we have recommended withholding votes from compensation committee members in the past and the addition of an advisory vote will reinforce the message. An ad hoc group was formed early last year to explore where there is any middle g round on the adv isor y vote issue. The original leaders — AFSCME, Walden Asset Management, and Pfizer — have now been joined by Yale’s Mill- stein Center for Corporate Governance and Performance. On April 8, 2008, a roundtable discussion was held at which it seemed apparent that major corpora- tions are not about to embrace the advi- sory vote concept voluntarily, much less actually propose it as a management recommendation. So it will be particularly interesting to fol- low the vote results this year and compare them to last year’s. There will likely be nearly a hundred such resolutions voted on this year. (There are about 75 on ballots for the spring season.) An early indicator could be Morgan Stanley, which was the subject of a withhold vote campaign against several directors as fallout from the mortgage-related write-offs announced last fall. Despite a very public campaign led by the CtW Invest- ment Group (Change to Win is a coalition of several labor unions that broke off from the AFL-CIO), not only did the effort to oust directors fail by a wide margin, but a shareholder proposal filed by AFSCME seeking an advisory vote actually got fewer affirmative votes this year than last (37% approval versus 39%). So far this season, only three say-on-pay resolu- tions have received majority support (Apple, Lexmark, and Motorola) while 22 others with reported tallies have failed. Legislation that would mandate an advisory vote has passed the House of Representatives and awaits action in the Sen- ate, where a similar bill has been introduced by Sen. Barrack Obama. While it seems unlikely that the Senate will act before the November elections, the outcome of those elections will probably have a major bearing on whether Congress again attempts to intervene in the executive compensation arena, where it has had a notable lack of success. “Vote No” and Other Campaigns “Vote no” campaigns are on the increase this proxy season, particularly targeting directors of financial institutions that have been roiled by the collapse of the subprime mortgage market. As noted above, CtW’s campaign at Morgan Stanley flopped, but shareholder resentment, fueled by the very pub- lic opposition of the AFL-CIO, led directly to the resignation of C. Michael Armstrong as chair of the audit and risk com- mittee at Citigroup. In addition, CtW was more successful at Washington Mutual, where it forced the resignation of Mary Pugh as chair of the finance committee. Although CtW also had Wachovia, Merrill Lynch, and Bank of America in its sights, the union group did not target any directors at those three, apparently because it was satisfied with the outcome of discussions with those financial institutions. However, it has taken on other firms for board accountability and compensa- tion issues, such as Tyson Foods, Ryland Group, and, most recently, Health Man- agement Associates, where it is promot- ing a withhold vote against directors from both the audit and compensation committees. Director opposition campaigns will not be confined to the high-visibility firms whose travails have been so much in the press lately. This year, CalPERS w i l l b e t u r n i n g u p t h e h e a t on p a s t focus list companies that have been unresponsive to shareholder concerns, such as majority-supported shareholder resolutions. CalPERS’ annual focus list is derived from companies in its portfolio whose shareholder re- turn performance and corporate governance are deemed un- satisfactory. Where dialogue with the company is unsuccessful, CalPERS will resort to shareholder resolutions or, this year, vote “no” campaigns against directors. La-Z-Boy, Cheesecake Factory, Standard Pacific, Invacare, and Hilb Rogal and Hobbs all had the dubious distinction of making the list. Hedge Fund Activism In yet another sign that times are changing, a number of cor- porate boards have chosen to negotiate, even with investors holding a relatively small percentage of the company’s stock, rather than wage a disruptive, and conceivably futile, proxy contest. The Wall Street Journal recently reported that, in the first quarter of 2008, 30 U.S. companies agreed to give board seats to dissidents without going to the mat and waiting to see how the vote turns out at the annual meeting. This compares to 23 in the same period last year and nine in 2006. At our firm we find that, in an increasing number of in- stances, both company management and dissidents will ask to meet, not just with the largest shareholders, but also with the proxy advisory services to tell their story. A few of the share- holders choosing to challenge the board for its alleged poor direction of the company are familiar faces such as Carl Icahn, who this year won the battle for board seats at Motorola that he waged unsuccessfully last year. Both Relational Investors and Breeden Partners have also frequently succeeded in win- ning board seats at companies they target through negotiated settlements. But a growing number of challengers are less well-known hedge funds, such as Pershing Asset Management, Crescendo Partners, and Harbinger Capital Partners. As the economy has Proponents of ‘say on pay’ insist that they are not trying to micromanage board compensation policies. Proxy rePort 52 directors & boards deteriorated, we are seeing more and more instances where these funds have determined that board representation is critical in order for them to achieve their financial objectives. For example, Harbinger Capital Partners succeeded in getting two board seats at the New York Times Co. (a follow-up to an unsuccessful attack on the board composition and struc- ture last year by Morgan Stanley Investment Management), and is now waging a proxy battle against another dual-class board at Media General, where the fund is being supported by Mario Gabelli’s firm, GAMCO, which owns a 22% stake in the Class A shares. And Crescendo, flush from its recent success at O’Charley’s, where its threat of a proxy fight led to the compa- ny’s agreement to allot three board seats to its representatives, is now battling with Charming Shoppes. Family-controlled companies with dual-class stock have been a favorite target; not only media companies but also long-established firms like Dillard’s have come under attack, in that case from Barington Capital Management, which recently reached an agreement with the board on the Class A nominees. It remains to be seen, of course, how much influence these new directors will have in a situation where family control has been the norm. Proxy Access Lurking just behind the scenes this year is perhaps the most important issue of all — proxy access. In its simplest terms, proxy access means that shareholders holding some designat- ed percentage of company stock for a defined period of time could propose director nominees that the company would have to include in its proxy statement (thus the shorthand term “proxy access”). Assuming there were more nominees than available board seats, those nominees who received the greatest number of votes would be elected. With the U.S. Second Circuit Court of Appeals decision in October 2006 in the lawsuit that AFSCME brought against AIG, the expectation was that the floodgates would be opened and that proponents of proxy access would propose such reso- lutions at a number of companies. However, perhaps because the decision was handed down close to the deadline date for submitting shareholder proposals at many companies, in 2007 there were only two high-profile battles over proxy access. The first was at Hewlett-Packard, where AFSCME and several state pension funds sought a bylaw amendment permitting proxy access. The resolution received a 43% affirmative vote. The second was at UnitedHealth, where a similar proposal from CalPERS garnered a 42% vote. The SEC, which had declined to grant a no-action letter to HP, then got back into the act. After proposing two contradic- tory approaches in July, and holding a series of roundtable meetings at which all sides were represented, the commission in December 2007, by a split vote, essentially reaffirmed the position that it had been taking before the Second Circuit de- cision. By then, AFSCME had filed proxy access proposals at Board-Related Proxy access . . . . . . . . . . . . . . . . . . . 4 . . . . . . . 1 . . . . . . 36.1% Majority voting . . . . . . . . . . . . . . . . . 42 . . . . . . 17 . . . . . . 50.4% Majority voting reincorporation . . . . . 3 . . . . . . . 1 . . . . . . 42.3% Declassify board . . . . . . . . . . . . . . . 38 . . . . . . 30 . . . . . . 65.0% Cumulative voting . . . . . . . . . . . . . . . 25 . . . . . . . 0 . . . . . . 33.8% Independent chairman . . . . . . . . . . . 44 . . . . . . . 4 . . . . . . 26.7% Board/committee independence . . . . 3 . . . . . . . 1 . . . . . . 24.7% Director qualifications . . . . . . . . . . . . 7 . . . . . . . 0 . . . . . . 3.7% Term/age limits . . . . . . . . . . . . . . . . . . 2 . . . . . . . 0 . . . . . . 3.0% Board size . . . . . . . . . . . . . . . . . . . . . 2 . . . . . . . 0 . . . . . . 3.4% Overboarded directors . . . . . . . . . . . . 3 . . . . . . . 0 . . . . . . 17.3% Ignored shareholder vote committee . 3 . . . . . . . 1 . . . . . . 38.0% Solicitation expense reimbursement . 2 . . . . . . . 0 . . . . . . 7.9% Takeover-Related Poison pill . . . . . . . . . . . . . . . . . . . . . 19 . . . . . . . 3 . . . . . . 33.8% Supermajority voting . . . . . . . . . . . . 21 . . . . . . 19 . . . . . . 68.0% Dual-class stock . . . . . . . . . . . . . . . . . 8 . . . . . . . 1 . . . . . . 28.5% Call special meetings . . . . . . . . . . . . 18 . . . . . . 13 . . . . . . 56.5% Amend bylaws . . . . . . . . . . . . . . . . . . 2 . . . . . . . 1 . . . . . . 64.7% Anti-greenmail . . . . . . . . . . . . . . . . . . 1 . . . . . . . 0 . . . . . . 15.0% Maximize value/sell company . . . . . . . 7 . . . . . . . 1 . . . . . . 16.4% Compensation-Related Say on pay . . . . . . . . . . . . . . . . . . . . 53 . . . . . . . 8 . . . . . . 41.4% Performance-based awards . . . . . . . 27 . . . . . . . 3 . . . . . . 32.4% Pay-for-superior performance . . . . . 41 . . . . . . . 1 . . . . . . 27.7% Severance pay . . . . . . . . . . . . . . . . . 12 . . . . . . . 7 . . . . . . 54.3% SERPs . . . . . . . . . . . . . . . . . . . . . . . 13 . . . . . . . 2 . . . . . . 33.8% Clawbacks . . . . . . . . . . . . . . . . . . . . 10 . . . . . . . 2 . . . . . . 28.7% Stock ownership . . . . . . . . . . . . . . . . 8 . . . . . . . 0 . . . . . . 20.7% Compensation consultant independence . . . . . . . . . . . . . . . . 3 . . . . . . . 0 . . . . . . 40.2% Option backdating . . . . . . . . . . . . . . . 3 . . . . . . . 0 . . . . . . 37.2% Independent directors approve CEO pay . . . . . . . . . . . . . . 2 . . . . . . . 0 . . . . . . 5.3% Pay disparity . . . . . . . . . . . . . . . . . . . . 5 . . . . . . . 0 . . . . . . 7.9% Ban stock options . . . . . . . . . . . . . . . . 5 . . . . . . . 0 . . . . . . 4.3% Disclose compensation over $500,000 . . . . . . . . . . . . . . . . . 4 . . . . . . . 0 . . . . . . 9.9% Cap executive pay . . . . . . . . . . . . . . . 8 . . . . . . . 0 . . . . . . 4.6% Cap director pay . . . . . . . . . . . . . . . . . 1 . . . . . . . 0 . . . . . . 7.7% Cash balance pension plan . . . . . . . . . 1 . . . . . . . 0 . . . . . . 11.5% Pension income accounting . . . . . . . . 1 . . . . . . . 0 . . . . . . 42.8% Source: PROXY Governance Inc. 2007 Shareholder Proposals (Non-SRI) Number Majority Average Voted On Votes Support Number Majority Average Voted On Votes Support Proxy rePort annual report 2008 53 Countrywide Financial, JPMorgan Chase, E*Trade, and Bear Stearns, and CalPERS had filed at Kellwood. AFSCME also threatened to litigate if its proposals were not included in the proxy. However, when the SEC issued no-action letters to all targeted companies, the momentum died, and it became clear that proxy access would not be a major issue at any of the spring 2008 annual meetings. What happens next is more problematic. The SEC promised to revisit the issue when it has a full complement of commis- sioners. The political balance of the commission, specifically the chairmanship, could itself change following the presiden- tial election. But at least for now it appears that the battle at annual meetings over shareholder access to the proxy will not be rejoined until the 2009 season. Some Modest Proposals … … Although nothing as radical as that proffered by Jonathan Swift. With the sea change in institutional investor focus on governance over the last few years, epitomized by the rapid shift to major- ity voting in director elections, board members have good cause to focus on issues on which they would formerly have largely relied on the general coun- sel or corporate secretary. The reason is simple: We will likely see an increasing number of instances where directors are forced to tender their resignations because they don’t receive a majority of affirmative votes. This will be particularly true if the SEC adopts (as it is likely to at some point) the NYSE’s proposed change in Rule 452, eliminating the uninstructed broker vote in uncontested director elections. It won’t be a tidal wave, but it is highly improbable that there is any director who wants to become the poster child. Shareholders do take the position that they have elected the directors (even if they wish they had more choice in can- didates), and that the directors are their representatives, not those of corporate management. It used to be that the CFO or investor relations VP would report periodically to the board on what the sell-side analysts and largest shareholders thought about the financial performance and direction of the com- pany. Now the board should also insist on being briefed pe- riodically on where the company’s largest shareholders stand on governance issues that could become the subject of a proxy proposal. Such a proposal filed by a trade union or public pen- sion fund is unlikely to pass unless it parallels the position of the institutional investors and mutual fund companies that typically vote well more than half of the company’s shares. And with today’s reporting requirements for mutual funds and the fact that many other institutional investors, even if they are not required to report their votes to the SEC, post their voting policies on their Web site, it is not difficult for the company’s corporate secretary or its outside proxy solici- tor to track how its largest shareholders are likely to vote on specific issues. Wh e n a n i s s u e a r i s e s v i a a p rox y proposal, or prior to that time if the company is approached by an activist shareholder with a track record of fil- ing proposals, the board should care- fully pick its battles. In today’s environ- ment, a majorit y vote proposal, or a proposal to eliminate a classified board or supermajority voting provisions, will almost undoubtedly win, generally by a substantial margin. Similarly, in the compensation arena, tax gross-ups, the absence of a clawback provision, single- trigger golden parachutes, SERPS that are perceived as excessive, and severance provisions that are a large multiple of annual cash compensation are at the very least suspect in the minds of most shareholders. A board today would be well advised to get out in front of most or all of these issues. Or if directors choose not to address them, they need to have a good reason, tailored to the particular circumstances of the company. There is little point in letting, for example, a shareholder proposal to adopt a majority vote requirement in director elections go to a vote at the annual meeting when the outcome is foreordained, and the board will likely have to embrace it prior to the next year’s meeting or risk the possibility that directors will receive a very high percentage of withhold votes at that meeting. ■ The authors can be contacted at melicanj@proxygovernance.com and westcotts@proxygovernance.com. More hedge funds are determining that board representation is critical in order for them to achieve their financial objectives. reprints from Directors & Boards A reprint or licensed .pdf file is a professional way to educate your board or your customers on a key corporate governance issue. Call Barbara Wenger at 215-405-6072 or email bwenger@directorsandboards.com.
 


Other related articles

  • Corporate Governance at Mid-Market Companies
    Published July 19, 2019
    By April Hall
    Survey finds most companies have independent chairs, and a rise in dual-class stock structuresA new survey of mid-market public companies sheds light on a host of corporate governance practices, from ...
  • Compensation Committees & ESG
    Published July 16, 2019
    By Don Delves and Ryan Resch
    Human capital management and oversight should be a bigger part of the agenda.By Don Delves and Ryan ReschEnvironmental, social and governance (ESG) issues are increasingly important to boards and thei ...
  • Director Data Annual Report 2019
    Published June 28, 2019
    By Directors and Boards
    Trends for the 2019 Proxy SeasonShareholder voting during 1,024 meetings held during the “mini-season” between July 1 and Dec. 31, 2018 provides a window into what’s in store for the 2019 proxy ...
  • Elizabeth Warren’s Accountable Capitalism Act
    Published May 13, 2019
    By Eve Tahmincioglu
    Delaware’s supreme court chief justice sees merit in calling for employee representation in the boardroom and ESG disclosure for all large companies — public and private. Last year, U.S. Sen. ...