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Preparing for a Busy, and Political, Proxy Season

Stephen Davis and Jon Lukomnik | November 3, 2015

for DeAnnThe 2015 annual meeting season was a whirlwind, driven by surprise voting outcomes and regulatory flip-flops on proxy access. But 2016 could well be tougher, because presidential politics promises to turbocharge the corporate governance debate.

Candidates and influence groups are already using corporate governance issues to make public policy points on matter such as income inequality, American competitiveness, drug pricing, and climate change. If you doubt that politics can make that much of a difference, consider the building furor around stock buybacks and the unfolding nightmare that is Valeant Pharmaceuticals.

Stock buybacks may not be controversial to corporate finance staff, who view them as an alternative use of capital akin to capital expenditures or ordinary dividends. In the political world, however, candidates have begun to tar the practice as fueling short-termism.

They argue that buybacks reward today’s investors, and that the money could be put to better use by building productive capacity that would grow revenues in the future. Multiply that by the hundreds of companies with buyback programs, and you have a ready-made argument that buybacks reduce long-term investment in the American economy. That’s exactly what Democratic front-runner Hilary Clinton said in July when she called them part of the “tyranny of today’s earnings report.”

By this time in 2016, we fully expect buybacks to be even more controversial, thanks to both politicians and shareholders. A number of institutional investors are considering submitting proxy resolutions calling for any executive compensation plans based on earnings per share to adjust those earnings to account for buybacks. 

Next, consider Valeant. For the past five years, the pharma firm was deemed a high-flyer. Its stock climbed from $25 in 2010 to a peak of $258 in July 2015.  Then came a spate of negative publicity about its opaque interest in a specialty pharmacy distributor, along with allegations of channel stuffing and improper accounting.

While all that would have been bad enough, politicians might not have been drawn to the case but for CEO J. Michael Pearson’s business strategy. For years, Valeant’s philosophy was simple: slash R&D, but buy other firms with proven drugs and pump up their prices by as much as 525 percent, sometimes as soon as the day Valeant won rights to them, according to the Wall Street Journal

Consumers, doctors, and insurance firms may have squawked. But shareholders couldn’t get enough of what Pearson was spinning. Then came a potent convergence of media inquiry and presidential politics to stop the party.

The New York Times ran an investigative story in September not about Valeant, but about a start-up called Turing Pharmaceuticals. Run by a brash young man from a hedge fund—already code for avarice in the public eye—Turing had purchased rights to a 62-year-old drug used to fight dangerous parasitic infections. And it jacked the price 5,000 percent from $13.50 to $750 a pill.

Ironically, institutional investors, as well as companies, will be vulnerable to scrutiny in presidential politics. Investors depicted as enabling or abetting bad corporate behavior could find themselves taking a reputation hit.

Overnight, Turing became a national poster child of extreme pharma greed. Moreover, the public revulsion lent fresh momentum and media attention to a congressional attack on Valeant, launched in August, for big price hikes it had applied to other drugs. Yes, Democratic presidential candidates Bernie Sanders and Hillary Clinton swiftly weighed in with detailed plans to counter price gouging. But even GOP contender and Tea Party darling Marco Rubio began campaigning against “pure profiteering” by some drug companies.

Once Valeant’s other issues emerged, its business practices started to share, and then steal, the unwelcome spotlight. By late October Valeant’s stock price had sunk to $110, a 57 percent decline in just three months.

Of course, not every issue will follow this trajectory as the political calendar moves toward next November’s vote. Given the dominant role of the private sector in the United States, making the link between those corporate issues and public policy issues will be like oxygen for candidates. Candidate staffs on both sides of the aisle will be prowling for developments to seize on as a way of seeking an edge against rivals and traction among voters.

CEO compensation will be used to illustrate either the problems of income inequality or the positive attributes of free enterprise, depending on your political philosophy.  The Volkswagen emissions scandal will be used to explain why the private sector can’t be trusted to deal with climate change issues by itself. Boards with no women or minorities will be evidence of the lack of progress in creating a more equal society—and the increased number of somewhat diverse boards will be cited by others that progress, though slow, is happening.   

Meanwhile, the normal background of recent proxy seasons will play out. Consider, for instance, that next year will be just the second time in which U.S. shareholders will be voting on say-on-pay resolutions during a presidential election. The first time, in 2012, the provision was in its infancy. This time around, with more candidates and an open presidential seat, expect some outlier corporate pay plans to become fodder for media headlines and campaign stump speeches.  Similarly, the tide of proxy access resolutions is expected to surge further in 2016. By some estimates, shareholders are likely to target more than 200 companies.

Keep in mind that the presidential primary timeline parallels proxy season. Most U.S. annual meetings convene between March and May. Super Tuesday, when 13 states hold primary votes, takes place March 1. Another 16 states are scheduled to go the polls before the end of that month. In April and May, another 12 join in. And both parties will gather for national nominating conventions earlier than in recent years: Republicans in Cleveland on July 18-21, Democrats in Philadelphia July 25-28.

Keep an antenna tuned to that political calendar when preparing your proxy statement for next season. You may consider adding an extra layer of sensitivity when shaping both substance and communications about compensation, proxy access, share buybacks, board diversity, and other issues already on the radar screen.

Ironically, institutional investors, as well as companies, will be vulnerable to scrutiny in presidential politics. Investors depicted as enabling or abetting bad corporate behavior could find themselves taking a reputation hit.

Like the Valeant case, there is precedent. Last year Westbrook Partners, a New York-based private equity fund, bought a London housing block with working-class renters. Westbrook’s aim was to overhaul the building and reap gains from big rent hikes. Politicians entering the British general election season flocked to the cause against rapacious investors ready to toss low-income Londoners onto the street. After enduring scalding headlines, Westbrook surrendered and sold its interests.

Westbrook is a sophisticated investor with a concentrated portfolio, yet it failed to gauge political risk. Investors at far bigger shops may be that much more susceptible because most investment houses vastly under-resource the monitoring of extra financial factors. One big mutual fund complex, for instance, has just two part-timers patrolling environmental, social, and governance risk for a portfolio of more than 9,000 public companies worldwide. That’s not atypical. So they have only partial eyes on the potential for being associated with companies that trigger political storms.

With presidential candidates campaigning against short-termism by investors, big institutions may want to keep their heads down in 2016, but may have little choice but to toughen their approach to portfolio companies. After all, they know that their annual N-PX filings, where mutual funds have to disclose their voting records, must be released in August—smack in the heat of campaign season.

So corporate boards and big funds look set to share the same boat next year: They will each have to guard against political risk as the line between politics and business blurs ever further in the approach to the 2016 election. Enjoy.