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Investor's Business Daily


The Strange New World Of Corporate Governance

October 07, 2011

By James R. Copland

Over the last decade, corporate governance as we know it in the United States has been significantly transformed. A new breed of shareholder activism is reshaping boardrooms, both influencing and being reinforced by the federal-oversight regime created through the 2002 Sarbanes-Oxley and 2010 Dodd-Frank laws.

Traditional shareholder activism, in which investors seek to topple management in underperforming companies, largely improves corporate performance by holding executives’ feet to the fire. Though certain individual shareholders and hedge funds continue this type of active investing, today’s shareholder activism largely focuses instead on submitting shareholder proposals through the annual proxy process.

Shareholder proposals have been around for decades, and certain investors ranging from social-investing funds to religious groups have long used the proxy process to agitate for public-policy agendas. But it’s only recently that some shareholder proposals have begun to win majority support.

Among the proposals most likely to win shareholder backing have been those that force directors to stand for election annually and that require directors to win the support of a majority rather than a mere plurality of shareholders.

These changes have theoretic merit: Staggered board terms and plurality-voting rules can insulate companies from potential takeover bids and thus entrench poorly performing managers. But the effect of such changes has also been to make corporate boards far more sensitive to the shareholder-proposal process, as directors’ positions themselves are now far more tenuous.

With directors increasingly reactive to shareholder votes, new classes of shareholder proposals have emerged and gained traction. So-called “say-on-pay” rules, which force companies to submit their executive-compensation packages to shareholders for an advisory vote, were unheard of in the United States until recently.

Five or six years ago, such rules began to be proposed by shareholders and occasionally adopted, before Dodd-Frank mandated them for all public companies — a clear example of how the shareholder-proposal process can drive political agendas.

Say-on-pay was largely pushed by labor unions, which are among the most active players in the new shareholder activism. In a new report examining all shareholder proposals submitted to the 150 largest U.S. public companies over the last four years, I show that labor-affiliated pension funds have sponsored 30% of all shareholder proposals and 48% of those related to executive compensation.

Labor unions’ special focus on executive pay likely stems from a deep-seated conviction that corporate managers are overpaid. But something more may be afoot. Labor-affiliated funds are more than 30% more likely to submit proposals to financial companies and almost 70% more likely to submit them to retail companies than to manufacturing or energy companies.

Since companies in the retail and financial sectors are much less likely to be unionized than their heavy-industry counterparts, and since these lightly unionized sectors are the targets of ongoing labor-organizing campaigns, union pension funds may be using the shareholder-proposal process as a lever against management rather than to drive shareholder return.

Unions are hardly the only shareholder-proposal sponsors with an agenda that differs from the typical diversified shareholder. A limited cohort of special-interest investors tends to dominate the shareholder-proposal process.

Ninety-eight percent of all proposals are sponsored by labor funds, social-investing funds, religious or public-policy groups, or individual investors. Two-thirds of the individual-investor-backed proposals come from just four small investors and their relatives.

Hedge funds and ordinary mutual funds essentially stay on the sidelines, a telling indicator of the relationship between the new shareholder activism and share values.

Reinforcing this inference were the 2011 say-on-pay votes under the Dodd-Frank mandate, in which 98.5% of all executive-compensation plans received shareholders’ backing, even as pay grew year-over-year.

Such overwhelming support for CEO pay packages undercuts the rationale for mandatory say-on-pay votes and suggests that shareholders generally view boards’ compensation approaches as appropriately structured to align managers’ incentives with shareholders’.

Nevertheless, there’s every reason to believe that the new shareholder activism is here to stay. An increasingly assertive Securities and Exchange Commission has been buttressing such activism despite a recent setback.

The D.C. Circuit Court of Appeals overturned the SEC’s proposed new rule that would have forced companies to allow shareholders to nominate directors on corporate proxy statements — a rule that had been structured to empower labor pension funds but to exclude hedge funds agitating for corporate takeover.

But the Commission has already signaled that it will permit such proposals if submitted by shareholders, and “proxy access” proposals are all but certain to be a major new corporate-governance battleground.

Moreover, the new class of shareholder activists has been emboldened by its successes and continues to introduce proposals that would alter the director-shareholder balance of power.

Shareholders at some companies have already passed proposals allowing equity investors to call special meetings and act by written consent. Such shifts will force boards to be vigilant about the new shareholder activism year-round, rather than only around the annual-meeting cycle.

At a minimum, the new shareholder activism is consuming much more of managers’ and directors’ scarce time — time that could be spent instead looking for new profit opportunities.

Riskier still is the prospect that the special-interest orientation of the shareholder-proposal process could begin to erode one of the critical underpinnings of the corporate form itself: the alignment of equity owners’ interests along a single variable: share value. It’s time corporate leaders — and judges, legislators and regulators — took notice.

Original Source:



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