Tag Archives | say on pay

Waste Connections: How I Voted

Waste Connection (WCN) is one of the stocks in my portfolio. Their annual meeting is coming up May 20.

ProxyDemocracy.org had only one fund voting, CBIS, when I looked yesterday. MoxyVote.com had none. Checking the Summary Compensation Table, it appears CEO/Chair Ronald J. Mittelstaedt was paid less than the $4.3 median for mid-cap stocks, using the United States Proxy Exchange (USPX) released draft guidelines and adjusting for company size. I’m happy with the relatively steady performance of the company, so I’m voting with management, except that I am voting for an annual say-on-pay.

1 Elect Director Robert H. Davis For Against
2 Increase Authorized Common Stock For For
3 Ratify Auditors For Against
4 Advisory Vote to Ratify Named Executive Officers’ Compensation For For
5 Advisory Vote on Say on Pay Frequency One Year One Year


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Nay on Pay: Comments Sought on Draft Guidelines

The United States Proxy Exchange (USPX) released draft guidelines for shareowners to use in making say-on-pay voting decisions. Comment letters are due by June 2nd to [email protected]. Please put “Say-on-Pay Guidelines” in the e-mail subject line. Letters will be posted to the USPX website, unless you indicate you would rather remain anonymous. (Disclosure: I am a member of USPX. Anyone can join for a nominal cost.)

Our draft guidelines lay out the problem of rising CEO pay, largely unrelated to performance. Shareowners now have a “say-on-pay.” However, if we mindlessly vote in favor of executive pay packages we will be adding to the problem, providing “insulation” for compensation committees and CEOs who can then point to shareowner approval.

Indeed, at a webinar earlier this week, Equilar indicated that 77.4% of votes at S&P 500 companies have so far resulted in 90% shareholder support for pay packages. A recent post by Dominic Jones, of IR Web Report, shows that most Investors spend just 5 minutes on annual reports and proxy materials.

To help shareowners make the best use of that five minutes we propose two general tests:

  1. The ratio test:  Vote down all pay proposals where companies paid their CEO more than whatever pay ratio to average pay you think is outrageous. Peter Drucker warned it should be no more than 20. You may willing to pay up to 50, 100, 150 or more. We show you how. (For an interesting series of posts on the effort to kill the Dodd-Frank requirement to report company ratios, see Jay Brown’s series on Executive Compensation and Ratio Disclosure.)
  2. Median executive compensation:  Vote against compensation packages of any firm at which executive compensation exceeds median pay (or some variation of that) in the previous year. Almost every year, median CEO pay rises because no board wants to think of their CEO as average. Paying above average of surveyed peers results in an average that continually ratchets up. Some of us think it is time for CEO pay to ratchet down for a while.

We also recommend that when you vote down a pay package, you also vote against the compensation committee that recommended its approval by the board. At a recent meeting of the Silicon Valley chapter of the National Association of Corporate Directors, Abe Friedman, former global head of corporate governance and responsible investing at BlackRock and Barclays Global Investors, concluded that voting out five compensation committee chairs and putting their pictures in the Wall Street Journal would do more for the pay issue than say on pay rights granted by Dodd Frank.

Again, comment letters are due by June 2nd to [email protected] Please put “Say-on-Pay Guidelines” in the e-mail subject line. Letters will be posted to the USPX website, unless you indicate you would rather remain anonymous.

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Another Pay Package Rejected

With my decision to vote against all pay packages above the median, I am voting against more than ever. Apparently, I’m not alone. Others are waking up as well. Here’s part of a report from Ted Allen of RiskMetrics/ISS from last week:

This week, Cogent Communications Group failed to get majority support from investors on its executive compensation, bringing to 10 the number of U.S. companies where shareholders have made such protests this year.

In addition, investors withheld more than 39 percent support from the pay practices at Pfizer and Johnson & Johnson on Thursday amid “vote no” campaigns by the American Federation of State, County, and Municipal Employees, according to news reports. This dissent is significant, given that S&P 500 companies have been averaging 90 percent support during advisory votes on compensation this year.

via Another Failed Vote on Executive Compensation – Governance.

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EU May Mandate CorpGov Measures

A “say on pay” could be introduced across Europe, along with potential quotas for the number of women in boardrooms, as a result of proposals outlined by the European commission.

British companies have been required to put their remuneration policies to a shareholder vote since 2003 when pharmaceutical company GlaxoSmithKline became the first company to have its pay plan opposed by its investors.

Europe is now asking whether companies across the 27 member states should be forced to put their remuneration policies to a vote by shareholders – and indeed even make disclosure on pay mandatory for both executive and individual directors for the first time in some countries.

The green paper said: “A mismatch between performance and executive directors’ remuneration has also come to light.”

(EC proposes ‘say on pay’ and quotas for women in the boardroom | Business | The Guardian., )
Responses to 25 questions outlined in a green paper are due by July, the commission asked whether companies should be required to “ensure a better gender balance on boards” than the current 12% across the EU.

I found several of the 25 questions equally interesting, including the following:

  • Should the EU seek to ensure that the functions and duties of the chairperson of the board of directors and the chief executive officer are clearly divided?
  • Should recruitment policies be more specific about the profile of directors, including the chairman, to ensure that they have the right skills and that the board is suitably diverse? If so, how could that be best achieved and at what level of governance, i.e. at national, EU or international level?
  • Please point to any existing EU legal rules which, in your view, may contribute to inappropriate short-termism among investors and suggest how these rules could be changed to prevent such behaviour.
  • Are there measures to be taken, and if  so, which ones, as regards the incentive structures for and performance evaluation of asset managers managing long-term institutional investors’ portfolios?
  • Should EU rules require a  certain independence of the asset managers’ governing body, for example from its parent company, or are other (legislative) measures needed to enhance disclosure and management of conflicts of interest?
  • Are there measures to be taken, and is so, which ones, to promote at EU level employee share ownership?

Interested parties are invited to submit their views on the suggestions set out in the
Green Paper. Contributions should be sent to the following address to reach the Commission by 22 July 2011 at the latest: [email protected]. Contributions will be published on the internet.

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SWOP Reaches Tipping Point

The debate over the best frequency for “say on pay” votes has reached a tipping point, as a majority of S&P 500 and Russell 3000 firms have urged their investors to support annual advisory votes on executive compensation.

As required by the Dodd-Frank Act, this year’s corporate proxy statements include a “say when” vote that asks investors to express their views on whether advisory votes on compensation should be held every year, every two years, or every three years. The percentage of annual recommendations has been growing in recent weeks, as more boards have heeded the large majority votes by investors for annual votes at early season meetings.

So far, 105 (60.7 percent) of the 173 large-cap firms that have filed proxy materials had endorsed annual votes, as compared to the 56 companies (32.4 percent) where management endorsed triennial votes, according to ISS data as of March 22. Seven firms have favored a biennial frequency, while five issuers made no recommendation.

via A Tipping Point on Pay Vote Frequency – Governance.

See also Shareowners Going “Off the Reservation” on SWOP and Addressing CEO Pay.

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Australia ‘Say on Pay’ Enhancements Too Radical

Shareholders of Australian public companies have been having their say on pay by law since 2005. The Australian Parliament is currently considering amendments to its say on pay rules that are aimed at increasing the impact on companies of significant shareholder votes against.

The ‘two-strikes’ test is a key proposed change included in the Corporations Amendment Bill 2011 (the Bill). If 25% or more of all shareholder votes are cast against a company’s remuneration report, this ‘first strike’ requires that the company respond to the negative vote in the following year’s compensation report…

The Bill requires that strike two triggers a shareholder vote within the meeting to decide whether the directors must stand for re-election. The vote on director reelection is called a ‘spill resolution’, If the director re-election resolution is supported by 50% or more of votes cast, the directors must stand for re-election at a “spill meeting” within 90 days…

A review of the comments that were submitted reveals that although the requirement that companies respond to the first strike was generally well received, the board spill resulting from a second strike was almost universally panned by investors and corporate spokespersons alike. The thrust of much of the opposition to spill votes was that director elections should not be triggered by fewer than 50% of shareholder votes. (Australia proposes ‘say on pay’ enhancements – SHARE – Shareholder Association for Research and Education)

Generally, I find myself coming down on the side of empowering shareowners at just about every turn. However, I agree this Australian measure would go too far. A second 25% vote could trigger a second report but I don’t think anything less than a rejection by a majority of shares voted should trigger a vote to “spill” the board. McRitchie, defending the rights of entrenched boards, who would have dreamed?

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PotashCorp wants you to “Like” its pay disclosures

PotashCorp (TSE, NYSE:POT) is tackling the touchy topic of executive pay with a web-based communication campaign that includes a shareholder survey, a series of videos, and pay disclosures you can easily tweet or Like on Facebook.

The Canadian company, which voluntarily adopted an annual say-on-pay vote two years ago, yesterday announced the availability of a new shareholder survey and director videos explaining the company’s pay practices. It did so in a note that was posted on its website and distributed to its Twitter account and Facebook page.

via PotashCorp wants you to “Like” its pay disclosures | IR Web Report, 3/4/2011.

Dominic Jones walks readers through one of the most innovative efforts I’ve seen to date to educate shareowners about a company’s compensation practices. I think I’ve seen the near-term future of CD&A’s, HTML proxy statements, online surveys and use of social media to better ensure favorable say on pay votes for management.

I took Potash’s survey (you have to say your a shareholder or else it kicks you out). Although I didn’t click on enough links to satisfy myself that executives at Potash are paid reasonably, I did note that they hit the right buttons and presentation was great. Drilling down further might yield issues though. For example, as I recall, they had a clawback policy that calls for the recoupment of unearned compensation that results from misconduct by an executive that causes the company to restate its financial statements.

That doesn’t go far enough, as far as I’m concerned. I would recommend a “no-fault” clawback provision, which would require recoupment following a determination that the prior achievement of performance goals was based on incorrect data. Like clawback provisions triggered by any restatement, a “no-fault” provision addresses the argument about the unfairness to shareowners that results from allowing executives to keep compensation awarded on the basis of performance targets that were not actually met. However, a “no-fault” provision would also require recoupment in circumstances where incorrect data result from an innocent mistake, not fraud or misconduct or where applicable accounting standards would not require a restatement of financial statements. Why should an executive get a bonus for a target not actually met?

Although I can’t fully endorse Potash’s pay plans (primarily because I haven’t done the analysis), they certainly deserve credit for presentation. I’ve seen the future. It is in Canada.

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Controversy Among Corporate Secretaries

I’ve been getting some interesting comments in response to last week’s newsletter and I want to share them. Here are a few of the more interesting e-mails I’ve received. I’ve deleted the authors’ specific designations to safeguard their privacy:

‘You are missing a key fact. The recommendations to shareholders are not management’s recommendations as repeatedly said in your letter. They are Board recommendations; made by the directors, and appropriately so since the directors are elected by the shareholders and answerable to them. Yes, management advises the directors, and maybe convinces the directors of management’s view of what their recommendation should be. But, in the end, it’s Board recommendations that are made to the shareholders.’

‘So the situation may be even more serious than shareholders not following management. Shareholders are not listening to their elected directors. I think that’s what we’ve been seeing increasingly in the past few years. Perhaps rightly so, if the Board has simply passed on, without challenge and scrutiny, management’s recommendations. But it’s unfair to Boards to imply, without discussion, that that’s what all Boards do.’

–Corporate secretary and general counsel of a Fortune 500 company (Corporate Secretary editor’s blog, Janine Sagar, 3/7/2011)

This comment is followed by others, including one from CorpGov.net. Addressing this first comment, I think there are varying interpretations of “management.” Yes, I can see corporate secretaries and corporate counsels might often make the distinction made by the commentator above.  Shareowners also distinguish between boards and executives. However, I consider proxy recommendations to be from “management,” executives and board inclusive.

Additionally, the idea that “They are Board recommendations; made by the directors, and appropriately so since the directors are elected by the shareholders and answerable to them” is somewhat laughable. Elected by shareowners? Most corporate boards still don’t even have majority vote requirements for the election of directors… although they actually do in the Fortune 500.

Answerable to shareowners? I don’t think so. Board members, in most cases probably consider themselves answerable to those who asked them to join the board… usually, that means key board members and the CEO. True, in surveys they probably know enough to say they answer to shareowners but everyone knows this is a myth. Once shareowners have proxy access, actual accountability may begin to change but it will take many years, since shareowners will only be able to nominate up to 1/4 of board members and only a few outliers are likely to be targeted in the foreseeable future.

See also: Shareowners Going “Off the Reservation” on SWOP and Just How Clever Are Directors on Pay Issue?

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Shareowners Going "Off the Reservation" on SWOP

Of 95 companies that held say-on-pay votes as of Feb. 25, 93 had favorable votes. The vast majority of those won more than 90 percent of the votes cast, according to an analysis of the first month of proxy filings under the final Securities and Exchange Commission rules by Schulte Roth & Zabel. Companies, however, haven’t had as much luck on their frequency recommendations.

In particular, triennial SOP vote recommendations, the overwhelming choice among boards of the 93 companies that have held frequency votes so far, have had mixed success. While 52 of those companies recommended triennial votes, just 27 won majority support for triennial votes from shareholders.

via Parsing the Early Say-on-Pay Votes – Compliance Week. As we have said before, why would shareowners vote for power once every three years, instead of to have it every year. See Addressing CEO Pay.

Don’t you just love this quote? “There was some concern early on that shareholders would ‘go off the reservation,’ but most companies are getting significant shareholder support, not just squeaking by,” says Michael Littenberg. When shareowners aren’t supporting management, we’re off the reservation? Wow, I guess we know who’s in control.

For much more on the subject and analysis of vote counting issues, see the March RR Donnelley Securities Newsletter, with content provided by TheCorporateCounsel.net.

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Just How Clever Are Directors on Pay Issue?

Interesting post from Dominic Jones, brilliant author of the IR Web Report, who wonders if directors fumbled, given that so many three year Say When on Pay proposals are being voted down. Or did directors intentionally channel investor anger “towards the less important of the two say-on-pay proposals.”

Such a diversionary tactic gives “a window-dressing opportunity to their institutional investors,” writes Jones. When funds disclose their votes, they can seem to take a hard line, while taking attention away from the fact that they are also voting in favor the more concrete executive pay proposals. “In fact, 87% of pay votes so far have received more than 80% support from investors.” (Say-on-pay frequency battles a clever diversion | IR Web Report, 2/25/2011)

Interesting theory, but I don’t really see directors taking that much interest in providing cover to funds so that fund managers can say they “stood up for the little guy.” The driver here is more likely to be proxy advisory firms that have drawn a line in the sand that is easily understood, publicized, and followed.

Investors can easily understand, “give me power every three years or give me power every year.” What we can’t understand, unless we devote a lot of resources to filling out scorecards on executive pay proposals using the typical metrics used by large and conscientious institutional investors,  is whether or not we should vote in favor of a board’s pay proposal.

We often know in our gut that the bottom line pay that a proposal yields will be outrageous. But aren’t basketball players paid outrageous amounts too? Unless we’re willing to crunch all the numbers, we generally vote with the board’s recommendation.

While I’m all in favor of incentives to increase the holding period on option and/or stock grants, clawbacks for unearned bonus and incentive payments, cutting back on absurd perks, tying bonuses to performance that take into account market movements and peers, limits on severance or change-in-control payments, and the myriad of other details these good governance funds are concerned with, I also think we also need a few simple overarching guidelines.

  • Will the CEO earn more than 100 times the average worker?
  • Will they take more than 5% of the company’s net profit?
  • How are funds voting that actually put themselves out there by announcing their votes in advance on ProxyDemocracy.org?

I’m sure there are more simple guidelines and these examples may not be the best. As I said in a recent post, which I’m delighted Jones cites (Addressing CEO Pay), members of the United States Proxy Exchange will soon begin working on a paper to address the issue of CEO pay. I’ll be advocating a few simple metrics to ratchet down the “Lake Wobegone effect” and to help wean America away from what has increasingly become a “winner take all” mentality.

As long as directors keep thinking their company’s CEO is above average, the average will keep going higher and higher every year as the baseline comparison rises. Between 1980 and 2004, real wages in manufacturing fell 1%, while real income of the richest one percent rose 135%. The top 1% average $3.2 million a year, while the bottom 90% average $31,000 based on 2008 data. The top 1% control 35% of America’s net worth, while the bottom 90% control 27% based on 2007 data. (It’s the Inequality, Stupid, Mother Jones, 3-4/2011) Looking at the world as a whole, the richest 1% control 43% of total assets according to The Economist (More Millionaires Than Australians, 1/22/2011), whereas the bottom 50% control 2% of assets.

I don’t think we should wait for these gaps to widen further before taking action. If average CEO pay for S&P 500 firms moved from the current $9.25 million per year to $4.6 million a year, would average CEO performance be cut in half? I doubt it. Conscientious institutional investors will go after the outliers, the most outrageous examples. Somebody needs to go after the herd. Let’s make use of the pay ratios that have to reported in the CD&A because of Dodd-Frank while we still can.  That requirement could be gone before we know it the way things are headed in Congress.

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Addressing CEO Pay

Regarding CEO pay, Nell Minow recently wrote, “there is a little flicker of light at the end of the long, dark tunnel of outrageous pay.” Her signs of hope:

  • Required advisory “say on pay” (SOP) vote. Last year after a “no” vote,  Occidental Petroleum’s board reduced the pay package for CEO Ray Irani and announced his retirement. Shareowners have voted down pay plans at several companies already. Additionally, “Some companies are adjusting their pay plans in anticipation of a new level of scrutiny by shareholders, tightening pay-performance links and getting rid of especially unpopular compensation components like “gross-ups” (paying the executive’s taxes).”
  • Shareowners at four of seven companies proposing a triennial say when on pay (SWOP) vote instead voted for an annual vote.
  • The UK may soon require new additional disclosures.
  • “Groups like Public Citizen are working to remove further legislative and regulatory obstacles to shareholder oversight on pay and disseminating information on the bonuses of bailout-company executives.”
  • The FDIC is moving forward with rules to requiring pay-performance links in bank executive compensation as part of insurance risk assessment.

“These are all welcome signs that compensation is finally being seen as an essential element of securities analysis and risk management, and that’s what markets are all about.” (The Days of Outrageous CEO Pay May Be Ending | BNET, 2/14/2011).

High CEO pay is symptomatic of a host of issues. An important one for me is income inequality. It seems to me that a disappearing middle class is not good for America. This seems to be a concern of many, but we still seem to be heading in the wrong direction. For some interesting research on American opinion in this area, see The Return of Dan Ariely: The Survey Results Are In (ChrisMartenson.com, 2/7/2011). His conclusion:

Taken as a whole, the results suggest to us that there is much more agreement than disagreement about wealth inequality. Across differences in wealth, income, education, political affiliation and fiscal conservatism, the vast majority of people (89%) preferred distributions of wealth significantly more equal than the current wealth spread in the United States. In fact, only 12 people out of 849 favored the US distribution. The media portrays huge policy divisions about redistribution and inequality – no doubt differences in ideology exist, but we think there may be more of a consensus on what’s fair than people realize.

From Eagle Rock Proxy Advisors, most companies are generally recommending that shareholders vote for say-on-pay votes once every three years. Here is a snapshot of overall board recommendations/ intentions for recommendation at the beginning of the season:

Annual Biennial Triennial None
All Companies 32% 8% 52.7% 7.3%
S&P 500 21.7% 8.7% 65.2% 4.3%

As we previously reported, shareowners are pushing for the annual option, so I expect many more rejections of triennial proposals. See “Say on Pay” to be Annual.  Timothy Smith, Senior Vice President, Director of ESG Shareower Engagement at Walden Asset Management recently sent out an e-mail noting he is among many strongly opposed to the triennial proposals by management and is “frustrated that we even had to have a frequency vote (thanks to Idaho Senator Crapo’s midnight amendment).” But the surge of votes for annual say when on pay SWOP is “helping investors pay more attention to the value and use of SOP votes. In the end this frequency vote may help solidify the importance of SOP to investors vindicating the initiative AFSCME, Walden and others started 6 years ago.”

Yes, with SOP and SWOP votes this year and companies reporting the ratio of executive pay to the average of all employees for the first time, the topic of CEO pay may come into focus more this year than in the past and shareowners will now at least have the power to voice their opinion.

However, I see little evidence that any of the current measures address the “Lake Woebegone” effect documented by Rachel M. Hayes and Scott Schaefer. According to those researchers, “no firm wants to admit to having a CEO who is below average, and so no firm allows its CEO’s pay package to lag market expectations.” (CEO Pay and the Lake Wobegon Effect, December 11, 2008, Journal of Financial Economics (JFE) Their analysis suggests SOP votes might be counterproductive. Before SOP was required by Dodd-Frank, many voices warned it would simply provide boards and managements with cover for a continued upward spiral.  Hayes and Schaefer offer up a “potential solution to the problem of shareholder myopia.”  Delegate pay decisions to directors and motivate them through contracts “to take a longer-term view.” But isn’t that what we’ve been trying all along? Clearly, something more is needed.

India’s Sonia Jaspal does a good job of citing some of the more more relevant papers and issues that have received too little attention to date. (The Negative Impact of CEO Pay & Power on Corporate Culture and Governance, 2/15/2011) Jaspal’s concern was apparently set off by a recent study conducted by Economic Times of India, which showed that in 2009-2010 CEOs of top companies earned 68 times the average pay of employees, up from 59 times their prior year. To Americans facing a pay disparity of 264 (with a high point of 558 in the year 2000), the differences in India may seem paltry. (Mind the Compensation Gap, Portfolio.com, 1/26/2011)

Many of us “feel” an injustice when CEOs earn so much more than average workers, but Jaspal points to academic studies that show the potential impacts are more harmful to society than simply hurt feelings.

When Executives Rake in Millions: Meanness in Organizations.  “Higher income inequality between executives and ordinary workers results in executives perceiving themselves as being all-powerful and this perception of power leads them to maltreat rank and file workers.” Some powerful executives perceive those with lesser power as sub-human. They demonstrate reduced empathy, being inclined to objectify and dehumanize others through behaviors such as sexual harassment and an increase likelihood of  unethical and corrupt behavior.

Jaspal also points to another real impact of this dehumanization, “the fact that CEOs who fired the maximum number of employees during recession in US, received the biggest pay packets.”  They apparently felt little remorse in benefitting from the tragedy they impose on others. “The social and psychological consequences of income disparity are borne by the society” and the consequences may be greater in the United States than it is in India because of the much larger average disparities.

An article published by The Economist titled The psychology of power: Absolutely looks at experiments that appear to confirm Lord Acton’s dictum that “Power tends to corrupt, and absolute power corrupts absolutely.” According to the studies, “The powerful do indeed behave hypocritically, condemning the transgressions of others more than they condemn their own… It is not just that they abuse the system; they also seem to feel entitled to abuse it.” Researchers conclude that “people with power that they think is justified break rules not only because they can get away with it, but also because they feel at some intuitive level that they are entitled to take what they want.”

Of course The Economist comes to a different conclusion than many of us would: “Perhaps the lesson, then, is that corruption and hypocrisy are the price that societies pay for being led by alpha males (and, in some cases, alpha females). The alternative, though cleaner, is leadership by wimps.” I’d say the lesson, instead, highlights the need to ensure leaders remain accountable, knowing corruption and hypocrisy will not be tolerated.

We keep Searching for a Corporate Savior in our CEOs but ending up with charismatic narcissists, with too many focused on short-term profits when we know we should be promoting CEOs from within to move from Good to Great.

Fraudulent Financial Reporting 1998-2007- An Analysis of U.S. Public Companies by  the Committee of Sponsoring Organizations of the Treadway Commission found that CEOs were involved in 72% of the 347 alleged cases of fraudulent financial reporting listed with SEC during 1998-2007 period. The average period of fraud was 31.4 months. Why Do CFOs Become Involved in Material Accounting Manipulations? shows that 46.15% of CEOs involved in fraudulent activity benefitted financially from accounting manipulations. “CFOs are involved in material accounting manipulations because they succumb to pressure from CEOs, rather than because they seek immediate personal financial benefit from their equity incentives.” Since CEO performance and benefits are measured by financial numbers submitted to the stock market, CEOs rationalize the need to report fraudulent financial numbers to protect their own positions.

Based on this analysis, Jaspal makes the following recommendations (I’ve taken liberty to reword some slightly.):

  • The law should place a limit on the number of times CEO pay can excede the pay of average workers. This will ensure some balance is maintained.
  • Because studies show that some powerful people tend to dehumanize their underlings and studies on emotional intelligence indicate that emotionally intelligent people are aware of their own and others emotions and drivers, we should explore methods to keep CEOs emotionally connected.
  • Since research found that women are less likely to feel a sense of entitlement or power we should appoint more women  CEOs to maintain a balance and keep senior management grounded.
  • Independent board members should be included on compensation committees. “This will ensure that a realistic view is taken of CEO and other top executives’ salary. Basing salary structures on performance rather than favorable circumstances is required.” (This is already the norm in the United States; unfortunately, it doesn’t appear to “ensure a realistic view.”
  • Employees may be empowered by forming trade unions and using whistle blowing lines inside and outside the organization. (Again, we have this in the United States and the whistle blowing tools are improved under Dodd-Frank.)
  • Last but not the least, the public should play an active role in curtailing income disparities. The issues should be brought to government and media attention. (Name and shame seems to have little impact but perhaps heightened awareness of the issues will lead to real sanctions.)

It is a nice list. I certainly agree with the idea of keeping CEOs emotionally connected, appointing more women CEOs, and getting the government involved in reducing income gaps. However, for the most part Jaspal’s recommendations don’t provide much guidance for shareowners entering the proxy voting booth. The one exception is placing a limit on the number of times CEO pay can exceed the pay of average workers.

Institutional investors have developed a plethora of guidelines and scorecards for voting down CEO pay. For example, section 3 of the CalPERS Global Principles of Accountable Corporate Governance, which contains too much to cover in this brief post but here are a few examples:

  • To ensure the alignment of interest with long-term shareowners, executive compensation programs are to be designed, implemented, and disclosed to shareowners by the board, through an independent compensation committee.
  • Executive contracts be fully disclosed, with adequate information to judge the “drivers” of incentive components of compensation packages.
  • A significant portion of executive compensation should be comprised of “at risk” pay linked to optimizing the company’s operating performance and profitability that results in sustainable long-term shareowner value creation.
  • Companies should recapture incentive payments that were made to executives on the basis of having met or exceeded performance targets during a period of fraudulent activity or a material negative restatement of financial results for which executives are found personally responsible.
  • Executive equity ownership should be required through the attainment and continuous ownership of a significant equity investment in the company.
  • Equity grant repricing without shareowner approval should be prohibited.
  • “Evergreen” or “Reload” provisions for grants of stocks and options should be prohibited.

We can find many more lists, but again they don’t seen to be too helpful for the average investor who isn’t going to hire a proxy advisor or put a lot of time into analyzing the proxy. Last year, the Council of Institutional Investors issued a brief paper, Top 10 Red Flags to Watch for When Casting an Advisory Vote on Executive Pay aimed at addressing this issue. “Many investors, however, lack the time and resources to do deep dives on compensation at each of the hundreds of companies in their portfolios. They need rules of thumb to identify executive pay programs that are ticking time bombs.” That statement might even ring truer for retail investors holding a dozen or fewer companies. Again, even CII’s “top 10” are too extensive to list here because many items are broken into multiple items. Here are the top 10 with much of that elaboration stripped away:

  1. Do top executives have paltry holdings in the company’s common stock and can they sell most of their company stock before they leave?
  2. Does the company lack provisions for recapturing unearned bonus and incentive payments to senior executives?
  3. Is only a small portion of the CEO’s pay performance-based or is the basis a single metric?
  4. Are executive perks excessive or unrelated to legitimate business purposes?
  5. Is there a wide pay chasm between the CEO and those just below?
  6. Stock options should be indexed to a peer group or should have an exercise price higher than the market price of common stock on the grant date.
  7. Did the CEO get a bonus even though the company’s performance was below that of peers?
  8. Does the company guarantee severance or change-in-control payments not in the best interest of shareowners?
  9. Does the disclosure fail to explain how the overall pay program ties compensation to strategic goals and the creation of long term shareowner value?
  10. Does the firm advising the compensation committee earn much more from services provided to the company’s management than from work done for the committee?

Key to the the usefulness of CII’s advice is how easily answers can be obtained by individual retail shareowners. A second major concern is even if all this advice is followed, how will we ratchet down the Lake Woebegone effect and decrease the growing disparity between the rich and the rest of us? That seems important if we are to move from a culture of narcism, where many of the rich feel entitled to break the law and treat underlings with disrespect.

Members of the United States Proxy Exchange will soon begin working on a paper to address the issue of CEO pay. I think it is likely to revolve around the issue of what pay packages to vote down. Most retail shareowners don’t subscribe to ISS, Glass Lewis or other services that can rapidly assess pay packages. We need simple metrics so that we can gather all the information we need to vote in just a few minutes. Three possible examples:

  • Pay that is over 100 times average pay.
  • Pay that takes more than 5% of a company’s net profit.
  • Majority of those disclosing votes in advance on ProxyDemocracy.org recommend against.

For less than $4 a month, your voice can be heard by joining in this important effort.

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"Say on Pay" to be Annual

I believe ISS/Risk Metrics created a policy on the Frequency of Advisory Vote on Executive Compensation (Management “Say on Pay”), a new proxy item required under The Dodd-Frank Wall Street Reform and Consumer Protection Act.

Their Recommendation: Vote FOR annual advisory votes on compensation, which provide the most consistent and clear communication channel for shareholder concerns about companies’ executive pay programs.

Rationale for Update: The Dodd-Frank Act, in addition to requiring advisory votes on compensation (aka management “say on pay” or MSOP), requires that each proxy for the first annual or other meeting of the shareholders (that includes required SEC compensation disclosures) occurring after Jan. 21, 2011, include an advisory voting item to determine whether, going forward, the “say on pay” vote by shareholders to approve compensation should occur every one, two, or three years.

In line with overall client feedback, ISS is adopting a new policy to recommend a vote FOR annual advisory votes on compensation. The MSOP is at its essence a communication vehicle, and communication is most useful when it is received in a consistent and timely manner. ISS supports an annual MSOP vote for many of the same reasons it supports annual director elections rather than a classified board structure: because this provides the highest level of accountability and direct communication by enabling the MSOP vote to correspond to the majority of the information presented in the accompanying proxy statement for the applicable shareholders’ meeting. Having MSOP votes every two or three years, covering all actions occurring between the votes, would make it difficult to create the meaningful and coherent communication that the votes are intended to provide. Under triennial elections, for example, a company would not know whether the shareholder vote references the compensation year being discussed or a previous year, making it more difficult to understand the implications of the vote.

From my understanding, ISS held a conference call on the new policy. I wasn’t on the call but I understand 250 were. I also understand that during the call it came out that CalSTRS, State Street and Vanguard all support annual votes. CalSTRS was expected but State Street and Vanguard supporting annual votes is likely to mean greater success. Annual vote seems headed for the default position.

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CEO Pay in an Age of WikiLeaks: Reporting, Rationale and Ratios

As has been widely reported, WikiLeaks will soon release thousands of documents revealing malfeasance, greed and incompetence at the highest levels of a major American bank, most likely Bank of America. According to WikiLeaks’ Julian Assange, this may be the biggest expose of unethical corporate behavior since the Enron scandal. (Facing Threat From WikiLeaks, Bank Plays Defense, NYTimes, 1/2/2011) For broader “leaks,” see Ex-Banker Gives Data on Taxes to WikiLeaks, NYTimes, 1/17/2011.

This will focus new attention on the subjects of greed, fraud and abuse at the highest levels of Corporate America. See Gary Larkin’s post, Wikileaks Episode Should be Wake-Up Call for Companies. (The Conference Board Governance Center Blog, 1/14/2011)

Last year’s Dodd-Frank bill includes Section 922, which provides that the SEC must pay rewards to whistleblowers who provide original information about violations of the federal securities laws that leads to successful enforcement actions resulting in more than $1 million in penalties. (Concerns Grow Over New Dodd-Frank Act Whistleblower Provisions). Additionally, a pay disclosure rule will require many U.S. companies to report the ratio of CEO pay to median employee pay in the annual proxy statements and also requires votes on corporate proxies concerning how often shareowners will have a “say on pay.”

A recent Towers Watson poll of 135 U.S. publicly traded companies found that 51% expect to hold annual say-on-pay votes, while 39% prefer the vote be held every three years, and 10% anticipate holding biennial votes. Meanwhile, nearly half 48% of companies surveyed are making some adjustments to their executive pay-setting process, while 65% are devoting more attention to explaining their programs in the Compensation Discussion & Analysis (CD&A). Some of the best advice for companies on these issues can be found regularly at CompensationStandards.com, including a program today, The Proxy Solicitors Speak on Say-on-Pay.

Clearly, the issue of executive pay is one that stay with us for years to come but 2011 could set the tone, not just in America but around the world. One of the more interesting discussions I’ve read is in the recent posts of an an Indian blogger, Sonia Jaspal, who cites a recent report of COSO “Fraudulent Financial Reporting 1998-2007- An Analysis of U.S. Public Companies,” which states that CEOs are involved in 72% of the 347 alleged cases of fraudulent financial reporting listed with SEC during 1998-2007 period. (see Fraud Symptom 1- Insatiable hunger of CEO, Fraud Symptom 2- A Weak CFO, and Fraud Symptom 3 – Board’s failure to exercise judgment. We need mechanisms to reduce the likelihood of collusion between CEOs and CFOs, such as making directors and/or audit committee responsible for recruiting and terminating CFOs and not linking CFO pay to stock market performance.

Shareowners are also grappling with how to address the issues. Manifest, a UK-based proxy advisory firm has something of an advantage, since UK shareowners have had a say on pay for many years. See an example of relatively recent discussion at “Excessive” bonuses lead to higher dissent. Other sources of advice include books such as Money for Nothing: How CEOs and Boards Enrich Themselves While Bankrupting America and the classic Pay without Performance: The Unfulfilled Promise of Executive Compensation.

Members of the United States Proxy Exchange have initiated a forum to discuss where individual shareowners and USPX should come down on pay issues. Get in on the conversation for $3.95 a month, if only to monitor what direction this increasingly influential group will take. There are thousands of sites providing investment advice but USPX is one of only a few on investors as owners.

While I have often advocated that any any principles regarding limits should be grounded on academic research, it is difficult to envision a mass movement based on the complex formulas and principles contained in most CD&As, even if they may be grounded in research. Should founding CEOs be given a pass? I don’t think so. CEOs like Steve Jobs of Apple and John Mackey of Whole Foods can easily afford to work for minimum wages because they own a substantial portion of their companies. Their real pay comes through ownership, not by working.

CEOs will try to convince their boards they should be paid in the top 25% of their peers and we have the Lake Wobegon Effect. Since companies will be reporting the ratio of annual CEO pay to median annual total compensation for all employees, that number may drive a popular movement. What will be considered fair? 1 to 25? 1 to 50? 1 to 100? 1 to 200?

In 2007, CEOs in the S&P 500, averaged $10.5 million annually, 344 times the pay of typical American workers, but that was a steep drop in the ratio from 2000 when CEOs earned 525 times average pay. With companies forced to report their ratios, expect more pressure than ever from shareowners in 2011.

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Board or Shareholders – Who Should Determine Management Compensation? A Model of Compensation Governance

The efficacy of boards of directors as a critical governance institution has attracted increasing scrutiny in the wake of the recent financial meltdown. CEO compensation which consequentially determines overall management compensation in a firm, is a key governance decision entrusted with the board. A relevant, though unexplored question would be whether shareholders are better served by making the compensation decision themselves.

In this paper, in a game theoretic set up, we analyze shareholder payoffs under the traditional delegated- governance structure wherein shareholders set the compensation of the board, but delegate the management compensation decision to the board, and contrast such delegated- governance with an alternate owner-governance structure wherein shareholders determine the compensation contracts for both the board and management. Under unobservable effort, we consider both deterministic and stochastic firm performance, jointly determined by the effort of the board and management.

We find that shareholders are never worse off under owner-governance, though management wages as well as effort are higher under certain conditions. Within a deterministic setting, board wages as well as effort are equal or higher with centralized governance. Under extreme stochastic effects, which might describe boom or bust environments, it does not pay to incentivize the board or management to expend effort. In a stochastic environment where output is determined primarily by board effort, it does not pay to incentivize management for effort. Our analysis suggests a possible explanation for the puzzling observation of rising managerial compensation, often not in congruence with firm performance, as the board faces no penalty for misaligned managerial wages under delegated-governance. We show that owner-governance generally eliminates non-aligned incentive structures.

via SSRN-Board or Shareholders – Who Should Determine Management Compensation? A Model of Compensation Governance by Shivendu Shivendu, Joseph Vithayathil.

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NACD Wants SEC to Back Off Say-on-Pay Provisions

In response to the SEC request for comment on say-on-pay rules, the National Association of Corporate Directors (NACD) issued formal concerns, cautioning against dependency on regular, yes-or-no votes.

NACD’s opinions are grounded in its more than 30 years of proprietary research across a broad range of board leadership and corporate governance topics, insights expressed through confidential peer exchanges with its membership spanning F100 through mid-cap and small cap companies, and best practices detailed in its Blue Ribbon Commission reports. NACD’s comments were reinforced by a national survey that drew 280 responses from its members.

Representing the voice of its more than 10,000 corporate director members, NACD urges the SEC not to issue universal requirements, but to allow companies to determine the most appropriate means of communicating with and seeking feedback from shareholders as a more effective governance practice. Additionally, NACD provided the SEC with specific views on frequency of say-on-pay votes, say on golden parachutes and other matters pertaining to executive compensation on behalf of the director community.

NACD appreciates the symbolic value of say-on-pay. However, we believe it is a poor substitute for dialogue. It is much more valuable to have shareholder communication well in advance of plans or votes on plans. Say-on-pay is a yes-or-no, backward-looking vote that may have little utility except to express a very general shareholder view of a pay plan already in effect,

the Association wrote in a letter signed by Honorable Barbara H. Franklin, chairman of NACD and former U.S. Secretary of Commerce, and Ken Daly, NACD’s president and CEO.

In addition to the survey, NACD cited recent board research indicating that dialogue between companies and institutional investors is increasing.  Additionally, say-on-pay votes for early adopters has been substantially positive, calling out the potential for say-on-pay voting to become a meaningless and burdensome ritual for companies and shareholders alike. According to the organization’s letter, “NACD would urge caution in the area of rulemaking. Compensation terms can be interpreted in an overly broad manner, regulating areas that are best left alone.”

Issues also under SEC consideration where NACD offered an opinion include:

  • Small company exemption: NACD strongly supports an exemption on say-on-pay for small companies (those with less than $75 million in public float), as the compliance and paperwork requirements are particularly costly for small businesses that can less easily absorb the cost. Notably, 73 percent of respondents in the director survey indicated preference for small business exemption.
  • Superclawbacks in financial institutions: NACD encourages the SEC to work alongside it in serving as a “voice of reason” when identifying standards and process for whether directors and officers of a company are in fact “substantially responsible” for insolvency. NACD has concerns of this rule being misused for “witch hunts.”
  • SEC disclosure rules regarding compensation consultant conflicts: NACD urges caution that a consultant for an independent board committee should not be considered in conflict just because it performs a significant amount of work. The key point is that the same consultant does not also work for management, a position long-held by NACD and first raised in its 2003 Blue Ribbon Commission report.
  • Recovery of executive compensation: NACD has serious concerns that this provision is ripe for abuse, and may unfairly target honest executives whose compensation and bonus was reasonably earned. NACD recommends an exemption for companies that obtain shareholder approval for retention of the originally rewarded compensation.
  • Disclosure of pay for performance and pay ratios of CEO to median pay of all other employees: Pay for performance, as detailed in the Report of the NACD Blue Ribbon Commission on Performance Metrics: Understanding the Board’s Role, is a value that has long been championed by NACD and practiced by its members. Boards of directors should be able to express how they link pay to performance. However, NACD cautions that companies should be provided the flexibility to describe their philosophy in their own terms, and disclosures should be allowed to vary. NACD commends the SEC for its decision to postpone implementation of pay ratio rules until after the next proxy season. The median pay figure can be highly misleading for a number of reasons, particularly for a global company.
  • Exemption for newly public companies from issuing a say-on-pay vote: With 72 percent of directors indicating preference for exemption, directors believe road shows for IPOs already offer investors ample opportunity to evaluate compensation packages. Furthermore, these requirements place a focus on process during a critical growth phase of a newly public company.
  • “Golden parachute” plans during exceptional corporate transactions (e.g., mergers and acquisitions): NACD does not believe it is necessary to require disclosure during M&A periods above and beyond what is required of companies in general. However, NACD strongly supports disclosure requirements for any newly named executive officers of the company following a merger or acquisition, a view supported by 79 percent of directors surveyed. Any senior executive at a target company joining the leadership of an acquiring company is important, and stockholders have the right to know about leadership.
  • Disclosure of previous say-on-pay: Aligned with 79 percent of surveyed directors, NACD recommends that only the most recent say-on-pay vote should be disclosed. In the current proposal, issuers are required to consider “previous” votes on compensation, but the proposal does not offer a specific definition of “previous.”

“NACD represents the collective voice of the director, and we urge the SEC to closely consider these clear messages coming from America’s boardrooms as it continues to implement new regulations,” said Daly.

I was never a big fan of say on pay to begin with but if we’re going to have it, personally I can’t see carving out so many exemptions as NACD recommends. In my experience, small companies are in greater need of corporate governance “guidance” than many large companies. If the paperwork is burdensome, that should be addressed by reducing paperwork requirements, not through exemptions. Sometimes I wonder if NACD represents the needs of the shareowners its members represent or the more parochial interests of its members… operating like a union for directors. Your thoughts?

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Help With Say on Pay

Towers Watson launched an online survey tool to help companies better understand their shareholders’ views and perceptions on their executive compensation programs.

Dodd-Frank requires publicly traded companies to conduct periodic shareholder votes on their executive pay programs, including how often to conduct say-on-pay votes. In preparation for the say-on-pay era, many companies are trying to engage their key shareholders in a dialogue about executive compensation and related issues. According to Eric Larré, a Towers Watson consulting director who spearheaded the survey’s development:

For most U.S. companies, giving shareholders a say on pay will be a new experience when the 2011 proxy season arrives.  And most companies are still trying to determine how to address the shareholder engagement process. This survey offers shareholders an easy way to express specific views that Congress and the SEC determined they were entitled to communicate via the proxy process.

The Towers Watson online survey tool allows shareholders to complete a questionnaire and provide their views on a wide range of executive compensation programs and issues including pay philosophy, performance measurement, pay levels, governance and shareholder preferences regarding the frequency of future say-on-pay votes. The questionnaire consists of both multiple-choice and open-ended questions. Companies receive a detailed report summarizing shareholders’ responses, including an analysis of differing views of shareholders and what percentage of all company shareholders the respondents represent. Said Larré:

Many companies are concerned about say on pay, and want to avoid the embarrassment and reputational damage resulting from negative or less-than-favorable shareholder votes on their pay programs. They are also concerned that the actual proxy voting process, which allows only for a yes or no vote, will provide little insight into shareholder views of a company’s program and the hot buttons that can spark negative votes. Our survey is a simple, cost-effective way for companies to engage with key shareholders and gain the insight needed to help enhance shareholder support for their pay programs. The institutional investors we consulted in developing the survey are also looking for an efficient way to make their views and concerns known, so this survey tool benefits everyone involved in the process.

Of course, the survey is designed to help companies gain more shareowners support for say on pay votes but I believe its development signals a shift and I expect many more such tools designed to increase communication between boards and shareowners. (Fact Sheet) Hat tip to Gary Lutin’s Shareholder Forum for bringing this new to our attention.

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Financial Sustainability: Restoring Market Stability, Corporate Value & Public Trust (ICGN Mid-Year 2010)

Disclaimer: Given Dodd-Frank, proxy plumbing and all those comments I want to provide the SEC, the report below doesn’t do the ICGN Mid-Year Conference justice.  I wrote this up more than a week later with poor notes and memory. Comments, corrections and substitute photos are solicited.

Sharing Perspectives Across the Atlantic. Phil Angelides, Lord McFall and moderated by David Pitt-Watson.

The Financial Crisis Inquiry Commission will report in December to give an unbiased historical accounting of the causes of financial crisis. It will be out in book form but will also be available through download.

Phil Angelides

$11 trillion in wealth was wiped away. The market took until 1954 to get back to the levels of 1929. Let’s hope this one doesn’t take as long but, more importantly will we learn the lessons necessary to prevent or minimizes future bubbles?

It was a failure of accounting and deregulation. Too many were rewarded based on volume not on performance and their was no continuity in risk (they thought) after all the slicing, dicing and creative complexity.

Lord McFall

Rewards can’t be asymmetric and function properly. This was not a natural storm; the clouds were seeded. Signs were there, such as a 2004 warning from the FBI about a housing fraud epidemic, but they were glossed over. Now, our remaining investment banks are largely trading banks, not focused on generating capital but on gaming the markets. The betting market is much larger than the real economy… with more than 85% of transactions being synthetic.

Dodd-Frank requires the investment banks to hold 5% of the securities they sell but I’m not sure what good that does since that portion of their business is now minor. We need to rethink the role of finance in our economy. Continue Reading →

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Pay Ratio Nightmare Fitting Concern for Labor Day

US companies face a “logistical nightmare” from a new rule forcing them to disclose the ratio between their chief executive’s pay package and that of the typical employee, lawyers have warned.

Yes, the disclosure required by section 953(b) of Dodd-Frank “will provide ammunition for activists seeking to target perceived examples of excessive pay and perks.” Maybe the Tea Party will focus.

S&P 500 chief executives last year received median pay packages of $7.5m, according to executive compensation research firm Equilar. By comparison, official statistics show the average private sector employee was paid just over $40,000.

Admittedly, it may be a “logistical nightmare” for multinationals to calculate the median annual total compensation for all employees in the US and abroad, especially if you’re trying to take into account currency fluctuations.

Companies are now gearing up to lobby the Securities and Exchange Commission, which has to write detailed provisions for the new rule. The rule could also reward with a relatively low ratio those companies that outsourced low-paid work rather than keeping jobs in-house, lawyers said. (US pay law branded ‘logistical nightmare,’ FT, 8/30/10)

I’m not sure there’s any “reward” involved, but explanations will be required.  However, it is likely to bring pressures for a more equitable distribution of the wealth. According to research by Emmanuel Saez and Thomas Piketty, who examined tax returns from 1913 to 2008,  in the late 1970s, the richest 1 percent of American families took in about 9 percent of the nation’s total income; by 2007, the top 1 percent took in 23.5 percent of total income. As Robert Reich points out:

In the decades after World War II, legislation like the G.I. Bill, a vast expansion of public higher education and civil rights and voting rights laws further reduced economic inequality. Much of this was paid for with a 70 percent to 90 percent marginal income tax on the highest incomes. And as America’s middle class shared more of the economy’s gains, it was able to buy more of the goods and services the economy could provide. The result: rapid growth and more jobs. (How to End the Great Recession, NYTimes, 9/2/10)

Why not repeal George Bush’s tax cuts for the rich? A CBS poll found that repeal is supported by 56% and opposed by 36%.

Repeal would cut $700 billion off the federal deficit over the next decade and, because consumption by the wealthy doesn’t depend very much on small changes in income, it wouldn’t noticeably affect consumer spending either. (One Dollar, One Vote?, Mother Jones, 9/3/10)

Unfortunately, it isn’t likely to happen. Why? Look to the scientific research by Professor Larry Bartels. (Economic Inequality and Political Representation, August 2005)

Senators appear to be considerably more responsive to the opinions of affluent constituents than to the opinions of middle-class constituents, while the opinions of constituents in the bottom third of the income distribution have no apparent statistical effect on their senators’ roll call votes…

These disparities are especially troubling because they suggest the potential for a debilitating feedback cycle linking the economic and political realms: increasing economic inequality may produce increasing inequality in political responsiveness, which in turn produces public policies increasingly detrimental to the interests of poor citizens, which in turn produces even greater economic inequality, and so on.

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Say on Pay: Six Years On — Lessons from the UK experience

In the Winter 2010 Barroway Topaz Bulletin, Deborah Gilshan reports on her Railpen Investments research report. Findings include:

  • Both investors and companies report that since the introduction of the vote there has been an increase in engagement over remuneration. Whilst this has led to some friction, it has also created an improved dialogue between companies and their owners over this important governance issue.
  • There has been a sharp reduction in directors’ typical notice periods since the introduction of the shareholder vote. 75% of directors were on one year in 2001, compared to over 95% now. This has reduced the risk of payment for failure.
  • Performance-related elements of remuneration now account for a much larger percentage of the total, with long-term incentive plans (LTIPs) becoming a more significant element.
  • Between 2000 and 2008 there was a clear movement away from the use of option schemes towards LTIP share awards. And from 2003 onwards there was a small increase in the number of share matching (or bonus deferral schemes) being introduced, suggesting that following the introduction of the vote in 2003 companies were more innovative in considering their remuneration structure.
  • But total remuneration has continued to grow even when markets have fallen, suggesting shareholders need to do more to achieve true performance linkage.
  • Some shareholders do not appear to have used their voting rights effectively, with the average vote against a company’s remuneration report falling from a peak in the 2004 season. Therefore the report argues that shareholders must use their new ownership rights actively if it is to have a meaningful effect.

The report identified three areas that need further consideration:

  1. What pay for what performance? The vote has not addressed the appropriate levels of pay for performance achieved, and the report evidences that the total remuneration for directors of the UK’s largest companies continues to rise rapidly, and not always reflective of the performance achieved. This leads to the next question: what is defined by “exceptional performance”? Finally, we come to the quantum question — should shareholders take a view on what is “too much”?
  2. Pay differentials. The difference between pay at board level and pay for other employees has generally not been debated, except for the observation that such pay differentials continue to widen rapidly. Should pay at other levels of a company influence pay at board level? Should shareholders be voting on all pay across an organisation? The Companies Act 2006 includes a requirement for quoted companies to report on how they have taken pay and employment conditions elsewhere in the group into account when they are setting directors’ pay. Beyond this requirement, which is merely a reporting requirement, how should shareholders dialogue with companies over this?
  3. Advisory or binding? Should the remuneration report vote stay in advisory form or become a binding vote on a company? What would be the consequences of a binding vote, especially if the vote was defeated?

Gilshan concludes, “The UK’s experience demonstrates there is nothing for companies to fear from the introduction of a vote on remuneration, and much for them, and their shareholders, to gain.”

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CEO Efforts to Ensure His Pay Worked: Will Others Follow Suit?

Near the end of March, I posted an article, Alarm Bells at Waddell & Reed. As I noted, shareowners of Waddell & Reed Financial Inc. would soon receive a troubling letter from CEO Henry Herrmann in advance of the company’s April 7 annual meeting claiming that giving shareowners an advisory vote on his compensation could put the company “at a serious competitive disadvantage and could erode the value of your investment.”

It looks like the letters to shareowners and employees worked, the “say on pay” proposal failed with a vote of 32,003,590 in favor and 43,681,524 opposed. William L. Rogers, who sat on the compensation committee, was reelected by a vote of 45,445,984 in favor and 32,259,727 withheld, with 3,225,602 non-votes. (see Form 8-K filing)  Will other CEOs now campaign, using corporate funds, to ensure noninterference with their pay packages?

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Alarm Bells at Waddell & Reed

Shareowners of Waddell & Reed Financial Inc. will soon receive a troubling letter from CEO Henry Herrmann in advance of the company’s April 7 annual meeting.  In a special solicitation filed alongside the company’s proxy statement, Mr. Herrmann claims in bold print that giving shareowners an advisory vote on his compensation and that of other executives could put the company “at a serious competitive disadvantage and could erode the value of your investment.”  Mr. Herrmann further exclaims that an advisory vote could “reduce executive compensation below competitive levels,” “lead to the loss of executive talent” and that a vote of disapproval on the company’s compensation policies and practices “creates the risk of unintended consequences and negative publicity.” He also sent an alarm to his own employees.

It is hard to reconcile the alarmist picture painted by Mr. Herrmann with reality.  To date, over 60 companies have pledged to implement say on pay including financial leaders such as Goldman Sachs, JPMorgan Chase, Capital One, Ameriprise Financial, Morgan Stanley, Wells Fargo, State Street, Bank of New York Mellon and hundreds of other financial institutions that received TARP funds, many of which voluntarily agreed to continue the advisory vote after their TARP obligations ended.  Furthermore, in 2009, Waddell & Reed announced that 50.6% of its very own shareowners supported an advisory vote on executive compensation.  The company later reported that just under 50% of shareowners supported the reform after the company took the extraordinary step of asking the Delaware Chancery court to re-open the polls and count missed votes it identified as being cast against the reform.

Dawn Wolfe, Associate Director of ESG Research at Boston Common Asset Management, the firm leading the advisory vote initiative at Waddell & Reed for the past three years issued the following statement:

Mr. Herrmann’s letter contradicts the positive responses from companies that have implemented an advisory vote. In addition to the numerous companies that have implemented say on pay, rejecting the notion that it will erode shareholder value, institutional investors actively involved in promoting good governance publicly support this reform, including the State of Connecticut, CalSTRS, CalPERS, TIAA-CREF, and the Council of Institutional Investors. Waddell & Reed is one of the outliers in its aggressive campaign against this important reform, and that concerns us as shareowners.

California State Teachers Retirement System (CalSTRS) and Calvert Asset Management are co-proponents of the advisory vote proposal at Waddell & Reed Financial, Inc. this year. Anne Sheehan, CalSTRS director of corporate governance, said:

CalSTRS has a long history of promoting responsible compensation policies that link pay to performance and align shareholder and management interests and that is one reason we support an advisory vote on pay. We view say on pay as a way to help improve long-term returns and as shareowners of Waddell & Reed Financial we are asking the company to adopt this important reform.

Waddell & Reed Financial’s 2010 Annual Meeting of Stockholders will take place at 10:00 a.m. CDT on Wednesday, April 7, 2010 in Overland Park, Kansas. “Financial services companies such as JPMorgan Chase and American Express have voluntarily adopted say on pay.  Waddell & Reed’s position on this reform is clearly out of line with its peers and general public opinion on executive pay,” said Aditi Mohapatra, Sustainability Analyst at Calvert Asset Management.

The Waddell & Reed letter goes on to argue the proposal would not “result in meaningful dialogue with stockholders.”  Experience simply proves this false.  “Scores of companies that have implemented an advisory vote on executive compensation are demonstrating that it can and does stimulate dialogue, especially when the company reaches out and seeks investor advice and input,” stated Tim Smith, Senior Vice President of the Environment, Social and Governance Group at Walden Asset Management and a primary organizer of the say on pay campaign with the American Federation of State, County, and Municipal Employees (AFSCME) union. See their January letter to 17 financial institutions.

“Waddell & Reed is attempting to manipulate its shareholders through scare tactics,” said AFSCME President Gerald W. McEntee. “The time has come to implement an advisory vote on Say on Pay. Sixty companies have made the commitment already. It’s time that Waddell & Reed did the same.”

Despite growing investor support for this reform, Mr. Herrmann’s alarmist letter is just the latest in a string of actions by Waddell & Reed Financial to undermine say on pay.

In February, Boston Common, CalSTRS, and Calvert submitted a letter to the SEC arguing that the company’s proposed statement formally urging a vote against say on pay in the proxy was materially false and misled shareowners in stating that none of the company’s peers had adopted a similar reform.  Waddell & Reed later altered its statement.

At the 2009 annual stockholder meeting, Waddell & Reed announced that the say on pay proposal received over 50 percent support from investors.  Over 3 months later, the company filed its 10-Q with the SEC, stating that the proposal did not receive majority support.  Investors were left in the dark about why the result changed between the annual meeting and the quarterly report.  During that period, Waddell & Reed Financial argued to the Delaware court that it should be allowed to retroactively count approximately 3.2 million additional votes, more than 2 months after the close of the polls.

Henry Hermann claims that “the company supports the goal” of letting stockholders provide feedback on compensation practices by directly contacting the Board or Compensation Committee.  Shareowners tried that method as well, only to receive correspondence from the company’s legal department on March 3, 2009 that “management does not desire, nor see any need for, further discussion.”  It appears painfully obvious that Waddell & Reed has no interest in communicating with shareholders on executive compensation in any form.

Coming on the heals of Apache’s SLAPP suit against John Chevedden, we’re beginning to see something rear guard action by desperate CEOs afraid of working in partnership with owners.  It took until 1987 for shareowners to finally win their first resolution. By 2007 shareowners were winning 24% of those taken to a vote. That has since gone up to 30% in 2008 and 37% in 2009. Last year, “say on pay” proposals averaged 46% support. The tide is turning toward more democratic forms of corporate governance. What could be more reasonable than giving shareowners some say, in the form of an advisory vote, on pay?

Mr. Herrmann earned almost $10 million dollars last year, according to Forbes. I notice he didn’t include that information in his letters to shareowners or employees. However, a recent issue of Proxy Governance Spotlight said: “Company has reasonable pay.” Additionally, The Ontario Teachers’ Pension Plan announced it won’t support shareholder proposals for “say on pay” advisory votes at companies, arguing that “say on pay” is new to many companies: “We do not wish to unfairly burden companies that are making efforts to involve shareholders in compensation matters by voting against management advisory compensation proposals.” (RI round up – 3/26/10) Although reasonable people can differ, Waddell and Reed’s opposition still appears a little over the top.

For further background on say on pay, see Say on Pay Facts and Background (compiled by the AFSCME Office of Corporate Governance and Investment Policy),  Say on Pay: Where Are We Heading in North America? (from 3XCD) and  The Herrman doth protest too much, methinks (The Corporate Library). Thanks also to the Shareholder Forum.

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July 2008

ESG Gaining Acceptance

Since 2005, KLD has studied the S&P 100’s sustainability reporting practices for the Sustainable Investment Research Analyst Network, a working group of the Social Investment Forum. The 2008 Sustainability Report Comparison reveals encouraging news. Of the 100 largest U.S. publicly-traded companies, 86 maintain corporate sustainability websites and 49 produced sustainability reports in 2007. These numbers represent significant progress over the past three years.

Now, Watson Wyatt says ESG to be one of six major investment trends in next five years. (Responsible Investor, 7/31/08) The rise of integrating environmental, social and governance issues into investing will be predicated on four major trends:

  • demand for big institutional funds to apply responsible investing principles,
  • sustainability and climate change as mainstream or specialized propositions,
  • the impact of politically motivated activism, and
  • responsible investment becoming more personalized through defined contribution pensions saving.

CalPERS: The Opposite

The Opposite” was a famous Seinfeld situation comedy episode where George Costanza decides that every decision he has ever made has been wrong and resolves to do the complete opposite of his normal instincts. He suddenly begins to experience good luck — getting a girlfriend, moving out of his parents’ house, and even landing a job with the New York Yankees. Maybe CalPERS should use the same tactic with regard to its own governance.

When it comes to advising corporations, CalPERS emphasizes transparency, getting input from shareowners and a wide variety of good governance measures. (As I began to write this, I got a press release from CalPERS on improving governance at La-Z-Boy.) I applaud these efforts, which have been widely credited with moving directors to action and increasing shareowner value. Yet, when it comes to their own governance, perhaps CalPERS should adopt the strategy of doing the opposite of what Board members want to do instinctively.

I’ve tangled with CalPERS over many internal governance issues, as documented at PersWatch.net. The latest involves AB 2940, scheduled for hearing in California’s Senate Appropriations Committee. The bill, authored by Kevin de Leon and sponsored by the New America Foundation, would set up a low-cost IRA option administered by CalPERS. The Program would facilitate the ability of millions of Californians to save for retirement, reduce future dependency on taxpayers, increase California’s tax base, and broaden the base of CalPERS stakeholders, thus decreasing vulnerability of the System to attack by those who have sought to reduce or eliminate our defined benefit plans.

The trouble is, as a condition of neutrality, CalPERS asked the author to amend the bill to permanently exempt the Board from contracting and rulemaking laws with respect to the Program. Unfortunately, de Leon was forced to accept those changes if he wanted to see his bill pass. In contrast to CalSTRS, which recently adopted regulations to guard against the appearance of “pay to play” on investment decisions, the proposed new law would open the CalPERS Board to the increased likelihood of such dishonest behavior.

In my letter of opposition for an otherwise excellent bill, I wrote, “One major ‘pay to play’ scandal involving a large sole-source contract could put the whole System in jeopardy, making CalPERS politically vulnerable. Additionally, what moral authority would CalPERS have in advising corporations to be transparent, if its own contracting procedures were suspect?” Additionally, “The language exempting the Board from the APA disenfranchises millions – ironically, the same Californians which the bill seeks to empower through an inexpensive and convenient savings program.”

For many years, CalPERS claimed California Constitution, article XVI, section 17, exempted the agency from the Administrative Procedure Act and other laws that apply to state agencies. That claim was thoroughly rejected by Connell v. CalPERS in appellate court. The APA offers an opportunity to comment and have those comments addressed in a legal framework that includes many protections for public involvement.

I understand the need to keep costs low, especially during start-up. I even suggested that initial contracts could be noncompetitively bid for up to two years and that initial rules could be adopted as permanent “emergency” regulations. However, any such exemptions should be temporary. These suggestions have been rejected by a Board that too often sees itself as above the law.

If successful, the new fund will quickly have assets in the millions, if not billions. Don’t sacrifice good governance for expediency. CalPERS Board members should consider a new mantra with regard to their own governance, “Do the opposite.”

CorpGov Bites

The final version of the AFL-CIO’s 2008 AFL-CIO Key Votes Survey scorecard is now available.

I’ve added implu to our growing list of Stakeholders. Find out about the comings and goings of corporate officers and directors. Plus, the site lists at least rudimentary contact information and sometimes you can even learn about their associations. Enter a list of companies or people and get automatic e-mail alerts.

A total of 70 federal securities class actions were filed during the first half of 2008, a roughly 17% increase from the total filings in the first six months of 2007. (Securities class actions increase in ’08, Investment News, 7/29/08)

Do Boards Pay Attention when Institutional Investor Activists ‘Just Vote No’? finds they do. “Boards take a variety of value-enhancing actions; 31% of these targets experience disciplinary CEO turnover and 50% of the remaining targets that do not dismiss the CEO make other strategic changes. Consistent with these board actions being value enhancing, post-campaign operating performance improvements are economically and statistically significantly higher in these sub-samples of target firms.”

Businesses must incorporate environmental, social and governance (ESG) factors into their management strategies, says Peter Kinder, President of KLD Research & Analytics, in Q&A with an Australian business reporter.

ResponsibleShopper.org (updated) ranks companies by industry from best to worst based on global research and campaign information regarding the impact of the largest corporations on human rights, social justice, environmental sustainability and more.

Gibson, Dunn & Crutcher LLP offer advice on “clawbacks” of executive compensation. What is your company doing in this area?

Subchapter S companies owned by their employees through ESOPs generate some 85,000 new jobs each year and create $14 billion in new savings for workers that otherwise would not have been earned. A study by Knoll and Freeman also found S ESOPs’ higher productivity, profitability, job stability and job growth collectively help ESOP companies amass $33 billion more in combined earnings than what they would earn if they were not ESOP-owned S corporations.


Sign-up online to gain free access. Articles in the Summer ‘08 issue include:

  • Non-Deal Roadshows: Latest Developments and Trends
  • Lessons Learned: How Funds Vote on Proxy Proposals
  • Hedge Fund Attacks: Eight Lessons Learned from the In-House Perspective
  • How Blogging Can Enhance Your Investor Relationships (and Your Career)
  • My Ten Cents: The SEC’s Coming Guidance on IR Web Pages
  • SEC Staff Says “No” to Non-GAAP Financial Statements

Written to aid the corporate investor relations function, InvestorRelationships.com is also a valuable resources for shareowners. Broc Romanek is doing a great job on this new offering.


Broc also posted a podcast interview with another of our favorites. Andy Eggers discusses his website, ProxyDemocracy.org. Their discussions include:

  • Where did you get the idea for the site?
  • How long did it take to launch?
  • What features does ProxyDemocracy.org currently have?
  • Any plans to tweak things going forward?
  • What have been the biggest surprises in how the site is used so far?


Fraud Risk Guide

“Managing the Business Risk of Fraud: A Practical Guide” can be downloaded for free from the sponsoring organizations’ Web sites from sponsoring organizations – the Association of Certified Fraud Examiners (ACFE), the American Institute of Certified Public Accountants (AICPA), and The Institute of Internal Auditors (IIA). Principles for establishing effective fraud risk management, regardless of the type or size of an organization, are outlined in the guide.

According to the ACFE’s 2006 Report to the Nation on Occupational Fraud, U.S. organizations lose an estimated 5 percent of their annual revenues due to fraud. When applied to the estimated 2006 GDP, those losses added up to approximately $653 billion. Organizations with anti-fraud programs – such as fraud hotlines, internal audit departments, and anti-fraud training – lost approximately half as much as those without such programs.

Key principles for proactively establishing an environment to effectively manage an organization’s fraud risk include:

  • Principle 1: As part of an organization’s governance structure, a fraud risk management program should be in place, including a written policy (or policies) to convey the expectations of the board of directors and senior management regarding managing fraud risk.
  • Principle 2: Fraud risk exposure should be assessed periodically by the organization to identify specific potential schemes and events that the organization needs to mitigate.
  • Principle 3: Prevention techniques to avoid potential key fraud risk events should be established, where feasible, to mitigate possible impacts on the organization.
  • Principle 4: Detection techniques should be established to uncover fraud events when preventive measures fail or unmitigated risks are realized.
  • Principle 5: A reporting process should be in place to solicit input on potential fraud, and a coordinated approach to investigation and corrective action should be used to help ensure potential fraud is addressed appropriately and timely.

The new guidance provides a practical approach for companies committed to preserving stakeholder value. It can be used to assess or improve an organization’s fraud risk management program, or to develop an effective program where none exists.

We added a link to the paper from our small list of online articles, as well as a Team Performance Scorecard from Brown Governance for evaluating boards of directors. CorpGov.net depends on input from readers to bring these resources to our attention. Thanks to Scott McCallum, of IIA ,and Dan Swanson of Dan Swanson & Associates.

Say on Pay Denial

Support for an advisory “say on pay” continues to grow, if more slowly than expected, rising from 41% last year to 42% in 2008. Directorship, reporting the results of a Corporate Library study, notes that “say-on-pay proposals received majority support at a total of 15 companies in 2007 and 2008. But not all of those companies are rushing to put the advisory vote in place. In fact, only five of those companies, or roughly two-thirds, have adopted the vote.”

Vote results are lower this year at financial institutions, where CEOs have been replaced with lower compensation packages. (Companies Ignore ‘Say on Pay’ Votes, 7/23/08)

Look for shareowners to increase the pressure on companies that filed to implement resolutions that obtained a majority vote (MV) next year. Board of Directors’ Responsiveness to Shareholders: Evidence from Shareholder Proposals by Yonca Ertimur, Stephen Stubben and Fabrizio Ferri investigated board responses to advisory shareholder proposals between 1997 and 2004. The frequency of implementation of MV proposals almost doubled after 2002, from approximately 20% (1997-2002) to more than 40% (2003-2004), “consistent with an increase in the cost of ignoring MV resolutions in the post-Enron environment.” “Directors failing to implement majority-vote (MV) proposals are often the target of ‘vote-no’ campaigns and receive a ‘withhold vote’ recommendation by ISS. Firms ignoring MV proposals end up on CalPERS’ ‘focus list’, receive lower ratings from governance services and attract negative press coverage.”

Perhaps more striking is that “implementation of a MV shareholder proposal is associated with approximately a one-fifth reduction in the probability of director turnover at the targeted firm.” In short, the market rewards those companies that follow the advice of shareowners.

Time will tell at Citigroup, which just named new chairs to its audit and risk, nomination and governance, and personnel and compensation committees. The AFL-CIO labor federation urged investors to vote against then-audit and risk committee chair C. Michael Armstrong, but dropped its campaign after Citigroup announced chairs would be rotated.

But will rotations be enough, especially when two of the three received significant withhold votes at Citigroup’s annual meeting. AFSCME’s Richard Ferlauto says the union sees little value in rearranging committee chairs. “What we really need is new blood on the board that will expand strategic vision for the future of the company that includes focus on the core business,” Ferlauto told R&GW. (Citigroup Names New Board Committee Chairs, RiskMetrics Group, 7/25/08)

Congratulations Race to the Bottom

Once of our favorite sources of legal commentary, TheRacetotheBottom, has been chosen by the Library of Congress for inclusion in its historic collections of Internet materials related to “Legal Blawgs.”

Aim’s Race to the Bottom

Speaking of a race to the bottom, a study released by PwC found that while 77% of the Aim’s top 100 comply with some aspects of the Combined Code, just 3% chose to fully adopt it. A record 28 companies were suspended, raising doubts about the exchange’s voluntary approach to governance. (Junior index must aim higher to improve reputation, FT.com, 7/24/08)

New Election Rules at CalPERS

New election rules take effect on July 26, 2008, thanks to action taken by Corpgov.net publisher, James McRitchie. At McRitchie’s request, the Office of Administrative Law determined several CalPERS election rules were illegally adopted “underground regulations.” (see 2007 OAL Determination No. 1) The amended regulations clarify many election procedures and significantly reduce the risk of CalPERS members to identity theft.

Back to the top

Further information about the next three items and more at Corporate Watchdog Radio.

Get the Lead Out and Protect Genitals

More than your money is at risk. Independent laboratory testing initiated by the Campaign for Safe Cosmetics in 2007 found that two-thirds of 33 sample lipsticks from top brands contain lead. The Environmental Working Group’s six-month investigation into the health and safety assessments on more than 10,000 personal care products found major gaps in the regulatory safety net. A recent government-funded study by Dr. Shanna Swan links linking phthalate levels with feminized genitals in baby boys. Independent laboratory tests found phthalates in more than 70% of health and beauty products tested – including popular brands of shampoo, deodorant, hair mouse, face lotion and every single fragrance tested. Have I got your attention yet?

If you own shares in a company that makes personal care products or just don’t want to use poison products, check the growing (600) list of those that have pledged to not use chemicals that are known or strongly suspected of causing cancer, mutation or birth defects in their products and to implement substitution plans that replace hazardous materials with safer alternatives in every market they serve. Several major cosmetics companies, including OPI, Avon, Estee Lauder, L’Oreal, Revlon, Proctor & Gamble and Unilever have thus far refused to sign the Compact for Safe Cosmetics.

Take action for safe cosmeticsSign on to have Congress empower the FDA to ensure that cosmetic ingredients and products are safe before they reach store shelves. DisclosureThe publisher of CorpGov.net owns stock in Proctor & Gamble and has requested they join the Campaign for Safe Cosmetics. Please make similar appeals to the companies in your portfolio.

Unfortunately, P&G sent a canned response. “I’m sorry you heard a report that caused you to question the safety of our beauty care products. The claims you’ve heard are completely false. Consumer safety is always our first priority and all our products are tested extensively before going to the market. We stand firmly behind their safety. It’s important to know that cosmetic products sold in the U.S. are regulated by the Food, Drug, and Cosmetics Act. We comply with all legal requirements wherever our products are sold.” Of course this misses the point that current laws are totally inadequate. When I brought this to their attention, investor relations wrote back with an oops; “I can understand your concern and I’m sharing your comments with our Health and Safety Division.”

Chamber Attacks Resolution Process

Members of the U.S. Chamber of Commerce should be questioning use of their dues money for a study that is so deeply flawed it would be laughable, if the money to pay for the study wasn’t coming out of your pocket.

The study, Analysis of the Wealth Effects of Shareholder Proposals by Navigant Consulting, purports to make the following finding: “Taken as a whole, these results provide little evidence that shareholder proposals increase target firm value.” What is the basis of the study?

First, Navigant (under the pay and direction of the Chamber), reviewed the academic literature from about a decade ago and found mixed results. “There is little evidence of measurable improvements in (sort-term or long-term) stock market or (long-term) operating performance in target companies as a result of shareholder proposals.” However, “Certain types of proposals, especially those concerned with removing companies’ takeover defenses, appear to be supported by the market.” Updated findings would probably be different, since their is increasing recognition by shareowners and the market that social and environmental factors can have an economic impact on the firm. Thus, the support for resolutions, such those to address a company’s carbon footprint, have been increasing.

Second, Navigant examined five resolutions for short-term impact and another five resolutions for long-term impact. How did they select these resolutions? Were they randomly selected from all resolutions during a specified period? No, they were picked by the Chamber! This would be like a drug company selecting 10 patients out of thousands to represent the efficacy of their product for FDA review. Even if the resolutions had been randomly selected, the samples would have been too small to have any statistical significance. However, the fact that they were picked by the Chamber, which has for years advocated doing away with the resolution process, completely destroys the potential validity of findings.

Additionally, that portion of the study uses deeply flawed statistical modeling based on “abnormal returns.” The implication is that stock price is predictable. If the academics who invented the Fama-French three-factor model were actually able to predict price, they wouldn’t be working at universities. Instead, they would be reaping huge financial rewards in the stock market.

The study then goes on to look at the cost of the shareowner resolution process and cites an estimate by Bainbridge of $90.654 million, based on an “implied cost” of $87,000 per proposal and the assumption that corporations seek to exclude all proposals. The study fails to note that with e-proxy, costs are going down, sometimes dramatically. (Thanks to William Michael Cunningham of Creative Investment Research, Inc. for providing a copy of his meeting notes and his analysis of the Chamber’s study. This article draws heavily upon those notes but the opinions expressed are those of Corpgov.net publisher, James McRitchie.)

Businesses should ask their local and state chambers, which may be members of the US Chamber of Commerce, to seek new leadership at the federal level. Sure, shareowner resolutions and annual meetings are a bit of a pain in the ass and a circus, but they keep us in touch with what is coming. Social and environmental resolutions often seek to address “externalities,” the costs of business to society. Without such resolutions, shareowners would immediately seek regulations and legislation. The resolution process is an early warning system that allows us to gauge the popularity of a given issue. Often we can avoid regulations by working out less burdensome voluntary measures. Even when businesses fully adopt resolutions, the costs can be substantially less than complying with mandatory rules.

Tell your local chamber that the U.S. Chamber should spend its time and money on more important efforts. For example, they could push Congress to legislate higher margin requirements for speculators. That might lower the cost of oil. They could push for single-payer universal health insurance to put an end to our competitive disadvantage due to rising health care costs. They could also seriously address global climate change. Failure to resolve that issue will cost trillions of dollars and millions of lives. Fighting wildfires now takes nearly half of the U.S. Forest Service budget. That’s up from just 13% in 1991. Fighting shareowner resolutions pales in comparison.

About a million and a half people have already signed on to support Al Gore’s Challenge to Repower America. McCain said, “If the vice president says it’s doable, I believe it’s doable. Obama said, “I strongly agree with Vice President Gore that we cannot drill our way to energy independence, but must fast-track investments in renewable sources of energy like solar power, wind power and advanced biofuels, and those are the investments I will make as President.” Local chambers and the U.S. Chamber of Commerce should focus on fighting the real issues, not our own shareowners.

Improve Corporate Disclosure

A proposed accounting standard would require corporations to disclose more to investors regarding their potential losses due to product toxicity, environmental remediation and other liabilities. Investor input is critical on these issues, as the corporate lobby is expected to turn out in force to oppose expanded disclosure.

While the proposal is on the right track, it stops short of requiring full disclosure of risks that would impact investors, most notably long-term severe impact risks. The proposal may also allow corporate lawyers to routinely block disclosure of almost any information that they designate as prejudicial.

The proposed FAS 5 changes would be subject to three important exceptions and loopholes, which the Investor Environmental Health Network believes can be addressed by the following changes:

  • FASB should require a disclosure of “severe impact risks” deemed by the reporting company to be remotely possible and long term.
  • FASB should apply the new standard to asset impairments, not just legal liabilities.
  • FASB needs to eliminate or strictly limit this ”prejudicial” exception to avoid misuse.

Submit comments on the Exposure Draft entitled Disclosure of Certain Loss Contingencies to the Federal Accounting Standards Board (FASB) by August 8, 2008. Send them via email to[email protected]. Put File Reference No. 1600-100 in the subject line. For more information, see the relevant FASB documents and IEHN’s Investor Alert and model letter and watch Sanford Lewis, Counsel to the Investor Environmental Health Network discuss the proposal.

CorpGov Bites

Eighty-six percent of companies on the Standard and Poor’s 100 Index have corporate sustainability websites, compared to 58 percent in 2005, according to the “2008 S&P 100 Sustainability Report Comparison” from the Sustainable Investment Research Analyst Network (SIRAN), a working group of the Social Investment Forum. (More S&P 100 Companies Reporting CSR Progress: Study, GreenBiz.com, 7/22/08)

ECOFACT has released a report listing the top ten most environmentally and socially criticized companies. The top ten companies were: Samsung, Total, Wal-Mart, China National Petroleum Corporation (CNPC), Shell, ExxonMobil, Citigroup, Nestlé, ArcelorMittal, and Chevron. The companies have been consistently and severely criticized by the world’s media and NGOs for issues including human rights abuses, severe environmental violations, corruption and bribery, and breaches of labor, health and safety standards. Rankings are based on the Reputational Risk Index (RRI), as measured by RepRisk in the first six months of this year. For a copy of the report, please contact Charlotte ManssonDisclosureThe publisher of CorpGov.net is happy to announce he owns none of these companies directly.

“Most big businesses now require directors to be elected by a majority of shareholders, giving board members incentive to court investor goodwill.” Joann S. Lublin, writing for WSJ (New Breed of Directors Reaches Out to Shareholders, 7/21/08) Lubin appears to credit this reform with the fact that more shareowner resolutions are being withdrawn. Think of how many resolutions would be withdrawn or would not even be submitted with a rise in proxy access.

“People are focusing on whether there is going to be a tomorrow in the market, and not on these traditional governance issues,” James Cox, a securities law professor at Duke University, told Risk & Governance Weekly. Boards are also meeting more frequently with investors. Yet, in reading RMG’sPreliminary U.S. Postseason Report, it appears many of those meeting may have been to simply cave on issues where they were likely to lose. For example, 47 of the 90 majority vote resolutions filed have been withdrawn by proponents because companies agreed to adopt their own bylaws. More than 72% of S&P 500 companies have adopted some form of a majority vote standard, according to Claudia Allen, a partner with the law firm Neal, Gerber & Eisenberg.

Highlights included the resignation of Mary Pugh, chair of the finance committee at Washington Mutual, after getting 49.9% opposition in a campaign by CtW. Overall support for “say on pay” advisory vote proposals increased marginally at U.S. companies. Other results:

  • Pay-for-performance proposals have averaged 27.4 percent support over nine meetings where results are known, as opposed to 29.5 percent support over 38 meetings last year.
  • Independent board chair proposals received record support this year–31.3 percent support over 20 meetings, 4.6 percentage points higher than last year, when they averaged 26.7 percent support over 43 meetings.
  • Resolutions asking firms to end staggered boards received slightly less support so far this year, with 60.2 percent average support at 16 meetings where results are known. This compares to 63.9 percent support over 38 meetings in 2007.
  • 2008 is on pace to shatter the all-time record for proxy challenges, although few contests have gone to a vote. Given the market meltdown, many boards have been willing to provide board representation to dissidents… including at Yahoo (Yahoo, Icahn Let Bygones Be Bygone, David Gaffen, WSJ, 7/21/08) and How I Spent My Weekend, The Ichan Report, 7/22/08)

Gretchen Morgenson’s Borrowers and Bankers: A Great Divide clarifies the current conventional wisdom. “Borrowers should shoulder the consequences of signing loan documents they didn’t understand, but with punishing terms that quickly made the loans unaffordable. But for executives and directors of the big companies who financed these loans, who grew wealthy while the getting was good, the taxpayer is coming to the rescue.”

“Might not the American people be better off with regulators who curb market enthusiasm — whether in the form of errant lending or voracious, ill-considered deal making — when it reaches manic levels, to protect against the free fall, and the bailouts, that ensue?” (NYTimes, 7/20/08)

Over the weekend, Jane Bryant Quinn also brought our attention to the question or whether or not the Public Company Accounting Oversight Board, created by Sarbanes-Oxley, is constitutional. The challenge to PCAOB revolves around whether the president rather than the SEC should appoint board members. Because the law lacks a “severability” clause, if one of its provisions is found to be unconstitutional, the whole law may go down. (Lawsuit Threatens Sarbanes-Oxley Act, Washington Post, 7/20/08)

Investors are responding to the sharp falls on equity markets around the world by shifting from what are now being seen as vulnerable emerging markets to relatively safer developed ones. State Street says the flows it tracks amount to a “safety first” mood… MSCI’s emerging market index has lost 0.6% in the past week. The developed market index has gained 1.9%. (See America first? Investors suddenly fleeing emerging markets, Financial Week, 7/21/08) Perhaps a rush to relative corporate governance quality?

Mandatory Reimbursement Bylaw Could Breach Board’s Fiduciary Duty

The Delaware Supreme Court ruled that CA shouldn’t be forced to pay for dissident shareholders’ proxy fights and the SEC issued a no action letter. (decision)

Under a procedure established under Delaware law last year, the SEC asked the state’s Supreme Court to decide whether a bylaw proposal by AFSCME to CA, formerly Computer Associates, was “a proper subject” for shareholder action under state law. The bylaw would have required CA to reimburse a shareowner for proxy costs, including legal expenses, printings and mailings, if the shareowner unseats at least one CA director in a slate of candidates representing less than half the board.

The Court held that the bylaw was a proper subject for stockholder action. However, the Court also held that if adopted the bylaw would violate state law because “the bylaw contains no language or provision that would reserve to CA’s directors their full power to exercise their fiduciary duty to decide whether or not it would be appropriate, in a specific case, to award reimbursement at all.” (Del. Supreme Court rules for CA on shareholder issue, delawareonline, 7/18/08)

John Olson, a corporate-governance lawyer at Gibson, Dunn & Crutcher, is quoted in the WSJ saying, “The court is soundly affirming that shareholders have the right to propose bylaws relating to the process of electing directors. I think people will try to be creative in ways of using state law to get access to the corporate proxy.”

In the same article, Richard Ferlauto, director of pension investment policy for AFSCME, said discussions about shareholder election rights now focus on “the creation of an appropriate right of shareholder access at the federal level” through the SEC. (Delaware Court Rules for CA in Suit, 7/18/08)

With regard to the question of whether or not he AFSCME Proposal a proper subject for action by shareholders, the court wrote, in part:

The shareholders are entitled to facilitate the exercise of that right by proposing a bylaw that would encourage candidates other than board-sponsored nominees to stand for election…That the implementation of that proposal would require the expenditure of corporate funds will not, in and of itself, make such a bylaw an improper subject matter for shareholder action.

With regard to the question of whether adoption of the bylaw would cause CA to violate Delaware law, the court wrote, in part:

As presently drafted, the Bylaw would afford CA’s directors full discretion to determine what amount of reimbursement is appropriate, because the directors would be obligated to grant only the “reasonable” expenses of a successful short slate. Unfortunately, that does not go far enough, because the Bylaw contains no language or provision that would reserve to CA’s directors their full power to exercise their fiduciary duty to decide whether or not it would be appropriate, in a specific case, to award reimbursement at all. (footnotes omitted) (Supreme Court Decides SEC-presented Delaware Bylaw Issue, Francis G.X. Pileggi, Delaware Corporate and Commercial Litigation Blog, 7/17/08)

Getting into more of the details of the decision, analysis by Travis Laster, reported by Broc Romanek, explains that Section 109 gives stockholders the statutory right to adopt bylaws, which may contain “any provision, not inconsistent with law or with the certificate of incorporation, relating to the business of the corporation, the conduct of its affairs, and its rights or powers or the rights or powers of its stockholders, directors, officers or employees.” However, Section 141(a) vests the power to manage the business and affairs of every corporation in the board of directors. Consistent with Delaware’s historic model of director-centric governance, the Supreme Court makes clear that Section 141(a) has primacy over Section 109.

An interesting discussion of implications and possible unintended consequences follows. For example, “A bylaw mandating the inclusion of stockholder nominees on the company’s proxy statement should fare much better under a CA analysis.” However, the court’s analysis “should doom any substantive component to a [poison] pill redemption bylaw, such as a requirement that directors not adopt or renew any pill that could be in place longer than a year.” (CA v. AFSCME: The Delaware Supreme Court Giveth and the Supreme Court Taketh Away, TheCorporateCounsel.net Blog, 7/18/08)

AFSCME proposed a similar bylaw change at Dell. At the company’s annual meeting, management noted that a preliminary tally showed the proposal received 33.7% of the vote. A similar proposal last year garnered only 14% of shareholder votes. (Union loses proxy reimbursement battle, but may have won war, Financial Week, 7/18/08)

Much more commentary at Delaware Supreme Court Issues Opinion on Shareholder-adopted Bylaws(The Harvard Law School Corporate Governance Blog, 7/18/08), Delaware Supreme Court Rejects Reimbursement Proposal (Risk & Governance Blog) and in at least a 20 part series atTheRacetotheBottom.org.

If the SEC fails to adopt a proxy access rule this year, where will shareowners concerned with the lack of democracy in corporate elections turn in 2009? One possibility is to seek reincorporation in North Dakota. Such proposals bring up several issues that could be the subject of negotiations. Among the most significant features of North Dakota law are the following:

  • Majority voting in election of directors. In an uncontested election of directors, shareholders have the right to vote “yes” or “no” on each candidate, and only those candidates receiving a majority of “yes” votes are elected.
  • One year terms for directors.
  • Advisory shareholder votes on compensation reports. The compensation committee of the board of directors must report to the shareholders at each annual meeting of shareholders and the shareholders have an advisory vote on whether they accept the report of the committee.
  • Proxy access. The corporation must include in its proxy statement nominees proposed by 5% shareholders who have held their shares for at least two years.
  • Reimbursement for successful proxy contests. The corporation must reimburse shareholders who conduct a proxy contest to the extent the shareholders are successful. Thus, if a shareholder conducts a proxy contest to place three directors on a corporation’s board and two of the candidates are elected, the shareholder will be entitled to reimbursement of two-thirds of the cost of the proxy contest.
  • Separation of roles of Chair and CEO. The board of directors must have a chair who is not an executive officer of the corporation.
  • A “special meeting” shall be held if demanded by shareholders owning 10% or more of the voting power.

No Action Letters

The SEC posted the no-action letters relating to Rule 14a-8 that it processed during the recent proxy season. These letters include any responses provided by the Staff after January 1st of this year (and incoming request going back as far as October ’07). According to Broc Romanek, we should expect to see new 14a-8 no-action letters posted going forward – although not likely on a real-time basis during the proxy season. (Corp Fin Goes “Live” with Shareholder Proposal No-Action Letters, TheCorporateCounsel.net Blog, 7/17/08)

I wish they would have posted the letters using a database sortable by resolution type or searchable by word/phrase. If anyone dumps this data into a file and makes it available as a searchable database, please let me know. I’m sure it is available by paid subscription. I want to know if it is available for free. It would be a great resource for small shareowners and for a class I’ll be teaching in the fall.

What is Broadridge Thinking?

About 10 years ago Sona Shah and Kai Barret began filing complaints against their employer, ADP Wilco, now a subsidiary of Broadridge Financial Solutions, for discriminating against its employees based on their citizenship and immigration status. Amazingly, Wilco called its foreign recruitment program ‘Project Delhi Belly.’  Delly Belly is a derogatory slang term coined during the British occupation of India.  If an officer arrived in Delhi and had stomach problems it was called getting a ‘Delhi Belly.’  Why Wilco’s management thought this was an appropriate title for its recruitment of foreign programmers is anyone’s guess but it gives you some sense of their cultural sensitivity.

Their complaints went out to Immigration, Department of Labor, Department of Justice. Their campaign even led to Congressional testimonypress and blog coverage. They also filed with the EEOC and began the currently pending litigation.

The case progressed with usual ups and downs. Lawyers would come into the case attracted by positive publicity and press. Then when they saw how much work was involved they wouldd abandon their effort or seek to withdraw. In 2006 Shah attempted to settle the case but noticed her attorney may have committed fraud with both the settlement and the case.  Simultaneously, Wilco went through a corporate restructuring with Broadridge.

Four months ago Shah attempted a mutual discontinuance but Broadridge refuses. Instead, they continue to spend thousands of dollars on unnecessary legal expenses, with no apparent benefit to shareowners. The disputed settlement sought by Wilco/Broadridge basically pays Shah and her attorneys $100,000. Shah she says the settlement exposes her to tax consequences worse than if she had lost the case, so she opposes it.

Since it appeared that outside counsel seeks to continue the lawsuit simply to continue billing Broadridge, Shah wrote a letter to Broadridge’s CEO of her offer. When there was no response, she began contacting large shareowners, alleging that Broadridge was wasting money on a lawsuit she was willing to discontinue. (typical email) After several investors wrote to the company, Broadridge’s outside counsel then sought to enjoin Shah from communicating with Broadridge’s investors — a motion which the court summarily dismissed.

Investors should ask Broadridge why the company continues to waste potentially hundreds of thousands of dollars defending a lawsuit which the plaintiff is willing to discontinue. For further background information Google Sona Shah or Shah v. Wilco. See also Stipulation to Discontinue.

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Big Changes Coming

E.J. Dionne at Truthdig.com (The Death of Reaganomics) writes, “This is the third time in 100 years that support for taken-for-granted economic ideas has crumbled. The Great Depression discredited the radical laissez-faire doctrines of the Coolidge era. Stagflation in the 1970s and early ’80s undermined New Deal ideas and called forth a rebirth of radical free-market notions. What’s becoming the Panic of 2008 will mean an end to the latest Capital Rules era.” Markets need regulated.

Stephen Davis and Jon Lukomnik, writing for Compliance Week, argue “by late next year the United States may well see two things happen that most boardrooms today consider impossible.” The first is “say on pay,” since both Obama and McCain favor it. Votes on resolutions may be lagging public opinion. Mutual funds, pensions and insurance companies that dominate the vote are more tolerant than the public, whose own economic pain adds to the strain. Davis and Lukomnik call say-on-pay in 2009 “a no-brainer, as it shows them (politicians) to be sensitive to the issue without imposing arbitrary caps antithetical to U.S.-style capitalism.”

The second change they see coming is the non-executive chairman. GMI has found that only a bare majority—52%—of companies in its U.S. database now still combine the chairman and CEO roles. Three years ago the figure was 62%. According to Spencer Stuart, 35% of S&P 500 companies separated the posts last year, compared to a 16% in 1998. “The ‘Chairmen’s Forum‘ is to debut with an Oct. 7 session in New York, aiming to adopt best practices and explore collaboration on common issues. The forum stems from a project initiated by the Millstein Center for Corporate Governance and Performance at the Yale School of Management, which will start off serving as secretariat to the group.” Stephen Davis is the project director. That change is expected to take a little more time. (Dreaming the Impossible Governance Dream, 7/8/2008)

Let Them Eat Bugs

Little to do with corporate governance, other than the growing disparity between rich and poor, but I couldn’t resist citing The Economist article with the above title (7/12/2008). “Bugs provide more nutrients than beef or fish, gram for gram.” Feed crops gobble up some 70% of agricultural land but crickets take up just a small space in the home.

E-Proxy Vote Bleak

Retail vote goes down dramatically using e-proxy (based on 468 meeting results); number of retail accounts voting drops from 21.2% to 5.7% (over a 70% drop) and number of retail shares voting drops from 31.3% to 16.4% (a 48% drop). (Broadridge’s “Near-Final” E-Proxy Stats for the Proxy Season, TheCorporateCounsel.net Blog, 7/14/2008)

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ICI Defends Mutual Fund Votes

With almost 30% US company shares and 90 million shareholders, how mutual funds vote is a matter of great public importance. That’s why many of us fought to have the SEC require disclosure of votes and policies several years ago. While ICI opposed the measure, they now claim to have embraced their new role and have recommended that Congress require that other fiduciaries also be required to make similar disclosures.

ICI President and CEO Paul Schott Stevens presented a comprehensive new study by the Institute on proxy votes cast by registered investment companies in an address, In the Shareholders’ Interest: Funds and Proxy Voting, at the American Enterprise Institute. Proxy Voting by Registered Investment Companies: Promoting the Interests of Fund Shareholders, examined more than 3.5 million proxy votes cast by funds in 160 of the largest fund families during the 12 months ending June 30, 2007. The study is the largest known examination of proxy votes cast by funds. Key Findings are as follows:

  • Funds play an important role in corporate governance. Proxy voting is one of several ways that funds promote stronger governance and better management, and in turn promote shareholder value. By law, funds must vote proxies in the best interests of funds and their shareholders.
  • Proxy proposals cover a wide range of governance and other issues. Proxy proposals can be initiated by company boards of directors (“management proposals”) or company shareholders (“shareholder proposals”). More than 80% of management proposals relate to election of company boards and ratification of company audit firms; most of the remainder concern fundamental changes that must be approved by company shareholders. Shareholder proposals cover a range of issues but tend to be sponsored by a small number of individuals and organizations. One-third of the more than 600 shareholder proposals that came to a vote in the year ending June 30, 2007, were sponsored by five individuals and three labor unions.
  • Funds and their advisers devote substantial resources to proxy voting. As part of this effort, they adopt and publish proxy voting guidelines. The guidelines of 35 of the largest fund families indicate that their funds generally support management or shareholder proposals that align the interests of company employees with those of shareholders or that bolster shareholders’ rights, including proposals to remove antitakeover devices such as poison pills or classified boards. Funds’ guidelines are often silent on, or indicate that funds will vote against, proposals on social and environmental issues.
  • Funds supported the majority of management proposals and voted in favor of shareholder proposals about 40% of the time, giving especially strong support to shareholder proposals calling for elimination of antitakeover provisions.
  • Funds’ votes are not outliers. In many areas funds’ votes mirrored the vote recommendations of proxy advisory firms.
  • Funds establish procedures to manage potential conflicts of interest in proxy voting. Academic research indicates that funds’ proxy votes are not influenced by the business interests of fund advisers. Funds’ votes are not swayed, for example, by their advisers’ management of 401(k) plans.

This report certainly represents a step in the right direction. Yet, ICI acknowledges that there are many funds “with broader investment purposes — including about 260 that pursue financial returns in tandem with social, environmental or other objectives, and whose advisers manage with these additional objectives in mind.” Unfortunately, it rationalizes most funds ignoring such issues because there goal is to “maximize financial returns.” Since they “do not have a mandate from their investors to engage portfolio companies on social, environmental or similar issues — valid as these may be,… they neither can nor should vote proxies simply on the basis of these considerations.”

However, many environmental and social issues have direct financial impact. Additionally, consider climate change. Even the wealthiest among us cannot escape the assaults of global warming and acidic oceans. As Robert Monks observes, “The primary thing that workers need for their retirement [is] money, but don’t workers also need a safe, clean, decent world in which to spend it. These ends are not economically exclusive…”

Environmental, social and governance (ESG) issues should be integrated into financial analysis. As Stephen Viederman notes, “There is no triple bottom line. There can only be a single bottom that offers positive social and financial returns against which all business decisions must be measured. Fiduciary duty… must give weight to how ESG factors, more broadly understood than at present, affect both risks and opportunities, now and in the future.”

A more fundamental criticism of the ICI’s methodology is that it only presents aggregated data. It reminds me of Robert Reich’s frequent quip that “basketball player, Shaquille O’Neal and I have an average height of over six feet.” By aggregating the data, voting patterns look normal.

More informative are reports at Fundvotes.com where, as its author Jackie Cook notes, “the most striking thing about the graphical representation of the data by fund family is the difference between fund groups’ voting profiles on various issues.”  “Most reports that criticize mutual funds’ proxy voting, including those mentioned in the ICI report) are more detailed with respect to who are the leaders and who are the laggards in particular areas of voting (for instance, why does one fund family support every board nominee at portfolio companies, whereas others support nominees less than 80% of the time, where the two might hold many of the same securities?), says Cook.  Not only does the ICI report fail to dissaggregate, it doesn’t even tell us which funds are included and which are not.

Unrelated to ICI’s report, but also of interest is a new Morningstar Inc. study which looks at how much managers invest in their own funds. The study looked at 6,000 issues and found that in 46% of the domestic stock funds surveyed, the manager hadn’t invested a dime. Nearly 60% of foreign stock funds reported no manager ownership, two-thirds of taxable bond funds have no managers with money in the fund, up to 70% of balanced funds have no manager cash and some 78% of muni bond funds have shareholder cash only. See table showing fund ownership. (No skin in the game, Chuck Jaffe, MarketWatch, 7/6/08)

Chuck Jaffe seems to believe the report shows Proxy voting (by funds is) more than a rubber stamp(Philiadelphia Inquirer, 7/13/08) However, he also notes that “At most large firms, fund managers still don’t sit on the proxy-voting committee. And so long as investors favor results to disclosures and returns to process – which is true in all funds except for those that pursue a social agenda – there will always be some lingering sense that fund firms don’t care that much about these issues. Further, there are no studies showing any kind of link between how funds vote their shares and how they perform.” Once those two threads are connected, we should see a lot more emphasis on voting. See also Shareholders’ Voices Hold Little Clout, mmexecutive.com, 7/14/08.

Lukomnik to Head IRRCi

The Investor Responsibility Research Center Institute for Corporate Responsibility (IRRCi) hired Jon Lukomnik as program director. Lukomnik will spearhead the Institute’s efforts to become the preeminent source of objective and relevant research examining the intersection of investments with environmental, social and governance issues.

“The Institute will encourage and support important research in the fields of corporate governance and corporate responsibility and will be a convener and coalescing force in this area of growing importance. Jon is the right person to lead us, and our board looks forward to working with him as he develops relationships with educational and other research organizations in these fields which are critically important in the securities markets and for the economy,” said Peter Clapman, Chair of the Institute.

“This is an opportunity of a lifetime – the chance to give back to the industry,” said Lukomnik. “If we do it right, the IRRC Institute will contribute to building the solid, independent research base which will affect how investors view and value corporations’ environmental, social and governance efforts for decades, even while allowing corporations to understand how to profit by being responsible. I envision the Institute as the go-to non-profit organization for such independent, objective research.”

Lukomnik is well-known globally for his corporate governance efforts over a quarter of a century. He is a founder and former Governor of the International Corporate Governance Network which now boasts 500 members representing some $15 trillion of assets under management, ex-chair of the executive committee of the Council of Institutional Investors, former Deputy Comptroller of New York City in charge of investing that City’s pension funds and treasury assets, a founder of GovernanceMetrics International, and co-author of The New Capitalists: How Citizen Investors Are Reshaping the Corporate Agenda (Bargain price of less than $10 for hardcover edition) Lukomnik will also continue as Managing Partner of Sinclair Capital LLC, a strategic consultancy for the asset management industry.


In a CFA Institute survey of1,956 investment professionals, 11% said they had seen a credit rating agency change a bond grade in response to pressure from an issuer, underwriter or investor.

Many respondents felt the most harmful conflict of interest results from the payment structure under which rating agencies such as Moody’s Investors Service and Standard and Poor’s are paid by the same issuers whose securities they grade. (Investors cite rating agencies’ conflicts of interest, Financial Week, 7/8/08)

An SEC report found that none of the rating agencies examined had specific written comprehensive procedures for rating residential mortgage-backed securities (RMBS) and collateralized debt obligations (CDO). Furthermore, significant aspects of the rating process were not always disclosed or even documented by the firms, and conflicts of interest were not always managed appropriately. (SEC Examinations Find Shortcomings in Credit Rating Agencies’ Practices and Disclosure to Investors) See also: Rating agencies in-depth, FT; SEC proposed rules.

Procedural Error in SEC Request to Delaware Court

J. Robert Brown argues that the decision by the Delaware Supreme Court to consider the certified question re AFSCME’s Proposed Bylaw at CA violates its own rule. No action letters represent requests for “informal” advice from the staff of the SEC.  The advice is not attributable to the Commission.

The petition provides that the answer “will determine whether the Division will ultimately concur in CA’s view that it may exclude the AFSCME Proposal . . . ”  (emphasis added).  In other words, it will be the staff that rules once the answer has been received, not the entire Commission. The fact that a no action letter is not a position of the Commission means that it can be easily disavowed (by the Commission or the staff) and cannot be challenged as a final action under the APA. Procedures matter. [As Predicted: The SEC and the Further Denial of Shareholder Access (Delaware Supreme Court and the Lack of Jurisdiction)(Part 4), theRacetotheBottom.org, 7/8/08)

TIAA-CREF Faces Pressure at Annual Meeting

Shareholders and advocacy groups will press TIAA-CREF officers on its investment in companies with socially irresponsible practices at its July 15 meeting. After years of pressure, TIAA-CREF agreed to become a shareholder activist on issues of social responsibility. Now it’s time for them to either put pressure on five industry leaders that consistently display egregious behavior or divest their stock, says the Make TIAA- CREF Ethical coalition, which includes Corporate Accountability International (formerly Infact), World Bank Bonds Boycott, Press for Change, Social Choice for Social Change, Canadian Committee To Combat Crimes Against Humanity (CCCCH) , Citizens Coalition (Frente Civico), Educating for Justice, National Community Reinvestment Coalition, Campaign to Stop Killer Coke/Corporate Campaign, Inc., Campaign for a Commercial-Free Childhood, and Sprawl-Busters. The Coalition urges that TIAA-CREF “reform them or dump them.”

  • Nike and Wal-Mart, condemned for selling products produced by overseas sweatshop labor;
  • Wal-Mart, widely criticized for its domestic labor practices, hurting local businesses, and promoting urban sprawl;
  • Philip Morris/Altria, responsible for Marlboro, the leading cigarette for youth;
  • Costco, which promotes police brutality in Mexico and the destruction of its cultural heritage and the environment;
  • Coke, with complicity in widespread labor, human rights and environmental abuses; exploits child labor and aggressively markets harmful products to children.
  • While TIAA-CREF did divest from harmful World Bank bonds, it should now pledge to buy “no more.”

According to coalition group representative Neil Wollman, a Senior Fellow at Bentley College in Massachusetts, TIAA-CREF claims that outside of their socially responsible fund, they cannot use non-financial criteria in their financial decisions. Yet, Wollman asks, “Would TIAA-CREF have invested in the production of Nazi gas chambers in World War II if it meant a healthy financial profit? It’s time for TIAA-CREF to answer that kind of question.” He adds, “Our coalition praises TIAA-CREF for changes over the years in its social responsibility practices often spurred by participant lobbying; but now they need to move on our companies of concern.” For further information, contact Neil Wollman, Ph.D., Senior Fellow (for the Make TIAA-CREF Ethical coalition): 260-568-0116. DisclosureThe publisher of CorpGov.net is a Costco shareowner.

Audit Committee Practices

TheCorporateCounsel.net recently conducted a survey and found that more than 90% review company earnings releases prior to their release to the media. Most hold a meeting by telephone a day or two prior to the release. (Survey Results: Audit Committees and Earnings Releases)

Sweeping Resoution at Hain

Congratulations to Kenneth Steiner and John Chevedden for creating and submitting what is certainly one of the most innovative and important resolutions of 2008. The SEC Rules on Shareholder Resolutions (Rule 14a-8) limit shareowners to one resolution per annual meeting. Yet, Steiner’s resolution to the Hain Celestial Group covers a lot of territory simply by asking Hain to reincorporate in North Dakota.

RMG/ISS blog points out that the United Brotherhood of Carpenters and Joiners of America filed proposals at a handful of Ohio-based companies’ 2007 annual meetings calling for their reincorporation to Delaware. At the time, Ohio law required companies to use a plurality voting standard, and the proposals served to eventually pressure local lawmakers to amend Ohio corporate law statutes to allow for a majority voting standard in director election. The proposal was voted on at FirstEnergy, DPL, and Convergys, according to RiskMetrics records, where it received 34.9, 32.6, and 59.5 percent support of the “for” and “against” votes, respectively. At least we know such proposal aren’t likely to be excluded by “no action” requests.

As RMG/ISS report, there is some dispute as to the benefits to be gained by reincorporation. “Ultimately, it comes down to the judiciary, and the view is that the Delaware judiciary is investor protective,” said Delaware University professor Charles Elson. “There is no corporate judiciary in North Dakota dedicated to the resolution of corporate disputes.” But being based at the University of Delaware, Elson is hardly be viewed as unbiased.

William H. Clark, Jr., who served as president of the North Dakota Corporate Governance Council, which drafted the statute, of course, sees things differently. “My preference as an investor would be to make sure the law is clear, rather than having to run to the courts to establish my rights,” said Clark. “The Delaware judiciary is limited by the statute in the rights it can provide investors. There’s no way, for example, that the Delaware judiciary could create a right of proxy access, which North Dakota has.” (Reincorporation proposal seeks to address “major issues in corporate governance,” 7/2/08)

Regardless of the merits of incorporating in North Dakota, the proposal brings up several issues that could be the subject of negotiations. Among the most significant are the following:

  • Majority voting in election of directors. In an uncontested election of directors, shareholders have the right to vote “yes” or “no” on each candidate, and only those candidates receiving a majority of “yes” votes are elected.
  • One year terms for directors.
  • Advisory shareholder votes on compensation reports. The compensation committee of the board of directors must report to the shareholders at each annual meeting of shareholders and the shareholders have an advisory vote on whether they accept the report of the committee.
  • Proxy access. The corporation must include in its proxy statement nominees proposed by 5% shareholders who have held their shares for at least two years.
  • Reimbursement for successful proxy contests. The corporation must reimburse shareholders who conduct a proxy contest to the extent the shareholders are successful. Thus, if a shareholder conducts a proxy contest to place three directors on a corporation’s board and two of the candidates are elected, the shareholder will be entitled to reimbursement of two-thirds of the cost of the proxy contest.
  • Separation of roles of Chair and CEO. The board of directors must have a chair who is not an executive officer of the corporation.
  • A “special meeting” shall be held if demanded by shareholders owning 10% or more of the voting power.

See text of the law and discussion, The North Dakota Experiment, at Harvard Law School Corporate Governance Blog, 4/23/07, Expect to similar proposals at a great many companies next year.DisclosureThe publisher of CorpGov.net is a Hain Celestial Group shareowner and will be voting in favor of Steiner’s proposal.

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CorpGov Bits

Writing for FT, Kristin Gribben concludes Shareholder democracy is on hold (7/6/08) based on mid-year voting results, which show “say on pay” support has remained flat. However, since both Barack Obama and John McCain have said they support say on pay, why should shareowners exert much effort on such proposals this year? Yes, many are waiting to see what the next administration brings.

One out of every four working Americans (25%) describes their workplace as a dictatorship and only 34% believe their bosses react well to valid criticism, according to a new Workplace Democracy Association/Zogby Interactive survey. 80% of workers said they work better when they are given the freedom to decide how to best do their job. (Workplace Democracy Survey, Workplace Democracy Association and The WorldBlu Blog, 7/5/08) The revolution continues.

A socially responsible investment (SRI) global equity allocation could produce 40% lower CO2emissions than a conventional portfolio indexed to the MSCI World, according to a study by Pictet Asset Management (PAM). Such a portfolio also showed the positive impact on job creation for 2007, creating half again as many as compared to the benchmark increase.

There is growing recognition that proactive management of social and environmental issues by corporations will have a material impact on their long-term value. Pension funds should disclose the extent to which (if at all) LTRI issues are taken into account in investment-related decisions, including proxy voting policies, selection of investments, engagement with companies or regulators, and selection of investment managers. (Responsible investing requires full disclosureDavid Hess, P&I, 6/9/08)

Karthik Ramanna and Sugata Roychowdhury find that outsourcing firms donating to congressional candidates in closely watched races managed their earnings downwards in the two quarters immediately preceding the 2004 election, deflecting attention away from outsourcing and negative media. As expected, such candidates to do better in elections. Conclusion: Accounting Information (can be used) as Political Currency. Ah, another form of corruption. People are so creative.

A bill signed into law in June positions Vermont as a leader in incorporating so-called virtual firms — those without a physical headquarters, actual paper filings, and directors’ meetings (they’re all online.) The state will charge virtual companies the same amount — about $235 per year — that standard corporations pay when filing. (Vermont Wants to Be the “Delaware of the Net,” CFO.com, 6/30/08)

Dennis Johnson, Director of Corporate Governance, will be leaving CalPERS  to become Managing Director of Shamrock Activist Value Fund. He also intends on stepping down from the post as Chair of the Council of Institutional Investors Board of Directors. (press release, 7/2/08) It looks like 3 years is all we can hope for at CalPERS until they move to the private sector for higher pay.

CalPERS also reached an $895-million settlement of a class-action lawsuit brought against UnitedHealth Group, over its stock-option grant practices… probably the largest stock option backdating recovery to date.

The Delaware Supreme Court accepted questions from the SEC on AFSCME’s binding bylaw proposal seeking reimbursement for third-party solicitations at CA. Briefs are due July 7; oral argument is scheduled for July 9. (Delaware Supreme Court: CA/AFSCME Certification Accepted and Fast Tracked, TheCorporateCounsel.net Blog, 7/2/08)

It has now been more than 10 years since DOL wrote a letter to Calvert advising them that the fiduciary standards of ERISA didn’t preclude socially screened funds as long as “the investment was expected to provide an investment return commensurate to investments having similar risks.” (Socially conscious investing blossoms with DOL’s blessing, Investment News, 6/23/08)

Preliminary 2008 AFL-CIO Key Votes Survey Preliminary Scorecard posted.

Former SEC chairman Arthur Levitt Jr. called on the SEC to immediately take up proxy access with “a significant, but not onerous, threshold amount of stock one must own to put forward a vote, a framework regarding disclosure and conflicts of interest, and rules that ensure that any changes to a board do not violate stock-exchange listing standards.” (How to Boost Shareholder Democracy, WSJ, 7/1/08)

Lipton and Democracy

In Shareholder Activism and the “Eclipse of the Public Corporation”: Is the Current Wave of Activism Causing Another Tectonic Shift in the American Corporate World?, Martin Lipton discusses the pressures that have been “pervasively eroding the centrality of the board of directors and transforming its role in the governance structure of public companies, with the end game being a new conception of the corporate organization.”

Lipton cries out that “directors risk embarrassment for any misbehavior or other failures of their companies, however diligent they may have been.” Of course, since board minutes are not routinely made public, how can shareowners assign blame other than to responsible committees and their members? “Many active CEOs and other senior business people now restrict themselves to only one outside board…” leading to a situation “where few members are CEOs or former CEOs, and too few members are fully qualified to provide the best possible business and strategic advice.” Yes, shareowners want fully engaged directors with a variety of skills and perspectives, not primarily CEOs.

Of course, not all his criticisms are baseless. For example, he points to a recent study by Bhagat, Bolton and Romano that found “no consistent relation between governance indices and measures of corporate performance… the most effective governance institution appears to depend on context, and on firms’ specific circumstances.” Similarly, Robert Daines and Dave Larker found no correlation between the corporate governance ratings given by four services to various corporations. (Rating the Ratings: How Good Are Commercial Governance Ratings?, Daines, Gow and Larcker, 6/26/08)

The bottomline question for Lipton is, will the subprime and leveraged loan financial crisis sufficiently move us from “director-centric governance to shareholder-centric governance, along with a concomitant transformation of the role of the board from guiding and advising management to ensuring compliance and performing due diligence.” I certainly hope so, and I’m sure shareowner-centric directors will also offer plenty of excellent advice.

When Berle and Means wrote The Modern Corporation, pointing out the separation between the ownership of property and the control of property, they didn’t blame performance failings on the greed of shareowners but on their passivity. They looked to the court as the ultimate arbitrator of the corporation’s legitimacy and viewed its ultimate purpose as maximizing not shareowner profits but the general interest of society. “The control groups… have placed the community in a position to demand that modern corporations serve not alone the owners or the control but all the society.” (p. 312, 1968, London: Transaction Publishers) As New Dealers, they believed political intervention was necessary to support market forces.

Managers and economists have sought for decades to avoid political regulations by overcoming the inherent inefficiencies of separate ownership and control by relying on and developing more efficient market forces. Through the pure economic model (PEM), financial markets take on the role of the entrepreneur, ensuring profit maximization by directing the flow of capital. However, markets behave more in line with crowds and mass movements, than as rationally efficient. Shareowners seek to exploit imperfect information.

Advocates of PEM have concentrated on designing mechanisms to reduce agency costs, by aligning CEO pay, for example, with stock price. However, PEM depends on all shareowners expecting the same maximized level of profit over the same time and different shareowners have different timeframes. PEM also underestimates the fragmentation of ownership and the consequences for corporate governance.

Lipton is right that costly regulatory checklists could kill the goose that lays the golden eggs, but the solution is not to return to a Fordist management dominated system that worked when corporations were conservative bureaucracies, politically counterbalanced by unionionized employees.

In a recent interview, Bob Monks describes some of his thoughts in returning from the 2008 ExxonMobil meeting. “Coming back from Dallas, I sat down and I began to write, ‘Shareholder Democracy, R-I-P’ which is inscribed on tombstones for Requiescat in Pace, or ‘Rest in Peace.’ Unhappily, the bold experiment that came out of the 1930s and some very idealistic people who tried to repair some of the damage of the Depression has now been thoroughly thwarted by people like Exxon, who view shareholder involvement as being at best a tax and at worst a crime.” (Bob Monks: ExxonMobil Exemplifies Corpocracy, SocialFunds, 6/30/08)

It would be a mistake, however, to think we have moved from a golden age of shareowner primacy. That only existed when corporations were owned, controlled and operated by families. The most interesting book I’ve seen in years on the evolution of the corporation is one that Bob knows well. His cover note says, in part, “The ideal of democratization of economic values, following de Toqueville, is a perilous voyage for which this book is a fine route map. Everyone can benefit from understanding the underlying precepts of tomorrow’s dialogue.”

Entrepreneurs and Democracy: A Political Theory of Corporate Governance by Pierre-Yves Gomez and Harry Korine identifies three “models of reference ” for corporate governance: the familial, managerial and public — each corresponding to distinct stages of evolution. The first stage began with the liberal thought of equal rights and the emergence of private property, which initiated enfranchisement of the entrepreneur. The second stage had roots in the separation of powers between owners and management. The third stage, emerging now, is typified by increasing representation and public debate, giving shareowners effective oversight of the corporation.

Gomez and Krine view the tension between individuals and the collective as opposing forces: that of the entrepreneur, a force necessary for directing and channeling the energies of individuals, and that of social fragmentation, a force that divides and balances individual interests, involving increased exercise of authority and control. Democracy, through institutions and processes, helps to establish equilibrium between these two forces. The governed view governance as legitimate only if there is balance between the directing force of the entrepreneur and the contrary force of fragmentation and independence.

“Management finds itself increasingly subordinated to the markets and has to take investors’ reaction into account to define and weigh decisions.” (p. 184) Shareholders have taken the entrepreneurial mantle and drive the market in two ways. “Investors” exercise the entrepreneurial force by allocating resources to the highest performers based on extrinsic comparisons. “Shareowners” seek to integrate active owners at specific firms based on their interpretation which also includes more intrinsic data. Contemporary corporate governance is characterized by the omnipresence of information, the de-privatization of the corporation, debate and the representation of different interests. Public opinion has become the counterweight to the entrepreneurial force of direction.

Under familial governance, business secrecy was paramount. Under managerial governance, we relied on the primacy of management expertise. Today, good governance depends on a mass of standardized information that allows easy comparison by the investing public of risks and opportunities. It depends both on relatively efficient markets to direct large capital flows and on actively involved shareowners to improve efficiencies at specific corporations.

Under the managerial form of governance that has been in dominant for most of Lipton’s brilliant career, the board is composed of experts and operates primarily to provide internal technical advice. Under public governance, the board is composed of outside directors, shareowner interest groups and even more broadly defined stakeholders to link the corporation to mass markets and society… functions increasingly important for companies operating in a global context.

Lipton’s clients would be better served if he helped them adapt to the process of democratic deliberation, rather than fighting a rear guard action. How can they evolve to a system of selecting board members nominated by and directly accountable to shareowners? How can they supplement the annual meeting with an assembly of elected shareowners who provide advice to management throughout the year? By inviting public discussion in areas heretofore regarded as the exclusive domain of management, companies deliberate matters of public concern in advance and are less vulnerable to the vagaries of market bubbles and crashes. Lipton can best help his clients avoid the imposition of overly burdensome regulations by advising them on how to build democratic mechanisms into the very structures and processes of corporations themselves.

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