The enactment of the Dodd–Frank Wall Street Reform and Consumer Protection Act transformed the corporate atmosphere in 2010, two years after the peak of the financial crisis. Some laude it, some loathe it, others still have mixed reactions, but one thing is indisputable: Dodd-Frank has reinvented investor-board discourse. The 2,300-word document produced a greater level of transparency for stakeholders, and subsequently, an ever-increasing number of repercussions in the boardroom and beyond.
“With apologies to Charles Dickens, I think it’s the best of times and the worst of times from the perspectives of both investors and issuers,” Bob Lamm, Independent Senior Advisor to Deloitte’s Center for Corporate Governance, says. “Many companies have adopted enlightened (at least in my view) governance practices, and shareholder engagement is increasingly becoming the norm—including engagement by board members.”
Lamm continues: while some boards are increasing their effectiveness by focusing on needed skills and diversity, others are reluctant to adopt steps toward more efficient action. “Some companies are philistines,” he says, resisting what he sees as “enlightened practices.” Meanwhile, certain investors are shifting focus to long-term performance while others choose “box-ticking,” or “applying identical solutions to multiple companies” particularly in terms of director tenure. “To say that a director ceases to be independent or should simply get off the board after X years does not make sense to me,” Lamm says.
Dodd-Frank has knocked off the balance between informed investors and investors given authority without proper backing. “Boards are not guarantors of corporate performance, yet whenever something goes wrong—and on occasion when a board merely decides to take certain actions—some investors feel compelled to question the board’s action, even when it’s an area where the board is likely to know better than the investors.”
The enactment of Dodd-Frank may have given investors and boards a wealth of tools to create effective engagement, but in some cases, the requirement structure and company execution tip the scale either one way or the other.
Exhaustive Reporting vs. Effective Engagement
The standard for disclosure has reached new heights—or more accurately, lengths—over the last six years in terms of content, which can discourage effective shareholder communications. Arthur Kohn, a partner of Cleary Gottlieb Steen & Hamilton LLP, believes disclosure in proxy has gotten “too technical and detailed” to inform shareholders efficiently. “A proxy statement for a large company these days can run 50, 60, 70 pages…way too much of it is about comp detail that shareholders won’t understand.”
Directors are burying more relevant details deep in these intricately detailed proxy reports, particularly those involving executive compensation. A 2015 Investor Survey conducted by Stanford, RR Donnelley and Equilar found that a dismal 65% of institutional investors say that the relation between compensation and risk is “not at all” clear in corporate proxy; only 38% institutional investors believe that corporate disclosure on executive competition is clear, easy to understand and effectively disclosed.
“Effective shareholder engagement implies an interaction between parties—and saliently, an interaction means a dialogue or discussion that includes questions, comments, concerns and even debate,” Paula Loop, leader of PwC’s Governance Insights Center, explains. “Merely presenting to an investor audience does not meet the definition of engagement. The company must identify and understand the investors’ interests; and then align the discussion to meet those areas of focus.”
Maximizing effective engagement strategies relies not on frequency, but the quality of discourse according to Tom Johnson, CEO of Abernathy MacGregor. “Every company will tell you, ‘We know our shareholders well because we meet with them all the time.’ But the more difficult question is, do your shareholders understand your strategy and, more importantly, do they support it? The answer there can often be murkier. That is why outside of proxy season, we advise companies to really pressure test their strategy with their largest shareholders.”
Three separate drivers have steered the direction of shareholder engagement over the last 10 years, according to Ken Bertsch, Executive Director, Council of Institutional Investors: the enactment of say on pay, a rise in shareholder activism and general unease among shareholders.
“As larger asset managers—not activist asset managers, but mainstream asset managers—came to deal with proxy voting issues following disclosures around mutual fund voting records following first the Enron problems and later, the financial crisis, they came to be more skeptical on what they were voting on over time,” Bertsch explains. “It was important for companies to reach out; it wasn’t a given how folks were going to vote.”
The 2001 fall of Enron was a pivotal moment in investor-corporate relations. That one of America’s largest corporations had the ability to peak as one of the largest traded companies, then decline into bankruptcy within a year brought about a dreaded question: what other corporations were defrauding shareholders?
The dire possibilities highlight the importance of consistent, effective engagement practices for investors. Through her work with PwC, Loop has observed that shareholders would prefer more frequent dialogue. “Investors are expecting a new approach to engagement,” Loop says. “This emerging discourse incorporates many important topics, and it will require directors to engage in the dialogue as well. Forward-looking companies are seizing this opportunity to build important relationships and bridges before crises hit.”
About Face: Spinning a Turnaround Environment
Jamey Seely, Executive Vice President of General Counsel and Corporate Secretary of ION Geophysical, experienced investor-board tensions firsthand following the dramatic change in oil prices last year, starting from a high of $100 per barrel in the first half of 2014 and falling to under $35 per barrel in late 2015. “My focus and area of specialty has been managing through very difficult periods of declining earnings caused by such dramatic swings in commodity prices.”
The consequences of dramatic price swings in smaller companies—those with less than $500 million in revenue—range from decreases in headcount and spending to negative earnings and lower stock prices, according to Seely, the latter of which may trigger the potential for delisting.
“The conversations that management must have with shareholders in a turnaround environment can be described as very difficult conversations, at best,” she says. “Shareholders want positive returns and, as much as they may understand the dynamics of your market, they are never happy about declines in stock prices. So, the discussions require a well-seasoned and strong management team. When restructuring proposals are voted down by shareholders, it usually occurs because management did not have a good outreach plan and did not have a robust plan for turning-around the business that they could present to shareholders.”
Shareholders say that they’d like to hear from key executives—even directors—on a periodic basis, according to Loop. “Investor insight is very helpful to both the executive team and the board of directors. It helps with understanding where shareholders believe there are lurking vulnerabilities and allows companies and boards to address issues proactively,” she says. “This engagement is particularly important in today’s activist shareholder environment as it allows companies to be better prepared if—or when—an activist comes calling.”
The evidence points to “when”—an increase in activist shareholders has been observed over the past few years. “We’ve seen a long-term rise in shareholder activism,” Bertsch says. “There was quite a winning streak for about five years following from the financial crisis that was drawing more money into the activist strategies, and making boards and managements worry more about activism.” Boards and management “felt it critical to engage,” he continues, given the heightened number of activist activity. According to Activist Insight, 473 activist campaigns were initiated worldwide in the first half of 2016—306 in the U.S., up from 278 a year ago.
“For a long time, companies did a very poor job of communicating with their shareholders and listening to their concerns,” Johnson explains. “Activists successfully exploited that communication deficiency and, much like a political election, companies are realizing it is on them to get the message out and gain support.”
We’ve seen a number of high-profile activist takeovers this year, including Starboard Value’s successful takeover of Yahoo and subsequent cash-out to Verizon (despite the unfortunate timing of their cyber breach) and the Herbalife battle between activist stalwarts Carl Icahn and Bill Ackman this summer. The question remains: will shareholder activism remain high on the agenda for the 2017 proxy season?
That depends, says Seth Duppstadt, Senior Vice President of Proxy Insight. “Board seat activism may heat up even more with the increased popularity of proxy access bylaw amendments over the last few years. Depending on whether institutional investors choose to take advantage of the new mechanism we could actually just be seeing the start of shareholder activism.”
A Glance Back Moving Forward
At least partially due to Dodd-Frank, shareholder engagement as a principle has become a more static process—no longer an exceptional request met by internal frustration. Creating an opportunity for investor input has evolved to a new corporate standard going above and beyond a mandatory annual shareholder meeting.
Not only has the frequency of engagement changed, but the structure of discourse as well. According to Bertsch, it’s become fairly standard among large- and mid-size companies to make a board member a liaison for the lead director in the event that a shareholder requests a meeting. Five years ago, this wasn’t the case. “I think that a lot of directors have realized that in speaking with investors generally is really more of a listening exercise. It is both speaking about what the board’s doing and the board’s role, but it’s more importantly listening to investor views and trying to solicit these views.”
Loop predicts that the c-suite and directors will have a greater role in shareholder relations, the latter of which can have “a very positive influence” on engagement efforts with adequate preparation. “Engagement will primarily be led by the CEO, however, in some cases, the involvement of directors will be critical. For example, when discussing the CEO’s compensation package, investors typically prefer to speak to the director leading the compensation committee.“
A number of Dodd-Frank elements affecting shareholder-director relations will come into play in 2017, like the say-on-pay frequency vote (the initial rules come into effect for an issuer’s first shareholder meeting occurring on or after January 21, 2011—the next six-year iteration arrives in 2017). Under the pay ratio mandate, any med- to megacap corporations with fiscal years beginning on or after January 1, 2017 will be required to disclose the following: median annual total compensation for all employees (except the CEO), annual total compensation of the registrant’s CEO, and the ratio between the median annual total compensation and the CEO’s annual total compensation.
The 2016 proxy season saw shareholders shifting dramatically in the ways of social issues. The Harvard Law School Forum’s 2016 proxy season review reported an emphasis on proxy access for a second consecutive year, with over 200 resolutions filed. Environmental issues and campaign finance were second and third most frequent ballot items raised by shareholders respectively. A record number of climate change proposals were made, though there were a lower number of E&S resolutions overall.
The Paris Agreement (to go into effect November 4), heightened awareness of gender disparity, and, of course, the passage of Dodd-Frank have all played a part in 2016 proxy patterns. While increased engagement over executive compensation received high approval rates and the lowest failure rate in five years, several new facets of the say-on-pay regulation are being examined into the 2017 season: gender pay equity, golden parachutes and the influence of stock repurchases on executive compensation.
While issues like gender disparity and climate change are only now beginning to rise to the top of proxy agendas, Josh Zinner, CEO of the Interfaith Center on Corporate Responsibility, has always realized the relationship between ethics and finance. “I would dispute the notion that financial performance and ethical behavior are separate interests in need of reconciliation,” he says. “Responsible investors begin with the belief that positive, sustainable financial performance emerges from good environmental and social practices, including the ethical treatment of all stakeholders.”
Ethical treatment implies respectful consideration of shareholder perspectives, which would be impossible without transparency between corporate behavior and its investors. As such, NASDAQ issued the “golden leash” rule this year, in which a director’s compensation arrangements are required to be published on or through a company’s website or in the definitive proxy or information statements. The broad distribution of this kind of information directly to shareholders has created an interesting development in the way of proxy advisors.
“I think that it’s a little too early to say definitively, but the trend seems to be that [ISS’s and Glass Lewis’s] influence is slightly diminishing on account of the role of big shareholders and the fact that they seem more willing to make their own policy preferences and voting preferences clear,” Kohn says, reflecting on his participation in compensation committee discussions. “The directors regularly want to know how ISS and Glass Lewis or both are going to react to a particular provision or decision, and that aspect is still present—that has not passed, and I don’t see it passing quickly—but I do think that the fact that the big shareholders are exercising more, or seem to be exercising more independent judgement, is going to have that impact over time.”
Christopher P. Skroupa is the founder and CEO of Skytop Strategies, a global organizer of conferences.