Balance sheet-driven shareholder activism is here to stay
‘It’s quiet. Too quiet,’ says Pat McGurn, special counsel at proxy advisory firm RiskMetrics Group, recalling the old movie line. ‘It’s almost the middle of April and we haven’t seen a single high-profile activism campaign emerge. No major proxy fight hovers on the horizon.’
With the stock market rebound, has financially driven shareholder activism gone underground? With all eyes focused on say on pay and ballot access, are we in an era of governance-dominated activism? Can companies breathe more easily?
Don’t bank on it. Traditional balance sheet-driven activism has not gone away. As IR magazine went to press, the 2010 proxy season was just getting underway, but a few things are clear: several new requirements have already changed the proxy landscape, with more change to come. A couple of players that have been sitting on the sidelines in recent years are also getting into the game and are well worth watching: the SEC and Congress.
Midstream in 2010, what should issuers be thinking both this year and in anticipation of changes to come? First, the opportunity for companies is clear. The what, how and why of IR practice is front and center with the board like never before, as so many of the changes affect board members themselves.
All change, please
Here’s a rundown of major changes already in place: elimination of broker voting in uncontested elections, real-time reporting of vote results, enhanced discussion of risk surrounding compensation practices and climate change, discussion of board diversity, enhanced disclosure of board members’ past affiliations and litigation involvement, and – finally – greater transparency about board members’ experience, qualifications, attributes and skills (EQAS).
And that’s not all. Several developments are expected after this proxy season is over. A presumed centerpiece of the financial reform package working its way through Congress will likely include a say on pay mandate that cuts across all companies. A long-awaited pronouncement from the SEC on opening up proxy access to shareholder nominees is also pending. In addition, the SEC has indicated it will dive deep into the entire proxy voting process with likely positive implications for non-objecting beneficial owners’ and objecting beneficial owners’ access and empty voting.
‘Vote no’ is the major action this proxy season, according to McGurn. He describes the synergy brewing between the elimination of broker voting and the ‘vote no’ movement as one that may deliver some surprising and unwelcome election results, both this year and down the road. Do the math: after several years of shareholder agitation, many large-cap companies have adopted rules requiring directors to achieve a majority, not just a plurality, of ‘yes’ votes. Last year, nearly 100 directors failed that test but none of them lost his/her job. At majority-vote companies, losing directors submitted their resignation, which the board rejected in every case. Firms with a plurality rule simply ignored the negative vote.
In addition, nearly 800 directors chalked up at least 30 percent of ‘no’ votes last year. With the broker vote at some public companies ranging as high as 30 percent, and the dismal track record of individual investors actually casting proxy ballots, many of these directors would be at risk if majority voting were in place at their companies, McGurn observes. And governance activists are pushing majority voting downstream as they press smaller firms to adopt it, he adds.
Rise in governance activism
Phil Garon, senior partner at the law firm Faegre & Benson in Minneapolis and a veteran of corporate proxy contests, looks at the stock market gains from last year’s dismal levels to explain the absence of high-drama activist contests. ‘When stocks are depressed, you’re going to see activists get a better audience for their issues,’ he says.
While he is watching contests at Genzyme, Denny’s and Kona Grill, Garon points to the settlement earlier this year by USA Technologies – in which the classified board was eliminated and two seats were surrendered to dissidents – as a more typical MO for companies under siege.
McGurn sees several reasons why no high-profile proxy fights have emerged this year. In an email exchange, he says activists ‘hope to see broad mandates on core issues: say on pay, majority voting and proxy access’ from Congress and the SEC. Investors are also ‘trying to digest the smorgasbord of new disclosures that has their heads spinning. Additionally, activism is hidden from public view as it now focuses on firms below the S&P 500.’
McGurn predicts high-profile campaigns against boards at some former Troubled Asset Relief Program fund holders this season. RiskMetrics recommended a ‘no’ vote a year ago for the Citigroup slate but, this year, McGurn praises the ‘full-court press’ Citigroup mounted to defuse ongoing criticism, including state-of-the-art proxy disclosures and outreach to the Council of Institutional Investors.
Garon also predicts a continuing rise in governance-oriented activism from unions and pension funds, depending on the actual proxy access mandates from the SEC. ‘The lower the threshold for proxy access, the more proxy contests are likely,’ he says. He also dismisses rumored boasting among some activists that they’re acting on behalf of larger mainstream institutional investors that want to remain in the background. ‘I don’t believe it. Large institutional shareholders are not afraid to speak up,’ he says, pointing out that the vast majority of people in management and on boards ‘are very good listeners’ who welcome direct dialogue with shareholders.
Financial activism is alive
Beth Saunders, managing director at consultants FD, who counsels both activists and corporate clients, does not believe balance sheet activism has gone dormant. Saying she’s ‘never had a conversation about good corporate governance’ with activist clients, Saunders notes that they care about removing obstacles that prevent them from ‘doing what they want: getting a board member.’
Saunders is convinced that even the most skillful investor relations departments executing the best IR program can still be targeted by activists. In a survey of portfolio managers carried out last fall, FD found that nearly half of respondents (48 percent) feel ‘the presence of activist investors indicates a company is being mismanaged.’
It’s more missed potential than relative performance that activists zoom in on, Saunders says. ‘The very worst-performing companies are not necessarily the ones that have activist problems,’ she notes. ‘Even if a stock is at a 52-week high and the CEO is well regarded, if activists are saying they don’t like the strategy and management is perceived as ignoring the issue, they’ll take the activist route.’
Companies need to focus on the importance of transparency and communication, access to management and even possibly the board, Saunders says. ‘If management isn’t communicating, there’s always something negative an activist can find in a story,’ she adds. ‘The best IROs have the ear and respect of their management team,’ she observes. ‘Get in early, deflect all the venom and change the paradigm so we never hear about it; it never hits the press.’
She suggests you talk about what and why and try to defuse tough messages with additional facts. Your company should also maintain as diverse a shareholder base as possible. ‘If 30 percent of your shareholder base is outside the US, you probably won’t be its first target,’ she explains.
Getting to know you
Some observers have described the new board members’ EQAS disclosure as a potential heat map, guiding activists to craft appealing dissident slates that fill in any gaps. In response, Saunders says IR thought leaders among her clients are considering new ways to highlight board members’ bona fide EQAS scores.
‘What if, for example, once a month, you dig deeper on one board member on your website to make sure shareholders have all the background information they should?’ she suggests.
Greater transparency on compensation ‘is here to stay,’ Saunders adds, counseling clients to ‘look smart about it’ and lay out a defensible position. Most institutional investors view the issue as a check-the-box question. If a pay package appears extreme, they’ll send the proxy to compliance. ‘If not, they’ll ignore it and move on,’ she observes.
Saunders further notes that ‘the world has completely changed. Boards know it, but they don’t know the information they should be looking at.’ For example, she questions the value of the standard board report synopsizing what the sell side wrote and what the stock did, supplemented by an annual shareholder attitude survey. IR teams should make sure that ‘every time the board meets, it gets an update’ on what major holders are thinking, not just the sell side. In addition, it should know who is and isn’t in the stock, and why.
If 2010 is more a transition year than a brave new world, it nevertheless gives companies time to adjust to the new activist landscape. While some investors complain the SEC is not forcing change fast enough, ‘others think this is year one in a 10-year process,’ Saunders concludes.
