Stiffed Board

"Shareholder pressures are making it into the boardroom," says Ira Kay, global director of compensation consulting for Watson Wyatt Worldwide Inc. in New York. "They are changing the dialogue and changing the answers, and withhold votes are a big part of that."

Embarrassing directors into paying attention has been the main reason for waging no-vote campaigns. "Directors are highly sensitive to public criticism," says Joseph Grundfest, a professor of law and business at Stanford Law School and a former Securities and Exchange Commission commissioner, who in a 1990 speech urged institutional shareholders to "Just Vote No." At that time, companies were just being required to disclose voting tallies. "It was obvious to me then, and remains obvious to me now, that a large number of directors don't do it for the money," says Mr. Grundfest, who also is codirector of the Rock Center for Corporate Governance at Stanford and a former Oracle Corp. director.

Organized Campaigns

Withhold votes are especially effective when drummed up as part of a campaign organized by a specific shareholder or group of shareholders.

A study conducted by Diane Del Guercio, a business professor at the University of Oregon, and colleagues at the University of Tennessee found that about a quarter of companies targeted by withhold campaigns forced out their CEOs in the 12 months following the campaign, compared with 8.4% of companies with comparable performances that weren't targeted by withhold votes. The study was published last year.

SENDING A MESSAGE

 

The Issue: Shareholders irked by high executive pay are withholding votes for directors up for re-election in an effort to grab the board's attention.

The Significance: Some companies hit with sizable withhold votes last year changed their pay practices.

What's Next: More companies are adopting policies that require directors to garner a majority of votes cast, which would give withhold votes more teeth than they currently have.

Consider the case of home-improvement retailer Home Depot, where shareholders last May waged one of the most closely watched no-vote campaigns in recent years. Shareholders were unhappy with payments made to Chief Executive Robert Nardelli, including guaranteed bonuses and the forgiveness of a $10 million loan.

One large pension fund sent letters urging investors to withhold their votes for directors on the compensation committee. Union funds organized protests at the annual meeting. Ultimately, shareholders withheld at least 30% of votes cast from 10 of the 11 directors up for re-election, including Mr. Nardelli.

The pressure didn't stop there. In late June, the director of the compensation committee, Bonnie G. Hill, received a letter from the AFL-CIO, urging her, among other things, to request the resignation of one of her fellow directors because of the pay brouhaha, which also involved revelations of backdated stock options.

By September, Ms. Hill announced that the board was discussing major changes to its executive-compensation programs. In January, Mr. Nardelli was replaced by Vice Chairman and Executive Vice President Frank Blake.

Ms. Hill and other Home Depot officials declined to be interviewed about whether the no-vote campaign played a role in the board's actions. In an emailed statement, the Atlanta company said: "During proxy season, 'withhold vote' campaigns are one way that shareholders sometimes choose to express themselves in a broad way about particular issues. Members of the board and company management meet with shareholders throughout the year and are actively engaged in discussions on a wide range of issues."

But people close to the situation say the withhold votes, and the threat of more this proxy season, played a role in the changes at Home Depot. Mr. Nardelli was fighting the board's effort to revise his compensation, says Daniel Pedrotty, director of the AFL-CIO's Office of Investments. "Things came to a head, and the board basically said it's him or us," Mr. Pedrotty says.

Directors have received withhold votes of as much as 20% to 30% even without an organized campaign because institutional shareholders often follow in-house policies or proxy-advisory-firm formulas that call for withhold votes when a pay package meets certain criteria -- for example, it exceeds the compensation awarded to executives at peer companies that have performed better.

This type of withhold vote can be less effective than an organized effort because there are no leaders pushing shareholders to keep up pressure on the board, governance experts say. ExpressJet Holdings Inc., a jet-charter company in Houston, maintained its compensation practices last year despite a withhold vote by shareholders protesting an increase in stock compensation for CEO James B. Ream to $229,150 from $126,600 the year before. The board felt the votes were misguided because the increase in stock-based pay followed reductions in Mr. Ream's cash compensation made for competitive reasons. But there was no lead shareholder with whom the company could present its case, general counsel Scott R. Peterson says.

He adds that company officials also didn't pursue negotiations with investors because they knew that the targeted director, compensation committee chairwoman Janet M. Clarke, would be re-elected, and figured the one-time payment wouldn't spark another protest vote this year.

Several ExpressJet shareholders say they won't know how they will vote this year until the company mails its proxy materials. Institutional Shareholder Services, which advised shareholders to withhold votes from Ms. Clarke last year, also is waiting for the proxy to make its recommendation.

Some companies are starting to give withhold votes teeth by adopting "majority voting" policies that require directors up for re-election to garner a majority of votes cast. Those that don't must either step down or submit their resignation to the board, which can decide whether to accept it.

At the start of February, 52% of companies in the Standard & Poor's 500-stock index had adopted majority voting, up from 16% a year earlier, according to a report from Claudia Allen, chairwoman of the corporate-governance practice with law firm Neal, Gerber & Eisenberg LLP in Chicago.

New Rules

The average percentage of withhold votes -- which rose to almost 15% in 2000-03 from about 6% in the 1990s, according to Ms. Del Guercio -- could go higher next year when rules kick in prohibiting brokerage firms from voting in director elections on behalf of clients unless they receive specific instructions on how to vote. Currently, brokerage firms can vote for clients on certain issues, and they tend to automatically cast their votes with management.

"The repercussions of not being in tune with shareholders' views could be more serious as majority voting plays into this," says Peter Gleason, chief operating officer at the National Association of Corporate Directors, a nonprofit group in Washington, D.C.

In mid-February, Jennifer O'Dell drafted a letter to Toll Brothers Inc. shareholders, urging them to withhold votes for Carl B. Marbach, chairman of the board's compensation committee. Chief Executive Robert I. Toll pocketed $29 million in fiscal 2006 at a time when the home builder's performance was lagging, Ms. O'Dell's letter said. She is a representative of construction workers' union Laborers' International, which owns 70,000 Toll Brothers shares.

At the March 14 annual meeting, company officials said investors withheld 25% of votes cast for the re-election of Mr. Marbach, according to Ms. O'Dell, who was present at the gathering. Mr. Marbach and other company officials declined to comment or confirm the numbers.

Toll Brothers doesn't have a majority-voting policy, but Ms. O'Dell hailed the vote as a victory anyway. "We think we got the company's attention," she says.

Write to Kaja Whitehouse at kaja.whitehouse@dowjones.com⁵