Issue 6 - December 2011
New Investor Power
Companies waiting until proxy season to engage investor issues may find themselves scrambling to address concerns that have been festering for months.
Imagine a company that always waited until a product was launched before finding out why customers would or wouldn’t buy it. Or a company that started its tax planning in the last two weeks of the tax year. Highly unlikely. Yet when it comes to shareholders, most companies wait until the hectic proxy season to engage the concerns of these powerful stakeholders.
The shift in power from management to shareholders is inexorable and, most recently, has been furthered by the 2010 Dodd-Frank Act. The era of the proxy process as an annual rubber-stamping ritual of a company’s policies and actions has passed. Investor actions on a myriad of issues such as Say on Pay (SOP) and Say on Frequency (SOF) are growing.
Investor concerns aren’t seasonal. Trying to influence or change investor votes during proxy season is risky at best. It is too late in the game to capture investors’ attention and change their minds. Companies need to engage shareholders systematically throughout the year to understand and address their concerns.
Companies May Have Gotten a Break in 2011
By many broad measures, it might seem as though the 2011 proxy season passed without the storms that SOP and SOF votes threatened. Most executive pay plans were approved, even the majority of plans that received negative recommendations from proxy advisers. According to the global law firm Latham & Watkins, only 2% of the companies that filed proxy statements by June 23, 2011, failed SOP votes — 71% of the Russell 3000 secured more than 90% approval.
However, the 2011 proxy season may not have fully reflected the depth of investor sentiment and the pressure that investors will continue to apply. Research conducted by FTI Consulting (“What Are Investors Saying About Say-On-Pay?” February 2011) found that investors viewed SOP votes as more than an issue of pay. Many saw SOP as a referendum on company and executive performance and a forum to air their displeasure. This past year, investors had to digest thousands of compensation packages. We suspect that they didn’t have sufficient time to fully digest the implications of SOP and SOF. Nevertheless, their strong preference for annual SOP votes clearly indicates a desire to keep management on a tight leash. We expect investors to keep leveraging their newly acquired rights — and for them to be better prepared to do so in the future.
Companies were not sufficiently prepared for SOP and SOF votes either. Many were surprised by shareholder pushback and negative recommendations from the proxy advisory firms. A key factor in the negative recommendations was a disconnect between compensation and performance as measured by total shareholder return. A prominent financial services company, for example, received a recommendation against the chief executive’s pay. Although it finally passed, it did so with less than 60% of the vote. And three other management recommendations (of eight) were thwarted.
Other companies with negative recommendations passed the vote. But average support was only 72% vs. 92% for those with a favorable recommendation. Companies with pay/performance disconnects and subpar shareholder support (70% is generally regarded as the inflection point) are essentially “on notice.” Support for their SOP votes could erode next year if management doesn’t discover and remedy the issues.
It is important to note that although SOP and SOF votes are “advisory,” they have teeth. Their influence extends into boardrooms and legal domains. Negative investor sentiment on SOP can be directed at compensation committee directors. To wit, at companies where SOP votes failed, these members garnered an average of 13.5% fewer votes than other directors on the ballot. Furthermore, losing a vote on pay can expose a company to damaging litigation. Four companies that failed to secure SOP approval had shareholder derivative lawsuits filed against them, alleging breach of fiduciary duty and corporate waste.
More Investor Concerns Are Brewing
Historically, strong recoveries following recessions have generally produced a calming of the public mood and dissipation of the rancor previously targeted at those institutions perceived to be poor corporate citizens. Given the muted economic recovery, corporate performance may not sustain its current pace, fracturing business confidence and undermining shareholder returns. Public angst, represented by the Occupy Wall Street protests, along with regulatory agency actions and government legislation, may continue to influence investors and drive demands for more influence over corporate affairs.
Some areas to watch
Oversight of Political Spending. Support for disclosure and oversight of corporate political spending is surging on the heels of the 2010 U.S. Supreme Court Citizens United decision. While a high-profile proposal at Home Depot was soundly defeated, a corporate political disclosure and accountability resolution captured a majority vote — at Sprint Nextel the resolution passed with 53% of votes cast. Close on these heels, resolutions from the U.S.-based Center for Political Accountability, which requires companies to divulge details of their political contributions, gained more than 40% of the vote at the annual meetings of four more companies.
Proposals concerning the oversight of political spending are multiplying, and support for them is rising:
- In the first half of 2011, according to Institutional Shareholder Services, shareholders filed 78 proposals seeking disclosure and oversight of corporate political spending, up from 48 during the first half of 2010.
- According to the Council of Institutional Investors, the average support for the 39 proposals that came to vote as of June 2, 2011, was 31%. Six years ago it was 9%.