The clearest conflict: How executive
compensation sets off alarms
in Washington | Updated
03:36 PM, May-08-2015 ET
big negative shareholder vote on CEO pay, a few red flags from a proxy
adviser and an economic thesis to unlock value may be all that is
needed to bring an activist fund into the fray. At least that's how Peter
Michelsen views activism.
He should know. Michelsen, a managing
partner at San
Francisco-based CamberView Partners LLC, is a veteran
adviser to companies targeted by insurgents. He spent nine years at Goldman
Sachs Group Inc. (GS), including five years in the big bank's
unit that was established to advise companies besieged by activist
investors and hostile takeover threats. Last year, Michelsen joined
CamberView to advise management and boards of public companies with
the goal of trying to keep activist shareholders away or at least at
bay. At CamberView, which was formed in 2012, Michelsen joins a cast
of institutional investor and proxy adviser heavyweights, including
former heads of governance at
BlackRock Inc. (BLK), Vanguard, State
Street Corp.(STT), Wellington, TIAA-CREF, Morgan
Stanley Investment Management and Institutional Shareholder
In an interview, Michelsen discussed some
of the often misunderstood connections between shareholder votes on
executive compensation and activism.
The Deal: Do you believe that
companies that receive particularly negative 'say on pay' votes from
shareholders expose themselves to a potential attack from activists
down the road?
Michelsen: Yes, absolutely.
Executive compensation is perhaps the clearest potential
principal-agent conflict in a public company. In many cases, 'say on
pay' is the only thing on the ballot where the investors are making a
clear, substantive up-down vote on management, and because of that it
is often positioned by activists as a proxy for the level of
shareholder confidence or support for management.
Q: But a big negative vote on
executive pay isn't enough, right? Doesn't there need to be some sort
of financial catalyst that the activist can identify at the company?
A: An activist will target a
company if they can establish two things-one, that there is a strong
economic thesis and two that there is a key governance hook. A poor
'say on pay' outcome is an objective, highly visible governance hook.
In most recent activist fights, compensation structure is an important
element of the argument attempting to undermine investor confidence in
the management and the board. Open up a recent white paper or proxy
fight presentation and you will typically find several pages devoted
to compensation issues. And on the pension fund side, it tends to
precipitate additional pressure on governance structure-for instance,
the New York Comptroller used poor 'say on pay' votes as one of the
selection factors for its 2015 proxy access initiative.
Q: How do the two proxy advisory
firms play into all this?
A: Given the average 'say on
pay' vote is greater than 90%, this vulnerability exists even if the
proposal passes. ISS and Glass Lewis have set the threshold for an
automatic review [by the advisory firms] in the subsequent year at 70%
and 75% respectively, and these thresholds have become somewhat of a
break point for when you have a poor vote.
Now, a negative 'say on pay' vote alone
will not create activist exposure. However, this is a strong indicator
for an activist with an economic thesis to dig in.
Q: What will an activist say to
management at companies with poor 'say on pay' votes?
A: They'll say, I can go to your
top five long-only shareholders and tell the voters: The company
underperformed, the board didn't hold management accountable and did
not pay for performance, and you voted against them at the last AGM.
I can generate significant returns for you and the company clearly
needs new oversight. I will get their support.
Q: Can an activist with a small
stake succeed at a company where there is a major negative say on pay
A: A significant governance
concern, like a poor 'say on pay' vote, acts as a force multiplier for
an activist if they are reputable and have an attractive thesis. While
they may have a small stake, if the broader shareholder base and the
proxy advisers don't trust the board, the activist will have a
significant number of the governance-driven funds and pension funds on
their side of the ledger-this is often the swing vote that will
determine success or failure for the activist, and is much more likely
to impact the outcome than the difference between a 2% and a 6% stake.
Q: Can you give me an example of
the kind of advice you give companies to make sure they don't ever get
targeted by an activist?
A: Build a relationship with the
teams at your investors who will make voting decisions. Consider that
many of the activists are iterative players with these teams because
they are in front of them multiple times a year-corporates are
inherently at a disadvantage, so there is an urgent need to close that
gap. For large institutions, these teams will cover thousands of
companies in the portfolio, and it is often too late to reach out to
them to ask for a favor when you have a problem like an activist or
challenging pay vote.
There is real interest at these teams to
engage with their portfolio companies-a letter sent by Vanguard
earlier this year encouraging engagement with companies and directors
on strategic and governance issues is a prominent example. And when
you do reach out, understand your audience and what they care
about-they do not want a traditional IR presentation to talk about the
quarter. Companies should focus on drivers of long-term value and
proof points of effective independent oversight by the board.
Q: Who at the company should talk
to the institutional shareholders?
A: While this once was primarily an
interaction between the finance/investor relations teams and portfolio
managers/analysts, the growth of investor engagement on governance
issues has significantly broadened the role of other key groups.
Depending on the company, we also see
general counsel and corporate secretaries heavily involved, chief HR
officers are involved in challenging 'say on pay' situations, and
selectively directors in areas where board oversight is important.
While director involvement is not
pervasive at this point, it is increasing and we anticipate
director/shareholder interaction to be prevalent in the next several
Q: Can you talk about proxy access
and what happened over the past 12 months?
A: Companies must understand
emerging trends. The New York Comptroller's submission of proxy access
proposals at 75 companies in 2015 is a watershed event and this is
likely the first step toward proxy access becoming common across U.S.
Initially, companies took an approach of
attempting to exclude the shareholder proposals by adopting more
stringent provisions-similar to how companies responded to proposals
seeking a special meeting right.
Shareholders were acutely aware of the implications of letting
these tactics play out and moved aggressively to pressure the SEC to
prevent their exclusion.
So, many proposals are going to a vote
this year, and companies are taking a range of actions in response,
including fighting the proposals and adopting or submitting to a vote
proxy access proposals at ownership thresholds higher than the
shareholder proponent's proposal. Many votes still need to occur, but
results have been mixed thus far, demonstrating that shareholders are
not all supportive of proxy access and, in particular, proxy access
requiring a low level of ownership.
Q: What do the voters at
It depends on the institution, but for the most part the teams that
are controlling the voting decisions, and therefore the leverage in an
activist situation, want to make sure that the company is being run
for the benefit of shareholders, the right strategy is in place for
generating long-term shareholder value, the board is providing
appropriate oversight of management, and that risks are being
appropriately managed. This sort of messaging isn't always a key
component of typical investor relations efforts, and so a concerted
effort needs to be made to get that message out through shareholder
engagement and shareholder communications.
©Copyright 2015, The Deal.