Florida SBA 2013 Corporate Governance Annual Summary

Editor’s Note: Michael McCauley is Senior Officer, Investment Programs & Governance, of the Florida State Board of Administration (the “SBA”). This post is based on an excerpt from the SBA’s 2013 Corporate Governance Report by Mr. McCauley, Jacob Williams and Lucy Reams. Mr. Williams and Ms. Reams are Corporate Governance Manager and Senior Corporate Governance Analyst, respectively, at the SBA.

The Florida State Board of Administration (the “SBA”) takes steps on behalf of its participants, beneficiaries, retirees, and other clients to strengthen shareowner rights and promote leading corporate governance practices among its equity investments in both U.S. and international capital markets. The SBA adopts and reports clearly stated, understandable, and consistent policies to guide its approach to key issues. These policies are disclosed to all clients and beneficiaries.

The SBA supports the adoption of internationally recognized governance practices for well-managed corporations including independent boards, transparent board procedures, performance-based executive compensation, accurate accounting and audit practices, and policies covering issues such as succession planning and meaningful shareowner participation. The SBA also expects companies to adopt rigorous stock ownership and retention guidelines, and implement well designed incentive plans with disclosures that clearly explain board decisions surrounding executive compensation.

The complete publication is available here.

Annual Voting Review

During the fiscal year ended June 30, 2013, the SBA executed votes on 9,820 public company proxies covering 89,060 individual voting items, including director elections, audit firm ratifications, executive compensation plans, mergers, acquisitions, and other management and shareowner proposals. The SBA makes informed and independent voting decisions at investee companies, applying due care, intelligence, and judgment. The SBA ordinarily seeks to exercise all voting rights tied to its investments.

The SBA’s proxy votes were cast in 80 countries, with the top five countries comprised of the United States (2,875 votes), Japan (1,175), Hong Kong (645), United Kingdom (443), and Canada (385). The SBA voted “for” 80.4 percent of all proxy issues, “against” 15.9 percent, and abstained or did not vote due to share blocking on 3.7 percent of issues. Of all votes cast, 18.2 percent were against the management-recommended vote, down from 19 percent during the same period ending in 2012. While SBA staff is not pre-disposed to disagree with management recommendations, some management positions may not be in the best interest of all shareowners. Among all global proxy votes, the SBA cast at least one dissenting vote at 6,559 annual shareowner meetings, or 66.8 percent of all meetings.

On behalf of participants and beneficiaries, the SBA emphasizes the fiduciary responsibility to analyze and evaluate all management recommendations very closely. Particular attention is paid to decisions related to director elections, executive compensation structures, various anti-takeover measures, and proposed mergers or other corporate restructuring.

Director Elections

Board elections represent one of the most critical areas in voting since shareowners rely on the board to monitor management. The SBA supported 81.6 percent of individual nominees for boards of directors, voting against the remaining portion of directors primarily due to concerns about the candidate’s independence, attendance, workload, and overall board performance. The SBA may also withhold votes from directors who fail to observe good corporate governance practices or demonstrate a clear disregard for the interests of shareowners.

During the first half of 2013, 43 directors at 27 companies in the Russell 3000 stock index failed to receive majority (50 percent) support by shareowners as part of uncontested director elections—representing a mere 0.3 percent of all 14,774 director candidates. The SBA withheld votes for 88 percent of these same directors.

A review of these same 43 directors by the Council of Institutional Investors (CII) concluded that multiple variables explained the failure to receive a majority level of investor support: 1) service on three or more boards (a.k.a., “over-boarded” directors); 2) weaknesses in executive compensation practices; 3) a history of unresponsiveness to majority-supported shareowner proposals or majority-opposed directors; 4) a lack of director independence; 5) extended board tenure (defined as 10 or more years); and 6) attendance problems (participating in less than 75 percent of board/ committee meetings).

CII found that 72 percent of the rejected directors had at least two of these criteria. Only 6 of these 27 companies have implemented a majority voting election procedure, underscoring the need for U.S. companies to move away from the inferior method of plurality voting in uncontested elections.

Within the large capitalization S&P 500 index, seven companies had directors receiving less than 50 percent investor support. The following company directors were opposed by a majority of their investors for a variety of reasons: Cable Vision Systems (two directors opposed for failing to abide by majority votes against directors in prior periods); Nabors Industries (two directors opposed for failing to respond to majority supported shareowner proposals); Netflix (one director opposed for failing to submit a poison pill for shareowner ratification); Occidental Petroleum (one director opposed for failure to adequately manage succession planning); The AES Corp. (one director opposed due to poor attendance); and Vornado Realty Trust (four directors opposed for failing to respond to majority supported shareowner proposals).

Notable Votes

Significant votes during 2013 included the May 3rd vote in which Occidental Petroleum Executive Chairman Ray Irani was ousted from the board after receiving a scant 24 percent support from all voting investors. Mr. Irani had served on the board of directors for 23 years, but was required to step down after the shareowner vote in accordance with the firm’s majority voting bylaw. The SBA voted against Mr. Irani’s reelection.

Another significant vote occurred at JPMorgan, when on June 7th shareowners signaled their strong disfavor with several members of the firm’s Risk Committee. The SBA voted against several members of the board, including director nominees Laban Jackson, James Crown, James Cote, and Ellen Futter. The latter two have since resigned from the board of JPMorgan. James Cote, the Chairman and CEO of Honeywell International, had served six years on the JPMorgan board, while Ellen Futter, President of the American Museum of Natural History, had been on the board for 12 years. Mr. Cote and Ms. Futter received voting support from only 59 percent and 53 percent, respectively, of all voting shareowners. JPMorgan directors came under pressure from shareowners due to poor oversight that led to losses exceeding $6 billion tied to high-risk trading by an employee dubbed the “London Whale.”

Other companies experienced high levels of dissent in response to performance of individual board members. Three incumbent directors at Hewlett-Packard (HP) were removed within 10 days after they received less-than-majority support at the company’s annual shareowner meeting. The Chair of HP’s Finance and Investment Committee, John Hammergren, received support from approximately 53 percent of investors, whereas Audit Committee Chair G. Kennedy Thompson received support from 55 percent. The SBA voted against both directors.

As well, five directors on the Cablevision board received very low levels of support in late May, with the lowest member receiving approximately 45 percent. The company has a long history of maintaining directors who have lacked a majority level of support.

Independent Chairman

The SBA considers on a case-by-case basis whether to support separating the duties of Chairman and Chief Executive Officer, but generally supports separation unless the company has a strong governance structure which includes a designated lead director with the authority to develop and set the agenda for meetings and lead sessions outside the presence of an insider Chairman.

The SBA supported 96 percent of shareowner proposals to require an independent board chairman during the fiscal year. These proposals garnered a fair amount of success, achieving an average support level of 31 percent. An independent chair shareholder proposal at Kohl’s annual meeting won support from 51.5 percent among investors voting at the annual shareowners meeting. Other votes on independent chair proposals ranged from a low of 8.9 percent at Dean’s Foods, to 43.7 percent at IBM. Some of the notable independent chair proposal votes included: Aetna (33.3 percent), Gentex (40.9 percent), Northrop Grumman (29.7 percent), and Vulcan Materials (31.2 percent). Many investors are beginning to incorporate a company’s performance track record when making voting decisions on such proposals.

External Auditors

The SBA voted to ratify the board of directors’ selection of external auditors in 93.7 percent of such items. Auditors are responsible for safeguarding investor interests and assuring financial statements are presented fairly. Therefore, auditor independence and impartiality are paramount in maintaining public trust. Votes against auditor ratification are cast in instances where the audit firm has demonstrated a failure to provide appropriate oversight, significant financial restatements have occurred, or when significant conflicts of interest exist, such as the provision of outsized non-audit services or an alternative dispute resolution.

While the SBA does not have any restrictive policies on auditor tenure, the external audit firm’s longevity is a factor that is analyzed. In a report released by the Public Company Accounting Oversight Board (PCAOB), the average auditor tenure for the largest 100 U.S. companies by market capitalization equaled 28 years. The PCAOB found the average tenure for the 500 largest companies to be 21 years. The PCAOB also found that 59 percent of the Fortune 1000 companies had the same auditor for more than 10 years and 37 percent have had the same auditor for more than 20 years. Although not definitive, some researchers highlight links between longer auditor tenure and lower quality audits.

Executive Compensation

The SBA considers on a case-by-case basis whether a company’s board has implemented equity-based compensation plans that are excessive relative to other peer companies or that may not have an adequate performance orientation. As part of this analysis, the SBA reviews the level and quality of a company’s disclosures in order to assess the transparency of their compensation practices.

During the 2013 proxy season, the SBA utilized compensation research from Equilar, Inc., Farient Advisors, LLC, Glass, Lewis & Co., GovernanceMetrics International, Manifest Information Services Ltd, and MSCI Institutional Shareholder Services to evaluate and make voting decisions on say-on-pay (SOP) items. This year’s proxy season was the first year that smaller reporting companies (issuers with a public float of less than $75 million) were required to submit their executive compensation plans for a shareowner vote. At U.S. companies, the SBA voted against approximately 23 percent of all SOP voting items.

Over the last fiscal year, the SBA supported 58.2 percent of all non-salary (equity) compensation items, 70.5 percent of executive incentive bonus plans, and 60.8 percent of management proposals to adopt restricted stock plans in which company executives or directors would participate (60.8 percent support for the amendment of such plans).


The SBA has continued to support sustainability reporting requirements and improved environmental disclosures issued by companies held within its portfolios. The SBA supported 80 percent of shareowner resolutions asking companies to publish sustainability reports. According to the Global Reporting Initiative (GRI), which has developed a consistent disclosure format for corporate reporting of environmental data and practices, estimates that 95 percent of the world’s largest 250 companies now produce a sustainability report for their investors. Approximately 80 percent of these firms use the GRI guidelines, which were enhanced this year to provide a greater focus on the materiality of factors as gauged by investors.

Company Dialogue

Investor engagement continued to play a key role in 2013 as boards were again proactively reaching out to investors for feedback and support for upcoming proposals and to clarify and refute analyses offered by proxy advisors. This increased dialogue was a welcomed byproduct of the ‘say on pay’ vote as companies were called on to improve their disclosure of executive compensation practices. The SBA has seen a significant increase in company engagement in which companies have provided explanations of board procedure and decision making. In the 2013 proxy season, shareowners continue to show strong support for governance proposals including board declassification and majority voting. For more information on the SBA’s engagement activities, please see the ‘Proactive Engagement’ section.

Proxy access shareowner proposals facilitate investor-nominated director candidates. Such proposals garnered a lower level of support and attention during the 2013 proxy season than they did in 2012. Through the first half of 2013, only two proposals have passed, with an average support level of 30 percent among all proposals submitted. The SBA voted in favor of all 16 proxy access proposals submitted by investors during fiscal year 2013.

Impact of Activist Investing

Over the last several years, the rise in hedge-fund activism at large companies including Apple, Hess, Timken, Microsoft and others has raised serious concerns by the companies and their consultants. Opponents of such efforts view investor activism as a threat to the corporate business model and long-term performance of targeted firms. The perception of an overly short-term orientation by such activist investors has been coined “myopic activism.”

However, there is a growing body of research that outlines the positive effects of activist investment funds (hedge funds, etc.) and the proxy contests pursued by such activist investors. Several important studies surfaced over the last couple of years that clearly demonstrate the short and long-term effects of such efforts, describing their influence and changes to market structure that result from their actions. As noted by Teneo, a consulting firm which provides services to corporations, “activist challenges often target a range of the corporate target’s strategy, ranging from board composition to vertical integration to positioning, acquisition, or disposal of whole operating divisions. The most sophisticated challenges present a detailed financial analysis of the challenger’s proposed alternative strategy, including an estimated effect on earnings per share and share valuation.”

One such study looked at the impact of proxy contests on incumbent directors’ future and outside board service. In “Shareholder Democracy in Play: Career Consequences of Proxy Contests,” researchers found that following a proxy contest, incumbent directors experienced a decline in the number of directorships in the future, not only at the company involved in the proxy contest but also at other companies on which the same director(s) served. The study found that directors were significantly affected by their involvement in contested director elections, with a 45 percent increased likelihood of losing outside board elections. The study examined proxy contests, controlling for a number of variables, over a 10 year period ending in 2010.

Another study from 2013, titled “Myths and Realities of Hedge Fund Activism: Some Empirical Evidence,” finds that the vast majority of actions by activist hedge funds were not hostile to incumbent management and board members, underscoring a friendly bias in fund tactics and strategies. The study examines 432 activist campaigns launched by 129 unique activist hedge funds across 17 countries between January 1, 2000 and December 31, 2010. This study on activism outside the United States found that activist hedge funds were not short-term in their focus, nor do they frequently seek control of target companies. This study presents empirical data in non-U.S. equity markets on the nature of activist hedge funds, offering policymakers further evidence of the positive impact of hedge fund activism. The study’s author concludes that activist hedge funds do not undermine the role of the board of directors as the central decision-making body.

In “The Disciplinary Effects of Proxy Contests,” researchers examined the direct and indirect effects of proxy contest actions, finding evidence to suggest that targets of proxy contests increased leverage, reduced spending on research & development, reduced capital expenditures, increased dividend payouts, and decreased CEO compensation in the period before the proxy contest took place. The study’s author states, “companies experience positive and significant stock returns when a proxy contest materializes, without reversals in the long run. Hence, shareholders of ex post targeted companies benefit from a proxy contest.”

The research confirms other studies showing that changes in corporate policies of both targeted and non-targeted companies are also associated with stronger operating performance. The study’s author notes the regulations surrounding investor communications were changed in 1992, reducing the constraints on communications among shareowners of public companies. This allowed more investors to pursue proxy contests, with the average number of proxy contests rising to 55 during the 1994 to 2008 time-frame from only 17 during the 1979 to 1994 time period.

The study analyses the effectiveness of the proxy contest mechanism, examining all U.S. proxy contests taking place from 1994 to 2008. Several studies attempt to examine the effects not only on companies that have experienced a proxy contest (what researchers call, “ex post” effects) and those that have never experienced a proxy contest (dubbed, “disciplinary” effects). The study confirmed that stock liquidity is a significant positive determinant of the likelihood of a proxy contest. Researchers concluded that the proxy contest does indeed play a strong, positive disciplinary role. They also find that proxy contest mechanisms provide companies with “monitoring pressure” thereby positively impacting their policies and corporate conduct.

Perhaps the most comprehensive study on the effects of proxy contests and activist investors was published in 2013, titled “The Long-Term Effects of Hedge Fund Activism” (discussed on the Forum here). In this study by Harvard Law School professor Lucian Bebchuk, Duke University’s Alon Brav, and Columbia University’s Wei Jiang, empirical evidence is presented showing the long-term impact of hedge fund activism.

The researchers find that such activity contributed positively to both the short and long-term performance of targeted companies. The study’s authors evaluate whether hedge fund activism produces long-term declines in either operating performance or shareowner value, using comprehensive data from 2,000 interventions by activist hedge funds during the 1994 to 2007 time period.

Researchers found that activist interventions were much more likely to identify and pursue target firms where there was a clear pattern of financial and stock price under performance. Target firm operating performance was found to significantly lag their corporate peers during the preceding three years leading up to the intervention.

Furthermore, the companies’ stock price returns were abnormally negative. The authors of the study observed that target firms’ post-intervention operating performance and valuation measures over the subsequent five-year period improved significantly. Finally, target firms’ short-term spikes in stock price performance (approximately six percent) were found to persist over the subsequent five year period. Researchers also adjusted for activist interventions associated with enhanced leverage, increased investor payouts, reduced capital expenditures, as well as the level of hostility. In all adjusted data sets, authors found activist interventions to be followed by significant improvements in operating performance over the subsequent five-year period. The study concludes that activist interventions are not detrimental to the long-term financial and valuations of target firms.

Activist hedge funds have had a very strong proxy season through the first half of the 2013 calendar year, successfully winning votes (or settling with boards) to nominate their own directors in 67 percent of all proxy contests where results are available. The 2013 experience is on pace to far exceed the 52 percent success rate achieved by dissident candidates during all of 2012, and is the most successful year on record since 2001.

A proxy fight is a campaign under which a shareowner or group of shareowners (the “dissident”) solicits the proxy or written consent of other investors in support of a resolution it is advancing. This usually involves the election of dissident nominees to the company’s Board of Directors in opposition to the company’s director nominees but may also involve campaigns to approve a shareowner proposal or to vote against a management proposal (including approving a merger).

In a proxy fight, the dissident files a separate proxy statement and card from the company’s proxy materials. The SEC requires the dissident to follow prescribed procedural and disclosure requirements to conduct a proxy fight (Rules 14a-1 to 14a-13 of the Securities Exchange Act of 1934). As soon as a dissident publicly discloses that it has delivered formal notice to the company that it intends to solicit proxies from shareowners (for example, for the election of its own slate of director nominees), it is considered a proxy fight.

Issue: Classified Boards

The SBA continued its partnership in 2013 with the Harvard Law School’s Shareholder Rights Project (SRP), submitting shareowner proposals at a half-dozen U.S. companies. (More information about the Shareholder Rights Project is available here.) The shareowner proposals urged repeal of the companies’ classified board structure and a transition to annual director elections. Shareowner proposals voted on by investors during 2013 received very high levels of support, averaging 80 percent through June 30th. The SBA votes in favor of all proposals to de-stagger director terms and has been a long-standing advocate of annual elections for all companies, regardless of size or domicile.

The SRP is a clinical program operating at Harvard Law School and directed by Professor Lucian Bebchuk. The SRP works on behalf of public pension funds and charitable organizations seeking to improve corporate governance at publicly traded companies, as well as on research and policy projects related to corporate governance. The SRP’s eight participating investors have been highly effective engaging large capitalization companies within the Russell 3000 index.

The institutional investors working with the SRP during the first half of 2013 were the SBA, the Illinois State Board of Investment, the Los Angeles County Employees Retirement Association, the Massachusetts Pension Reserves Investment Management Board, the Nathan Cummings Foundation, the North Carolina State Treasurer, the Ohio Public Employees Retirement System, and the School Employees Retirement System of Ohio.

As a result of the work of the SRP and its participating investors, 77 S&P 500 and Fortune 500 companies have declassified their boards of directors during 2012 or the first half of 2013. The companies that declassified: 1) have an aggregate market capitalization approaching one trillion dollars; 2) represent over 60 percent of companies with which engagement took place; and 3) represent more than half of the S&P 500 companies that had classified boards at the beginning of 2012.

During the first six months of 2013, 51 S&P 500 and Fortune 500 companies have agreed to move toward annual elections following the submission of board declassification proposals for 2013 meetings—of which the SBA sponsored three proposals. The SRP provides participating investors with a range of services, including assistance in connection with selecting companies for proposal submission, designing and submitting proposals, engaging with companies, negotiating and executing agreements by companies to bring management declassification proposals, and presenting proposals at annual shareowner meetings.

Through June 30th, every one of the companies the SBA engaged had conducted their annual shareowner meetings, with each SBA-sponsored investor proposal receiving a majority level of support from all votes cast. One notable vote occurred at which the management supported proposal did receive greater than majority support, although due to the company’s supermajority voting requirements, the proposal was not legally approved.

The SBA-sponsored investor proposal receiving the highest level of support occurred at Netflix, which has had an extraordinary rise in its share price since the company was initially tracked in 2011 due to its prior underperformance up to that point in time.

Since inception in 2011, SBA-sponsored proposals to move toward annual elections have achieved an average support level of 81 percent, with 80 percent (16 out of 20 total firms) moving to de-stagger their boards. SRP staff estimate that, by the end of 2013, just under 100 board declassifications by S&P 500 and Fortune 500 companies will have occurred, comprising over 60 percent of the S&P 500 companies that had classified boards as of the beginning of 2012. These results, if achieved, will bring the percentage of companies that maintain staggered terms for their board members to just under 10 percent of the entire S&P 500 stock index.

Issue: Majority Voting

Majority voting is a basic shareowner right that is necessary to ensure a board’s accountability and responsiveness to investors. Director candidates failing to receive a majority level of support are not viewed by many to be legitimate investor representatives.

The SBA’s corporate governance principles and proxy voting guidelines have long supported the view that electing directors by majority vote is a basic shareowner right and that directors who lack the support of the shareowners they represent should not serve on the board. The SBA strongly endorses majority voting for the meaningful accountability it affords shareowners and because it provides an additional component to the system of checks and balances of power within the corporate structure. More specifically, the SBA supports investor proposals encouraging companies to adopt majority voting procedures whereby the legal election standard requires a majority level of support, achieved through the implementation of a formal bylaw amendment.

A true majority vote standard, embedded in a company’s bylaws, provides shareowners the ability to better monitor the board of directors and assures them the highest level of accountability for the companies in which they invest. Some companies have adopted board policies that require any director nominee failing to receive a majority level of support to submit an irrevocable resignation (developed in advance of the election, which then becomes effective upon the failure of that nominee to receive a majority of votes in an uncontested election). Such a policy and resignation outcome is now expressly permitted under corporate securities law of the State of Delaware. However, other policies allow boards to retain the authority to reject director resignations, undermining the shareowners’ vote.

One concern noted with majority voting is the potential for a subset or even the full board to be removed as part of a shareowner campaign to unseat individual directors. In practice, this concern has not proven to be valid, as failed directors can continue to serve in a ‘holdover’ status until the board appoints new directors. Of course, most investors are averse to a lengthy holdover period and prefer a more immediate change among board representatives.

Recognition in the U.S. that majority voting in the uncontested election of directors is a basic shareowner right has grown significantly in recent years, with approximately 80 percent of large capitalization firms within the Standard & Poor’s (S&P) 500 stock index implementing either a majority vote standard in their bylaws or adopting a board policy. However, among the ranks of smaller companies the uptake has been much slower and remains in the minority. Director candidates at small and micro-capitalization companies receive even higher levels of shareowner dissatisfaction, on average, than do mid- and large-sized firms—with director nominees at the smallest companies receiving 10 percentage points lower support than at the largest ones. As well, majority voting has been the norm in many other developed global capital markets, including those in the United Kingdom, Australia, and Hong Kong. There are no systemic reasons why U.S. investors should not be accorded the same rights.

This movement to implement majority voting procedures has coincided with strong investor support for such election practices—with shareowner resolutions advocating majority voting standards receiving 54 percent support on average in 2013. As the most significant element of proxy voting decisions, the election of directors is one of the best ways shareowners can influence a firm’s governance structure, its strategic direction, its executive compensation framework, and a host of other corporate practices. In short, these proxy voting decisions can impact the valuation and performance of invested companies. Such corporate governance policies can help to align boards of directors with shareowners’ interests. Investors wonder if directors can truly be effective at protecting the interests of shareowners if they are not supported?

A study released late last year titled, “The Election of Corporate Directors: What Happens When Shareowners Withhold a Majority of Votes from Director Nominees?” found that only five percent of corporate directors receiving majority withhold votes are actually removed from boards. However, about 50 percent are unseated at companies with majority voting standards. The study, conducted by GMI Ratings (GMI) and commissioned by the Investor Responsibility Research Center Institute (IRRCi), also found that stricter voting standards lead to better disclosure of election results.

The three-year period ending June 30, 2012, included over 40,000 director votes at Russell 3000 companies, with only 175 directors failing to win majority support. Of these 175 directors, an anemic five percent actually left their respective boards. Other findings of the IRRCi study indicate that high levels of withhold votes are clearly associated with significant investor concern with a firm’s corporate governance. The study correlates over 75 percent of historical withhold votes with several factors: 1) poison pill adoption without shareowner approval; 2) poor director attendance; 3) related party transactions; 4) over-boarding (serving on multiple boards simultaneously); 5) poorly designed executive compensation; and 6) poor oversight.

Even at the minority of listed companies that have adopted a majority voting standard, the market experience has shown that only half of directors actually step down from the board after failing to obtain a majority level of support. Many companies with a majority voting standard give the board discretion to reseat a “failed” director. This practice has the effect of rendering director elections to nothing more than advisory votes.

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