Cisco Systems (CSCO) faces challenges as never before. For example, see Here’s What Happened When Cisco Lost A $1 Billion Deal With Amazon. Meeting those challenges will take a concerted effort by management and the board of directors. Shareowners, who elect the board and vote on major proxy issues facing our company, also play an important role in Cisco staying competitive and profitable. Yet, most shareowners are passive. Most of us don’t even bother to vote our proxies and who can blame us? This year’s Proxy materials are over 80 pages long. Who has time to read, digest and make decisions on all that information? Finally, we could have the help we need with a proxy advisor contest paid by all shareowners (through Cisco) and chosen by a vote of shareowners.
Proxy Advisors and Research Providers
Even many huge institutional investors don’t do more than skim the proxy… but at least many of the largest funds subscribe to proxy advisor services, such as ISS or Glass Lewis. Analysts from these advisors read through the thousands of proxies each year and compare the items to be voted with policies shaped with the help of their clients. Since they need to review thousands of proxies and are only paid by subscribers (usually a small minority of shareowners), they can’t spend much time on each proxy. Their analysis helps their customers but the bulk of shareowners who are not subscribers never see the advice and that’s bad for all of us.
Additionally, the current system is mired in controversy. 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 is longstanding and ongoing, 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. For excellent analysis of the issues, see The trouble with proxy advisors…. and Public Consultation on Best Practice Principles for Governance Research Providers. 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 Proxy Advisor Contest
Mark Latham looked at the problem years ago ago and came up with a simple solution – a proxy advisor contest paid for largely by the company but awarded through the direct vote of shareowners. Everyone would have access to information from competing advisors, so there would be a competitive market. The analysis would be better because by spreading the cost to all shareowners (through the company) the cost to each would be minimal, so much more could be spent in total. Since the analysis would be company specific, it would be better for the company as well because it would be more accurate. (See “Proxy Voting Brand Competition,” Journal of Investment Management, First Quarter 2007; free download at http://votermedia.org/publications)
Latham left a lucrative career as the Director of Quantitative Equity Trading for Merrill Lynch in Tokyo to devote himself full-time to developing voter information systems, founding the nonprofit VoterMedia.org. Before his position with Merrill Lynch (now part of Bank of America) Latham was a Vice President at Salomon Brothers (now part of Citigroup) heading their Risk Management Department and before that was an Assistant Professor at the University of California at Berkeley. Latham’s credential are impeccable and his solution insightful.
According to Mark Latham (Proxy Voting Brand Competition):
The biggest obstacle to paying advisors is the shareowners’ free-rider problem. Whether you are an individual or an institution, if you pay for advice to improve the quality of your voting, that helps all other shareowners even if they do not pay for or receive the advice. For example, if you own 1% of a company’s shares then only 1% of the beneﬁt from your voting comes back to you. So most shareowners have almost no incentive to pay for voting advice.
The solution Latham proposed eliminates the free-rider problem:
By paying as a group, we shareowners would beneﬁt from better voting advice than any we have now. All shareowners of a company would get the advice instead of just the minority that currently subscribes to such research. Competition for advisor reputation would maintain pressure for high quality and moderate pricing.
Holding a contest for the best advice could bring in new proxy advisors specializing in specific industries or companies. In-depth analysts might comment not only on items on current proxies but might provide investors with key comparisons with competitors and could delve into issues on the horizon, such as the advent of Software Defined Networking (SDN) architectures and how that might be expected to impact Cisco.
Here’s the language of the proposal we Cisco shareowners will vote on:
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.)
As I indicated in the opening paragraph, Cisco’s primary business is facing a real threat. 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.
Some might see SDN as leading to a black swan event, but we can easily see what is on the horizon, so it isn’t an unpredictable black swan. The issue is what to do about it. Will Cisco’s game-changer be enough? Of course the SDN issue is only one challenge and Cisco faces many. For example, 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, WSJ, 8/25/2013)
Several of the risks and possible threats facing Cisco are in the area of corporate governance. These issues are more easily resolved by shareowners. We can expect to see shareowner proposals in future years attempt to address them.
- Cisco routinely faces shareowner proposals each year. In fact, there have been shareowner proposals on each proxy since 2002, with the exception of the year 2004. Let’s get advice on these proposals that is specific to our company, not based on abstract “best practices.”
- GMI Analyst, an independent research group focused on risk and governance, 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.
- Two of our directors held no actual shares in Cisco when I filed my proposal. Sure, all Cisco directors are given restricted stock unit awards for their board service but that is not the same as actually owning shares. Why don’t they invest some of their own money? I’d like our directors to have real “skin” in the game. According to the latest information I have available, all directors that have served more than a year now hold stock.
- Half of our 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, the roles of the CEO are combined. That makes it hard to evaluate the board. Additionally, from page 4 of the proxy, “Mr. Brown was brought to the attention of the Nomination and Governance Committee as a potential candidate by Mr. Chambers, Cisco’s Chairman and Chief Executive Officer.” Sometimes too much power in one person can lead to problems.
Finally, let’s take a look at Cisco’s opposition statement to the proxy advisor contest. Cisco provides three reasons. I will address each in turn.
As a technology company, we do not possess significant knowledge relating to the market for proxy advisory services. The structure and health of the proxy advisory market is not our business focus, nor should it be; our shareholders determine if they wish to have advisors and which advisor they wish to have. If required to implement a proxy advisor competition, we would be forced to commit financial resources and employee time to an activity that is related to neither our revenue and profitability objectives nor our brand and corporate reputation. Moreover, Cisco has no experience implementing proxy advisor competitions.
Response: The proposal contemplates Cisco awarding $50,000 but taking in entry fees of $8,000 or more, if there are more than four entries. With net profits running $2-3 billion a quarter, such expenditures are almost a rounding error. If it was deducted from John Chambers’ 2013 (I’m not suggesting it should be.), he would still earn $21 million in 2013. The vote would come like one more item on the proxy. Administrative expenses would be minimal.
If in fact there are problems with the current quality of the proxy advisory services market, we believe it is more appropriate for our shareholders to address these issues via their hiring decisions, or for regulatory bodies to address them, rather than corporate issuers. Requiring a company such as Cisco to conduct a proxy advisor competition is neither an efficient nor an effective way to improve the operation of the proxy advisory services market.
The proposal doesn’t “require” Cisco to do anything; it simply asks the Board to take action based on the vote of shareowners. The controversy surrounding proxy advisors has gone on for 25 years and isn’t likely to be settled in the near term. For shareowners, getting together presents a collective action problem. Meeting on this issue alone would be prohibitively expensive. Adding it as an additional item at the Cisco meeting is economical and the most efficient way to improve proxy advice at Cisco.
Another reason for opposing this proposal is that, if implemented, it could raise questions about Cisco in the eyes of our key constituents. Certain customers, business partners and shareholders may view Cisco’s efforts to undertake a proxy advisor competition as an implicit interference in shareholder choice of proxy advisors.
The proxy advisor competition avoids this issue by allowing shareowners to easily select the winners. Their choices are tabulated the same as any vote on the proxy. There will be no “interference” from Cisco because our company would have no role in choosing the winners.
Wouldn’t it be good to have competing proxy advisors digging out information and advising shareowners on all the issues outlined above and more? A proxy advisor contest would dramatically increase the public conversations around election issues. Think about it. Is it better for a few subscribers to be poring over recommendations in secret or is it better for ALL shareowners to get analysis from several proxy advisors and have a public discussion?
Please vote “For” Item 5 on your proxy: APPROVAL TO HAVE CISCO HOLD A COMPETITION FOR GIVING PUBLIC ADVICE ON THE VOTING ITEMS IN THE PROXY FILING FOR CISCO’S 2014 ANNUAL SHAREOWNERS MEETING.