Don’t expect executives, directors, and institutional investors to join hands and sing “Kumbaya” any time soon. But a common push from all three parties for improved corporate governance has emerged throughout this year’s proxy season.
“We are hearing a lot more about shareholder engagement, and most boards are getting more involved,” Paula Loop, leader of PwC’s Governance Insights Center, said during a recent webcast she moderated. “Shareholder engagement is now taking on a broader view. It is becoming more important to think about a dialog on bigger topics, including strategic plans, capital allocation plans, and any of the risks associated with them. The big question is not how important shareholder engagement is, but when do directors get involved and what role do they need to play?”
“There is significantly more shareholder engagement than a few years ago,” says Ken Bertsch, executive director of the Council of Institutional Investors. “I think say-on-pay was the biggest reason for that…Executive pay discussions tend to move rather quickly to strategy and an understanding of what the company is doing and why.”
In 2011, as mandated by the Dodd-frank Act, the Securities and Exchange Commission enacted final rules requiring shareholder approval of executive compensation, a demand colloquially known as say-on-pay.
“A lot of times companies that fail their say-on-pay vote are targeted by a group of investors that are filing shareholder proposals beyond just pay,” says Jamie Carroll Smith, assistant director at EY’s Center for Board Matters. “It becomes a red flag for other concerns. If a company fails their say-on-pay vote. they are likely to get a cluster of proposals, not just on pay practices but also on other governance practices. They might receive a proxy access proposal, or a proposal to adopt majority voting, or appoint an independent chair.”
“A lot of times, companies that fail their say-on-pay vote are targeted by a group of investors that are filing shareholder proposals beyond just pay.”
Jamie Carroll Smith, assistant director, EY’s Center for Board Matters
If say-on-pay is a catalyst for improved shareholder outreach, then proxy access is the evidence.
Proxy access—versus having directors by boards without shareholder influence—allows investors to nominate director candidates. Once fiercely opposed by business leaders, the concept has seen a resurrection even though rulemaking on the subject has been effectively abandoned in recent years by the SEC due to various legal challenges.
Not every company is receptive to the exact terms shareholder activists desire (usually giving a shareholder or group of shareholders holding at least 3 percent of a company's shares for at least three years the right to nominate up to 25 percent of a board's directors), but there is at least a general receptiveness.
The EY Center for Board Matters recently released a report on its takeaways from the 2016 proxy season. It found that active—not just activist—institutional investors are reshaping the corporate governance landscape and challenging how boards think about strategy, risk, capital allocation, and board composition. It also highlighted an accelerated adoption of proxy access.
“Many companies are embracing it and not fighting it,” Smith says. “They have been fighting it for decades, but now we are seeing more than a third of S&P 500 companies adopting access within the past two years and most of the companies that are receiving the proposals are adopting access. Around 60 percent of the companies that received proxy access shareholder proposals this year adopted access bylaws before the proposal even went to a vote. We are definitely seeing a sea change.”
What changed? “Companies are seeing the writing on the walls, that this is something investors want and will continue to push for,” she says. Also, once several leading companies went ahead and adopted proxy access, “others realized the sky isn’t going to fall and started to have really substantive conversations with the investors filing these proposals and found common ground.”
“I think they understood where the investors were coming from, saw that they were reasonable people, and that they could move forward with this in a way that is constructive and increases accountability.”
BUILDING A BETTER BOARD
The following is an excerpt from “Commonsense Corporate Governance Principles,” a document issued by a committee of top U.S. business leaders.
Companies should consider paying a substantial portion (for some companies, as much as 50 percent or more) of director compensation in stock, performance stock units or similar equity-like instruments.
Companies also should consider requiring directors to retain a significant portion of their equity compensation for the duration of their tenure to further directors’ economic alignment with the long-term performance of the company.
Boards should have a robust process to evaluate themselves on a regular basis, led by the non-executive chair, lead independent director or appropriate committee chair. The board should have the fortitude to replace ineffective directors.
Robust communication of a board’s thinking to the company’s shareholders is important. There are multiple ways of going about it.
For example, companies may wish to designate certain directors, as and when appropriate and in coordination with management, to communicate directly with shareholders on governance and key shareholder issues, such as CEO compensation. Directors who communicate directly with shareholders ideally will be experienced in such matters.
In addition, the CEO should actively engage on corporate governance and key shareholder issues (other than the CEO’s own compensation) when meeting with shareholders.
The full board (including, where appropriate, through the non-executive chair or lead independent director) should have input into the setting of the board agenda.
Over the course of the year, the agenda should include and focus on the following items, among others: a robust, forward-looking discussion of the business; and the performance of the current CEO and other key members of management and succession planning for each of them.
One of the board’s most important jobs is making sure the company has the right CEO. If the company does not have the appropriate CEO, the board should act promptly to address the issue.
Creation of shareholder value, with a focus on the long term, means encouraging the sort of long-term thinking owners of a private company might bring to their strategic discussions, including investments that may not pay off in the short run.
The board should not be reflexively risk averse; it should seek the proper calibration of risk and reward as it focuses on the long-term interests of the company’s shareholders.
The board should minimize the amount of time it spends on frivolous or non- essential matters–the goal is to provide perspective and make decisions to build real value for the company and its shareholders.
As authorized and coordinated by the board, directors should have unfettered access to management, including those below the CEO’s direct reports.
At each meeting, to ensure open and free discussion, the board should meet in executive session without the CEO or other members of management. The independent directors should ensure that they have enough time to do this properly.
Source: Commonsense Corporate Governance Principles
Directors will need to adapt. “It is important for boards, in this new world of proxy access, to really verify that director qualifications align with the company’s opportunities going forward, that they are ensuring regular refreshment is bringing in current expertise and increasing diversity, and that they are optimizing their conversations with investors around board composition and keeping that line of communication open,” Smith says.
EY also noted: “Companies continue to enhance investor communications.”
“Proxy disclosures are an efficient way to take the company’s targeted governance message to a broad audience of investors and other stakeholders,” it says. “Through direct engagement, companies are better positioned to proactively respond to investor concerns.”
Sixty-one percent of companies now issue a proxy statement executive summary, up from 43 percent in 2014, the report says.
“If you look at proxy statements now, versus even just five years ago, the changes are dramatic,” Smith says. “Regarding board composition, in particular, you are seeing many more graphics, charts, tables, and skills matrices to really give investors a clearer understanding of the kind of diversity the board has in terms of skills, ethnicity, gender, and tenure. It is an exciting development. These disclosures are giving investors a better window into how directors are representing their interests in the boardroom.”
Smith is also watching, with interest, letters to shareholders from the board or independent board leadership that discuss governance topics. It signals improved transparency and should emerge as a valuable communication tool, she says.
Other findings in the EY study:
Board composition remains a key focus—with director tenure and board leadership coming under increased investor examination.
Boards’ record of refreshment, assessment process and leadership structures are under heightened scrutiny.
There is a continued push for increased transparency and accountability around environmental sustainability practices. Average support for proposals on climate risk have jumped from 7 percent in 2011 to 31 percent so far this year.
Shareholder resolutions related to political and lobbying spending are showing increased popularity.
It isn’t just shareholders looking for better boards and improved governance.
On July 21, a coalition of top business leaders stepped up to the plate with a recitation of best practices they are calling “Commonsense Principles of Corporate Governance.”
Those signing the document included:
GE CEO Jeff Immelt
General Motors CEO Mary Barra
Warren Buffett, chairman and CEO of Berkshire Hathaway
Larry Fink, CEO of BlackRock
JPMorgan Chase CEO Jamie Dimon
Verizon Chairman and CEO Lowell McAdam
Mark Machin, president and CEO of the Canada Pension Plan Investment Board
Capital Group Chairman and CEO Tim Armour
Mary Erdoes, CEO of JPMorgan Asset Management
Vanguard CEO Bill McNabb
State Street Global Advisors CEO Ronald O'Hanley
Brian Rogers, board chairman and chief investment officer of T. Rowe Price Group
Jeff Ubben, CEO and CIO of ValueAct Capital
“Good corporate governance must be more than just a catch phrase or fad,” they wrote. “It’s an imperative—especially when it comes to our publicly owned companies…We think it essential that our public companies take a long-term approach to the management and governance of their business (the sort of approach you’d take if you owned 100 percent of a company).”
“Corporate governance in recent years has often been an area of intense debate among investors, corporate leaders and other stakeholders,” the group wrote. “Yet, too often, that debate has generated more heat than light.” While most everyone agrees that we need good corporate governance, “there has been wide disagreement on what that actually means.”
Among the group’s recommendations:
No board should be beholden to the CEO or management.
Every board should meet regularly without the CEO present, and every board should have active and direct engagement with executives below the CEO level.
Diverse boards make better decisions, so every board should have members with complementary and diverse skills, backgrounds and experiences.
It’s important to balance wisdom and judgment that accompany experience and tenure with the need for fresh thinking and perspectives of new board members.
Every board needs a strong leader who is independent of management. The board’s independent directors usually are in the best position to evaluate whether the roles of chairman and CEO should be separate or combined.
If the board decides on a combined role, it is essential that the board have a strong lead independent director with clearly defined authorities and responsibilities.
Financial markets have become too obsessed with quarterly earnings forecasts. Companies should not feel obligated to provide earnings guidance—and should do so only if they believe that providing such guidance is beneficial to shareholders.
A common accounting standard is critical for corporate transparency. While companies may use non-Generally Accepted Accounting Principles to explain and clarify their results, they should never do so in such a way as to obscure GAAP-reported results.
Since stock- or options-based compensation is plainly a cost of doing business, it always should be reflected in non-GAAP measurements of earnings.
Effective governance requires constructive engagement between a company and its shareholders.
The company’s institutional investors making decisions on proxy issues important to long-term value creation should have access to the company, its management and, in some circumstances, the board; similarly, a company, its management and board should have access to institutional investors’ ultimate decision makers on those issues.
The Council of Institutional Investors offered its qualified support for the recommendations and said, in a statement, that “most are in sync” with its long-standing policies on corporate governance.
“That such an elite group has backed a broad governance framework makes clear that corporate governance has entered the mainstream and should be a focus for all public companies,” Bertsch, its executive director, says. “The publication of these principles is a call to action for U.S. companies large and small to adopt effective corporate governance standards and practices.”
Specifically, he applauded “robust expectations” for directors and an endorsement of such shareholder rights as electing directors by majority vote and a rejection of dual class voting structures. A call for consideration of ‘sunset’ provisions at dual class companies echoes, to some degree, CII policy that calls on newly public companies without “one share, one vote” provisions to commit to their adoption over a reasonably limited period through sunset mechanisms.
Nevertheless, “the principles should have gone further on shareholder rights,” Bertsch says. “While they acknowledge the recent adoption of proxy access mechanisms by dozens of U.S. companies, they stop short of endorsing the common-sense right of long-term shareholders at all public companies to place their nominees for director on a company’s proxy card.”
Another disappointment: The outlined principles were silent on the duty of boards to act on shareholder proposals that a majority of shareholders have endorsed.