Under the knife: executives and boards at this year's shareholder meetings should expect constituents to dissect business practices with new fervor. (Investor Relations).

Annual shareholder meetings, historically dull affairs, this year are expected to be heated, as companies struggle to readjust in the wake of recent corporate developments that pit shareholders against executives and boards like never before. Suddenly, it's not just the large, controversial companies that can expect increased shareholder scrutiny -- this year, all companies struggling to survive in a downturn must prepare for close examination.

Not surprisingly, concerns about what went wrong at Enron and the widening ripple effect are likely to reverberate at shareholder meetings in virtually all industries. "The sudden and total collapse of the seventh-largest company in the United States will forever change the way shareholders look at corporate boards," says Pat McGurn, director of corporate programs for Institutional Shareholder Services in Rockville, Md. "Enron will elevate some second-tier proxy issues, such as auditor independence and rotation, to front-line status."

And the proxy fight over Hewlett-Packard's proposed acquisition of Compaq could bring a new intensity to shareholder complaints.

ICN Pharmaceuticals, Hercules and VISX are just a few of the companies whose 2002 shareholder meetings could get particularly raucous.

VISX, a manufacturer of laser eye surgery equipment, could again come up against financier Carl Icahn, who is threatening to relaunch a proxy battle he lost last year. Meanwhile, Hercules, a supplier of water-treatment products and services to the pulp and paper industry, could see a renewed effort by dissident investors to take control of the board. ICN Pharmaceuticals faces investor pressure to complete a restructuring.

Those companies, while exceptional cases, are not alone. "Managements of companies that have had a major layoff or [that have] seen their stock price drop sharply--a fairly large universe now--need to think hard about what they will say to shareholders at this year's annual meeting," says John Wilcox, vice chairman of Georgeson Shareholder Communications in New York.

The smartest CEOs will prepare for this year's meetings by anticipating what will likely be pointed questions regarding revenue sources, assets, cost containment and risk management. "Shareholders are now interested in as much detail as we can give them about our operating divisions," says Richard M. Scrushy, chairman, CEO and founder of HealthSouth, a hospital operator in Birmingham, Ala., who doesn't anticipate any surprises at his company's annual meeting on May 16.

"With Enron knocking the war in Afghanistan off the front page of the newspapers, it would be silly for companies not to expect a lot of questions about accounting risk," adds William G. Jurgensen, CEO of insurance company Nationwide in Columbus, Ohio.

Unlike earlier years, when shareholders were dazzled by growth stories, they are now focused on the nuts and bolts of business. "Several years ago, investors saw us as an asset-heavy company without a lot of the new sizzle stuff," says Sue Becht, senior vice president of investor relations for utility giant Duke Energy in Charlotte, N. C. "Now they realize the value of our assets as an earnings-and-cash generator."

Shareholders are also concerned about directors' capabilities, independence and involvement. "There is now a definite feeling that directors are not behaving in the shareholders' best interests and that they are not providing effective oversight," says Nell Minow, founder and editor of corporate-governance Web site The Corporate Library. "This will make corporate governance a dominant theme of this year's proxy and annual meeting season.

Tough questions, good answers

Energy services companies will face particularly tough questions in the wake of Enron's downfall and the California energy crisis. "CEOs will need to communicate how their companies manage various risks [such as] credit risk, counterparty risk and commodity exposures, and how they are prepared to weather a downturn in industry conditions, such as a supply glut," Becht says. "A CEO can add real value by showing a good understanding of the sector's ups and downs and the company's ability to thrive under different scenarios.

Auditor independence will top the list of shareholders' corporate governance concerns this year. Responding to audit system failures that occurred before the Enron de bade--at Sunbeam, Waste Management and Micro-Strategy, for example--the Securities and Exchange Commission amended its rules governing auditor independence on Nov. 21, 2000, and began requiring companies to disclose in annual proxy statements fees paid for audit and nonaudit services. The numbers were reported for the first time in 2001, and as McGurn notes, "the picture wasn't pretty." On average, he says, "companies paid their auditors about $3 for nonaudit services for every $1 they spent on the audit." At some firms the ratio was as high as 10- and even 20-to-1.

"The numbers made it clear that a lot of the companies in our portfolios are giving their auditors a lot of nonaudit business," says Ed Durkin, director of special programs for the United Brotherhood of Carpenters. Late last year, the union submitted resolutions to 27 companies, including Allegheny Energy, American Power Conversion, Bristol-Myers Squibb and Kmart, urging them to adopt policies prohibiting the use of independent auditors for nonaudit services. The labor union plans to submit resolutions to at least 10 more companies.

Durkin acknowledges that while the union is engaged in negotiations with a number of companies, it isn't making much headway. "Despite all that's in the news, most companies are clinging to the ability to use their auditor for a full range of services," he complains. Most recipients of the resolution have sought SEC permission to exclude them on the basis that they pertain to ordinary business, but it seems unlikely they'll succeed.

Meeting shareholder demands

CEOs can also expect to take heat on staggered boards and poison pill initiatives, which prevent any one person from buying more than a certain amount of company stock without management approval. "These takeover defensives impede the maximization of shareholder value," says Herbert Denton, president of Providence Capital in New York. Last year, proposals calling for a return to annual elections received majority votes at 33 companies, including Bristol-Myers Squibb for the fifth straight year, and Airborne, Kroger and Merck & Co. for the third year in row. Resolutions calling for the elimination of poison pills received majority support at 22 companies in 2001. At heavy-duty truck producer Navistar International in Warrenvilie, Ill., for example, a resolution to rescind the poison pill was supported by 83 percent of the quorum. At Paramus, N.J.-based Toys 'R' Us, the proposal won 88 percent of the quorum. Despite these strong numbers, most boards failed to take action on either issue. "The directors of these companies made a conscious decision to ignore the shareholders' expressed wishes," says Denton. "It's now become a matter of shareholder democracy and corporate integrity."

Denton is trying to leverage corporate democracy principles to hold board members accountable for ignoring shareholder votes to eliminate poison pills. He is proposing a bylaw that would disqualify board members for an additional term if they failed to approve elimination of poison pill rights within 180 days after the passage of a stockholder resolution in favor of such action.

Other corporate governance issues that will be discussed at this year's annual meetings and throughout the proxy season include director independence, the splitting of the chairman and CEO positions, and the board's role in strategic decisions. A new carpenter union--sponsored resolution calls for disclosure of the board's involvement in strategic decision-making. The union has also filed resolutions promoting director independence. It believes key compensation, nominating and auditing committees should be comprised completely of independent directors.

Payback time

Another major theme at many shareholder A meetings this year will be an old standby, executive compensation. "There is a sense among institutional investors that we were not sufficiently vigilant during the bull market and that we allowed CEOs and other top executives to take home a larger share of the pie than was appropriate--especially in the form of stock options," says Beth Young, a corporate governance consultant for the AFL-CIO. "Now, having seen the value of their investments plummet, shareholders are looking to make sure that executives who touted stock options as a way to tie their fortunes to the shareholders' are not figuring out ways to get paid more."

In addition, shareholder resolutions propose that boards seek shareholder approval for options repricing and adopt policies requiring that some portion of future stock option grants to executives be performance-based. Other resolutions seek shareholder approval of future severance agreements in excess of 2.99 times the executives' salary and bonus, disclosure of executives' supplemental retirement plans and the exclusion of pension fund income when computing senior executives' performance-based compensation.

It promises to be a year full of challenging shareholder meetings for almost all CEOs. Recent developments make it unlikely for the head of any size company to breeze through a meeting without some kind of inspection. So what's the best way to react? CEOs this year must be "open and direct," says HealthSouth's Scrushy. "If there's an issue that shareholders are worried about, it's critical for the CEO to address it."

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RELATED ARTICLE: CEOs Take Heat over Global Warming.

Rev. Michael Crosby, corporate responsibility agent for the Midwest province of the Capuchin Franciscans, a Roman Catholic order of priests and brothers, for the past four years has worked to change Exxon Mobil's stance on global warming. He's at it again this year. "The company has not changed one iota on the issue of global warming," says Crosby.

In a shareholder resolution submitted by 28 institutional investors who are members of the Interfaith Center on Corporate Responsibility, Father Crosby proposes that the oil giant recognize the global warming phenomenon and that human factors, such as the burning of fossil fuels, contribute to it. He is calling for Exxon Mobil to develop a stronger emphasis on the development of renewable energy.

When confronted with tough social issues, CEOs are urged to face them head on. By not adequately responding to global warming, Exxon Mobil has become the target of a number of environmental activists. By contrast, Royal Dutch/Shell and BP, which have demonstrated an awareness of the issue and have taken steps to increase the development of renewable energy, face much less criticism.

CEOs encounter plenty of complex issues. Activists have filed more than 260 proposals raising social policy concerns for inclusion in 2002 company proxy statements, according to the Washington, D.C.-based Investor Responsibility Research Center, an independent research organization. Many focus on the environment and global labor standards.

About 60 social policy proposals related to energy and the environment have been submitted to U.S. corporations. Eighteen of these pertain to global warming -- "about twice as many as in any previous year of this eight-year-old campaign," says Meg Voorhes, director of social issues services at the organization.

Another 43 shareholder resolutions focus on global labor standards, according to the research center. Led by the New York City pension funds, one of the major proposals urges companies to commit to and have their suppliers meet a conduct code based on human rights standards of the International Labor Organization, a United Nations agency, and to a program of independent compliance monitoring.

Prompted in part by the terrorist attacks of September 11, a new shareholder resolution initiated by religious investors asks financial institutions, including Bank of America, FleetBoston Financial and JP Morgan, to develop policies to prevent money laundering.

Social activists are also asking nine pharmaceutical companies to make HIV/AIDS, malaria and tuberculosis drugs accessible to African nations.

Other social issues that will come up for discussion and vote at 2002 shareholder meetings include equality, the labeling of genetically modified foods and offensive media imagery of ethnic groups, particularly Native Americans.