Netflix Needs Proxy Access – Proxy Score 10 Out of 100

Netflix, Inc. ($NFLX) is one of the stocks in my portfolio. Their annual meeting is coming up on 6/7/2013. had collected the votes of one fund when I checked on 5/25/2013. I voted with management only 10% of the time.  View Proxy Statement. NFLX is another supposedly high-tech company with no hyperlinks in their proxy statement. In fact, they don’t even include an index. They either don’t want investors to be able find information or they just don’t care enough to bother. While the stock has risen recently, the company remains risky because of poor corporate governance.

Warning: Be sure to vote each item on the proxy. Any items left blank are voted in favor of management’s recommendations. (See Broken Windows & Proxy Vote Rigging – Both Invite More Serious CrimeI generally vote against pay packages where NEOs were paid above median in the previous year but make exceptions if warranted. According to Bebchuk, Lucian A. and Grinstein, Yaniv (The Growth of Executive Pay), aggregate compensation by public companies to NEOs increased from 5 percent of earnings in 1993-1995 to about 10 percent in 2001-2003. Few firms admit to having average executives. They generally set compensation at above average for their “peer group,” which is often chosen aspirationally. While the “Lake Woebegone effect” may be nice in fictional towns, “where all the children are above average,” it doesn’t work well for society to have all CEOs considered above average, with their collective pay spiraling out of control. We need to slow the pace of money going to the 1% if our economy is not to become third world.

NFLX’s Summary Compensation Table shows Ted Sarandos (Chief Content Officer), was the highest paid named executive officer (NEO) at about $6.5M in 2012. Reed Hastings (CEO/Chair) got $9.3M in 2011. I’m using Yahoo! Finance to determine market cap ($12.8B) and Wikipedia’s rule of thumb regarding classification. NFLX is a large-cap company. According to the United States ProxExchange (USPX) guidelines (pages 9 & 10), using data from Equilar, the median CEO compensation at large-cap corporations was $10.8 million in 2010.

NFLX’s pay is below median. However, their compensation and corporate governance practices are so egregious I voted against the pay plan and all directors. Executive compensation is not sufficiently linked to company performance. There is an over-reliance on stock options. While this is designed to align pay with shareowner return, it rewards fluctuations due to a rising market alone, regardless of individual performance. I judged their compensation policies as aligned with shareholders’ interests.

Netflix adopted a shareholder rights plan (“poison pill”) on November 5, 2012. The shareholder rights plan expires on November 2, 2015. The company has a classified board and charter and bylaw provisions that would make it difficult or impossible for shareholders to achieve control by enlarging the board or removing directors and filling the resulting vacancies. Each non-employee director receives stock options pursuant to the Director Equity Compensation Plan. Netflix has stock ownership guidelines that encourage directors to own its stock equal to the $80K annual base fee. Under these guidelines, directors are required to hold the stock portion of the annual base fee until achieving a certain ownership level. However, Timothy M. Haley (15 years) and Ann Mather (3 years) hold no stock, while Richard N. Barton (11 years) holds only 343 shares. 

Professor Stephen Bainbridge and I often disagree, but not on this issue:

I certainly agree that directors should have a fair bit of skin in the game. If nothing concentrates the mind like the prospec

t of being hanged in the morning, surely the prospect of financial ruin is a close second. (My good friend Charles Elson’s work in this area is seminal and excellent. See, e.g., this video and his article Director Compensation and the Management-Captured Board—The History of a Symptom and a Cure, 50 SMU L. REV. 127 (1996).)

Arbitrary dollar amounts, however, are a very bad idea. To somebody like Bill Gates, the prospect of losing $1 million is trivial. To somebody like me, the prospect of losing $250,000 would be so scary that I would refuse to serve on the board.

The right approach is to require the director to put a non-trivial percentage of his net worth at risk.

With regard to shareowner proposals:

I voted for the shareowner proposal by Florida SBA to repeal the classified board. The average percentage of votes cast in favor of shareholder proposals to declassify the boards of S&P 500 companies exceeded 75%. Almost 90% of the S&P 500 have declassified boards. This is a simple good governance measure that should have no trouble passing. 

I also voted in favor of the proposal by CalSTRS to require a majority vote in director elections. As their supporting statement says, more than 80% of the companies in the S&P 500 have adopted majority voting for uncontested elections. This is another good governance proposal that should have no trouble passing.

I voted in favor of New York City Pension Funds’ proposal to split the CEO and Chairman positions. As they point out:

According to a June 2012 study of 180 North American companies with market capitalization over $20 billion (“The Costs of a Combined Chair/CEO,” GMI Ratings), shareholders pay out more when there is a non-independent chair at the helm. The median total compensation paid to a combined chair/CEO was $16.1 million, 73% more than the $9.3 million paid in total to the positions of CEO and an independent chair.

Companies with a separate chair (independent or non-independent) and CEO also appear to perform better and to be more sustainable over the longer term, according to the GMI study. The 5-year total shareholder return was found to be 28% higher, and the GMI risk ratings lower, at these companies.

A major function of the board is to evaluate the CEO’s performance. It is obviously a conflict of interest to have the CEO chairing that effort, although passage of such proposals has been more difficult than declassification or majority voting.

Of course I voted in favor of the proposal I wrote and my wife submitted for proxy access.  The proposal presents two optional routes for shareowners seeking to place director nominees on NFLX’s proxy:

a. Any party of one or more shareowners that has collectively held, continuously for two years, at least one percent but less than five percent of the Company’s securities eligible to vote for the election of directors, and/or

b. Any party of shareowners of whom 50 or more have each held continuously for one year a number of shares of the Company’s stock that, at some point within the preceding 60 days, was worth at least $2,000 and collectively at least one half of one percent but less than five percent of the Company’s securities eligible to vote for the election of directors.

Both parties are limited to nominating 24% of the board, each so in the case of NFLX that would be 1 out of 7. Unique to this form of proxy access proposal, no party can overlap or use both options. If two shareowner-nominating parties arose, invoking both options then 2 directors out of 7 could possibly be replaced.

That might be considered “substantial change,” but not in the conventional sense, since neither party comes close to “control” with 1 out of 7 directors. We are hoping to create a new model of corporate governance where no one party “controls” the corporation. Such a multiparty structure will increase the likelihood that corporations are presented with alternatives… not just the company’s Plan A, or a challengers Plan B but also maybe a Plan C.

Corporate elections are just beginning a transition from contests among oligarchies to something more akin to democracy. The idea of multi-party elections may seem novel or foreign to the corporate governance industrial complex that has grown accustom to contests in which one side or the other is awarded with a victory, not much different than the spoils of war. We believe such multi-party monitoring will lead to less focus plundering by those in control and more on growing the business through sustainable long-term methods.

With regard to why NFLX was chosen as a specific target for proxy access: At the time we filed the proposal, our company’s stock price had been in relative decline since June 2011. Share price has taken a dramatic turn for the better since then, making passage a little less likely. Still, shareowners should question whether this dramatic swing can be attributed to good governance. I think not.

SharkRepellent provides an interesting analysis at Governance Activists Set Their Sights on Netflix’s Annual Meeting.

Five proposals related to board structure and shareholder rights/takeover defense will be presented by shareholders at the meeting. That’s the most such proposals appearing on the ballot of any S&P 500 company that has filed proxy materials so far this year (approximately 86% of S&P 500 companies have filed). Only General Electric Co., with six, has more shareholder proposals related to corporate governance practices in its proxy statement in 2013.

ISS also rates NFLX as risky. Netflix, Inc.’s ISS Governance QuickScore as of May 1, 2013 is 10. The pillar scores are Audit: 10; Board: 9; Shareholder Rights: 10; Compensation: 9. Institutional Shareholder Services (ISS). Scores range from “1” (low governance risk) to “10” (higher governance risk). Each of the pillar scores for Audit, Board, Shareholder Rights and Compensation, are based on specific company disclosure.

In their opposition statement of our proxy access proposal, unnamed agents of our Company state:

The thresholds proposed by the proponent require that a stockholder own only 1% of our outstanding shares for a minimum of two years, or a group of 50 or more stockholders own as little as $2,000 each of our outstanding shares for one year… Allowing stockholders with such an immaterial investment in Netflix to make nominations using the Company’s proxy heightens the Board’s concern regarding the potential for nomination and election of directors focused on special interests. Further, unlike the SEC Proxy Access Rules, the proponent’s proposal would not require that nominating stockholders disclaim any intent to effect a change in control, which could prevent such stockholders’ intentions from being fully transparent to all stockholders. The low thresholds could also result in the inclusion of multiple proxy access nominees in the Company’s proxy materials, making the nominating and election process unwieldy, confusing and uncertain for our stockholders, or turning every election into a proxy contest. Thus, the proposal’s thresholds subject us to potentially significant additional expense and diversion of management time and energy in managing such elections…

Unnamed agents of our Company allege that under our proposal, “50 or more stockholders (who) own as little as $2,000 each” could make nominations. Untrue. They left out the fact that such nominating groups must hold in aggregate 1/2% of the company or over $64M.

These same unnamed agents raise the specter that proxy access could lead to the election of directors focused on “special interests.” Yet, they fail to explain how “special interest directors” would win. It certainly wouldn’t be as a result of the votes of the 1% or 1/2% nominating. Insiders own about 6% of our Company. The top ten institutional investors, such as T. Rowe Price, Capital Research & Management, Ichan Associates, Vanguard, SSgA Funds, and BlackRock own more than 51% of outstanding shares. Why would these huge investors elect “special interest directors”? Obviously, they would seek to elect the best directors to serve the interests of their clients, the ultimate shareowners… hardly a special interest.

Lastly, these agents allege, ”The low thresholds could also result in the inclusion of multiple proxy access nominees in the Company’s proxy materials, making the nominating and election process unwieldy, confusing and uncertain for our stockholders.” Since when are elections that offer a choice of candidates confusing?  The proposal limits shareowner nominations to a total of two, given the current size of the board. How would adding two names to the proxy materials and a 500-word statement from each be unwieldy or confusing?

Please vote in favor of proxy access to ensure that at least one or two of our directors can be held fully accountable to shareowners.

How I voted (CorpGov) below:

Mark your calendar:

Proposals of stockholders that are intended to be presented at our 2014 Annual Meeting of Stockholders in the proxy materials for such meeting must comply with the requirements of SEC Rule 14a-8 and must be received by our Secretary no later than December 27, 2013 in order to be included in the Proxy Statement and proxy materials relating to our 2014 Annual Meeting of Stockholders.

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