Majority voting is taking center stage this proxy season in the US – and the SEC’s controversial shareholder access rule is on the back burner. The new system is rapidly picking up speed, with some companies voluntarily testing it this year and proponents pushing for widespread adoption.
Under the existing US proxy system of plurality voting, a candidate backed by the board can be elected with a single affirmative vote, even if a substantial majority of shareholder votes are withheld. While shareholders can choose to withhold their ballot or vote in favor of a nominee, they are not able to oppose the election of a director. The majority system, on the other hand, requires a majority of votes cast by shareholders to be in support of a director nominee in order for him or her to be elected or reappointed to the board. Shareholders get a say in director elections under this system – so it’s likely to increase director accountability.
The US is considered to be behind schedule in global best practices, with majority voting being standard conduct in the UK, France and Germany, as well as other European nations. ‘No one has been able to make any kind of argument as to why somebody who does not get a majority of the votes should serve,’ comments Nell Minow, editor of the Corporate Library.
Test cases
Some prominent US companies already use majority voting including Best Buy, Lockheed Martin, Teco Energy and US Bancorp. Others, including retailers Lowe’s and Dillard’s, are expressing their intent to adopt the system. And two companies, Gannett and Caterpillar, have so far had strong support for majority voting proposals this proxy season. Specifically, 48 percent of Caterpillar holders and 38 percent of Gannett investors voted in favor of the system.
The United Brotherhood of Carpenters and Joiners of America and other trade unions submitted majority vote proposals to Gannett, Caterpillar and 78 other companies this year. Also testing out majority voting are a group of eleven companies including ChevronTexaco, Gap, Intel, JPMorgan Chase, Merrill Lynch and Time Warner. They signed on to participate in a ‘majority vote group’ after pressure from union fund activists. ‘I have seldom seen an issue that has gained so much support so quickly,’ says Minow.
Along with unions, proponents of the system include the International Corporate Governance Network (ICGN), Institutional Shareholder Services (ISS), Calpers and the Council of Institutional Investors (CII).
‘We have a desire to hold directors accountable,’ explains Calpers spokesperson Brad Pacheco. ‘It doesn’t seem reasonable that a director can receive greater than 50 percent of withhold votes from shareowners while receiving a handful of votes in support and still remain on the board. It’s just not a very balanced or fair system.’
Board elections are governed in the US by state corporate law, making the transition to majority voting a state-by-state process. A majority of states – including Delaware, where half of S&P 500 companies are incorporated – allow companies to outline voting requirements in their bylaws or charters. When companies don’t specify requirements, plurality voting is used as the default system, which is what most companies use today. Currently, Nevada is the only state in which plurality voting is mandatory.
‘Majority voting compared with plurality voting is a clear state corporate law matter,’ comments Steven Wallman, founder of Virginia-based proxy adviser Proxy Governance. ‘It has been in corporate law since corporate law began. It would be hard to see a listing standard that would attempt to preempt the state law as well, which leaves you with changes to state law or changing charters and bylaws case by case and company by company.’
Rabble-rousers
Without taking any definitive stance on the majority voting issue, Lou Thompson, president and CEO of the National Investor Relations Institute (Niri), acknowledges that special interest groups might take advantage of this new system.
Theoretically, boards should represent all directors, he points out. ‘When you look at the core function of a corporation, it is an entity to produce products and/or services,’ he notes. ‘And, being a public company, the purpose is to maximize shareholder value for those who are investing in the company. When it comes to issues that are not necessarily related to increasing shareholder value, should these issues be addressed through public policy with rules and regulations or through the boardroom? Democracy in the boardroom translates into very broad terms that require clarification.’
Wallman doesn’t think boardrooms are supposed to be representative democracies. ‘If we get to the point where anybody really perceives the board as a bunch of individuals representing a particular shareholder block of interest, everyone is in trouble,’ he says. He feels the focus with majority voting should be shareholders that are interested in the long-term production of corporate wealth. ‘One issue that has to be kept in mind is that not all shareholders act as owners,’ he adds. ‘Not all shareholders care about the long-term wealth of the firm or its long-term capabilities.’
Others say the very fact that directors are elected implies a democratic system for boards. With words like ‘election’, ‘nomination’ and ‘vote’ being constructs of democracy, ‘what other structure could they refer to?’ asks Minow. ‘The principle of capitalism does not only state that because you provide the capital you run the company. It also means that if you do provide the capital, if you do put your money where your mouth is, they take your money but they also take your mouth – so if you are not happy with something, you get to throw the bums out.’
Symbolic gestures
The withhold vote category in director elections was introduced by the SEC in 1964. Over the years, the category has become a way for shareholders to express their dissatisfaction with board actions. As such, withhold votes have evolved into symbolic gestures that can have an impact on governance reform by sending a message.
Majority voting may sacrifice this facility altogether. Under plurality voting, a withhold vote serves as an expression of shareholder dissatisfaction, not with an individual director, but with the board’s governance practices. Changing to a majority voting system could sharpen this symbolic move to the point that it results in the unintentional elimination of a director.
The question is: how should a director’s expulsion be handled? The sudden removal of one or more directors violates SEC requirements. However, according to Cheryl Gustitus, senior vice president of communications at ISS, this is a manageable concern. ‘The proposals are non-binding so there wouldn’t have to be an immediate reaction from companies,’ she says. ‘If someone doesn’t reach majority level support, he or she won’t get tossed out the next morning. Companies and shareholders will work together to fill the seat in a way that is good for the company, good for the board and good for the shareholders.’
Should it happen that a board seat needs to be filled, there has to be a sufficient number of directorial candidates to draw upon. The concern that majority voting will bring about a shallow applicant pool has been voiced, but with so many other factors present, including increased personal liability for directors, majority vote should not pose much of a threat.
Effects on IR
If majority voting is widely adopted, investor relations professionals will take a greater role in the proxy process.
‘The IR function will have to be perceived as almost on par – if not actually on par – with other chief functions because of the critical nature of reaching out and having shareholders understand what the company is doing,’ explains Wallman. ‘This will occur with companies having or wanting to see the benefits of no longer taking shareholders for granted, as some companies do.’ Although IROs will be more heavily involved with the board, that doesn’t necessarily mean they will report more often to the board, Wallman predicts.
Thompson describes the IR function as having four roles in corporate governance: informing the boardroom of intelligence from the investment community, educating the board on IR issues, serving as a corporate conscience by raising the issue of what is best for the investor, and communicating with institutional and individual investors.
And individual investors‘ votes should not be under-estimated, Thompson points out. In fact, during the past two years, almost every time a shareholder proposal won majority support, it was individual investors who provided the swing vote. Under majority voting, it will become increasingly important for companies to lobby shareholders’ support for director candidates. Currently, there is a movement in the US to increase shareholder transparency (see Know thy investor, page 73) with the idea that companies need to be able to contact retail and institutional shareholders to garner their support on contentious proxy issues.
With all the discussions surrounding majority voting, the common thread is the need for communication. Companies, shareholders, advisers and others realize any change to board elections requires careful deliberation, and it will take lots of planning to figure out the best way to implement the majority voting system.
There is potential here to discuss making governance better on a broader scale. ‘To some degree, that is the whole ethic we have been trying to promote,’ says Wallman. ‘Governance should not be perceived as a game of power between shareholders and managers; it should be seen as a mechanism to improve long-term corporate wealth for all constituencies involved in a company. This maturation is occurring in some circles of governance discussion – and that is a good sign.’
