Who's in Charge
Listening to shareholders is easy. Making sense of their concerns is not.
- CFO Magazine
September 1, 2010
On the eve of the
2008 elections, Richard Ferlauto, a union-pension-fund executive, noted
that if the Democrats were to win big "it will be like Christmas for us."
While the Democrats
did, in fact, sweep Congress and take the Presidency, the ensuing weeks
hardly matched most people's idea of Christmas: the still-unfolding
financial crisis saw the S&P hit a five-year low. But Ferlauto wasn't
talking about performance gains; he wanted to find a host of
corporate-governance gifts under the tree, and he wasn't disappointed.
The past two years
have seen activist shareholders receive a sackful of goodies, from
"say-on-pay" initiatives to clawbacks of ill-gotten bonuses to new rules
on broker voting to more information about climate change, political
spending, and other social issues. And then there is proxy access, the
corporate-governance equivalent of a shiny new bike. True, some assembly
is still required, but it has leapt off the wish list and now sits under
But as these
governance gifts pile up, the question must be asked: Do shareholders need
them, or even want them?
The answer is
surprisingly elusive. Determining what investors truly want (beyond
consistently healthy returns) is difficult because investor groups are a
fractured, noisy, and widely divergent lot. They have different and
sometimes competing interests, and different methods of communicating;
some may not speak up at all.
CFOs and other
senior executives may feel like parents trying to read the lips of
children as they sit on Santa's lap. "You might think that the people
speaking the loudest are speaking for the larger group, but when you get
down to it, the majority may not support [their concerns]," says Robert
McCormick, chief policy officer at Glass Lewis, a proxy advisory firm.
"You have a very
vocal minority that is doing most of the talking," agrees Peter Clapman,
chairman and president of Governance for Owners USA, a
corporate-governance advisory firm, "and it can be difficult to determine
if those same concerns are held by the broader shareholder base."
What is often
referred to as the modern shareholder movement has its roots in a single
social issue: ending apartheid in South Africa. In the early 1970s,
attorney Paul Neuhauser led a religious group in filing a proxy resolution
urging General Motors to end its business in South Africa unless or until
apartheid was ended. (That group has since morphed into the Interfaith
Center on Corporate Responsibility, one of the most influential social
responsibility investment groups and a prolific proxy resolution filer;
its members filed 282 proposals this year alone.)
Other social issues,
such as labor and environmental practices, became increasingly popular
subjects for shareholder proposals, but they were largely ignored by
companies; most institutional investors didn't even bother to vote.
It wasn't until the
1980s, during the heyday of corporate raiders backed by Michael Milken,
that proxy resolutions (proposals that actually make it on to the ballot;
often proposals are either addressed or ignored by companies without
getting to the ballot stage) were embraced as a way to force companies to
put their takeover defenses up for a shareholder vote. Shareholders
embraced these resolutions because they often boosted corporate values,
and soon the proxy resolution became a powerful tool for shareholder
Another major boost
came from the rising popularity of index funds, which pushed pension
managers and other institutional investors to take a more active role in
influencing corporate behavior. Until then, investment managers who didn't
like certain corporate policies or practices simply sold their shares —
they voted with their feet. That became harder to do when index funds
(and, later, electronic trading) made it more difficult to walk away from
Lost in the
shareholder proposal is the main instrument through which investors make
themselves heard, and it's easy to play. All that's required to get a
resolution on the ballot is to own $2,000 worth of shares for at least one
year, a fact not lost on social activist groups such as PETA, Amnesty
International, and Greenpeace, all of which have recently launched
shareholder campaigns. This year so far, climate and energy-related
proposals alone number more than 100, according to Ceres, an
environmental-investor network; all told, 1,000 shareholder proposals have
been filed through early August, of which 500 have made it onto the
ballots, according to RiskMetrics.
experts expect the number of shareholder resolutions to continue to
increase, resulting in a cluttered and clouded process that can be
difficult for shareholders, boards, and management to make sense of. "The
misuse of the shareholder proposal process can be harmful in that serious
issues and problems can get lost in the shuffle," says Clapman. "It
damages the system if resolutions are filed that have no chance of
says that the proxy resolution process set up to put shareholder concerns
to a vote can provide an ideal way for company officers to determine which
shareholder issues have broad support among investors and which ones are
on the fringe. "It's pretty easy to tell what they think by looking at the
shareholder votes," he says. "Some issues, like majority voting, are
supported by most shareholders and get high voting percentages, while
other issues get only single-digit support."
Charles Elson, who
heads the University of Delaware's Weinberg Center for Corporate
Governance, agrees: "Voting on shareholder resolutions gives you a good
sense of where shareholder thought lies."
But not always. Some
issues, like compensation, vary hugely from one company to the next in
terms of shareholder support. And some experts, including Gary Lutin,
chairman of the Shareholder Forum, a Web forum devoted to investor and
corporate news, contend that the process can actually amplify the
squeaky-wheel effect. Lutin says that most proposals are filed by a small
group of institutional investors that includes state and local pension
funds, union pension funds, socially and environmentally oriented
investment groups, and some activist hedge funds. At most, he says they
represent about 5% of all the holdings of a typical large company.
institutional investors can't afford to follow all of the issues at every
one of their holdings on their own, they often rely on proxy advisory
firms, like RiskMetrics, Glass Lewis, and Proxy Governance, to make
recommendations on how they should vote. But since these firms have to
satisfy the same vocal minority, whose members tend to be their largest
clients, they often support activist causes, acting as echo chambers,
increasing the influence of the vocal minority. "The [reliance on] proxy
advisers results in a process where shareholders are directed to conform
to the 'good governance' views adopted by vocal, policy-oriented
investors," says Lutin. "It isn't good."
effect is further exacerbated by the fact that the whole notion of
governance policy took hold at a handful of funds and its definition
didn't change much as it moved out into the broader investment community.
Today, many mutual-fund companies and money managers are under increasing
pressure to open a governance office, and it's a safe bet that when they
do they will take the natural approach of hiring someone who has graduated
from this school of good-governance theory. "This can lead to a lot of
insularity," says Lutin. "They all hang out at the same bars, so to
Open Season on
Bellying up to that
same bar is the Securities and Exchange Commission, which, under Obama
appointee Mary Schapiro, is now, as the University of Delaware's Elson
puts it, "slanted toward more discussion of environmental and social
issues." The SEC has also made it easier for shareholders to get proposals
onto the proxy. In past years, the SEC gave many companies permission to
ignore certain shareholder proposals under what is known as the ordinary
business exclusion. That is, if the shareholder proposal dealt with an
issue that was related to the ordinary running of the business, companies
could get permission to keep them off the proxy.
This year, the SEC
has defined such exclusions very narrowly and granted very few. Issues
that could be left off the proxy in the past, such as succession planning
or risks associated with potential environmental liabilities, are now
being put to a vote. "The SEC is increasingly reluctant to disqualify
resolutions on substantive grounds," says Clapman. Elson puts it more
succinctly: "It's open season on the proxy."
That's not to say
that environmental and social issues are not important, but critics claim
they now garner a disproportionate share of attention and can distract
management from running the business. They can also create tension between
management and shareholder groups. "The more issues you have to address,
the harder it becomes to run the business," says Elson.
A study conducted
last year by Navigant Consulting for the U.S. Chamber of Commerce found
that "while [proxy] proposals may be successful in making qualitative
changes in companies' actions, there is little-to-no evidence that those
changes have an impact on the bottom line of target firms."
found that they may have a negative effect on performance over the long
term. While one explanation may be that inherently troubled companies are
more likely to face a bevy of shareholder proposals, the Navigant results
are consistent with other studies that find no correlation between good
corporate-governance ratings and economic performance. In other words, for
all the work that shareholder activists do to improve companies'
governance policies, those improvements appear to have little impact on
the one measure of success that nearly all shareholders care about: better
Can You Hear Me
Amid all these
changes, companies have begun moving away from their past habit of
ignoring or battling against shareholder activism and are now more willing
to listen to shareholders' governance concerns. But that doesn't mean
they're particularly good at responding.
One of the problems
is structural: shareholder relations is an activity that falls into two
distinct camps. In one, the investor-relations team, often with oversight
from the CFO, communicates with portfolio managers and other constituents
that make investment decisions and are concerned with performance and
valuation. In the other, the corporate secretary or chief governance
officer, often with oversight from general counsel, communicates with
governance directors at pension and investment funds.
The result is that
companies can get mixed signals from their investors. "The CFO might have
a great relationship with a portfolio manager of a large fund, and then be
completely caught off guard by what he perceives as a hostile shareholder
campaign by the same fund," says Lutin. CFOs should push for a more
integrated communications process, he says.
Another problem is
that companies often pay investors what might be called "ear service."
During road shows they open the floor to governance issues, but they don't
act on what they hear. "It's not enough to sit and listen," says Patrick
McGurn, special counsel for Institutional Shareholder Services. "Putting a
happy face on relations with investors, with no intention of taking into
account anything they say, will backfire on you."
Not everyone thinks
that companies should engage in an open dialogue with investors on
governance issues. When Pfizer set up a meeting with large shareholders
with that aim in 2007, heavyweight Wall Street lawyer Martin Lipton, of
Wachtell, Lipton, Rosen & Katz, wrote in a memo: "While
corporate-governance activists are applauding today's announcement by
Pfizer that members of its Boards of Directors will invite its largest
institutional shareholders to a meeting where they will have an
opportunity to provide comments and perspective on the company's
governance policies and practices including executive compensation, this
is another example of corporate governance run amuck."
To a large extent,
the concerns of opponents circle back to the aforementioned echo-chamber
effect: they fear that "improved" governance will simply lead to
"one-size-fits-all" or "check-the-box" approaches. They also argue that
certain good-governance no-nos, such as allowing the CEO to double as
chairman, or having a staggered board, have done nothing to hamper the
performance of, respectively, Berkshire Hathaway and Google.
It's also worth
noting that shareholder activism tends to be cyclical, peaking when
returns are down or after periods of widespread governance failures, such
as the recent financial crisis or the accounting scandals of the early
2000s. A recovery will prompt most shareholders to resume their intense
focus on quarterly earnings. This time around, CFOs might regard that as a
very welcome holiday gift.
is a freelance writer based in Boston who covers finance and corporate