This year, say on pay is not the only area where boards are likely to face shareholder scrutiny.
For the past two proxy seasons, public companies reporting a public float below $75 million have watched from the sidelines as activist investors have used their newfound muscle to pressure larger corporations to adopt say on pay. Now it is those companies’ turn to take center stage.
Proxy season 2013 marks the end of a two-year reprieve granted to smaller companies by the SEC on the advisory say-on-pay rules, and many shareholders are gearing up to expand their campaigns.
‘It’s the small-cap stocks in investor portfolios that are starting to get attention,’ says Ron Schneider, senior vice president of AST Phoenix Advisors. ‘These companies will need to be responsive.’
Indeed, say on pay is not the only area where these boards are likely to face shareholder demands. This year is also likely to bring an expansion of campaigns to pressure the boards of smaller public companies to adopt majority voting standards. Majority voting rules require directors running for seats in uncontested elections to receive a majority of the total votes cast as opposed to simply the highest number of affirmative votes, which means that a significant amount of withhold votes against a director can trigger a resignation.
While less than 10 percent of companies in the S&P 500 still maintain a strict plurality standard for director elections, more than two thirds of the small and mid-sized companies in the Russell 2000 still do; this prompted Anne Sheehan, director of corporate governance for CalSTRS, to publicly vow this past summer to ‘march our way down the Russell 2000’ on the issue.
Sheehan has good reason to believe her efforts will pay off. Last proxy season CalSTRS, which has a portfolio valued at $150.6 billion and is the second-largest pension fund in the US, engaged 95 companies and convinced 82 to adopt the standard.
Nor is CalSTRS the only one pressing the issue, notes Patrick McGurn, vice president and special counsel at ISS.
‘You have near unanimity in large-cap, so a lot of activist investors are setting their sights downstream on the mid-cap, small-cap range,’ McGurn says. ‘I expect majority voting to continue to make inroads into mid-cap and small-cap companies.’
Amy Borrus, deputy director of the Council of Institutional Investors, describes the campaigns on majority voting as a process of ‘building out’ support, and notes that activist investors are also using the strategy on classified boards. In addition to building out to smaller companies, they will continue to focus increasing pressure on the shrinking number of companies in the S&P 500 that remain holdouts on these issues. Both declassifying boards and majority voting continue to get ‘very, very high shareholder support’, Borrus says. ‘Investors will continue to press.’
Proxy access is also likely to be a hot issue again in proxy season 2013. Last year was a test year of sorts, following a 2011 US court decision to strike down a new SEC rule that would have allowed investors who have owned 3 percent of a company stock for three years to get their own director candidates onto the official company proxy statements. In its decision to strike down the SEC rule, the court upheld the right of investors to place their own proxy access proposals onto company ballots, and last year represented the first year in which such proposals were offered up at annual meetings.
Last year activist investors experimented with various forms of proxy access to see which ones would pass SEC muster and which ones would garner majority shareholder support. In the end, the proposals most closely aligned with proxy access proposals originally adopted by the SEC but later struck down in court – 3 percent ownership for three years – were the most successful. Two proposals received majority support at Chesapeake Energy and Nabors Industries, both of which were non-binding resolutions.
‘Last year we saw about two dozen proposals, and a dozen came to a vote,’ McGurn says. ‘I think we will see a significant increase this year. We could easily double that. There’s going to be a bumper crop.’
In the midst of all these impending challenges, shareholder engagement continues to grow, many industry experts say. More and more companies are improving the content, substance and presentation of their proxy statements, for clarity, graphics and the ease of subheads, notes Schneider. Meanwhile, those who have had problems on votes have largely responded by reaching out to speak with disgruntled investors.
Engagement on pay
About 90 percent of the companies that saw their say-on-pay plans voted down in 2011 were able to garner strong support in 2012 from those same shareholders by making changes to pay packages, in large part to increase outreach and in response to lessons learned by US-listed companies. It’s a trend many expect to continue.
‘There was a lot of engagement,’ Borrus says. ‘It’s embarrassing to have a high ‘no’ vote on say on pay, and directors do not like it. They don’t want to defend it.’
‘By and large, US investors were more satisfied with the way companies responded to the issues,’ says McGurn. ‘You just didn’t see the escalation that we saw in Europe and the UK last year.’
Perhaps the clearest indication of that comes from the actions of McGurn’s company, ISS. In the months leading up to 2012, the proxy advisory firm threatened to recommend ‘no’ votes against compensation committee board members who failed to respond to 2011 ‘no’ votes on say on pay. ISS didn’t have to follow through on the threat at most companies, because 90 percent made changes and received strong majority votes in favor of their 2012 pay packages.
‘We made very few ‘red card’ recommendations of board members this year, because most boards were responsive,’ McGurn says. ‘Based on what our institutional clients told us, we found that boards have been very responsive and engaged in aggressive outreach.’
Still, many observers are expecting a new crop of large-cap companies to fail say on pay or face other hurdles they might not expect.
Schneider notes that in year one, 40 companies failed, and that number rose to 55 last year. Only five of the 2012 companies were repeat offenders – ‘which means,’ he notes, ‘that 50 companies were first-time failures.
‘I think it’s reasonable, then, to expect that there will be an even larger class of failures in 2013,’ he continues. ‘Nobody is really immune from say on pay. Just because you did well two years in a row doesn’t mean you can relax.’
Despite the lack of ISS ‘red cards’ last year, the pressure to take action after future failed votes is only likely to increase. Both Glass Lewis and ISS have announced new proposals to take effect this proxy season that may well increase pressure. In the past, Glass Lewis looked for a board response from companies that received 25 percent opposition to management say-on-pay proposals. This year it announced a plan to extend that rule to 25 percent opposition to all proposals.
‘Glass Lewis is tightening the noose,’ Schneider says. ‘If any management proposal gets 25 percent against or a shareholder gets 25 percent and there is no board response, Glass Lewis may target individual board members.’
ISS is also strengthening its policies to ‘hold directors accountable’. In 2012, it recommended a vote against or withhold for the entire board if the board failed to act on shareholder proposals that received the support of a majority of shares outstanding the previous year. It also voted against if the board failed to act on proposals that received the support of the majority of shares cast in the last year, or one of the previous two years.
The new proposal would recommend ‘against or withhold’ if the board failed to act on a proposal that received a simple majority of the shares voted in the previous year.
The proposal ‘is going to put some real teeth into shareholder proposals going forward,’ says Sanjay Shirodkar, of counsel at DLA Piper. ‘Boards are going to take shareholder proposals a lot more seriously and will have to take certain actions before the next proxy season rolls around.’
There are other changes in the offing that might also affect the way boards are evaluated by proxy advisory firms. Glass Lewis has long evaluated pay for performance based on a forced curve of peer companies, applying grades ranging from A to F. This year it’s switching to a more complicated formula which may change the grades of a lot of companies. When Glass Lewis back-tested the new formula, 30 percent of companies received one grade higher or lower than under the old formula, while another 11 percent were two grades different.
Brad Robinson, managing director specializing in corporate governance at proxy firm Eagle Rock, predicts that the 2013 proxy season will be similar to last year. He says there will be ‘a continued shift and changing playing field towards shareholder rights. That means for issuers, it’s even more important to be aware of what the current trends are in governance, because this really doesn’t seem to be reversing. We have not yet hit the high water mark.’
For anyone who still doubts the imperative of shareholder engagement, proxy season 2012 offered a strong cautionary tale in the UK, which experienced a ‘shareholder spring’ marked by the outright defeat of remuneration reports at five companies – and the subsequent departure of CEOs at four companies.
Those results in the UK, notes Angelika Horstmeier, director of global corporate advisory services at Ipreo, were a ‘revelation to everyone’ and are likely to profoundly affect the way UK companies prepare for proxy season 2013.
‘Investors in the UK really gave boards a big slap on the wrist, and it’s not going to happen again,’ she says. ‘Companies are not going to want to be plastered all over the press again for something like that.’
In the months leading up to proxy season 2013, companies ‘will be looking more in advance for shareholder opinions and shareholder guidelines in policies. There wasn’t enough education. Companies are likely to engage much earlier with shareholders to find out what is important to them.’
Those lessons learned follow trends towards increasing pre-proxy season shareholder engagement in other European countries, many of which have had remuneration votes on corporate agendas for a couple of years. In Germany and France, Horstmeier says, engagement has only continued to expand in the lead-up to proxy season, as large investors are increasingly setting up in-house corporate governance teams and interfacing directly with companies rather than relying solely on outside advisory agencies. And these teams are engaging directly with the companies in which they invest.
Large French investors BNP Paribas and Amundi, Horstmeier notes, have been increasingly engaging with German companies in which they invest in order to discuss remuneration structure.
‘They used to write a letter to companies stating their guidelines and basically saying, <I>Have a look if you want to, but don’t worry if you don’t</I>,’ she says. But over the last three years, pre-proxy season investor relations has evolved and ‘now meetings are scheduled, they go through investor relations team, and then go to meetings with the board that sometimes include the CFO and CEO.’
Beware changes in the shareholder base
When considering proxy matters and shareholder proposals for 2013, John O’Grady, senior vice president of Laurel Hill Advisory Group, says a yearly assessment of a company’s shareholder base is necessary to fend off shareholder actions and proxy contests.
‘You need to find out who is holding your stock,’ he advises. ‘If you don’t know who is holding, you won’t know their tendencies.’
Issuers need to be aware that if the company has experienced a significant loss in stock value over the last year, it is likely that there will also have been a change in the shareholder base. That’s why year-round engagement is needed to make sure companies stay ahead of possible conflicts with shareholders that could lead to full-blown proxy contests or negative recommendations from ISS and Glass Lewis.
The corporate investor relations department and proxy advisory firms can help identify the type of concerns shareholders have about company governance policies or whether or not they would support activist investors seeking control. O’Grady suggests that companies identify the largest investors and then ‘Find out who it was that voted in favor of a particular shareholder proposal, then change your message slightly [in your proxy statement] and push it out publicly.’
Simple actions like these can prevent shareholder actions from evolving into a contest for control of the company.