It’s the compensation, stupid. There’s your slogan for the current proxy season – and it’s no surprise considering the tales of outsized executive pay stories moving through the courts of public opinion.
The current focus on compensation has led to a number of hot-button areas for this season, from golden parachutes to director independence. But for 2006, the issue getting the most attention is majority voting for director elections. ‘Our sense from our membership is that this is the big one.We know of some 130 proposals on this issue,’ says Alyssa Ellsworth, managing director of the Council of Institutional Investors in Washington, DC.
Experts are watching a number of shareholder meetings to see how much support majority voting receives this year. The results of two major test cases are already in: investors in Sprint Nextel and Novell have approved proposals for majority voting with 66.4 percent and 61.7 percent of the vote respectively.
Patrick McGurn, executive VP at proxy adviser Institutional Shareholder Services (ISS), says that while the hottest issue is indeed majority voting, proponents face a different environment this year than they did in 2005. Both McGurn and Ellsworth note that in 2006 many companies have taken proactive steps to address the issue of director elections rather than leaving a vacuum for shareholders with proposals of their own.
Taking action
‘How the votes are turning out is really a case of the haves and have-nots: companies that have done nothing to address shareholder concerns on majority voting are seeing very high results for the proposals, some above 60 percent,’ McGurn says. ‘Those that have done something are not experiencing support for majority vote proposals – in fact, very rarely is the support above 45 percent.’
The ‘something’ that companies have done is to address shareholder concerns by voluntarily adopting majority vote standards. There are a number of different benchmark models, with one of the most widely copied being the so-called Pfizer model.
‘The debate is now focused around two approaches: the Pfizer model, which is a policy that the director resignation will be handed in and considered; and the Intel model, which is the preference of the building unions,’ explains Con Hitchcock, outside counsel to Amalgamated Bank’s LongView Funds. ‘They prefer it because it’s a bylaw change and it says a director must be formally elected by a majority. Pfizer’s standard says the person is elected but the company must ask for his or her resignation because he or she didn’t get a majority. Pfizer can then do what it wants.’
Binding challenge redux
The twist to this year’s proxy season is the emergence of binding proposals that actually require changes to a company’s bylaws, rather than non-binding proposals that are far more commonly employed. This brings us to a note of shameless self-congratulation: in 2000, your correspondent asked the question in IR magazine: ‘Can shareholders really force binding bylaw changes on companies through a vote?’
Back in 2000, the practice was nearly unheard of. In fact, most investors did not consider binding proposals a realistic option. Now they are a much-discussed approach.
While still not prevalent, binding proposals are being mooted by a number of the building unions, such as the American Federation of State, County and Municipal Employees (Afscme). Pension giant Calpers has filed three, and Harvard professor and long-time compensation critic Lucian Bebchuk has targeted eight companies with bylaw amendments this year (AIG, Bristol-Myers Squibb and Time Warner have already accepted his proposals or some variation, while the remaining five are in opposition).
Doubts still linger over whether or not a binding proposal is an effective tool. One question is whether or not the various state laws allow them. Typically, states dictate what changes shareholders can make to corporate bylaws, with an eye toward not encroaching on boards of directors’ responsibilities.
But Gary Lutin, an investment banker at Lutin & Co in New York and an adviser in corporate control contests, says it’s possible in nearly every case to frame the proposal in a manner consistent with the purpose of bylaws to define the responsibilities shareholders have delegated to their board. In fact, Lutin issued what we called the ‘Lutin challenge’ in our 2000 article: ‘I’ll accept the challenge to put any proposal that concerns legitimate issues of corporate governance into a binding bylaw format.’ No one took him up on his offer.
As for the question of state laws, Lutin remains adamant in his support for the approach: ‘I’m not aware of any reason why you couldn’t do a binding proposal in almost any state, except maybe for someplace like Nevada, which designed its corporate law deliberately to frustrate investor rights. People said you couldn’t do it in Delaware, but that proved to be just a defense lawyer myth. All you need to do is read the statute to see how it really works, and use common sense.’
Double trouble
This year almost all binding proposals are on the issue of majority voting. And because they are binding, they remain extremely controversial. Companies don’t like having what they consider the duty of their boards subjugated, and some investors are queasy about employing such all-or-nothing tactics.
General Dynamics, for example, is facing a binding proposal from Bebchuk. The company is strenuously opposed to his action: ‘The Bebchuk proposal leaves no ability to address whatever issues caused a lack of a majority vote. And if a director doesn’t get a majority vote, he or she can’t stand for reelection again.We consider such a binding change to our corporate bylaws, especially one that would automatically disqualify a director from reelection, to be Draconian and to open the door to unintended consequences,’ says Ray Lewis, VP of IR at the Virginia-based company.
Afscme has been one of the most active in filing binding majority vote proposals. The union fund is using the proposals as a follow-up action aimed at companies that have not adopted what it views as adequate standards on majority voting following well-supported votes on non-binding proposals.
‘We know there is huge shareholder support for majority voting standards,’ says Rich Ferlauto, director of pension investment policy for Afscme. ‘The reaction of putting in director resignation policies hasn’t been sufficient. Many companies aren’t responsive to shareholders’ wishes to see an election process where a director is nominated by a majority. We’re filing binding proposals where we’ve seen support in the past from shareholders and where they’re likely to be enacted.’
One note of caution for companies: Ferlauto says Afscme plans to expand its use of binding proposals beyond the issue of majority voting. ‘Our new focus next year is going to be on ‘up and down’ votes on executive pay.We’re basing it on the UK model, which requires a shareholder vote.We have some non-binding proposals on the issue this year, and we’re expecting to do well. If we do have support and targeted companies don’t respond, we’ll come in with binding proposals next year to require companies to submit the compensation committee report for shareholder advisory approval.’
McGurn says he expects ISS to support non-binding proposals on the issue. ‘It is unlikely that a binding proposal on this topic would pass muster under state law, and it might therefore get the red light from the SEC staff. If it did, our analysis would be on a case-by-case basis.We would not be inclined to support proposals seeking annual binding votes on compensationpractices. That’s too much micromanagement for our tastes.’
But McGurn believes that, as with majority voting, companies should take proactive steps to head off shareholder dissatisfaction. ‘We do think it’s a good idea, especially for boards to have feedback on compensation,’ he says. ‘We don’t understand why more US companies don’t offer up an annual non-binding vote on compensation.’
