The 2008 financial crisis and the slow recovery that has followed has brought further evidence tending to support the view that the structure of our corporate sector needs adjustment, and that its faults affect the competitiveness of our economy. The crisis has resulted, as would be expected, in a raft of new rules and regulations, which as usual have been implemented before there emerged any consensus about the nature of the problems. There has also been a vigorous competition of ideas over causes and remedies.
Posts Tagged ‘Charles Nathan’
The principal corporate governance campaigns of the past decade have reached a plateau in terms of both investor commitment and implementation. These governance issues (such as majority voting, de-classifying staggered boards, eliminating super-majority votes and executive compensation excesses) are not by any means going away. Indeed, there are concerted investor-led efforts to push favored corporate governance “best practices” down the corporate chain to mid-cap and small-cap companies. However, the activist community has clearly won the policy battles surrounding these governance principles, and their “sizzle” is dissipating.
Policy stasis does not become corporate governance activism, as its very name implies. Corporate governance activists will develop new “green fields” to plow; otherwise they risk becoming irrelevant. The question is not whether corporate governance activists will move on but rather where they will go.
While there are a number of possible new foci, two stand out in particular:
Activist investing has become quite the rage in the equity marketplace. Activist investors are proliferating, and there is a marked inflow of new capital to this asset class. The discipline of activist investing is popping up in more conversations about the nature and role of equity investors. As a result, it is occupying the thoughts, and sometimes the nightmares, of an increasing number of corporate executives and their advisers. The phenomenon has even become a topic du jour of academics, who are busily finding sufficient economic value in the function of activist investing to justify urging the SEC not to shorten the historic minimum time frames for reporting accumulations of more than 5% of a company’s stock explicitly to permit activists to accumulate larger blocks before disclosure of their activities results in a rise in market trading values for the stock in question.
Activist investing has a long pedigree in the equity markets dating back to the late 1970’s. Back then and throughout the 1980’s, activist investors were known by less flattering sobriquets such as corporate raiders, bust-up artists and worse. Activist investing has changed since those heady, junk bond fueled days. Then, the favorite game plan of activist investing was to threaten or launch a cash tender offer for all, or at least a majority, of the target company’s outstanding stock with funding through an issuance of high yield bonds. Today, activist investors rarely seek equity stakes in target companies above 10%, and their financing comes not from the public debt or equity markets but rather through private hedge funds that they sponsor and manage.
Corporate America has weathered (with mixed results) two years of annual “Say on Pay” votes and is gearing up for a third. One theme which emerged during 2012 is that companies should not view the annual vote as a 60-90 day event that needs to be managed as best as possible given the hand the company has been dealt (or, in some senses, the hand it has dealt for itself). Rather, companies need to view Say on Pay as a year-round exercise in which the outcome of the annual vote can be positively affected if the company “engages” successfully with its investors on the topic of executive pay.
However, the meaning of the term “engagement” in this context is by no means obvious. And, while a number of companies have implemented sound engagement programs based on an accurate assessment of corporate governance dynamics, too many common prescriptions for engagement are based more on myth than reality.
We have been observing the corporate governance movement in the United States for the past several years. Share voting decision makers at most institutional investors inhabit an alternate universe from investment decision makers.  Two incompatible economic and philosophical belief systems drive these alternate universes:
- Investing professionals, overwhelmingly, are rationally apathetic about exercising the voting franchise embedded in stock ownership.  Absent a readily observable and positive correlation between exercise of the corporate franchise and creation of shareholder value (as is the case in most M&A votes and proxy contests), investing professionals view the task of making voting decisions on each ballot item for each of their portfolio companies as not merely time consuming and distracting but, worse, economically wasteful. 
- On the other hand, notwithstanding the lack of a demonstrable connection between what is labeled good corporate governance and a positive increase in share valuation, corporate governance advocates continue to maintain that good corporate governance does, in the aggregate, enhance share values.  Accordingly, in their view, voting on all ballot issues at each and every portfolio company in order to achieve better corporate governance is a value creator. Starting from this core ideology, corporate governance advocates have successfully persuaded many national politicians, most regulators of the securities and investment industries and virtually all of the financial press, that its so-called corporate governance best practices are an essential requirement for shareholder value creation and that professional investment managers, as a matter of their fiduciary duty to their customers, should be required to vote all portfolio shares on all ballot matters.
My colleagues, Jim Barrall and Alice Chung, and I have co-authored an article titled Say on Pay 2011: Proxy Advisors on Course for Hegemony. The article analyzes the results of the first year of mandatory Say on Pay advisory votes and discusses the implications of these results for Say on Pay advisory voting during the 2012 proxy season. We begin by noting that based on the Say on Pay votes of a universe composed of the Russell 3000 companies that were subject to mandatory Say on Pay voting, recommendations by the two principal proxy advisory firms (ISS and Glass Lewis) appeared to have a significant effect, with a recommendation by ISS accounting, on average, for an approximately 25% vote swing, and one by Glass Lewis accounting, on average, for about a 5% vote swing. The data also indicates that companies receiving a negative SOP recommendation from ISS averaged less that a 70% favorable vote.
The Prevailing One-Size-Fits-All Voting Policy Paradigm
A year ago, we published a Corporate Governance Commentary titled Future of Institutional Share Voting: Three Paradigms. We began by observing that the prevailing paradigm for institutional investors voting of portfolio company shares is to delegate all but the most obvious economically related voting decisions to either an internal or external corporate governance team that is largely, or all too often totally, separate from the investment policy decision making team— in effect, a parallel universe of voting decision makers. Because of the huge number of voting decisions facing institutional investors, the prevailing corporate governance methodology for deciding how to vote portfolio shares is to apply formulaic voting policies that push all portfolio companies, no matter how different their particular circumstances, through a uniform one-size-fits-all voting mold.
Good corporate governance is of the moment. It is talked and written about constantly by academics, the corporate governance community working for institutional investors and proxy advisors, boards of directors, corporate executives, corporate lawyers, judges, reporters and, yes, even politicians. Indeed, it is talked about and written about so often and at such length that it often seems to tower above all other aspects of the corporate world. The discourse, moreover, has come to resemble something of a Tower of Babel, where so much is said, from so many points of view, that it seems impossible to make sense of it all.
This essay attempts to bring some coherence to the topic by positing a 12-Step Program that we believe would lead to a useful and effective paradigm for truly good corporate governance.
Since the Delaware Chancery Court’s opinion in In re Revlon, Inc. Shareholders Litig.,  where Vice Chancellor Laster endorsed a Delaware entity’s right to mandate in its governance documents a chosen forum for the resolution of intra-corporate disputes, numerous boards of public companies have determined that such a provision is in the best interests of the corporation and its shareholders.
At least 36 boards of public companies have enacted bylaw amendments seeking to designate Delaware’s Chancery Court as the exclusive jurisdiction for intra-corporate disputes,  and at least 37 companies have included such provisions in their charters.  In addition, at least 11 public companies have included an exclusive jurisdiction provision for their charter or bylaws in proxy materials for their 2011 annual meetings. As of April 28, 2011, three of those proposals have been voted on and approved and the remaining eight will be voted on later in this proxy season. 
According to our research, more than 300 companies subject to Dodd-Frank’s say-on-pay vote requirements have filed proxy statements thus far this year. Of those, 125 companies have held shareholder meetings at which shareholders have voted on advisory resolutions on the frequency in which say-on-pay resolutions should appear on the proxy ballot (commonly referred to as “say-on-frequency” or “say-WHEN-on-pay”), including 77 companies in the Russell 3,000 index and 55 companies in the S&P 1,500 index. Of the 125 votes submitted to date, more than 50% of companies have recommended triennial say-on-pay votes to their shareholders.