From the November 2007 issue of Treasury & Risk magazine

Power to Investors

The current credit environment will no doubt put a crimp in the activities of activist hedge funds, draining them of the cheap money that financed buying sprees and board hijackings. Nevertheless, while this could take some punch out of the current shareholder activist movement that has energized the equities markets for the past year, governance experts do not expect it to shut down. "Sarbanes-Oxley focused on the empowerment of the board," says Mark Watson, managing director of the corporate governance specialist group for Moody's Investors Service. "Now, we're seeing the next phase--more power going to shareholders."

And it was a banner year with an avalanche of resolutions calling for changes in how board members are elected, growing support for new opportunities to weigh in on executive compensation, and a spate of interventions by activist hedge funds. Probably the biggest victory was in the area of so-called majority rule. About 140 resolutions were proposed, calling for a change in corporate bylaws regarding the election of board members. Many of the proposed resolutions were withdrawn before the vote, because the companies agreed to institute the change ahead of time, making the vote a moot point. Most of the remaining ones were passed. There's been growing support for the approach over the last three years.

What exactly is majority rule? Traditionally, companies used something called the plurality vote, through which directors would be allowed on the board as long as they received one vote. Shareholders who didn't favor that nominee couldn't vote against him or her. They were only allowed to withhold their vote. With majority rule, however, nominees who receive more "no" votes than "yes" votes must tender their resignation. The board would then have to decide whether or not to accept it.

Before this, many companies had adopted the so-called Pfizer rule (also known as "plurality plus"), a policy pioneered by the drug maker mandating that any nominee for director who receives more "withheld" votes than favorable votes has to submit his or her resignation to the board; the resignation would then be considered by the corporate governance committee, which would make a recommendation to the board. According to Patrick McGurn, executive vice president and special counsel for Institutional Shareholder Services Inc. (ISS), a corporate governance organization in Rockville, Md., "Over the last couple of years, more and more companies have upgraded from the half-way house of plurality plus to full-blown majority rule." Now, more than 60% of the S&P 500 have majority rule, up from 12% two years ago.

Another area of note was in resolutions about "say on pay." That approach would allow shareholders to vote on executive compensation. Similar measures have been accepted practices in the United Kingdom for about five years. Although non-binding, "it would make boards think twice before doling out exorbitant pay packages to undeserving CEOs," says Amy Borrus, deputy director of the Council of Institutional Investors, a shareholder-rights organization based in Washington, D.C. "It's a way of shareholders saying, 'we're unhappy and you have to go back to the drawing board.'" More than 60 proposals were considered, says McGurn, with such institutional investors as TIAA-CREF joining the ranks of T. Rowe Price, Schwab, and a handful of other backers. John Wilcox, TIAA-CREF's head of corporate governance, says his group changed its approach in response to new SEC compensation rules. "We're looking at targeting companies where disclosure quality or compensation policies are problematic," he says.

While only a handful of resolutions won majority support, many other votes were in the "low to high 40%," says McGurn, quite a showing for an idea that first appeared in 2006. In addition, before the proxy season started, Aflac Insurance adopted the policy. "There's a great deal of momentum," he says.

The proposal got an even bigger push in April from Congress. That's when the House passed say-on-pay legislation covering executive pay packages, introduced by Barney Frank (D-Mass.), chairman of the House Financial Services Committee. The same day it was passed, a similar bill was introduced in the Senate by Sen. Barack Obama (D-Ill).

Of course, hedge fund managers, who hadn't yet been hurt by the credit crunch, made up the most vigorous camp pushing for change. Unlike the corporate raiders of the 1980s, this new breed of activists has aimed their sights not on taking over companies, but on boosting stock prices. Case in point: Richard Breeden, former SEC chairman and founder of Breeden Capital Management. In September, he won a proxy fight against tax preparation company H&R Block, in which he and two other candidates were elected to the board. Breeden's motivation: to stop the company's expansion into other businesses, such as subprime mortgage lending. He also won a place on the board of Applebee's International, in an effort to push the company to put itself up for sale.

While this group's activities will likely be curtailed, shareholder rights groups nonetheless expect a busy proxy season in 2008. Since majority rule has taken hold among many of the biggest companies, some observers predict that midsize companies will begin considering it. "It's fertile ground," says Beth Young, senior research associate for The Corporate Library, a governance research group in Portland, Maine. As for say on pay, that's a different story. Observers anticipate stepped up say on pay activity. "We'll see at least as many proposals as the year before," says Young. It's also likely that a larger percentage of those votes will come out in favor of say on pay, and some previous votes against the proposals could turn the other way. That's especially likely if the topic becomes a full-fledged issue in the Presidential election campaigns.

The cloudiest battleground surrounds the issue of proxy access. A year ago, the U.S. Court of Appeals for the Second Circuit Court decided against a long-standing SEC position, which permitted companies to exclude proposals for director nominations made in shareholder proxies. The SEC--currently one member short--seems undecided, calling in July for comments.

Either way, proxy season 2008 is unlikely to be dull.


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