Shareholder activists have seen their influence rise over the last few years, buoyed by the increased attention of institutional investors on issues of corporate governance. But while a broader array of shareholders are willing to buck the company line and voice dissent, proponents of shareholder rights are encountering a disturbing trend: companies from blue chips to not-so-blue chips have been ignoring majority votes on a range of non-binding shareholder resolutions.
Of course, non-binding proposals are just that – non-binding. But while some of the companies have outlined their reasons for not adopting shareholders’ recommendations, others have chosen not to respond at all.
‘Clearly there’s been a real frustration with some of the responses from companies, especially when they’ve ignored majority votes for four consecutive years. For the most part, very few companies have agreed to do exactly what shareholders have recommended,’ says Ann Yerger, director of research at the Council of Institutional Investors, a Washington pension fund group. ‘I think there’s definitely been a lot of soul searching in the investor community over whether non-binding proposals are optimal.’ To date, says Yerger, companies have not faced any serious repercussions for ignoring proposals that win the majority of investor votes. But while shareholders in the past have had limited success enforcing their resolutions, they are beginning to explore a range of options to put additional pressure on unresponsive companies.
Skipping the niceties
Gary Lutin, an investment banker who’s been co-sponsoring corporate control forums with the New York Society of Security Analysts, has a simple solution for shareholders wanting to press for action by boards that ignore successful non-binding resolutions: submit binding resolutions. In other words, vote to amend the bylaws directly. ‘Under Delaware law, where most companies are incorporated, shareholders do have the right to modify bylaws,’ he says.
By submitting a binding proposal and winning a majority vote, shareholders effectively force the board to amend the bylaws. As powerful a tool as it might sound, however, bylaw proposals are seldom used. One reason for their rarity is that their legality is in considerable dispute.
‘The question of the binding bylaw provision is still up in the air,’ says Brian Lane, partner at legal firm Gibson Dunn & Crutcher and former SEC director of corporation finance. ‘It’s permitted in some states, but not in others, and there are uncertainties over whether or not it applies in Delaware. Some leading Delaware lawyers say the law doesn’t permit bylaw binding proposals, while other prominent professionals say it does.’
But Kenneth Bertsch, director of corporate governance at TIAA-Cref, believes that everyone has been too quick to assume that binding bylaw proposals wouldn’t succeed in Delaware. He adds that the pension fund giant has not ruled out resorting to binding proposals when companies ignore its non-binding resolutions. ‘If a proposal did succeed, it could really hamper companies’ flexibility in the future.’
Both Bertsch and Lane note that even if Delaware supported bylaw proposals, the courts might choose not to restrict the boards’ ability to amend the bylaw in the future. In other words, even if shareholders succeeded in amending the bylaws, the board could simply turn around and change them back. But they argue that it’s still an unenviable position for the company.
‘Under Delaware law if a poison pill bylaw proposal was upheld but the board was allowed to change it a day later, I think that board would face an investor backlash. In this case, the board is required to actively veto something; that’s a much more provocative act, and you’re going to have some people very angry about it,’ says Bertsch.
Given the legal uncertainties, as well as the unappealing option of ending up in a protracted court battle with companies choosing to fight binding proposals, shareholders tend to view them as a last resort. But that does not mean companies that ignore non-binding resolutions are home free.
‘A binding bylaw proposal is just one of many mechanisms being used by activist investors who are all geared toward the same end goal, which is to ensure greater accountability on the part of the board of directors to focus on shareholder value. That means the binding bylaw proposal is just one arrow in a quiver with many other arrows,’ says Corinna Arnold, former deputy executive director and chief of operations at the Investor Responsibility Research Center.
Just vote no
One option that has become popular in the last couple of years is what’s known as the just vote no campaign. ‘At US companies, you can’t actually vote no in a proxy, unlike the UK and a lot of other markets,’ says Patrick McGurn, director of corporate programs at Institutional Shareholder Services. ‘Instead, in the US you can vote for a proposal or you can withhold voting authority. You’re really withholding voting authority for the directors’ election or reelection to the board. It’s a vote of no confidence. It used to be unusual for more than one or two percent to be withheld, but you’re seeing much higher numbers today because of these campaigns.’
One of the most active proponents of the vote no campaign has been the New York City Employees’ Retirement System (Nycers), which initiated three this year, including an effort to protest Great Lakes Chemical board nominees’ failure to repeal the firm’s classified board following a 1998 majority vote. The vote no campaign attracted over 27 percent of the votes.
As for the effectiveness of those campaigns, the jury is still out, says Ken Sylvester, director of pension policy at Nycers. ‘We have not gotten any encouraging responses from the companies at this time. So I haven’t really seen any real change… yet. But in terms of bringing the issue to the floor and increasing awareness about the issue of the majority vote and the inaction on the part of boards to the majority vote of shareholders, I think the vote no campaign really helped to focus shareholder attention on that very critical piece of corporate governance. So it was positive from that standpoint.’
Final frontier
When it comes to countering unresponsive reactions to non-binding resolutions, McGurn says that the just vote no strategy is one of the easier, more accessible tools at shareholders’ disposal – the soft touch, if you will. Meanwhile, a binding proposal turns up the heat, forcing the company to respond in some fashion. But the most severe option shareholders can turn to is running their own slate of directors. ‘That’s the newest buzz – finding your own people to run for the boards,’ he says.
Investors have turned to this option with limited success in the past, but never in response to a majority vote being ignored. It is, says Yerger, the final frontier. ‘It’s been a topic that’s been discussed by council members, in particular a short slate, where you replace one or two of the seats. The council has recently formed a committee of members who will be exploring this issue and trying to educate our members about it.’ For companies, the stakes are high, as they face a proxy contest which costs them money to fight. If the proponent ultimately prevails, they get their nominees onto the board. Running a dissident slate may only be a threat at this point, but the strategy is gaining attention as proxy contests have become more accessible.
‘My prediction is that five years from now, you may see more proxy contests occurring because the costs are going down with the advent of the internet, and because the SEC has liberalized its rules in the area to allow for more communication,’ explains Lane. ‘You now have a more level playing field of information, and you’ve got lower cost access to shareholders. So that’s a recipe for a few years down the line when activists or proponents won’t see a downside to proxy contests. Maybe they’ll be low budget with little chance of success, but they may still try it just to get management’s attention.’
Slap in the face
Ultimately, the extent to which shareholders resort to aggressive tactics depends on the treatment their non-binding resolutions receive. That does not necessarily mean companies have to make those resolutions binding themselves – though many proponents would argue otherwise. But by communicating effectively, rather than pretending a majority vote didn’t take place, companies can dodge the binding bullet. Lane states his case: ‘From an IR standpoint, companies should seriously consider putting forward their thoughts about why they’re not going ahead with the recommendations of their shareholders, as opposed to ignoring them. For example, on the issue of redeeming the poison pill, a popular goal for activists shareholders, companies believe it would be bad not to have some sort of mechanism to slow down a rapid takeover. The company could say, Look, we hear that the majority of people want to get rid of the pill, but here are our views on why we think it’s important to have it in place.’
Lane advises companies to show responsiveness and a willingness to review policies. ‘That’s not much of a concession, and it’s what IROs do: they get the word out that the company cares about shareholders, and they want to be responsive to the needs and the wills of investors. I think it’s a good opportunity for the IRO to play a role in this.’
