Cisco Systems (CSCO): How I Voted – Proxy Score 56

Cisco Systems, Inc. $CSCO is one of the stocks in my portfolio. Their annual meeting is next week on Tuesday, 11/13/2013. ProxyDemocracy.org had collected the votes of 2 funds when I checked on 11/13/2013 (there have been more since). I voted with management 56% of the time.  View Proxy Statement.

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 Crime)

I 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. The rationale for peer group benchmarking is a mythological market for CEOs.

CSCO’s Summary Compensation Table shows John T. Chambers, CEO and Chairman of the Board, was the highest paid named executive officer (NEO) at about $21M in 2013. I’m using Yahoo! Finance to determine market cap ($121B) and Wikipedia’s rule of thumb regarding classification. CSCO is a large-cap company. According to Equilar (page 6), the median CEO compensation at larg-cap corporations was $9.7 million in 2012.

The latest GMIAnalyst report I reviewed gave CSCO a global ‘D’ rating for pay, up from the failing grade when I filed my proposal with CSCO in June. The pay is even more out of line since CSCO has only kept pace with the NASDAQ in the past year and has vastly underperformed for the latest five year period. I voted against the pay plan, the stock plan and the members of the compensation committee: Roderick C. McGeary, Chairperson, Carol A. Bartz, M. Michele Burns, and Brian L. Halla.

The CSCO proxy also includes my proposal for a proxy advisor competition to be paid for largely by our company but chosen by a direct vote of shareowners.

Mark Latham came up with that brilliant idea in the late 1980s: Shareowners should use their corporation’s funds to pay for external evaluations of governance and performance of the board and management. Shareowners would vote to choose among competing organizations to provide this service.It was a simple concept but SEC rules made subsequent proposals unnecessarily complex and excluded advice on director candidates, often among the most critical decisions on a proxy. In 1999 we submitted the first in a series of proposals to pay competing proxy advisors. Although we achieved votes as high as 20%, we held off on further submissions until the proposal could be further refined and until rules provided a more favorable climate.

Years of practical experience with student bodies, governments and cooperatives led Latham to simplify and shorten the process. In the meantime shareowners finally convinced the SEC to restore proxy access and loosen rules. After several further refinements to get through the SEC’s “no-action” process, including an attempt this year by Cisco management (See SEC response of August 9, 2013), Cisco shareowners will be the first in many years to vote on a proxy advisor competition and the first in more than a dozen years to vote on a proposal that includes evaluation of director candidates.

Compared to earlier proposals, this new version would support four advisors instead of just one; it would take two years to implement instead of three years; and shareowners would vote after seeing the proxy advice instead of before. These changes are based on successful tests, primarily at universities — see “Experiments in Voter Funded Media” at votermedia.org/publications.

The Congressional Committee on Financial Services hearing, “Examining the Market Power and Impact of Proxy Advisory Firms,” invited testimony from several experts. All had criticisms of the current system. Review the written material, watch the hearing, watch Darla Stuckey, Senior Vice President – Policy and Advocacy, Society of Corporate Secretaries & Governance Professionals, summarize a few of the issues on This Week in the Boardroom.  Criticism continues, primarily from the Business Roundtable, The Conference Board, National Association of Corporate Directors, and U.S. Chamber of Commerce. See Boards Should Minimize the Role of Proxy Advisors, How ISS Dictates Equity Plan Design, and Stanford Academics Focus on Wrong Problems at ISS. Here is our Cisco proposal:

PROXY ADVISOR COMPETITION

WHEREAS Cisco is so widely held that no principal shareowners or blockholders effectively monitor our Board;

WHEREAS some shareowners hire proxy advisors to help them vote in the best interest of their clients, but most do not;

WHEREAS many shareowners lack the time and expertise to make the best voting decisions, yet prefer not to always follow directors’ recommendations;

WHEREAS shareowners could benefit from greater competition in the market for professional proxy voting advice;

THEREFORE BE IT RESOLVED that Cisco Systems, Inc. shareowners request the Board of Directors, consistent with their fiduciary duties and state law, to hold a competition for giving public advice on the voting items in the proxy filing for the Cisco 2014 annual shareowners meeting, with these features:

• The competition would offer multiple cash prizes totaling no more than $50,000.
• Winners would be determined by shareowner vote on the Cisco 2014 proxy.
• To insulate advisor selection from influence by Cisco’s management, any person or organization could enter by paying an entry fee.

For example, the Board could choose competition rules such as:

• The competition could be announced and open for entries six months after the Cisco 2013 annual shareowners meeting. Each entry could be announced publicly, promptly after it is received. Entries’ names and website addresses (linked) could be shown promptly on a publicly accessible Cisco website page, in chronological order of entry. Entry deadline could be a reasonably brief time before Cisco begins to print and send its 2014 proxy materials.
• The competition could offer a first prize of $20,000, a second prize of $15,000, a third prize of $10,000, and a fourth prize of $5,000. The entry fee could be $2,000.
• The Cisco Board could include this voting item in that proxy: “Which of the following proxy advisors do you think deserve cash awards for the usefulness of information they have provided to Cisco shareowners? (You may vote for as many advisors as you like. See each advisor’s website for their information for Cisco shareowners. Prizes, of $20,000, $15,000, $10,000 and $5,000 will be awarded to advisors based on the number of shares voted to approve the usefulness of their advice.)” Then the name and website address of each advisor entered could be listed in chronological order of entry, followed by check-boxes for approval, disapproval and abstention for each entry. The advisor receiving the most approval votes could get first prize, and so on.
• It could be expected that each proxy advisor would publish advice on its website regarding the Cisco 2014 proxy, but there need be no formal requirement to do so. The incentive to win shareowner voting support and to maintain the advisor’s reputation could be considered sufficient motivation for giving quality advice.
• The decision of whether to hold such a competition in subsequent years could be left open.

(Further information on proxy advisor competitions: “Proxy Voting Brand Competition,” Journal of Investment Management, First Quarter 2007; free download at http://votermedia.org/publications.)

From Latham’s VoterMedia Finance Blog

The idea is that we shareowners can use our voting power to hold boards accountable more effectively if we have high quality professional voting advice. Although many institutional investors pay for proxy advice from the two major U.S. advisors, ISS and Glass Lewis, there is not enough economic incentive to pay for more than a minimal amount of proxy research, as explained on page 82 of “Proxy Voting Brand Competition.“ The result: complaints about lack of insight, and insufficient competition.

From the March 2011 Altman Group Report on Proxy Advisory Firms:

“… one of the primary complaints from corporate issuers is that proxy advisory firms rely heavily on a ‘cookie cutter’ or ‘one-size-fits-all’ approach, and may base recommendations on inaccurate and unreliable information in particular cases.” [page 9]

“The investment manager for one of the world’s largest sovereign wealth funds indicated that it would like to see measures taken to promote competition among proxy advisory firms.” [page 31]

The above Proxy Advisor Competition Proposal would increase competition among proxy advisors, and pay them enough to provide higher quality advice, tailored to the specific corporation. The proposal organizes a corporation’s shareowners as a group, pays for proxy advice once, and shares the advice with the whole group. This “advice consumers’ union” approach may well get better analysis for lower cost than the current system of paying for advice one (institutional) investor at a time. It would also make the advice available to all Costco shareowners, including retail investors who typically do not get professional voting advice now. This proposal is designed as a template to improve the governance of any publicly traded corporation.

Why Cisco (CSCO)? 

The proposal uses a generic template that could be submitted to any public US company and we welcome its use by shareowners at other companies. However, Cisco is an excellent candidate for a proxy advisory competition for the following reasons:

• Cisco routinely faces shareowner proposals. In fact, there have been shareowner proposals on each proxy since 2002, except 2004. Let’s get advice on these proposals that is specific to our company, not just based on abstract “best practices.”
• GMI Analyst also gives Cisco a global ‘D’ grade with regard to pay. They question if unvested equity awards lapse when the CEO’s employment is terminated and if the company only pays long-term incentives to the CEO for above-median performance against a peer group. Shareowners might like to have access to an independent analysis when casting their “say on pay” proxy vote.
• When I submitted the proposal back in May, two of our directors held no actual shares in Cisco. Why not? Sure, directors are given restricted stock unit awards for their board service but that is not the same as actually owning shares. I’d like our directors to have real “skin” in the game from the start.
• Half the current board has served for over 10 years and more than half are aged 60 or over. Are they really ‘independent’? Wouldn’t you like to see an independent evaluation of how each board member contributes?
• Additionally, Cisco faces new threats from heavyweights such as Google and Facebook, which are starting to design their own tech equipment such as servers, storage hardware, chips and network switches. (Facebook and Google Try Self Help)
• And, of course, there’s the whole issue of SDN and Cisco’s strategy to stem the losses. (see Cisco Asks the Killer SDN Question) According to a recent Credit Suisse report,
  

  the networking market from Software Defined Networking (SDN) architectures should be very real and accelerate over time, leading to further margin compression. We initiate with an Underperform rating and a target price of $21… networking stands as one of the least competitive and highest margin industries in the IT stack. SDN, by allowing software to be separate from the physical infrastructure, will allow competition at multiple points in the network, which was not previously possible. While the impact will take time, the threat will be very real, shrinking gross profit dollars for the industry… Based on five factors, we estimate that gross margins will decrease to ~60% and operating margins to 26% over the long term, with limited growth in organic operating income.

Cisco’s proxy materials are more than 80 pages long.  Contestants are likely to access much more publicly available data, including all the other documents Cisco files with the SEC. Browse through this data for a few minutes and ask yourself if you wouldn’t like proxy advisor contestants to analyze all that data, as well as more from other sources. If the contest proposals passes, you’ll be able to vote intelligently, while avoiding most of the work. That’s good for both you and our company.

As a result of discussions with analysts at other funds I am concerned that many may have been misled by ISS labeling our proposal to its clients as “Hire Advisor,” whereas our proposal’s actual title in Cisco’s proxy is more correctly “Proxy Advisor Competition,” with financial awards for four proxy advisors specified. Of course, ISS has a vested interest in limiting competition in its field. While much of the criticism of ISS and Glass Lewis is overblown, I think our proposal is worth trying to see if it can increase competition and improve company specific analysis.

For specifics on our proposed proxy advisor competition, see Cisco Systems: Prime Target For Proxy Advisor Competition and Cisco Systems: Proxy Proposal #5 – 11 Q&A.