The Rise of Engagement in the 2012 Proxy Season
For many years Georgeson’s Annual Corporate Governance Review has promoted the concept of engagement between public companies and their institutional investors. While Georgeson has noticed increased engagement, the nature of the engagement has generally been incremental and devoted to specific governance and compensation issues from year to year. After years of this slow, incremental growth, the 2012 proxy season became the Year of Engagement and witnessed a marked increase in company/shareholder interaction — engagement that was not limited to a few days out of the five- or six-week period between the mailing of the corporate proxy statement and the last days of a proxy solicitation campaign prior to the annual meeting. The types of issues discussed leading up to and during the 2012 proxy season ranged from executive compensation and board structure to negotiations with proponents over the potential withdrawal of shareholder-sponsored ballot resolutions to just open-ended discussions to understand each other better. The voting statistics contained between these covers cannot fully measure that activity — although they do make it clear that the level of communication was more frequent and intense than in the past.
What Was the Catalyst for More Robust Engagement?
A principal factor behind increased engagement between issuers and investors was the desire among institutions for more dialogue. Fund complexes like BlackRock and Vanguard, by virtue of their size and indexing strategies, are often a company’s largest owners. Funds reached out to the portfolio companies that represented their largest holdings, expressing their desire to engage those companies on governance issues rather than default to having their views — and voting decisions — on governance issues and other ballot items shaped by the proxy advisory firms. They were also more receptive to a wider range of companies that reached out to them for off-season and in-season engagement. Such funds hold shares in thousands of companies and their increased engagement required more resources and time. However, they nonetheless increased their correspondence with many companies and conducted many more meetings and calls than in the past. In many cases those interactions led to greater understanding on both sides and influenced votes.
Compensation Sparks an Increase in On- and Off-Season Investor Engagement
While some companies have carried the mantle of thought leadership and communication on governance issues in year-round engagement with investors for a number of years, nothing sparked the engagement of shareholders like the advent of the required advisory vote on executive compensation, or “say-on-pay.” To date relatively few companies have failed the say-on-pay’s vote on executive compensation — and close to 70 percent of companies examined in our report’s universe have achieved favorable votes of 90 percent or greater.
However, many companies saw even modest levels of opposition on the compensation vote as a lack of support for management, if not their compensation committees, stock option plans and their boards of directors as a whole. The proxy advisory firms Institutional Shareholder Services and Glass Lewis raised the bar for successful say-on-pay votes by establishing new ”red zones” that redefined what it meant to achieve significant support from shareholders. Thus, opposition votes of higher than 20-25 percent would invite greater scrutiny by the advisory firms of a company’s compensation practices and levels of shareholder engagement moving forward. That reality triggered greater outreach in and out of the traditional proxy season and those conversations sometimes morphed into discussions of other non-compensation issues
Engagement: Not Just Before and During Meeting Season Anymore
Off-season engagement on compensation issues provided companies with insight into institutional views and expectations on a wide array of factors that would ultimately determine investors’ votes. This would include views on the mix of awards, appropriateness of peer groups, general terms of severance packages and the importance of linking pay vehicles to a company’s specific strategies and performance. Some companies continued to express reservations to us about possible risks of off-season engagement on compensation and other governance issues, particularly if they ultimately disagreed with a shareholder’s viewpoint. We continue to believe that shareholder engagement is not and should not be only about negotiations over specific issues. The act of engaging, active listening and “bringing the message home” for board consideration often is a net positive, even if a shareholder’s recommended policy on governance or compensation issues is not adopted. In some cases companies do end up adopting recommendations suggested by their investors, often that had already been under board consideration for some time. In other cases their boards ultimately decide not to do so because they sincerely believe that their fiduciary duties under state law require them to do otherwise — for the best long-term interests of all of their shareholders and their companies as a whole.
Make Your Story and Communications Clear the First Time
Another advantage of engagement: off-season communications provides practical guidance for drafting the proxy statement and enhancing a company’s corporate web site, which by necessity remain important communication tools for the company. For example, the Compensation Discussion & Analysis (CD&A) is scrutinized by those same key readers who are engaged in arriving at their advisory votes and recommendations on executive compensation. While engagement was important in 2012, Georgeson also observed the redesign of the CD&A and in some cases the entire proxy statement — both in structure and the increased use of graphics — to enhance the ease of understanding by investors of the company’s pay-for-performance story. Companies continued to file supplemental proxy materials to add to or reiterate their story to investors, particularly when proposals were deemed by management to be misunderstood or misinterpreted by proxy advisory firms in their vote recommendation reports. Additional materials, particularly concerning social and environmental issues, were more easily posted on corporate websites in order to further explain positive steps companies were taking in these areas. All in all, however, we found that the most effective practice was to tell the substantive story in a clear and comprehensible way in the initial filing. Doing so also makes any subsequent direct communication with investors and the proxy advisory firms more productive.
Academically Powered Pension Funds Reclaim a Leadership Role in Activism; The Value of Takeover Defenses Revisited
When companies engaged on governance issues, what, if any, results did they achieve? In some cases engaging with shareholder proponents and other activists sponsoring ballot resolutions on governance issues, including proposals dealing with environmental and social issues or with right to call special meetings or take action by written consent, yielded settlements that resulted in withdrawal of those proposals. Private engagement before or after a shareholder proposal has been submitted, via letters and telephone calls, resulted in many proposals never even being submitted or made public. As we have advised for many years now, picking up the telephone simply to call and engage an investor who writes or submits a proposal to your company can result in a win-win resolution for both parties.
Who Were the Major Proponents with Whom Companies Engaged?
The 2012 proxy season saw a resurgence of activity by public pension funds, which more than doubled their total number of governance proposals submitted to S&P 1500 companies (22 to 57). The driving force behind much of this activity was the Harvard Shareholder Rights Project (SRP), which served as an engine that assisted several high-profile pensions in submitting resolutions. The SRP represented at least six public pension funds including the most prolific filers of 2012 — the Illinois State Board of Investment (13) and the North Carolina Retirement System (11). The SRP proposals focused on pushing companies to de-stagger their boards, with an emphasis on removing that antitakeover defense from S&P 500 companies. From SRP’s perspective the campaign was an unqualified success. In 2011-2012, 90 such proposals were submitted, resulting in 48 agreements by boards to bring de-staggering amendments to a vote resulting in the elimination of 28 classified boards (others presumably had not yet been put to a vote or voted on as of SRP’s most current report as of writing this report). The subsequent management declassification proposals that resulted from this effort met with close to a consensus by voters, averaging 99 percent of votes cast.
This ongoing level of support mystifies some familiar with academic literature on the value of classified boards in generating long-term shareholder value. Anecdotally, M&A lawyers often point to companies like CF Industries and Airgas, which in the past few years fended off recent high-profile takeover battles only to see their stocks soar well past the highest price offered in the period subsequent to each of these hostile events. But if the record on staggered boards remains mixed, the voting policies adopted by a large majority of institutions is fairly well decided against them.
Proxy Process Comes Into Focus
As forecast in our last review, the debate over the process of how directors are elected loomed large over the 2012 proxy season. Much of the S&P 500 (90 percent) has already moved from plurality voting to some form of majority voting in the election of directors (that generally requires that directors failing to receive a majority of votes cast submit an irrevocable resignation to the board, which the board is then free to accept or reject, usually with an explanation of the reasons therefor). As we forecasted, the proponents of majority voting, often individuals or labor union pension funds, shifted their focus from mostly large to smaller cap companies. Engagement on this issue resulted most often with capitulation on the part of companies. Within the S&P 1500 index, approximately 28 proposals produced an average vote of 61 percent of votes cast for these proposals. It remains to be seen whether the small caps will fall in line with their large cap brethren and simply adapt rather than challenge investors on this issue.
Although fewer in number, carefully watched were shareholder proposals on “proxy access.” These were submitted in the wake of the legal voiding of the SEC’s proxy access rule, which would have given qualified shareholders the ability to submit a limited number of candidates to be run on the company’s ballot with a supporting statement in the company’s proxy. Of the 24 tracked proposals, 13 went to a vote (including 7 binding ones with 4 from Norges averaging 34 percent of votes cast) with ISS recommending support for 6 of the 13.1 Currently, without proxy access activists seeking board change need to wage a formal proxy contest and ask shareholders to vote on a competing ballot, which limits shareholders’ ability to vote for nominees of both slates.
The view of institutional investors on proxy access is still developing. The long-standing campaign to encourage majority voting has targeted companies regardless of their performance or governance track record. The wide support among such proposals perhaps demonstrates the acceptance of some form of majority voting as a best practice for all companies. On the other hand, with respect to proxy access, the targets of the pension funds proposing these resolutions were generally companies that had a history of struggling performance and unpopular or questionable governance practices, as well as a general lack of shareholder engagement. Two of these proposals received a majority of votes cast.
The difference between the high and low vote getters on proxy access proposals was primarily the proposed ownership standards included in the resolutions. Institutions were less supportive of proposed proxy access regimes that afforded access to the proxy for investors with as little as 1 percent ownership of a company’s stock for one year. The two proposals attracting a majority of votes cast required 3 percent continuous ownership for three years. Many other proposals didn’t make it to a proxy vote, as they were deemed excludable by the SEC due to various defects. We expect proponents to address these flaws and resubmit them to many of the same targets and similar ones in 2013.
Activists continued to push vigorously for a different sort of proxy access through the right to call special meetings (averaged 41 percent of votes cast) or alternatively through the right to take shareholder action by written consent (averaged 45 percent of votes cast). Many companies engaged with investors on these issues and reached compromises, but success in dealing with these proposals generally required the company to adopt such rights in some form.
Activist Contests Prove the Benefits of Engagement
We continue to believe that increasing engagement will be the wave of the future. The results of traditional proxy contests from 2012 bear this out, with boards and managements winning their share of high-profile battles, such as those fought at AOL, Inc. (by Starboard, a spin-off of Ramius Capital) and Oshkosh Corporation (by Carl Icahn), where shareholders did not elect any of the proposed dissident directors. In these cases, directors and senior management engaging with shareholders made compelling arguments that their strategies were the right ones and produced victories for embattled boards. This was the case despite an environment where many observers believe that shareholders and proxy advisory firms work under the presumption of a “What’s the harm?” mentality in electing at least some dissident directors to boards. Clearly the communication programs that won the day in many of these contests were conducted during the heat of battle and were not the result of ongoing, year-round engagement. They demonstrated that the right story, properly communicated, could prevail under difficult circumstances. We believe that more companies will continue to expand their engagement in the months and years ahead beyond the compressed periods in which these battles take place. By engaging their shareholders on their business strategies and views on governance more frequently, companies may still disagree with dissidents. However, the dissidents will no longer be able to claim that boards have been inattentive or incommunicative, a common complaint that has fueled many contests and disagreements with shareholders on a broad array of issues.
The full publication is available here.