Here comes the flood. The moment of truth when all the plans and all the countless meetings and mailings and proxy promises crystallize; the time when management measures its success or failure in the minds of investors. It’s proxy season.
Navigating the corporate vessel through this year’s annual meeting means steering into a swelling tempest of investor activism amid a climate of uncertain markets. Batten down the hatches, because the winds of change are blowing harder than ever and this one should be a dandy. In the annual give-and-take game between management and shareowners, the rules are changing.
For starters, while perennial issues such as executive compensation and poison pills are certain to blossom anew, institutional activists have turned up the heat. With a flurry of binding bylaw proposals, they are targeting companies that have ignored precatory resolutions.
First used only a few years ago, the approach is escalating. State of Wisconsin Investment Board (Swib), for example, has joined some union funds and arbitrageur/activist Guy Wyser-Pratte in an unprecedented challenge to board decision-power in these areas. Other binding proposals will be submitted by Gabelli Funds and Lens.
‘When Swib backs something like this, how far behind are Calpers and Cref?’ asks Joe Spedale, executive vice president at Kissel-Blake. ‘Shareholders refuse to be ignored. By banding together, they can send management a strong message.’ Indeed, the fact that unions are joining with such ‘credible’ activists may herald things to come.
Seizing command
In addition to going over the board’s head with a binding resolution, another tactic on the upswing is simply taking over boards that ignore shareholders. In nearly 20 cases last year, dissidents seized corporate control without a tender offer. Emboldened by that thrifty example, dissidents seem set to take up the cause again this year.
Last year also marked the first time a big institutional investor took control of a company. The $240 bn Teachers Insurance and Annuity Association-College Retirement Equities Fund (TIAA-Cref) solicited to replace the entire board at Furr’s/Bishop’s Inc, a struggling cafeteria company with a highly institutionalized shareholder base. Here again, no premium was on the table. Cref calls the situation ‘unique’, but it may pave the way for future solicitations at this level.
‘Institutions feel they can take a much greater role in corporate governance than just voicing their opinions,’ says John Graw, head partner at Beacon Hill Partners, the proxy solicitor for most of the winning dissidents. ‘They want to make change and they can. Events last year proved it.’
Meanwhile, last year’s AMP/AlliedSignal conflict turned the spotlight on poison pills. Binding or not, shareholder proposals which ask companies to put their pills to shareholder vote are increasingly common. Attempting to deflect criticism, many managements have designed ‘chewable’ pills.
Activists have also filed about 200 social resolutions on topics ranging from environmental to employment issues, both domestic and international. Meanwhile, individual proponents, who accounted for nearly two thirds of resolutions coming to votes in 1998, will swarm back again this year. William Steiner, for example, will be active again in 1999, focusing on corporate control and governance.
Risk vs return
Last year’s market fall left a lasting impression on investors. Nor have all companies completely recovered. As always, companies most at risk on governance and control questions are those seen as underperforming or undervalued. Big ticket institutions like New York City funds, Calpers and Cref will continue with a host of governance questions at vulnerable companies. Many of these relate to board independence, structure and competency. This year, their activism targets include more small and mid-cap companies.
Gaining force behind many of this season’s storm fronts is the demand for board accountability and shareholder rights. Cref, for example, has introduced a resolution at several companies calling for a move toward more independent boards. Proxy advisory firm Institutional Shareholder Services (ISS) is considering withholding votes on compensation committee directors when compensation packages are deemed abusive. Meanwhile, prodded by accounting curiosities at companies like Cendant, Sunbeam and YBM Magnex, activists are also poised to focus much more on audit committees.
‘The classic role of the board is monitoring,’ comments Bill Fiske, vice president at proxy solicitor and corporate governance consultant CIC. ‘In the 1980s, people considered legal liability to ensure board accountability in that role. Now, the view is that equity ownership is the best incentive.’ Yet, as equity becomes the currency of compensation, the watchers are being watched more closely than ever.
Yes, we have no options
With unstable markets, stock option repricing has caused great consternation in investment circles. Is repricing fair? If so, under what conditions? Although usually a board responsibility, activist shareholders are clamoring for a say in the repricing process. That is taking two forms.
For example, as in 1998, Swib has targeted several firms for binding proposals requiring shareholder approval before a repricing. Last year, Swib offered, or threatened to offer, binding bylaw proposals at 22 companies. Eighteen of them adopted policies acceptable to Swib, which then withdrew its proposals.
Alternatively, companies that have repriced options may find themselves subject to other sorts of shareholder reaction. Even if shareholder proposals are not on the cards, they may face increasingly coordinated efforts to withhold votes for directors.
Few firms are willing to allow direct shareholder decision-making in this area (five companies sought shareholder approval for repricings last year), yet many are sensitive to shareholder concerns and are fashioning more palatable option repricing plans. For example, some plans exclude top officers. Others include setting a blackout period on vesting the repriced options, and restarting vesting schedules for options following exercise price adjustments.
Perhaps most in vogue is ‘value for value’ repricing. Using an options pricing model, the diminution in shareholder value caused by the repricing event is taken into account by pulling back some options. If, for example, a plan participant has ten options with a $10 strike price, they may only get back five or six at a $5 level.
Avoiding stigma
All in all, however, it is probably best to avoid option repricing, counsels David Drake, managing director at Georgeson. ‘Great stigma is attached to repricing,’ says Drake. ‘The market takes a negative view, particularly if it’s done without shareholder consent. Even if a company’s share price has dropped, repricings should be avoided unless critical to survival.’
‘The trend is investor outrage over the repricing issue,’ adds Patrick McGurn, director of corporate programs at ISS. However, McGurn points out that ISS, popularly considered a repricing ‘enemy’, recommended bringing repricings to a shareholder vote last year in four out of the five companies. ‘Our position is that we want votes on repricings but it is not so cut and dried as the corporate community sometimes paints it.’
‘The best move is to submit your proposal to shareholders,’ advises Jamie Heard, president of proxy advisor Proxy Monitor. ‘If your reasoning is sound, institutions will consider the proposal on its merits. The process generates considerable goodwill.’
However, a shareholder vote on option plans will put some companies in a precarious position. ‘The company is telling employees it will reprice options, only later to find out that shareholders vote it down,’ points out Georgeson’s Drake.
Nevertheless, some shareholders are still smarting after last year’s Cendant affair. During a market downturn, a repricing was approved. But when the market bounced back, employees and senior management saw a windfall profit and rubbed their hands with glee. Management said the repricing was necessary after an unsuccessful merger. As criminal allegations colored the issue, many shareholders were not convinced the windfall was really earned.
Fogging the issue
The mere fact that a stock’s price has dropped is no justification to reprice. But the issue gets murky with Silicon Valley companies which are subject to tremendous volatility, where employee loyalty is tenuous, and stock options are practically a birthright.
High-tech companies argue that option repricings are necessary to retain staff. However, some academic studies do not bolster that argument. Still, as with proxy advisors, institutions themselves will often consider specific circumstances before making a decision.
‘We don’t say all repricings are impermissible,’ says Peter Clapman, chief investment counsel at Cref. ‘But companies should be careful about how they go about it and their particular circumstances. There has been abuse in options repricing.’ Cref’s decision-making process considers who the repricings are available to and whether an historical pattern of ‘overgenerous’ options exists.
Clapman’s opinion is echoed by new provisions in the Council of Institutional Investors’ Shareholders’ Bill of Rights, which states: ‘Unless submitted to shareholders for approval, no ‘underwater’ options should be repriced or replaced.’ For its part, Calpers announced it will urge targeted firms to put any future repricings to shareholder votes.
Beyond shareholder anger, there is also the smouldering issue of SEC disposition on binding bylaw resolutions as they affect the repricing issue. Last year Shiva Inc obtained a ‘no action’ letter that indicated broad-based options repricing was ‘ordinary business’ and not subject to shareholder approval. Amid shareholder outcry, the SEC revisited the matter in connection with a Swib-sponsored proposal to amend bylaws at General Datacomm Industries. There, the SEC ruled proposals relating to option repricing cannot be considered matters relating to ordinary business.
In the end, however, the whole issue may fade Fasb has indicated its approval for a regime forcing companies to take charges against earnings when they reprice shares. That would effectively put the kibosh on repricings.
As 1998 drew to a close, Fasb tentatively set a deadline of December 15 for companies to complete repricings free from the threatened earnings charges. The irony is that the resulting wave of ‘buzzer-beating’ comes just after a survey showing most companies had refused to make knee-jerk repricing decisions due to the market’s recent volatility. Yet more irony may be in the offing as shareholders react to all the repricing this proxy season.
