Board directors in the US are breathing a sigh of relief following the announcement that the Securities and Exchange Commission has deferred its proposal to allow shareholders to nominate their own board directors. This will not happen before the 2011 proxy season.
Those directors should take a deep breath because they are still facing a fundamental shake-up in corporate governance. The SEC has already approved the elimination of broker discretionary voting on the election of directors at annual meetings.
The impact of that change, while not as obvious, could nonetheless alter boards of US corporations. How?
First, so-called “broker non-votes” represented up to 20 per cent of a company’s shares and were most often cast in favour of the status quo. With the elimination of these votes, a director who used to enjoy 69 per cent of the vote in elections may only be able to count on 49 per cent.
Now, combine that change with the increase in majority, rather than plurality voting for directors. The same director who triumphed with 69 per cent of the vote last year, just got voted off the board.
In this context, directors are also starting to worry that an immense amount of power has been transferred to the proxy advisory firms who are said to influence between 25 per cent and 40 per cent of the institutional investors’ votes in any board election. Directors are suspicious that these proxy advisory firms put their most esoteric corporate governance policies before the need to drive long-term sustainable corporate performance.
Indeed, US board directors now face a world where hedge funds with a focus on short-term results could prevail over those investors who take a long-term view of a company’s performance – and where the winners are picked at the Maryland offices of the most powerful proxy advisor, RiskMetrics.
An early skirmish occurred this year when US retailer Target was subject to a proxy fight led by Pershing Square IV, a hedge fund set up by Bill Ackman and supported by RiskMetrics and other proxy advisers. The Target directors under siege were re-elected at a reported total cost of over $20m. One director commented, “I fear there are more of those to come.”
Yet, the Target example also provides board directors with a solution. If they can form an alliance with many of the long-term investors then the long-termers can beat the short-termers. One institutional shareholder recently noted, “If boards are smart, they would reach out directly to long-term investors – effectively stitching in an automatic vote in their favour.”
The SEC itself is aware of the concerns that, in seeking to empower the long-term investors that tend to populate its own advisory board and those of other regulatory bodies, they have, in fact, created the conditions for short-term investors to flourish. The delay to the proxy access proposal will buy time for the SEC to figure out how to empower investors without letting loose the asset strippers.
The SEC’s recently published strategic plan for the next five years also commits it to “conduct a comprehensive review of the issues related to the mechanics of proxy voting and shareholder-company communications, including the role of proxy advisory firms”. The CEO of a Fortune 50 company has said, “I have grave concerns about [the proxy advisory firms] – they are a disaster waiting to happen.”
The proxy advisory firms have already been investigated once this decade. In 2007, the US Government Accountability Office (GAO) released a report on the industry and essentially gave it a clean bill of health. The report noted that the SEC conducted examinations of three proxy advisory firms that are registered as investment advisers and had not identified any major violations.
However, there are barriers in the way of board directors trying to counter the influence of the proxy advisers and hedge funds by building direct relationships with long-term investors.
How many of these conversations can large institutional investors conduct? Investors could be overwhelmed if every corporate board starts contacting them. The first movers will likely have advantage over those that arrive fashionable late.
And, it is often unclear who to build a relationship with and in what forum – the investor’s corporate governance people have demonstrated little power and their fund managers often show little interest. The regulatory framework, including the SEC’s Regulation FD, limits the information that can be shared in any interaction.
Additionally, many of the largest long-term investors such as the public employees’ retirement funds are perceived as having an anti-business, pro-trade union political agenda. Ironically, one of them owns a proxy advisory firm and many have investments with hedge funds.
An early sign of the emerging grand alliance of long-termers came with September’s publication of the Aspen Institute report on “Overcoming Short-termism: A Call for a More Responsible Approach to Investment and Business Management”. The 28 signatories included retirement funds and trade union bodies like Calstrs, TIAA-CREF, and the AFL-CIO, as well as board directors and other luminaries.
The report warned: “In the absence of real changes in the focus of institutional investors and related intermediaries, the various corporate governance reforms currently being discussed are unlikely to reduce the likelihood of boards and managers responding to short-term pressures.”
Faced with the might of the proxy advisers and predatory hedge funds, board directors need to build better relationships with those who share their long-term outlook and who can be persuaded to support both their strategy for the business and a slate of directors committed to oversee its execution.
They would be wise to start now ahead of what promises to be a critical 2010 proxy season, even with proxy access delayed a year.
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