On July 19, 2013, Halliburton Co. filed a Form 8-K with the SEC disclosing its board the previous day had amended Section 6 of the company's bylaws. That section governs director nomination matters. The change requires that any proposed director nominee must deliver to the company a signed representation and agreement that he or she:
“. . .is not and will not become a party to any agreement, arrangement or understanding with any person or entity other than the Corporation with respect to any direct or indirect compensation, reimbursement or indemnification, and has not received any such compensation or other payment from any person or entity other than the Corporation, in each case in connection with candidacy or service as a Director of the Corporation.”
The bylaw permits indemnification and/or reimbursement for out-of-pocket expenses a nominee may incur in seeking to be a director (but not service as a director). Also permitted is any pre-existing employment agreement the candidate has with his or her employer (not entered into in contemplation of an investment in the company or the nominee's candidacy). Permitted arrangements must still be disclosed to the company in writing. The provision looks in all directions temporally: past, present, and future. In its filing, the company didn't elaborate or provide commentary on why it adopted the amendment when it did.
So, it raises the question: Why adopt such an amendment?
The backdrop
Hostile takeover attempts have been trending down for a number of years. The drivers behind that have been reported and explored elsewhere. Meanwhile, broader forces have converged to make conditions favorable for activists. Campaigns have been increasing. Different moniker and maneuvers; same goal: Create Change, Enhance Value.
And activists have been winning. In contests for board seats, they've scored success rates (whether through settlements or elections) of 44%, 49%, and 41% in 2013, 2012, and 2011, respectively, according to data from FactSet Shark Repellant. These are higher success rates than in hostile contests.
To make their case more persuasively, and try to get shareholders to look and vote their way, activists have sought to pull from their talent banks experienced people with targeted knowledge to serve as director nominees standing behind the activists' value propositions. Finding talented people willing to climb in the ring and subject themselves to proxy contest gyrations for the rewards involved, however, can be challenging.
During the 2013 proxy season, in separate contests, two funds sought to deal with this challenge by turning to a newer page in the playbook: They offered incentive compensation arrangements to director nominees who were to be independent directors.
• Agrium. As part of its campaign against Agrium Inc., Jana Partners LLC nominated five directors. In seeking to align the nominees' interests with stockholders, Jana offered four of them (the fifth was a Jana executive) a percentage of Jana's profits from its investment over a three-year period (beginning Sept. 27, 2012). Each nominee would receive a slightly different amount (e.g., 0.60%). In the aggregate, it equaled a 2.6% profits interest if all were elected, and a 1.8% profits interest even if none were elected. This was in addition to paying each nominee a fee ($50,000) for agreeing to serve on the slate for the duration of the contest (for time and expenses). Jana had proposed a similar arrangement in its fight for CNET in 2008.
In mid-May 2013, Jana lost the proxy fight and none of the nominees were seated. The loss has not been attributed simply to the incentive compensation arrangements. Notwithstanding the loss, Jana's nominees appear to be in a position to receive payments depending on how Jana's economics work out given their agreements. Jana has continued to express its belief that directors should be paid for performance. As a side note, one of the directors sitting on Agrium's board, but who was not one of the directors Jana targeted to replace, is Halliburton's chairman and CEO.
• Hess. In its campaign against Hess Corp. during the same period, Elliott Management Corp. agreed to pay each of the five director nominees it put up for the 14-member Hess board $10,000 for each 1% that Hess shares outperformed the average total return of a selected industry peer group during the follow-on three-year period. If any of the candidates were appointed or elected to the board, they'd be eligible for an additional $20,000 for each 1% of outperformance, with the maximum incentive payment capped at $9 million per director.
After taking blowback on the arrangement, the nominees announced in May 2013 they had agreed to waive the right to receive the incentive payments, and would receive only the standard “tipping fee” ($50,000) from Elliott for agreeing to serve as a nominee. The nominees commented the issue had become a “distraction,” but they “believed the arrangements are appropriate and consistent with the performance of our duties as independent directors.” The contest was resolved in mid-May when Hess agreed just prior to its annual meeting to replace more than half of its board with new directors, including three Elliott-backed nominees.
In their contests, Agrium and Hess challenged the independence of nominees to be paid directly by the activists in amounts far greater than their company-paid director compensation, and raised conflict of interest claims and other criticisms. Hess noted, among other things, “large bonuses based on short-term stock price appreciation [encourages directors] to take excessive risks to achieve substantial payouts.” Jana and Elliott countered the arguments with their own. In each contest, the arrangements were fully disclosed up front for stockholders to see and evaluate for themselves.
This wasn't the first time activists offered incentive compensation. But as the issue gained visibility, some pyrotechnics started firing, with corporate governance experts, academics, investment professionals, institutional investor organizations, some proxy advisory firms, and pundits alike weighing in, taking sides, and staking the fallout zone. Considerations were raised in the train of larger themes, such as whether traditional concepts around the meaning of “independent” need to be re-contextualized. One law firm offered up a form of bylaw amendment companies might consider adopting that would disqualify director nominee candidates from serving as directors who were party to or had received any special compensation arrangements. Halliburton's bylaw resembles that template.
A review of the merits and demerits of the various arguments involved in the debate is beyond the scope here. But some observations flow from the skirmishes without getting into a polemic.
A view to the future
It's not clear other activists will push the incentive pay feature in future campaigns. No matter the views on pay for performance for directors, counterattacks by the targets here were predictable, as the activists no doubt knew would be the case. Arguments could easily be raised around such themes as independence, conflicts, board bifurcation, risk taking, and corporate governance generally. This notwithstanding available counterarguments the activist community can marshal on those and other topics, including certain prevailing realities around the “short-termism” argument.
As such, the arrangements can add a further complicating dimension and distraction to an already complex set of deal dynamics when there are larger issues on the table around value creation and how to achieve it. Using the incentive pay feature may unwittingly afford a target important strategic space within which to maneuver, and allow the issue to be used as a sword to allege financial self-interest while diverting attention from the target's own possible shortcomings that presumably should be the main attraction. When all that strategic coloring is factored in, the arrangements may become an inflection point in a deal the long-term benefits of which might get outweighed by the short-term harm of having it part of the mix. As with any deal-related tactics, its deployment must be contextualized.
Transparency is required
As Jana and Elliott each noted pointedly in their respective contests, any director nominee with such a compensation arrangement who ended up getting appointed or elected would still have to fulfill his or her fiduciary duties to the same degree as all other directors. But in the “Be Careful What You Wish For” category, the litigation risk profile for those directors, and presumably the activist group itself, would surely rise in transactions where such arrangements are present — especially given recent trend lines in M&A-related litigation. Shareholder plaintiffs' counsel would certainly be afforded an easier pathway to at least allege self-dealing and breach claims, resulting in potentially time consuming and expensive litigation for all.
But as noted, in their campaigns, Jana and Elliott each disclosed up front the arrangements with the director nominees, and were transparent and communicative on them. Nothing was hidden. Stockholders could stare at the arrangements as they wished and vote accordingly.
In Hess, the nominees waived their contractual right to the payments a few days before a negotiated settlement was reached. In Agrium, the arrangements stayed in place through the vote. It's unknowable if the vote would have been any different if the arrangements weren't part of the mix or the vote went against Jana for other reasons. Certain proxy advisers supported the campaigns notwithstanding the feature. If fully disclosed, one can argue what's the harm of letting stockholders decide for themselves if the dissident slate should be seated, arrangements and all, rather than limiting their nomination via a bylaw provision.
If a company had in place a bylaw of the sort described above, activists surely would be restricted in terms of what they could offer director nominees. They'd need to continue looking for strategic alternatives to draw talent. Trying to put some sort of compensation arrangement in place in advance with potential director nominee pools would be inefficient, since one wouldn't know what opportunity may arise somewhere downrange in what industry silo, or what skill sets might be called for, or what people might be available as potential nominees. And any such pre-agreed arrangement might nevertheless bump up against the bylaw's broad prescription. But perhaps other solutions can be imagined around compensation matters.
At the same time, a bylaw approach could reach beyond activists and have unintended consequences. There currently are hundreds of public companies where stockholders with significant stakes may have directors sitting on the board on their behalf, including large strategic investors. The full contours of all the compensation arrangements those directors may have (currently or in the future) with the party they represent is unknowable in terms of whether they'd get caught up in such a bylaw provision.
Then again, it's just a bylaw amendment. And boards typically can amend bylaws on their own when needed to address exigent facts and circumstances that arise. If no incentive pay arrangements were entered into with nominees in advance, and a dissident slate were to succeed, of course there is the prospect that such a bylaw provision could get eliminated by a new board afterwards.
Final judgment
It's not clear if others will adopt a bylaw provision of the sort discussed here, in the name of good corporate governance or otherwise. So we've moved downrange somewhat on the issue. But there likely will be more
debate to come.
If a company were looking to add such a bylaw provision as part of a calculation, it would be better as a strategic and planning matter to make the set-up move in advance of any possible contest as opposed to after it begins. But one thing is clear: If anyone is interested in knocking on someone's door and has an action plan that withstands the klieg lights and can persuade, a bylaw provision may help stymie an effort and/or dilute a potential nominee pool. But it's not a shut-down move that will slow anyone down for long if larger forces are at work. â–
The author can be contacted at jhughes@sidley.com. The views expressed in this article are the author's own and do not represent the views of the law firm's partners or its clients.