Giving shareholders short shrift: research shows that public companies decline to act on a substantial percentage of shareholder votes. Companies often say they know best, but some critics say they should be more accountable.
This past May, CNBC reported that 38 percent of boards of public companies acted contrary to shareholder votes. The Investor Responsibility Research Center's (IRRC) data shows similar results. Carol Bowie, IRRC's director of corporate governance research, says that companies have taken concrete, responsive action on 67 of the 167 shareholder proposals (about 40 percent) that received majority support in 2003.
Inaction on 60 percent of the votes suggests that CEOs and boards aren't afraid of making their shareholders angry. Why? Was the Disney upheaval the exception to the rule? (During the 2004 proxy season, more than 45 percent of shareholder votes cast at The Walt Disney Co. supported the ouster of longtime Chairman and CEO Michael Eisner. He stepped down as chairman, though he remained CEO.)
What are the ramifications when companies ignore shareholder votes? Are there any studies on this?
The SEC requires that the results of the shareholder vote be reported in the 10-Q following the vote. "Companies must announce the results on a pass-fail basis at the annual meeting. In the interim, after the annual meeting and before the 10-Q, some companies announce the votes immediately after the results are tabulated, in the form of a press release, and some will [report them] on an ad hoc basis when people call the company and ask," says Patrick S. McGurn, senior vice president and special counsel at Institutional Shareholder Services (ISS).
Measuring the effects on the stock price when companies ignore shareholder votes is difficult. Should the price tracking begin from the date the 10-Q comes out, or from the date somebody calls the company and gets the results? If the latter, how can it be determined how public and widespread that information becomes after the phone inquiry? (That would influence the stock price.) Unless they publicly and definitely state it, how does one know if management is going to act according to the vote, and how long should one wait to find out?
In other words, studies are hard to come by. Awareness of potential ramifications, however, is another story.
"Because shareholders have demonstrated they have had no power in the past, the SEC (Securities and Exchange Commission) and stock exchanges were more open to adopting stricter governance rules, including a proposal that might allow shareholders to nominate some board members directly," says Bowie. "Second, more and more shareholders are withholding their votes from directors, which sends a message to corporate boards, generates negative publicity and damages investor relations.
"Pre-Enron, companies routinely ignored majority votes in favor of shareholder proposals with no consequences whatsoever because most shareholder proposals are non-binding. Post-Enron, consciousness has been raised about corporate governance issues and the duty of corporate boards to put shareholder interests first. As a result, companies are less inclined to ignore shareholder votes. Now, they are at least responding.
"Increasingly," Bowie adds, "companies are beginning to implement shareholder proposals, especially when they address today's hot issues, such as de-classifying (electing them annually) staggered boards; eliminating 'poison pills' or agreeing to put them to a shareholder vote; expensing stock options and allowing shareholders to vote on golden parachutes that exceed three times an executive's compensation."
She cites big-name companies that have responded to shareholder pressure to reform on these issues, including Lucent Technologies, Merck & Co., Safeway Inc., Whole Foods Market IP, L.P., Xcel Energy Inc., First Energy Corp., Gerber Products Company, 3M Corp., Altria Group Inc., Arden Realty Inc., Goodyear Tire & Rubber Co., Delta Air Lines and Eastman Kodak Co.
"If companies ignore shareholder votes, they risk their ability to raise money in the public markets in the future," argues Nell Minow, chairman of The Corporate Library and a noted shareholder activist. "Corporate governance is not going away. It is increasingly being included as an element of securities analysis, which it should. Analysts are including corporate governance metrics in their reports as an element of investment risk."
In the portfolio manager commentary that accompanied Legg Mason Value Trust's 2004 annual report to shareholders, Nancy Dennin, senior vice president, wrote: "We strongly encourage boards to acknowledge shareholder rights and implement proposals that the majority of shareholders support ... Limitations on shareholder rights have a significant effect on stock returns. A Harvard Business School study by Professor Paul Gompers and his colleagues found that the decile of companies with the best corporate governance policies outperformed the decile with the worst [policies] by an enormous 8.5 percent annually during the 1990s."
Additionally, Dennin notes, "Some boards are starting to be sued for not following shareholder wishes."
"Occasionally, when the media picks up on their lack of compliance with shareholder votes and shines the spotlight on it, boards then focus on implementing good corporate governance practices as a result of the public embarrassment," said Richard H. Koppes, counsel to Jones Day and former general counsel and interim chief executive officer of the California Public Employees' Retirement System (CalPERS). He adds: "This is certainly not true of all boards."
Do shareholders tend to dump the stock when companies ignore their votes?
Koppes says most investors don't react by selling the stock because:
* They manage index funds and have to own the stock.
* Their portfolios are so large that they have to hold the stock otherwise they would not be invested in the broad stock market.
* The stock price is down, and the investors are trying to get it up by making suggestions via shareholder proposals. If they sold the stock, they would be shooting themselves in the foot because that action may further depress the stock price.
Aren't corporate boards afraid of making their shareholders angry to the point of being voted out of office, like at Disney?
According to Koppes, in the short run, "no." Shareholder disenchantment at Disney had gone on for years, he notes, and in general, shareholders don't vote against the board or its chairman unless they have been frustrated for a long time. As a result, Koppes says, "The board feels it can get away with acting contrary to shareholder votes for a few years--and, in the meantime, has hope and faith that it can turn around the company's fortunes and stock price, thereby getting the shareholders off its back."
The risk of this strategy, of course, is that the company is unable to reverse its fortunes after a couple of years. "Boards don't seem to care unless investors have been complaining for a long time, and most investors are short-term, with holding periods of less than one year," Koppes says.
The Case of MBNA
After years of defending bad corporate governance policies, according to an analyst who requested anonymity, the board of MBNA Corp., the credit card giant, woke up a year ago and began changing its policies.
However, its shareholders clearly think MBNA has a ways to go. The company is experiencing negative ramifications, such as:
* Guilt by association: On March 16, 2004, The New York Times published a story under the headline, "Despite Clashes, MBNA Didn't Cut Ex-Chief's Pay." The only other stories on the page were about Tyco International and Adelphi Communications--not the kind of company most want to keep.
* Bad investor relations: Before MBNA's annual meeting this past May, TIAA-CREF, the pension and mutual fund that manages teachers' pension funds and owns several million MBNA shares, wrote letters to all shareholders owning more than 5,000 shares. TIAA-CREF urged them' to support its push to make MBNA's board more independent by voting for its proposal at MBNA's annual meeting.
* Payback spells trouble: Last April, CalPERS said it would vote against MBNA's entire board because MBNA had ignored a proposal favored by a majority of its shareholders last year. That proposal called for the company to start counting the value of stock options it gave to employees as an expense.
MBNA did not return calls for comments.
What was management thinking when it ignored a shareholder vote?
"When I call companies to ask why they ignore shareholder votes, they often say the passed proposal was against their company by-laws--to which I say, 'Well then, change the by-laws.' They also frequently say that they know the company better than the shareholders, so they know what's best for it," said Legg Mason's Dennin.
Is this 38-40 percent of companies that ignore shareholder votes necessarily in the wrong?
Shareholders own a stake in the company, but so does management, via 401(k) plans, option and/or stock compensation plans. Both have a vested interest in the company performing strongly. While shareholders make compelling points, are there cases when the company is right and shareholder proposals are simply off-base?
"Rarely," says Charles Elson, director of the John L. Weinberg Center for Corporate Governance at the University of Delaware. What about the argument that members of executive management are shareholders too, and so they have the same motivation to get the stock price up? "[That] doesn't matter," Elson says firmly. "Majority rules. If the company does not want to listen to its shareholders, it shouldn't take their money. It should go private."
Is there merit to the argument that management knows best because they are inside the company and have the most detailed knowledge of the issues? "Shareholder proposals are not about day-to-day, operational issues, on which management is, indeed, best informed," Elson says. "Shareholder proposals are about the governance of the company." Typical governance issues addressed by shareholder proposals include expensing stock options, reforming executive pay, separating the roles of chairman and CEO, and improving board accountability.
While shareholder proposals that win a majority vote are getting more respect, that hasn't translated into significant power. Why? Because most investors are short-term, and companies don't seem to get into trouble with shareholders unless they've made them angry over the long term (witness Disney and MBNA).
Still, analysts are including corporate governance metrics in their reports, shareholder activism can be costly and time-consuming, and Harvard Business School's study says companies with good governance practices outperform others. Rather than trying to get companies to change their spots, investors may eventually shift their funds to companies with good corporate governance. These companies are certainly out there, and are not hiding their lights under a bushel barrel.
In Xcel Energy's 2003 proxy, there was a shareholder proposal to de-classify the board. Xcel recommended that shareholders vote against it because it felt that, among other things, a classified board (one that is not elected annually) had the advantages of continuity and experience. Fifty-two percent of the voting shareholders opted in favor of the proposal. The company decided that, if the resolution was proposed the following year, it would recommend in favor of the proposal.
It was proposed again in 2004, and Xcel recommended shareholders vote for the proposal, which was approved and implemented. The board believes that if it is doing a good job for its shareholders, then it will continue to be voted back year after year, thus providing the continuity and experience it wanted to retain in the first place.
Perhaps compromise, such as the one made by Xcel, is the solution. Corporate governance is a hot topic that's not going to hibernate, even if the proxy season is six months away. Good investor relations, good press and higher returns will never go out of style.
Mary Conger is principal of Conger Quarterlies, an investor relations consulting firm. She can be reached at firstname.lastname@example.org.
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|Date:||Nov 1, 2004|
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