The Mainstreaming of Shareholder Activism in 2013
The 2013 proxy season was in many ways unremarkable, yet in important respects it illustrates the developing nature of shareholder activism in our era of corporate governance. The issues in dispute, the voting results, and the overall trends were not significantly different from those in recent years. Nonetheless, there is an important takeaway from the 2013 season: Shareholder activism has gone from fringe to mainstream. While individual gadflies and labor union pension funds are still the most prolific sponsors of shareholder proposals,1 some elements of their agendas have begun to find support among traditional investors.
Not too long ago, large, profitable corporations were considered immune from economically-motivated activist attacks, and activism was not central to the agendas of establishment players in the corporate arena. In 2013, it became clear that even household-name companies with best-in-class corporate governance and rising share prices are liable to find themselves under siege from shareholder activists, often represented by well-regarded investment banks, law firms, public relations firms and other advisors. Even some academics praise shareholder activists' latest exploits. Shareholder activism, in its latest incarnation, is no longer a series of isolated approaches and attacks; instead, it is an environment of constant scrutiny and appraisal requiring ongoing monitoring, awareness and engagement by public companies. Proxy statement disclosures are an important tool in shareholder engagement and have been a focal point for companies in the 2013 season. In particular, companies successfully enhanced their proxy disclosures regarding executive compensation, shareholder outreach efforts, the qualifications, expertise and diversity of their board members, and audit committee reports.2 Companies also have been successful at communicating with investors throughout the year to minimize conflict during the proxy season. Some major institutional investors have established in-house proxy departments to engage directly with corporations and make voting decisions without relying on the recommendations of proxy advisory firms.
There are two primary types of shareholder activism. The first is corporate governance-related activism that centers on issues such as board structure, takeover defenses, compensation, and political, social and environmental concerns.3 The second might be called strategy-related or economically-motivated activism, frequently associated with hedge funds—sometimes viewed as the modern-day corporate raiders—and it aims to fundamentally alter the destiny of a corporation by, for example, replacing one or more directors or ousting senior management, with the intent to create short-term gains by returning capital to shareholders, causing the disposition of major assets through a sale or spin-off or instigating the sale of the entire corporation. Shareholder activism in both of these forms has been growing over the last decade, and both were prominent in the 2013 proxy season.
2013 Proxy Season Results
In 2013, shareholder proposals increased slightly overall for the second year in a row, and proposals made by hedge funds also increased slightly after a decline in 2012.4 The number of corporate governance-related proposals represented a smaller share of the total this year, due in part to the fact that so many companies have, in recent years, taken steps such as instituting majority voting, declassifying their boards of directors, eliminating takeover defenses and splitting the roles of chairman and chief executive officer.5 According to recent statistics, only 7 percent of S&P 500 companies have a poison pill in place, 15 percent have a classified board, and 8 percent have not adopted a majority or plurality-plus vote standard to elect directors.6
Board leadership structure remains a hot topic, however; more proposals were submitted to separate the chairman/CEO roles this year than ever before, though the levels of support for the proposals that went to a vote were lower than in recent years.7 It is possible that the successful model of independent lead or presiding directors has taken some of the steam out of proposals to separate the two roles.8 Board declassification proposals represented over 11 percent of the total number of corporate governance proposals submitted at Russell 3000 companies this year, as opposed to over 14 percent in 2012.9 The primary driver of board declassification proposals was the Shareholder Rights Project, operated by Harvard Law School. Now in its second year, the Shareholder Rights Project reportedly works with seven large pension funds and a foundation to sponsor governance proposals at companies whose shares are owned by the funds and the foundation.10 These proposals received, on average, nearly 80 percent support, slightly lower than last year's level but still the most widely endorsed proposal across ownership types.11 In light of the proposals' popularity and the potential negative consequences of the failure to declassify a board following a majority vote, at least 35 companies agreed to declassify after being approached by the Shareholder Rights Project this year. Overall, management at more than 70 companies sponsored declassification proposals on their own initiative in 2013, presumably to forestall critical attention from shareholders.12 It also appears that governance activists are starting to target smaller companies, which tend to have fewer resources available to resist the pressure from activists than their larger brethren.
There was a noticeable increase in the number of proposals relating to executive compensation, as proponents focused on specific pay practices such as tax gross-ups, death benefit payments, and severance agreements, and support for compensation-related proposals on these three topics averaged above 35 percent.13 There was also an increase in proposals on social and environmental policy issues, as well as in proposals on political spending and lobbying. Support in each of these categories hovered around 20 percent, though in recent years many of these proposals have seen a steady, albeit small, increase in favorable votes.14
Companies sought more no-action requests this year from the Securities and Exchange Commission (SEC) to exclude shareholder proposals, yet the percentage of exclusions granted was lower as shareholders carefully crafted their proposals in accordance with prior SEC responses and comments.15 On the other hand, the percentage of proposals that were withdrawn rose significantly, perhaps due to increased engagement and accommodation on the part of both companies and activists.16 Increased outreach and communication were also crucial for companies attempting to turn around failed say-on-pay votes from last season. Sixty companies experienced failed management say-on-pay votes in 2012; of the 48 that had held their votes by July 31, 39 had obtained shareholder approval.17 Nearly all of the 39 successful companies specifically mentioned shareholder outreach in their proxy statements, and many gave detailed descriptions of the extent of their communications efforts.18
The number of proxy contests rose significantly this year, from 24 in 2012 to 35 in 2013 for the Russell 3000 companies.19 Notably, large companies were among the targets. Fourteen of the 35 companies had market capitalizations of over $1 billion at the time the proxy contests were announced.20 Overall, large companies received a disproportionately high percentage of shareholder proposals this year, particularly regarding executive compensation and social and environmental policy issues.21 Institutional investors such as mutual funds that in the past typically did not participate in activism and proxy fights now are taking a more active role, which has emboldened activists to launch campaigns directed at large and prosperous corporations.22
One target was Walt Disney, which reported high profits and completed a successful major acquisition in the past financial year. The company's success was rewarded not with deference but with an activist-led attempt to separate chief executive Bob Iger from his role as chairman of the board. Though the initiative was defeated, it was a sign of the times that such a vigorous campaign would be waged against the governance structure of a company that, by all metrics, had a terrific year.23 No company is immune in the current environment, though it is still true that weak performance makes companies more likely to capitulate to activist demands.
Declining Reliance on Proxy Advisors
Two recent developments illustrating the changing nature of shareholder activism are the declining influence of proxy advisory firms and the establishment of in-house proxy departments at large investment funds.
There are two significant proxy advisory firms, Glass Lewis and Institutional Shareholder Services (ISS), and their recommendations have been powerful forces in influencing corporate behavior and voting results. Companies try very hard to avoid a negative recommendation from these two advisors, both for the sake of their upcoming vote and because of the unpleasant publicity it would generate. In the last decade, the influence of proxy advisory firms has increased. One factor has been the steadily growing emphasis on corporate governance ever since the fall of Enron and the adoption of the Sarbanes-Oxley Act of 2002. Another factor is the SEC's 2003 rule, designed to minimize potential conflicts of interest, that—along with no-action letters that followed—effectively created a safe harbor for fund managers who, in accordance with pre-determined policy, relied upon the proxy voting recommendations of a third party.24 This past July, SEC Commissioner Daniel Gallagher expressed concern about the influence wielded by proxy advisory firms and lamented the SEC's role as "a significant enabler" of the tendency of institutional investment advisers to "view their responsibility to vote on proxy matters with more of a compliance mindset than a fiduciary mindset."25 He indicated that the SEC should issue Commission-level guidance (as opposed to staff no-action letters) "clarifying to institutional investors that they need to take responsibility for their voting decisions rather than engaging in rote reliance on proxy advisory firm recommendations[.]"26 The Commissioner's view is a sensible one, and the release of Commission guidance as he describes would, in our view, be a modest yet highly beneficial reform.
Similarly, the Canadian Securities Administrators (CSA), an umbrella organization of Canada's provincial and territorial securities regulators, recently issued an update on their ongoing, consultative process concerning possible regulation of proxy advisory firms.27 The CSA has been concerned—like SEC Commissioner Gallagher—that proxy advisory firms have, to an alarming extent, effectively imposed uniform and somewhat arbitrary corporate governance standards on companies through investors' over-reliance on proxy advisors' voting recommendations.28 Following feedback from market participants on the impact proxy advisors are having on the integrity of Canadian capital markets and whether a response from the CSA was even necessary, the CSA has concluded that a response from Canadian securities regulators is indeed warranted. The CSA expects to develop a policy-based regulatory approach that would "promote transparency and understanding" and provide guidance on recommended practices and disclosure. The CSA's proposed approach is expected to be published for comment in the first quarter of 2014.