In early June shareholders representing some 40 percent of the outstanding shares of US natural gas giant El Paso joined together, by phone and in person, at the Washington, DC offices of the AFL-CIO (the federation of America’s labor unions). They heard two presentations: one from the company’s current board of directors, along with its interim chairman and CEO; and a second from a dissident slate of directors assembled by Selim Zilkha, a former board member himself and El Paso’s largest single shareholder.
‘Quite frankly, we didn’t go into this thinking we’d vote for the dissident slate,’ says Michael Garland, corporate transactions coordinator for the AFL-CIO. ‘But we were surprisingly disappointed by the company’s presentation and its inability to fully acknowledge past problems and the need for corporate governance reorganization. So we came out in support of the dissident slate, which is quite remarkable given the high threshold for such a change. I’m not sure this would have happened two years ago. The momentum has shifted.’
The AFL-CIO wasn’t alone in its conclusion. Institutional Shareholder Services, the influential proxy advisor, also came out in support of the dissident slate (minus Zilkha himself). But a few weeks later El Paso, which had suffered a devastating decline in its share price following an ill-fated foray into energy trading, eked out a victory. Preliminary counts the day after the June 17 annual meeting showed the incumbent slate elected by a margin of just 5 percent.
Record resolutions
That a company the size of El Paso – or any company for that matter – faces such a serious threat of losing control is shocking. But these have been shocking times in the corporate governance world.
Not surprisingly, the public’s outrage over corporate misbehavior was brought to a boil this past proxy season. In 2002 the number of non-binding resolutions jumped from the year before and this year’s figures have spiked even further.
According to the Washington-based Investor Responsibility Research Center (IRRC), there were 802 shareholder proposals filed last year with 529 focused on corporate governance. By May 2003, with another month to go in the season, 1,041 proposals had been filed. The pay debate, encompassing everything from stock options expensing to golden parachutes, is the number one issue, with 324 proposals filed through May versus 106 for all of 2002.
‘Shareholders are energized in response to the miserable performance of the stock market and the daily headlines reflecting out-of-the-sky executive compensation packages being awarded,’ according to Michele Soulé of the IRRC. ‘Even though shareholder resolutions that pass with a high percentage of votes are legally non-binding, [boards] will feel some accountability in their activities, especially if they act contrary to the wishes of shareholders.’
The number of votes cast in support of shareholder resolutions has also soared. That’s putting pressure on companies to launch aggressive counterattacks or to engage shareholders in an effort to have the proposals withdrawn through dialogue.
‘There’s no doubt certain shareholder proposals are receiving more support from more investors than ever before,’ says Bruce Goldfarb, senior managing director at Georgeson Shareholder. ‘In some cases there are shareholder proposals, such as those to rescind poison pills or destagger boards, that are almost certain to achieve the support of the majority of shares voted. Some of our clients determine that it makes no sense to actively fight those proposals. In other cases it makes sense for companies to campaign against a shareholder proposal because the proposals may not fully frame the issue and management may be successful in helping investors understand the position they’re taking.’
Compensation matters
A good example of a proposal receiving unusually high support this year is the expensing of stock options (see ‘Looking for options’, June 2003). Analog Devices faced such a resolution this year and saw a surprising number of investors vote against management. Like many companies, it considered petitioning the SEC to keep the proposal off the proxy.
‘I think this was the first shareholder resolution on our ballot,’ says Maria Tagliaferro, director of corporate communications at the semiconductor maker, which claimed 61 percent of the votes. ‘Around the time that we were looking at having it omitted, the SEC was trying to be very cut-and-dry, saying, If the proposal met the filing deadline, we don’t want to review it. But we didn’t contest it anyway.’
As for other companies looking to the SEC to help keep resolutions off the proxy, they may find it a hit-and-miss proposition. The commission recently let stand a decision by its division of corporation finance allowing Citigroup to omit a shareholder proposal submitted by the American Federation of State, County and Municipal Employees (AFSCME). The proposal asked Citigroup to allow the company’s shareholders or groups of shareholders holding 3 percent or more of the company’s stock to nominate board candidates, and for those nominations to be included in the company’s proxy statement.
Despite the ruling, the landscape may soon change for similar proposals. The SEC has directed its division of corporation finance to review current shareholder proposal rules covering everything from the election of directors to the solicitation of proxies for director elections and contests for corporate control. Proposals were due by July 15.
New activists
Along with the sheer number of shareholder proposals this year, the profile of shareholders taking activist stances is remarkable. Mainstream institutional fund managers have begun to raise their voices rather than leave the fight to traditional shareholder activists.
In May Tweedy Browne, a New York-based money manager, voiced its displeasure with newspaper publisher Hollinger International over payouts to senior executives including Conrad Black, the company’s chairman and chief executive. The firm filed a letter with the SEC asking Hollinger’s board to investigate payments totaling more than $70 mn.
According to Laura Jereski, an analyst at Tweedy Browne, the firm has always been vocal with management when there have been differences. ‘Contacting management in this way is business as usual for us,’ she says. ‘But executive pay is probably a bigger issue for others than it has been in the past.’
The issue of executive pay is so big that companies are being forced to take shareholder complaints regarding compensation seriously. At Hollinger’s annual meeting, Black agreed to limit his annual pay to $6 mn and cede some control of the company he runs. Current and former top executives of advertising giant Interpublic agreed to relinquish more than 1.2 mn stock options after shareholders expressed outrage over the size of executive rewards at a time when the stock price had plummeted.
In the UK, where investors have balked at US-style pay packages, a revision of the Companies Act at the beginning of 2003 now requires listed companies to disclose full details of their executive contracts and allow shareholders an ‘advisory vote’. The change has already claimed its first victim. Pharmaceuticals giant GlaxoSmithKline saw the proposed severance pay for its chief executive, Jean-Pierre Garner, voted down by investors. The package was estimated to be worth $35 mn.
‘GlaxoSmithKline is described as an Anglo-American company, but because it’s UK-based, it had to put the compensation to a vote,’ says Karina Litvack, director of governance and socially responsible investment at UK fund manager Isis Asset Management. ‘We’ve been talking to them for years about how they structure pay in relation to share price performance. It was a spectacular rejection of the plan.’
For investors, it seems the stars were aligned this proxy season, creating a favorable environment in which to push their demands. Last year shareholders including Isis won the vote calling for a majority of independent directors at data-storage company EMC. This year Apple Computer lost its vote on expensing stock options.
‘Certainly in the last couple of years we’ve seen an increase in the number of proposals put forth on a variety of issues,’ says Nancy Paxton, senior director, IR and corporate finance at Apple. ‘I wouldn’t say we’re dealing with shareholder proposals any differently than we have in the past. We’ll look at the proposal and see if it’s in the best interest of shareholders; and if it is not, we’ll try to initiate a dialogue with the investor.’
In fact, in such an environment, communication is critical. And this is no passing fad: ‘This proxy season is almost over, but next year, for most companies, is right around the corner in terms of the preparation and analysis that should be done,’ suggests Bruce Goldfarb. ‘Communication with shareholders should be a year-round event.’
Isis discloses its votes
In January the SEC voted to adopt rule amendments requiring mutual funds and other registered management investment companies to disclose their proxy votes. Funds will be required to make their first proxy voting disclosures by August 31 for the twelve months ending June 30, 2004. Despite its location, Isis Asset Management, owned by UK insurer Friends Provident, is ahead of the game. ‘The controversy over mutual funds publishing their votes hasn’t been as big an issue here, but we figure it will come,’ says Karina Litvack, director of governance and socially responsible investment at Isis Asset Management. ‘So we’ve taken a stand early, and we’ve taken the view that we have nothing to hide. We disclose every single vote executed on behalf of the Friends Provident portfolio. In a given year there are 14,000 such votes. We post the votes monthly, and we also explain the vote. We’re most active in the US and the UK, though we have investments all over the world. I do believe that companies are more apt to listen now that we’re disclosing.’
