2011 Annual Corporate Governance Review

The following comes to us from David Drake, President of Georgeson Inc, and is based on the executive summary of Georgeson’s 2011 Annual Corporate Governance Review by Mr. Drake, Rhonda L. Brauer, Rajeev Kumar, Steven Pantina, and Rachel Posner. The full review is available for download here.

The past decade has been a whirlwind for corporate governance in America. Since 2001, we have witnessed a myriad of scandals, epic corporate failures and legislative and regulatory attempts to prevent more of the same. Early on it was the failure of firms such as Enron, WorldCom and Global Crossing. More recently, the failure of financial stalwarts like Lehman Brothers, Bear Stearns and AIG nearly pushed our markets to the brink of collapse. These failures have ushered in a new era of shareholder activism and corporate governance initiatives, including extensive legislative reform efforts and new rules by the Securities and Exchange Commission (SEC), the New York Stock Exchange (NYSE) and the Financial Industry Regulatory Authority (FINRA).

While many of the proxy-related reforms have focused on enhanced disclosure requirements (the SEC has approved expansive new rules around director experience and qualifications, board leadership structure, board risk oversight responsibilities and Compensation Disclosure and Analysis (CD&A) disclosure), new regulations have been put in place that fundamentally shift what issues are considered by shareholder at annual meetings in the United States.

The Arrival of Widespread Say-on-Pay Votes in U.S.

The most recent and, arguably, highest-profile change came when President Obama signed into law the Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank” or the “Act”). Although Dodd-Frank was enacted largely to provide greater governmental oversight for the U.S. financial services industry, the Act went beyond bank reform and imposed substantial new requirements on publicly-traded companies, particularly in the area of executive compensation. More specifically, Dodd-Frank mandated that publicly traded companies include an advisory (non-binding) resolution on their ballots to approve executive compensation, known as “say-on-pay.”

The new rule created a high level of angst for members of the corporate community, many of whom feared that institutions would be susceptible to “knee-jerk” reactions against high executive compensation in the initial say-on-pay votes. However, these fears turned out to be unfounded because, as the voting results from the 2011 proxy season indicate, the vast majority of companies emerged unscathed. Of the 1,200-plus companies in our tracking range (Georgeson tracks companies in the S&P 1500 Composite Index that hold their annual meeting in the first six months of the calendar year), only 25 (or 2 percent) received less than a majority of votes cast in favor of their say-on-pay resolution (and in the greater community, only 41 had “failed” resolutions). [1]

Moreover, and likely much to the relief of companies, the resolution appears to have had the positive impact of lowering the level of withhold/against votes in director elections, particularly against compensation committee members. In 2010, Georgeson tracked 748 directors who received at least 15 percent of votes cast withhold/against, including 317 directors who sat on the compensation committee of their boards. This year, the total number of directors who received greater than 15 percent withhold/against votes fell to 549 (a decrease of 27 percent from 2010 and 47 percent over the past two years), and the number of directors sitting on the compensation committee fell to only 271, a decrease of 37 percent from 2010.

Strong voting results on say-on-pay and improved figures relating to the election of directors are largely attributable to two factors. First, many companies chose to enhance their CD&A disclosure and provided shareholders with a clearer understanding of their compensation philosophy, their current compensation practices and the metrics that were used to make their compensation decisions. Second, more companies engaged in dialogue with their largest shareholders, either prior to or at the outset of proxy season to gain a clearer understanding of the factors their shareholders use to evaluate executive compensation issues. Similarly, Georgeson found that companies were more willing to engage with their largest holders in the face of a negative recommendation from one of the major proxy advisory firms on key proxy issues like say-on-pay, particularly if the companies believed the advisory report was incomplete or inaccurate. For example, one common topic for discussion on say-on-pay vote recommendations related to the peer groups used by the proxy advisory firms in their benchmarking of relative pay, which often differed considerably from what companies had used in their proxy disclosure. This proved to be a useful point of engagement, because many of the larger institutional investors disclosed that they did not rely heavily on proxy advisory peer group analyses and that they would factor the company’s viewpoint into their analyses. Others questioned certain advisory firms’ narrow focus on total shareholder return as the sole measure of company performance.

Georgeson’s findings of a sizable increase in shareholder engagement are consistent with other reports within the industry, including a study by the Investor Responsibility Research Center Institute on the state of engagement between U.S. corporations and shareholders, which stated that “engagement between issuers and investors is common and increasing both in terms of frequency and subject areas.” [2] Georgeson believes that a strong dialogue between companies and their shareholders is essential, and we encourage companies to try and engage on a more frequent basis. In so doing, Georgeson believes that issuers can minimize the possibility of failed director elections, say-on-pay votes and other potential surprises.

Say-When-on-Pay Votes Yield Consistent Results

As for the related issue of “say-when-on-pay” (or “say-on-frequency”) to determine the frequency of the say-on-pay vote, a majority of companies saw the early writing on the wall and proposed annual votes on executive compensation (our research shows that 66 percent of companies in the S&P 500 and 60 percent of companies in the S&P 1500 recommended that shareholders adopt an annual approach). With most institutional investors supporting annual votes on executive compensation (there were a handful of larger institutions supporting triennial votes), it came as no surprise that over 90 percent of meetings for S&P 1500 and nearly 95 percent of meetings for S&P 500 companies had the annual option receiving at least a plurality of votes cast in favor. Moreover, Georgeson’s research has shown that the minority of companies that had their shareholders support an alternative option typically had a special circumstance working in favor of that option. The special circumstance varied by company but often included (i) a large inside position; (ii) a dual-class voting structure with one class (usually controlled) having supermajority voting rights; (iii) a top-heavy institutional profile with one or more of the larger holders supporting the triennial approach; or (iv) a large retail component that either followed management or didn’t vote at all.

It is worth noting that the say-on-frequency resolution is required to be submitted to shareholders only once every six years, although companies may choose to submit the resolution more often. Some clients have asked us if support for a longer period between votes could increase in the future, particularly as investors become more comfortable with assessing a particular company’s compensation practices. While there may be some merit to that argument, we believe shareholders will continue to opt for annual say-on-pay votes.

Governance-Related Shareholder Proposals Take a Back Seat

The number of governance-related shareholder proposals has steadily declined over the past few years and continued to do the same this year. In fact, the number of governance-related proposals either submitted or voted on fell to the lowest levels since the pre-Enron era. The number of shareholder proposals submitted to companies fell to 417 resolutions, a decline of over 21 percent from 2010. The number of resolutions that came to a shareholder vote fell to just 240, a decline of nearly 30 percent from 2010. The substantial decline in resolutions submitted and voted on did not come as a surprise because Dodd-Frank addressed many of the activists’ compensation-related concerns. These included: (i) requests for mandatory say-on-pay requirements (53 resolutions voted on in 2010), (ii) advisory votes on golden parachutes (a popular resolution over the past decade and three resolutions voted on in 2010), and (iii) mandatory clawback provisions (three resolutions voted on in 2010).

While Dodd-Frank was certainly a contributing factor to the overall decline in shareholder resolutions, it is not the only factor. As the level of engagement between companies and shareholders has increased considerably over the past few years, companies have shown an increased willingness to make changes to their governance practices. In addition, according to recent statistics, the number of companies with anti-takeover provisions, a common subject for shareholder resolutions, has continued to fall: the percentage of S&P 500 companies with classified boards dropped to 25 percent, [3] and poison pills fell to 11 percent. [4] At the same time, the percentage of S&P 500 companies that have formally adopted majority voting in uncontested director elections has risen to 77 percent [5] (up from 66 percent in 2007). [6] The percentage of companies providing shareholders with the right to call a special meeting is up to 51 [7] (up from 34 percent in 2006). [8] The percentage of companies that allow shareholders to act by written consent is up to 28 [9] (up from 15 percent in 2008). [10]

Among the resolutions that appeared on proxy ballots, board-related resolutions were the most popular this season, accounting for over 25 percent of the governance proposals voted on. Majority voting resolutions, considered by activists to be the “missing link” in Dodd-Frank, accounted for exactly half of the board-related resolutions, with 31 proposals going to shareholder vote. Overall support for majority voting shareholder proposals marginally increased from 2010, averaging approximately 57 percent of votes cast in favor, up 1 percent from 2010. One point worth noting is the growing disparity in the results of majority vote proposals between those companies that have chosen to retain a “pure plurality” voting standard and those that have adopted what is called a “plurality plus” standard (whereby the company formally retains a plurality voting standard but implements a board policy stating that any director who receives more votes withheld than in favor would be required to submit his or her resignation to the board, subject to the board’s final decision as to whether to accept the resignation). In 2007, support for majority voting shareholder proposals at companies that had a pure plurality voting standard averaged 57 percent of votes cast, with four of the eight resolutions receiving greater than a majority of votes cast. In 2011, that grew to 69 percent of votes cast with 14 of the 15 resolutions receiving greater than a majority of votes cast in favor. These results stand in stark contrast to those outcomes for companies that had implemented a plurality plus voting standard, where the average level of shareholder support has largely remained the same over the past five years. In fact, over the past five years the average level of support has dropped one percentage point, from 45 percent in 2007 to 44 percent this year.

Investor Support for Special Meetings and Written Consent Declines

Proposals seeking to provide shareholders with the right to call special meetings or act by written consent continued to be popular among activists again this year with 61 resolutions (29 special meeting resolutions and 32 written consent resolutions) going to a shareholder vote. However, shareholder support for these items declined for the first time since they were introduced. For special meetings, the 29 resolutions that were submitted to a vote of shareholders averaged 40 percent of votes cast in favor, a decline of two percent from 2010. Support for written consent resolutions fell six percent, from an average of 54 percent of votes cast in favor in 2010 to just 48 percent in 2011.

Both of these types of resolutions are recent additions to the annual meeting landscape (special meeting proposals started to appear as a Rule 14a-8 resolution in 2007 and written consent in 2010), and voting results for newer resolutions often experience periods of fluctuation before investors fully develop their policies. However, corporations being proactive in responding to shareholder concerns actually accounts for the variance. According to Georgeson’s research, 21 of the 29 companies that were subject to the special meeting resolution already provided shareholders with the right to call a special meeting. Nearly a majority of targeted companies had an established threshold of 25 percent to call a special meeting (13 of the 29), but a few had even lower standards, including four that had a 20 percent threshold and two for a 15 percent threshold. Similar numbers appeared with written consent resolutions, with 26 of the 32 companies targeted having special meeting provisions in place, including 12 with a 25 percent threshold, six with a 20 percent threshold, three with a 15 percent threshold and four with a 10 percent threshold. There was also one company who provided shareholders with the right to call a special meeting at a threshold higher than 25 percent.

Another contributing factor was ISS, one of the leading proxy advisory firms, and its new policy on shareholder proposals regarding shareholders’ right to act by written consent. In 2010, ISS recommended in favor of written consent resolutions without looking into other pro-shareholder governance practices that a company may have implemented to address the underlying concern of the potential for entrenched management and shareholders’ ability to act outside of the annual meeting process. However, after some companies and shareholders expressed concerns about the negative consequences of adopting written consent (particularly the potential for disenfranchising minority stockholders), ISS adopted a case-by-case approach that takes a handful of other factors into account. The new policy allows ISS to recommend against a resolution if companies have: (i) a formal majority voting standard in uncontested director elections, (ii) an absence of a poison pill or shareholder-approved poison pill, (iii) an annually-elected board, and (iv) an “unfettered” right to call a special meeting with no greater than a 10 percent threshold.

While a similar policy was not enacted for special meeting resolutions, it is worth noting that ISS took a more lenient stance in at least one case where the company had made a number of pro-shareholder changes to its governance profile and already had a 15 percent threshold to call a special meeting. Glass Lewis, another prominent proxy advisory firm, has a similar — albeit slightly more pro-shareholder — stance when evaluating these shareholder proposals. It takes into account the following factors (among others): (i) company size, (ii) company performance, (iii) shareholder structure, (iv) the existence of other anti-takeover provisions, (v) the opportunity for shareholder action outside of the annual meeting cycle, and (vi) board responsiveness to previous shareholder proposals.

With shareholder sentiment on these issues clearly in a state of flux, companies are urged to remain vigilant of the trends. The special meeting proposals being submitted ask companies to adopt the measure with a 10 percent meeting threshold. Yet, the results we have seen show that a majority of investors, while generally supportive of the right, will not automatically vote for the resolution if the company has already addressed the issue. Shareholders have even been receptive to the inclusion of other provisions, such as minimum holding periods, in the rule. Thus, companies are encouraged to assess their own shareholder base, engage with holders and respond to concerns as necessary.

Some Social Resolutions Pushing the Governance Agenda

Although Georgeson focuses its Review on governance resolutions, we occasionally focus on “hot button” issues outside the governance realm to the extent that these issues put pressure on boards to respond quickly to a growing activist issue. One of these issues relates to political contributions disclosure. Shareholder activists have focused on political contributions as a governance issue by questioning the appropriate use of corporate assets. Proponents of these resolutions, which include major labor unions and pension funds, believe that companies should provide greater transparency and accountability in their spending on and policies concerning political activities. While some companies have implemented policies to disclose contributions made directly to individual candidates, proponents say these policies are incomplete. They argue that policies should be expanded to include “direct and indirect political contributions to candidates, political parties, political organizations or ballot referendums; independent expenditures; or electioneering communications on behalf of a federal, state or local candidate.” [11]

The notion of providing detailed reports on political expenditures has received increased attention, principally as a result of the Supreme Court’s decision in Citizens United vs. Federal Election Commission (2010), which lifted restrictions on political spending by corporations and now allows corporations more latitude to donate indirectly in support of or against certain candidates. As a result, average support for the 40 resolutions we tracked that ask for companies to “Report on Policies and Procedures Contributions” (there are several different types of political contribution resolutions) was just over 26 percent of votes cast (relatively high for a social-based resolution), including a few that received greater than 40 percent of votes.

With the next U.S. Presidential election less than one year away, Georgeson believes that the issue of corporate political contributions will continue to grow. There are groups, including the Center for Political Accountability, that rate companies according to their policies and reporting transparency, and have gone so far as to draft model shareholder resolutions for shareholder activists to use. Furthermore, Georgeson expects the next round of popular resolutions to be similar to those that were submitted by the American Federation of State, County & Municipal Employees (AFSCME). The AFSCME resolutions go beyond contributions to political candidates and address contributions made to trade associations and grassroots organizations that indirectly influence political outcomes. Although activists’ efforts will likely focus on large cap companies, Georgeson encourages all companies to assess their vulnerability to these proposals, based on their current policies and levels of disclosure, particularly in comparison to their industry peer companies.

The Road Ahead

Undoubtedly, the growing pains of having to deal with say-on-pay in the 2011 proxy season were challenging for companies and investors alike. While some institutional investors went to great lengths to develop detailed policies on say-on-pay, many others had not fully developed specific guidelines on how to assess overall compensation and translate it into a vote. Even among those that have created detailed guidelines, we found that the particular areas of focus differed (some institutional investors expressed a greater interest in disclosure and looked to understand a company’s compensation philosophy while others reviewed a company’s performance and overall levels of compensation). Also, some of the post-season feedback from institutional investors indicates that their governance policies are not yet fully settled and could result in more say-on-pay against votes in 2012. With a high level of uncertainty for the upcoming season, it is important for companies to engage their largest investors early, to understand their investors’ approach to evaluating compensation and to make changes as they deem appropriate.

From a shareholder proposal standpoint, Georgeson expects the number of proposals submitted to increase in 2012 for several reasons. To begin with, as a result of the U.S. Court of Appeals for the District of Columbia decision in July to vacate the SEC’s “proxy access” rule (Rule 14a-11 of the Exchange Act of 1934), which would have required public companies to include shareholder nominees for director in company proxy materials, we expect activists to focus on “private ordering” (seeking proxy access on a company-by-company basis, through the submission of Rule 14a-8 resolutions). It is not yet clear how prevalent such resolutions will be or which companies will be targeted. We believe activists will focus on the weakest performers that lack many of the “best practices” in corporate governance advocated by the activists. We expect that the coming resolutions will focus on the key elements of the vacated SEC rule which included minimum percentage of and time periods for ownership.

In addition, Georgeson expects to see an increase in proposals submitted by unions and pension funds, which now have a new partner in the American Corporate Governance Institute (ACGI). The ACGI, which describes itself as a “research and advisory organization that seeks to contribute to improving corporate governance and accountability in publicly traded companies,” is headed by Lucian Bebchuk, a noted Harvard Law School Professor and long time advocate of shareholder rights. This past season, the ACGI worked with the Florida State Board of Administration (FSBA) and the Nathan Cummings Foundation to help identify potential targets for shareholder activism and assisted in the drafting of shareholder proposal and handling the no-action process at the SEC. With the ACGI’s help, the FSBA and the Nathan Cummings Foundation submitted 14 shareholder resolutions on declassifying boards, with 10 appearing on corporate ballots and four either withdrawn or omitted. [12] We expect that the ACGI will increase its efforts in the coming year, in both the number of investor groups with which it works and potentially the types of resolutions submitted.

The 2012 proxy season will be no less challenging than the last. As always, the keys to coping with increasing demands are knowing your shareholder base, engaging with its members and maintaining the flexibility to change.


[1] ISS Corporate Services
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[2] Marc Goldstein, The State of Engagement Between U.S. Corporation and Shareholders, Investor Responsibility Research Center Institute (February 22, 2011).
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[3] FactSet SharkRepellent
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[4] Ibid.
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[5] Ibid.
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[6] Neal, Gerber & Eisenberg LLP (C. Allen), Study of Majority Voting in Director Elections, (November 2007).
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[7] FactSet SharkRepellent
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[8] ISS Corporate Services
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[9] FactSet SharkRepellent
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[10] ISS Corporate Services
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[11] Caterpillar Inc. 2011 proxy statement. www.sec.gov/Archives/edgar/data/18230/000001823011000247/def-14a_2011.htm.
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[12] Rosemary Lally, FSBA, Nathan Cummings Target Large Cap Holdouts with Classified Boards, Council of Institutional Investors: Council Governance Alert (April 21, 2011).
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