Top Governance Issues
Executive compensation continues to be an American issue for a second straight year. Only for North America, a majority of both investor (60 percent) and issuer respondents (61 percent) cite the perennial issue of executive compensation as one of the top three governance topics for the coming year, similar to last year’s survey results.
On a global basis, investor respondents focused on board independence. Across every region, board independence was identified among the three most important governance topics by approximately 40 percent of investor respondents.
Issuers focus on risk oversight in North America and Europe. For issuers, the second most commonly cited topic in North America was risk oversight. In Europe, risk oversight was commonly cited along with board competence.
Engagement between issuers and investors remains strong. A majority of investor respondents (57 percent) indicated more engagement activity with issuers in 2011. Regarding engagement activity with institutional shareholders, issuer respondents almost equally cited “about the same as in 2010″ and “more engagement in 2011.”
Director’s recent experience a key issue when evaluating board nominees. When evaluating director nominees, a director’s recent industry/sector experience was cited as either “relevant” or “very relevant” by most investor respondents. For issuer respondents, this was the only category of information that received a strong majority (61 percent) for “very relevant.”
Other categories that strongly appeared relevant to both investor and issuer respondents include director biographic information; performance of companies where director serves (or served) on boards; and governance track record for firms where directors serves (or served) on boards.
As indicated by both issuer and investor respondents, ISS recommendations at other public companies where the director serves and whether directors were subject to continuing boardroom education were least relevant when evaluating director nominees.
Environmental, social, and governance issues are significant for a second straight year. Similar to last year’s survey results, a strong majority of both investor and issuer respondents indicated that a company’s performance regarding ES&G factors can have a significant impact on long-term shareholder value.
U.S. Compensation Practices
Pay levels relative to peers and a company performance’s trend are relevant for both investor and issuer respondents when determining pay for performance alignment. When determining whether executive pay is aligned with company performance, an overwhelming majority of investor respondents considered both pay that is significantly higher than peer pay levels and pay levels that have increased disproportionately to the company’s performance trend to be very relevant. Most issuer respondents, on the other hand, shared a similar sentiment with that of investors, but appeared to tone down the response by indicating both of these factors to be “somewhat relevant.”
Discretionary annual bonus awards can sometimes be problematic: investor and issuer respondents agree. A majority of investor respondents (57 percent) and 46 percent of issuer respondents agreed that discretionary annual bonus awards (i.e., those not based on attainment of pre-set goals) to be sometimes problematic if the awards are not aligned with company performance.
Investor and issuer respondents diverge on opposition levels to a say-on-pay vote that should trigger a board response to improve pay practices. The most commonly cited level of opposition on a say-on-pay proposal that should trigger an explicit response from the board regarding improvements to pay practices is “more than 20 percent” for investor respondents (36 percent) and “more than 50 percent” for issuer respondents (48 percent). However, on a cumulative basis, 72 percent of investor respondents and 52 percent of issuer respondents indicate that an explicit response from the board regarding improvement to pay practices should be made at opposition levels at “more than 30 percent” and “more than 40 percent,” respectively.
Less appetite from investor respondents in taking into account positive factors to mitigate cost of an equity plan. Responses from investor and issuer respondents varied as to whether positive factors (above median long-term shareholder return; low average burn rate relative to peers; double-trigger CIC equity vesting; reasonable plan duration; robust vesting requirements) mitigate an equity plan where shareholder value transfer (SVT) cost is excessive relative to peers. Most investor respondents were reluctant to indicate that any of those factors would “very much” mitigate the cost. For certain factors, e.g., above median long-term shareholder return and low average burn rate relative to peers, there was a strong showing from issuer respondents that these factors should “very much” be taken into account to mitigate the cost.
On the flip side, where SVT cost is not excessive and whether negative factors (liberal CIC definition with automatic award vesting; excessive potential share dilution relative to peers; high CEO or NEO “concentration ratio”; automatic replenishment; prolonged poor financial performance; prolonged poor shareholder returns) weigh against the plan, a majority of investor respondents indicated all of the factors, with the exception of high CEO/NEO “concentration ratio,” should “very much” weigh against the plan. Of all of these factors, a vast majority of investor respondents (73 percent) cited prolonged poor financial performance and prolonged poor shareholder returns.
While it did not appear that issuer respondents were emphatic about these factors weighing against the plan, a majority of the issuer respondents indicated that liberal CIC definition with automatic award vesting, excessive potential share dilution relative to peers, and automatic replenishment (“evergreen funding”) should “somewhat” weigh against the plan.
Investors indicate post-IPO equity plans seeking Section 162(m) tax deductibility should be evaluated under same guidelines as a standard equity plan. According to a vast majority of investor respondents (80 percent), equity plans coming to a shareholder vote for the first time after an IPO (in order to quality for Section 162(m) tax deductibility) should be evaluated under the same guidelines as a “standard” equity plan, even if no new shares are requested. While 59 percent of issuer respondents disagreed, a substantial minority (41 percent) shared the same view with investor respondents.
“Single-trigger” equity vesting in the context of equity plans elicits differing views from issuer and investor respondents. An overwhelming majority of investor respondents do not consider automatic accelerated vesting of outstanding grants upon a change in control or accelerated vesting at the board’s discretion after a change in control to be appropriate. The vast majority of issuer respondents disagree, and consider both scenarios appropriate. However, both issuer and investor respondents agree that accelerated vesting in certain circumstances after a change in control (e.g., if awards are not converted or replaced by a surviving entity) are appropriate.
U.S. Board Issues
Pressure from investor respondents for independent board leadership remains strong. Seventy percent of investor respondents indicated that companies should adopt a policy of appointing an independent chair after the current (combined) CEO/chair leaves the position. A substantial majority of issuer respondents disagree, with 73 percent indicating that companies should not commit themselves to an independent chair.
Certain restrictions on shareholders’ ability to call special meetings and act by written consent may be acceptable for shareholders. Regarding the question on whether various types of restrictions (notice, inclusiveness, timing, content, and ownership) on shareholders’ ability to act by written consent are appropriate for an issuer to adopt in response to a majority-supported shareholder proposal on this topic, 57 percent (includes response percentage for “all of the above”) of investor respondents indicated that notice restrictions were appropriate. In the same scenario, a vast majority (89 percent) of issuer respondents agreed. Relative to the other types of restrictions, content restrictions was least chosen as appropriate from both issuer and investor respondents.
Regarding a “net-long” restriction on the right to call special meetings (whereby a shareholder or group of shareholders must hold the requisite ownership threshold in a net-long position), a vast majority of both investor and issuer respondents indicated that this type of restriction would not raise board responsiveness concerns.
U.S. ES&G Issues
Investor respondents focus on corporate political spending. More than half of the investor respondents consider the various types of contributions of corporate funds for political purposes including direct contributions, contributions to trade associations, or payments made for grassroots lobbying as either “critical” or “important” to their organization. Furthermore, more than half of investor respondents also indicated that political spending-related disclosure, policies, and practices are either “critical” or “important.”
U.S. Shareholder Rights and M&A
Governance provisions carry weight for shareholders when evaluating reincorporation proposals. A substantial minority of investor respondents indicated that a company classifying its board and raising vote requirements for amending charter/bylaws and approving mergers could potentially outweigh the economic benefits, as a result of changing its state of incorporation.
Shareholders want the right to vote on stock-based transactions. Three-quarters of investor respondents indicated that it is not acceptable for a board to circumvent a shareholder vote on the merits of a stock-based transaction. This refers to a scenario whereby a board declines to put a +20-percent acquisition up for shareholder vote, and instead, unilaterally grants convertible instruments to the target and subsequently puts the conversion of the instruments to a shareholder vote, with severe risks of non-approval attached.
Remuneration disclosure practices a focal point. Overall responses from both investor and issuer respondents suggest that practices in disclosing remuneration for individual members of management broken down by category, performance criteria, and potential payout levels for CEO/senior executive bonuses, relative weighting of bonus performance targets for CEO/senior management, performance targets for long-term equity awards, and severance/change in control terms in executive contracts are all important in understanding and assessing a company’s remuneration practices.
Moreover, a majority of investor respondents cited disclosure practices in the areas of remuneration of the individual members of group management, broken down by category (e.g., base, fixed, LTIP, pension); performance criteria for CEO/senior executive bonuses; and performance targets for long-term equity awards as “critically” important in their ability to asses a company’s remuneration practices. A significant minority of issuer respondents consider these disclosure practices to be important.
Support for a limit on average annual burn rate that assesses a company’s use of equity remuneration over time gains some interest from investors. While a specific definition of an appropriate limit on average annual burn rate is unclear (41 percent indicated no opinion), the concept of such limit appears to be supported by a majority of investor respondents (58 percent). Only one percent of investor respondents do not support a burn rate. When excluding the percentage of respondents indicating “no opinion,” 58 percent of investor respondents indicated that a limit should be based on a combined assessment of practices in the same local market and of European companies in the same sector. For issuer respondents, only 22 percent indicated that they did not support a burn rate, and none of the issuer respondents selected a limit based on a combined assessment of practices in the same local market and of European companies in the same sector.
Disclosure of specific use of proceeds and benefit to shareholders in connection with general-purpose share issuance requests may support the waiver of preemptive rights. An overwhelming majority (77 percent) of both investor and issuer respondents, indicated that a specific statement on use of proceeds and benefits to shareholders (including qualifying value add) by management, relative to the other factors, would be most significant whereby a waiver of preemptive rights for issuances in excess of the accepted thresholds would be acceptable. On the other hand, having no inside shareholders with more than 25 percent ownership would be least significant as a contributing factor, as indicated by a majority of both investors and issuers.
Voting on ongoing RPTs is important to investors, but does not necessarily lead to automatically voting against directors for omitting the voting item. As a result of a company omitting a voting item regarding the auditor’s report on related-party transactions, most investor responses indicated that an adverse vote should be applied, but varied among voting against re-election of any incumbent director’s re-election, the approval of annual accounts, or all other related-party transactions, if any.
The role of censor (defined as an administrative role that amounts to an adviser to the board without voting powers) raises questions for investors. Only seven percent of investor respondents indicated that the nomination of a censor, or modification of company bylaws to set up the role of a censor, to be always appropriate. The remainder of the investor responses reflected a majority (61 percent) indicating a case-by-case approach (“it depends” or “if the appointment is temporary”) on this subject matter.
Investors have split views on taking into account the overall board independence level when voting on CEOs. Where boards are composed entirely of insiders, 45 percent of investor respondents indicated that they would not vote against reelection of CEOs across the board. However, 34 percent indicated that they would vote against CEOs, with the remaining 21 percent citing “it depends.”
Investors focus on merits of remuneration practices irrespective of potentially triggering “spill resolutions” and take a case-by-case approach to “no vacancy resolutions.” As a result of Australia’s newly approved legislation, a company that encounters more than a 25 percent “against” vote on its non-binding remuneration report (say on pay) two years in succession must give shareholders a vote at the next annual meeting on whether to convene a general meeting at which all incumbent directors must seek reelection (the “spill resolution”). An overwhelming majority (73 percent) of investor respondents indicated that if a company receives a 25 percent vote against its remuneration report in the first year, an appropriate response on the remuneration report in the second year would be to continue to evaluate the company’s remuneration practices on their merits without regard to whether it would result in a 25 percent vote against the remuneration report which would trigger the spill resolution.
As part of the same legislation regarding “no vacancy resolutions” (a resolution seeking shareholder approval to fix the size of the board with a simple majority vote requirement) in response to a dissident nomination, 73 percent of investor respondents indicated that the particular company’s circumstances and the identity of both the board-endorsed and dissident candidates should be considered in determining a vote.
Investors do not support executive directors serving on key board committees. A substantial majority (72 percent) of investor respondents indicated that it is not appropriate for an executive director to serve on audit, remuneration, or nominating committees.
Use of proceeds (raising cash versus other purposes) from share issuance requests not a determining factor for investors for mitigating excessive dilution. Regarding general share issuance and share reissuance mandate requests, the vast majority (72 percent) of investor respondents indicated that there should be no distinction made between share issuance requests intended for raising cash versus requests that are intended for other purposes.