As the 2011 proxy season has drawn to a close, in the first year of corporate governance after passage of the Dodd-Frank Wall Street Reform and Consumer Protection Act, some interesting trends have emerged for public company executives. By and large, investors have responded to new mandatory votes on executive compensation by approving managers’ pay but also preferring annual votes to review such packages.
In a major decision July 22, the D.C. Circuit Court of Appeals rejected the “proxy access” rule proposed by the Securities and Exchange Commission (SEC), meaning that—at least for now—companies will not have to put dissident shareholders’ proposed directors on their own proxy ballots. Nevertheless, labor union pension funds continue to play an aggressive role in submitting shareholder proposals, and prudent executives should be aware of increasing pressures arising through the corporate governance process.
Say on Pay Votes Largely Affirming Executive Pay Packages
In recent years, drawing upon British practice, proposals on corporate proxy ballots had increasingly called for “say on pay” votes giving shareholders the power to pass advice on senior executives’ compensation packages. Under section 14A of Dodd-Frank, such votes are now mandatory for all public companies, but at least in the first year, it seems as if investors will largely back executive pay plans.
According to The Wall Street Journal, the shareholders of only 39 out of 2,532 to hold votes by the end of June rejected executive pay plans—a passage rate of 98.5 percent. These trends essentially mirrored those in the Fortune 100 companies tracked in the Manhattan Institute’s Proxy Monitor database: of the 88 Fortune 100 companies to hold annual meetings through the end of June, only one—Hewlett Packard—saw its executive compensation plan fail.
Notably, however, the largest companies have shown themselves more likely to face contested votes on pay: overall, 71 percent of companies garnered at least 90-percent approval from shareholders, by the share of companies getting 90+ percent support fell to 63 percent among the S&P 500 and to only 50 percent among the Fortune 100. Five Fortune 100 companies—Safeway, Pfizer, Allstate, ConocoPhillips, and Staples—saw their pay plans pass with less than 60 percent support; and another five—Johnson & Johnson, Johnson Controls, Exxon Mobil, Valero Energy, and Lockheed Martin—fell under the 70-percent-support threshold.
Although the low percentage of shareholder votes rejecting executive pay would tend to signal that the say-on-pay votes have little value, shareholders overwhelmingly tended to call for annual rather than biennial or triennial votes on executive compensation. (Shareholders had each option under Dodd-Frank.) In the S&P 500, only 5 percent of companies’ shareholders opted for triennial say-on-pay votes, and only one company’s shareholders opted for a biennial vote. Those companies that deviated from the norm, such as Tyson Foods and Berkshire Hathaway, tended to have large insider holdings or dual class voting structures that protected insiders or founders. Thus, CEOs will largely see their pay put before shareholders on an annual basis, and should be aware of investor groups’ perspectives as well as the views of Institutional Shareholder Services (ISS) and others with an influence on the proxy process.
A Major Court Decision Rejects Proxy Access
Section 971 of Dodd-Frank authorized the SEC to adopt a “proxy access” rule forcing public companies to list shareholder-proposed directors on the companies’ own proxy ballots. On August 25, 2010—less than a month after Dodd-Frank was passed—the SEC in a divided 3-2 vote issued Rule 14a-11, which as adopted in the final rulemaking would have required companies to list on their ballots directors proposed by any shareholder that held at least three percent of a company’s stock for a minimum of three years. The proposed rule did not take effect for the 2011 proxy season, being stayed pending a court challenge.
In a decision of major importance, on July 22, a unanimous panel on the U.S. Court of Appeals for the D.C. Circuit rejected the SEC’s proposed rule, holding that the Commission had acted “arbitrarily and capriciously” in failing to assess adequately the likely economic effects of the proposed regulation. Moreover, the court found that “the Commission failed to respond to comments arguing that investors with a special interest, such as unions and state and local governments whose interests in jobs may well be greater than their interest in share value, can be expected to pursue self-interested objectives rather than the goal of maximizing shareholder value, and will likely cause companies to incur costs even when their nominee is unlikely to be elected.”
Though the D.C. court decision is a big win for corporate management and boards, the SEC could always appeal to the Supreme Court or return to the rulemaking process with an eye toward meeting the court’s concerns. Moreover, shareholders could always submit 14a-8 proposals calling on their boards to list shareholder-nominated directors on proxy ballots—continuing a shareholder-proposal trend that mandates majority voting for directors and grants shareholders increased powers to act outside the annual meeting process.
Labor Union Shareholder Activism Gains Increased Scrutiny
The D.C. Circuit decision highlighted the potential for labor unions, through their pension funds, to exploit corporate-governance processes to gain leverage over management for reasons other than share-price maximization. These concerns also emerged in a March 31 report of the Office of the Inspector General at the U.S. Department of Labor (OIG), which found that it lacked “adequate assurances” that retirement plans covered by ERISA were not being used “to support or pursue proxy proposals for personal, social, legislative, regulatory, or public policy agendas, which have no clear connection to increasing the value of investments.”
Manhattan Institute analysis drawn from the Proxy Monitor database reinforces these concerns. Union funds not only proposed 38 percent of all shareholder proposals submitted to large public companies over the last four years; they concentrated their proposals around topics and industries that appear calculated to leverage labor versus shareholder interests. In addition to executive pay, union fund proposals were most concentrated in areas highly sensitive to existing management—such as calls to separate the chairman and CEO positions—as well as those serving broad political agendas only tangentially related to share performance—such as statements of “health reform principles” and disclosure of corporate political spending. Furthermore, union fund proposals have been concentrated in lightly unionized sectors facing ongoing organizing campaigns, such as retail trades and financial services, while the unions have tended to avoid sectors such as oil and gas and manufacturing, in which unionization rations are already relatively high.
So what are 2011’s main take-aways for CEOs regarding corporate governance? The judicial rejection of the SEC’s proposed proxy access rule will eliminate the need to face contested director elections on an ongoing basis, and CEOs need only have limited worry about investors rejecting their executive pay plans at this time. That said, the overwhelming majority of executives will have to defend their pay annually, and union pension funds are increasingly active in the shareholder process, requiring executives’ continuing vigilance.