Yet if there is a wind of change sweeping through corporate America, it was not blowing hard at the Hyatt Regency in Santa Clara, California, where the information technology group last month held its annual shareholder meeting. As investors shuffled over the well-trodden carpets into the hotel’s ballroom, their thoughts seemed to be more on the free cookies and coffee than corporate governance.
“One time I came to the annual meeting and [HP’s co-founder] Bill Hewlett turned around and saw me coming,” said Mr Stewart, who bought 10 HP shares for $350 some 50 years ago. “He stuck out his hand and said ‘Hello, Bob, you still at Lockheed?’ I had never talked to him before in my life.”
The indifference of Mr Stewart and hundreds of other small shareholders hinted at how the meeting would unfold. The proposal to allow investor input on directors’ nominations – aimed at loosening companies’ near-absolute control over the composition of their boards – was defeated, with just over half of the shares cast supporting the No stance advocated by Mark Hurd, HP’s chief executive.
Yet the vote was close enough to enable Mr Hurd’s opponents to declare a moral victory. Richard Ferlauto, director of pension and benefit policy at American Federation of State, County and Municipal Employees (AFSCME), one of the unions behind the proposal, described the 52 per cent vote against the plan “an outstanding, almost phenomenal” result for the activist investors.
The HP vote, and the reactions of those involved, are emblematic of the corporate governance discourse in today’s America.
Over the past few decades, US shareholders’ attempts to challenge the traditional primacy of managements over company affairs have often been hampered by legal and practical difficulties. America’s highly decentralised legal system, which prevents federal authorities from interfering with state law on key corporate matters such as shareholder voting, coupled with the adversarial nature of the legal process, have been a big obstacle for shareholder activists.
The presence of pension funds that are much more diffuse than in the UK and Europe has further complicated matters, making it harder to build a broad-based consensus among investors. The long bull run enjoyed by US stock markets has contributed to making shareholders, especially the large mutual funds and retail investors, less keen to disturb a system that has rewarded them handsomely.
This web of historical developments and regulatory strictures has limited the expectations of activist fund managers to the point that a narrow defeat such as the HP vote is treated as a resounding victory.
But after years of setbacks, there is a growing sense that shareholders’ influence over boards is on the rise on several issues, ranging from executive compensation to the nomination and removal of directors.
What is in question, however, is whether this should be welcomed. Would such an outcome be a long-overdue improvement to a system of benign corporate “dictatorships” that has been exposed by scandals, lax controls and questionable accounting practices? Or is there a danger that moves to give shareholders more influence could obstruct companies’ efforts to keep abreast of fast-changing markets and leave them vulnerable to attacks from hedge funds and other special interest groups?
This year’s “proxy season” – the months-long period of shareholder meetings that begins in earnest in a few weeks – will be crucial in determining the extent and consequences of investors’ rising power.
Traditionally, the season has been a dull procession in which the concerns of meek shareholder audiences are airily dismissed by powerful management teams. But corporate governance campaigners are now talking about a confluence of factors that could bring reform. In their view, three elements have bolstered the governance agenda: scandals, politics and foreign shareholders.
With the crimes of the Enron era still fresh in the public mind, new scandals such as HP’s spying affair and the options backdating turmoil – which has seen executives at hundreds of companies accused of artificially inflating their compensation – fostered the perception that corporate America had not learnt from its mistakes. That, in turn, alerted Washington’s new masters, the Democrats who regained control of Congress in November, to the political importance of addressing perceived weaknesses in the US governance system.
Headline-grabbing examples of princely compensation packages for ousted executives such as Home Depot’s Robert Nardelli and Pfizer’s Hank McKinnell only added to pressure for change. Finally, the recent decision by foreign pension funds with large exposure to the US, such as Hermes of the UK and the Netherlands’ ABP, to lobby regulators on governance issues provided further impetus. Patrick McGurn at Institutional Shareholder Services, which advises more than 1,600 fund managers, says: “We are seeing companies’ boards reacting to the pressure by proactively responding to shareholder requests.”
Nowhere has this trend been more apparent than in shareholders’ efforts to have more say on executive compensation and its links to company performance. In just a few months, US chief executives’ pay packages have gone from being perceived as a largely acceptable by-product of American capitalism to – at least in some quarters – a symbol of corporate excess.
As the golden parachutes strapped to the likes of Mr Nardelli and Mr McKinnell opened, shareholders began demanding a non-binding annual vote on executive compensation, similar to one introduced in the UK in 2002. Within months, more than 60 companies found themselves on the receiving end of the campaign for a “say on pay”.
Politicians including George W. Bush took heed, mentioning the issue as a symptom of the income inequalities in contemporary America. Barney Frank, the Democratic congressman who chairs the House of Representatives Financial Services Committee, went further, proposing legislation on the so-called “advisory” vote and staging high-profile hearings last month.
By the time this whirlwind of activity was over, one company, the health insurer Aflac, had agreed to allow shareholders to vote on executive pay from 2009 – a first in the US. At least 10 of the original 60-plus targets caved in to the activists’ demands and granted investors the right to vote on whether to introduce the measure in the future.
Another group, which includes blue chips such as Pfizer, the drugmaker, and AIG, the insurer, tried to stave off shareholder revolts by joining activist investors such as AFSCME and the $220bn California Public Employees’ Retirement System (Calpers) in talks that are likely to lead to the introduction of advisory votes. In the triumphant words of one shareholder activist, “after our blitz, it is only a matter of when, not if, companies introduce an advisory vote on pay”.
The apparent success of the “say on pay” campaign and the speed with which it caught on are making America’s corporate chieftains nervous. Viewed from the corner office, the fight over executive compensation – and the threat that it could be repeated on issues such as investors’ right to nominate directors and companies’ long-standing secrecy over political donations – is the latest attack on a system that has served shareholders and the US economy well.
Defenders of the current regime argue that executives and directors must be given ample leeway to devise and implement strategies. They point out that dissenting shareholders have always had the right to vote with their feet and sell their shares.
As John Castellani, president of the Business Roundtable, the lobby group for some of America’s largest companies, reminded Mr Frank and his colleagues: “By definition corporate decision-making is not a democratic process.”
“If we moved to a referendum system,” he continued, “boards and CEOs would spend less time on planning, product development and oversight and more time meeting with advocacy groups and lobbyists.”
The concern is not just about waste of time. Corporate leaders warn that subverting the existing order could open the door to the guerrilla tactics of corporate raiders and hedge funds that might hijack a more open system to further their own short-term goals. “It is the worst thing that could happen to companies,” says Manan Shah at Jones Day, a law firm. “It will be like the Wild West, with hedge funds free-riding on investors who are trying to do good by pushing their own agenda at companies.”
Corporate America’s misgivings about the shareholders’ demands go beyond sporadic raids by hedge funds. There is a broader fear that, coupled with the tough post-Enron regulations and the rise of private equity, greater investor power could destroy listed companies’ entrepreneurial drive and blunt the US economy’s competitive edge.
Barry Diller, the media tycoon who has come under fire for his pay package, says the current environment is making boards “frightened” and chief executives “skittish” and could drive many of them into the grateful arms of the buy-out groups. “You really want that society? If you do get that society I promise you America’s competitiveness is finished,” Mr Diller, who controls the internet conglomerate IAC, told the Financial Times in a View from The Top video interview.
Such concerns are shared by regulators and governance experts. It is no secret that the Securities and Exchange Commission, the US financial watchdog, is split over whether investors should have more say on board composition. At the heart of the disagreement between the five commissioners is the recognition that hedge funds’ ability to vote borrowed shares could give them disproportionate power over companies.
Last month , Proxy Governance, a shareholder advisory firm, echoed these fears when it broke ranks with the “say on pay” coalition and said it would not support its proposals at each and every company. “We are concerned that advisory votes could become merely protest votes from shareholders,” said Jim Melican, its chairman.
Even some advocates of governance reform argue that a full-frontal attack on the corporate world by a vocal minority of activist investors backed by politicians may prove counterproductive.
“The politically oriented investors like Calpers and AFSCME deserve great respect for their identification of issues that everyone needed to address,” argues Gary Lutin, an investment banker who runs a corporate governance forum bringing together companies and investors. “But these issues require marketplace rather than political solutions.”
Others, especially overseas fund managers, retort that opponents of greater shareholder involvement conveniently forget that investors in the US are denied rights, such as votes on compensation and directors’ nominations, that are commonplace elsewhere.
“There is a real concern that corporate America is in denial about who controls the company,” says Paul Munn, director of the equity ownership service at Hermes. “There should be no conflict between companies and shareholders. We are all working for the same goal: a better valued company.”
That in itself could be a difficult concept to grasp for US companies and investors, whose relationship has been shaped by decades of confrontation within a litigious legal system. But if companies see the merit of allowing outsiders more of a say, and shareholders use new powers discriminately, corporate America has a chance of leaving investors such as Mr Stewart with better memories than a once-in-50-years handshake from an all-powerful corporate leader.
Directors cannot count on always being adored
What do a contemplative nun, an American prison guard and a retired UK telecommunications engineer have in common? They are all fighting to have more say in the way US companies are run.
While that alliance may not sound much of a threat to the powers of a Steve Ballmer, Microsoft’s chief executive, or Jeffrey Immelt, his General Electric counterpart, corporate America knows better than to ignore its ultimate owners.
The Benedictine Sisters of Perpetual Adoration as well as AFSCME, the largest union for public service employees, and Hermes, the UK investment group owned by BT’s pension scheme, have all invested significant amounts of their members’ retirement pot in US companies. They are also part of a sprawling coalition, including state pension funds, charitable foundations and private sector asset managers, that is pressing for reforms in US boardrooms.
The patchwork-like appearance of the group, which ranges from left-leaning “socially responsible” funds to conservative religious orders, is a testament to the diverse nature of US capitalism. In the UK and the rest of Europe, for example, share ownership tends to be concentrated in fewer hands. Yet the disparate origins of the activist movement have long prompted suspicions among corporate leaders that companies are held hostage by a motley crew whose varied vested interests clash with the needs of other investors. “Unions and special interests have always tried to influence corporate behaviour – and what better way of doing so than by buying shares in the company?” asks a long-time advocate of business interests in Washington.
Activist shareholders reject such accusations, arguing that their main goal – to make money to pay for their pension obligations – is perfectly aligned with the desire of management to improve the company’s performance.
“I really haven’t seen any evidence that shareholders are going to back special interests,” says John Wilcox, head of corporate governance at TIAA-CREF, the fund created by Andrew Carnegie in 1918 to provide for teachers’ retirement. “If shareholders have more power, they are going to use it responsibly.”
But there is little doubt that the financial might of pension funds of unions and other “social” organisations, coupled with the infamously adversarial US legal system, has often made for an uneasy relationship with company managers.
An overseas investor, who recently began looking at the US, recalls being struck by the “us-and-them” attitude of conversations between management and shareholders. “Coming from the outside, this confrontational approach seems a little bit odd. After all, shareholders and management should want the same thing.”
Both companies and activists argue that, in recent times, the tension has been easing, partly because the recent spate of corporate scandals has focused the minds of both management and shareholders. “Companies are no longer looking to fight first and talk last, they talk first and fight only as a last resort,” says Patrick McGurn at Institutional Shareholder Services, an advisory organisation.
On that at least, Mr Ballmer and a contemplative nun are likely to find some common ground.
Additional reporting by Jeremy Grant