A Push for Majority Rule Roils the Boardroom
from
January/February 2006
by Julie Connelly
Unless
you’ve been living in the trees all year, you are probably aware that a
number of shareholder proposals popped up this past proxy season
requesting that corporate directors be elected by majority vote instead
of the customary plurality. If the would-be reformers have their way, a
board candidate who doesn’t get more than 50% of the vote cannot be
elected—or reelected—even if nobody else is after the job.
Three
directors fell into that category in 2005, all at Career Education
Corp., a company that owns Katharine Gibbs schools and other teaching
establishments. More than 30 others came relatively close (see the
print version for examples). In some cases, shareholders were objecting
to boards as a whole—upset over a poison-pill provision, perhaps—and
singled out the board members who were up for reelection. Other times,
the withhold votes were personal: Shareholders just didn’t like a
particular director.
Either way, the push to make a
withhold vote more meaningful is gathering momentum. According to
Institutional Shareholder Services, which advises major investors on
how to vote, the 60 proposals for majority voting among the Standard
& Poor’s 500 that were filed through the end of June were the
largest number on any subject. (Board declassification, or ending
staggered elections, a proxy perennial, came in second with 42
proposals.) At 16 of the companies, including high-tech outfits such as
Advanced Micro Devices and Altera Corp., the proposals for majority
voting actually passed. Overall, their support from shareholders
averaged 45%, versus 12% for the dozen proposals submitted the previous
year, when none passed. As Patrick McGurn, executive president of ISS,
notes, the push for majority voting “has grown exponentially.”
The
plurality vote is a holdover from the 20th century, when many
corporations were owned by rival factions battling for control of the
board. Since no candidate was likely to win a clear majority of over
50% of the votes cast, there was a risk that board seats would not be
filled. So Delaware law, which covers more than half of public
companies, opted for a plurality vote instead, awarding victory to
whoever got the highest number of votes. Other states followed suit.
Battles for votes still happen in contested elections, but they’re rare
these days. More commonly, only one candidate runs for a board seat and
voters who don’t like him or her or who object to board actions as a
whole simply withhold their votes. In the case of institutional
shareholders, they also often recommend that others follow suit. But
this arrangement seems to be changing. Among recent developments:
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Thirteen
large companies, including Citigroup, Dow Chemical, Intel, and Time
Warner, have met with four union pension funds to discuss the
feasibility of majority voting. They were to issue a report as a group
late in 2005.
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The American Bar Association has
established a director-voting task force that is looking into whether
its Model Business Corporation Act should be revised to favor majority
voting. A substantial number of states follow the act, and Delaware is
influenced by it. The task force has no deadline.
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Roughly
two dozen companies, led by pharmaceutical giant Pfizer, have already
voluntarily changed their corporate governance guidelines to say that
any director who receives more withhold votes than votes “for” must
submit his or her resignation.
Clearly
activists want that withhold vote to mean a lot more. While Pfizer and
others have bought into this principle by altering their governance
guidelines, they have included a big escape clause that irks reformers:
Their boards do not have to accept the resignations of directors who
get a majority of withhold votes. To Margaret Foran, the drug company’s
senior vice president for corporate governance and associate general
counsel (and co-chair of the ABA task force), this gives everybody
breathing room. “We all need flexibility as we try to figure out what
works best,” she says. “If there is a problem with a specific type of
director, then ours is a very simple solution. It gives us time to talk
to the institutions and find out what’s going on.”
The
chief proponents of majority voting have been the union pension funds,
notably the United Brotherhood of Carpenters & Joiners of America.
They’ve been supported by big public pension funds like the California
Public Employees’ Retirement System, along with ISS and fellow
watchdogs Glass Lewis & Co. and the Council of Institutional
Investors. Says Richard Ferlauto, director of investment policy at the
American Federation of State, County and Municipal Employees, which has
also filed proposals for majority voting: “There seems to be a fairly
broad consensus, at least among shareholders, that votes need to count
for something.”
The demands for change began to gather
steam two years ago with the Securities and Exchange Commission’s push
to improve shareholder access to the ballot. The agency wanted big
shareholders to have the right to include their nominees for a board in
the company’s proxy materials (provided they met certain somewhat
complex conditions), rather than being forced to mount an independent
campaign. The idea suffocated under ferocious business-community
opposition and the departure of its chief proponent, SEC chairman
William Donaldson. So having lost out on the possibility of nominating
their own directors, the activists began to think about the flip side:
getting rid of directors they didn’t like.
With one
exception, all the 2005 proposals calling for majority voting were
“precatory”—that is, they asked that boards adopt majority
voting—instead of binding, which would force the companies to change
their bylaws. Explains Richard Ferlauto: “The purpose of precatory
resolutions is to alert boards that if they don’t move on these,
binding ones will follow.”
The 2005 exception came
about in October, when Ferlauto’s union submitted a binding proposal at
Paychex Inc.’s annual meeting. The motion was defeated 80% to 19% (1%
abstained). But it did find qualified support in a surprising
quarter—John Morphy, Paychex’s CFO. “I think majority voting is
probably the right answer,” he said before the vote. But Morphy wants
to wait until there is an established best practice and then adopt
that. “We think it’s better to go to majority voting because it has
become a best practice, and not because someone forced you to,” he says.
Loss
of their board seats may also mean that directors lose control of the
nomination process for new board members. But don’t turn to Ferlauto
for sympathy. “You have to add directors to the board who can shake up
a company that needs it,” he says. “You need to avoid ending up with a
cycle where, as [former SEC commissioner] Harvey Goldschmidt puts it,
one bozo replaces another.”
Some directors fear that
majority voting will enable special interests to hijack the corporate
agenda. In “The Case for Limited Shareholder Voting Rights,” a paper he
wrote in 2004, UCLA law professor Stephen Bainbridge said,
“Institutional investors with substantial decision-making influence
will be tempted to use their position to self-deal; i.e. to take a
non-pro-rata share of the firm’s assets and earnings.” He added a
footnote about how unions use their share ownership in a company to
obtain worker benefits they can’t get from collective bargaining.
Robert
McCormick, vice president of proxy research and operations at Glass
Lewis & Co., the activist group, believes this line of thinking
patronizes stockholders. “Yes,” he says, “there may be some who are
trying to put forth their own agendas, but all investors are looking to
maximize their returns.”
And what happens if majority
voting leaves a company way down on its board head count, or even with
no board at all? The likelihood of the latter, of course, is—or should
be—remote. If the board presents a director slate that objectionable to
shareholders, the company should know it, and know why, long before the
vote is tallied. Says Dan Dalton, director of the Institute for
Corporate Governance at Indiana University: “Public companies have
enormous exposure to institutional investors. If they manage to vote
four directors, say, off the board, it isn’t just disgruntled
shareholders—it’s the entire investment community speaking. Were that
to happen, almost certainly there has been a failed negotiation between
the company and the shareholders.”
The loss of an
individual director or two is a possibility, and even the CEO could
find himself a boardroom outcast. At the 2005 annual meeting of
publisher McGraw-Hill Cos., Harold W. McGraw III, the chairman and CEO,
received a 32% withhold vote. Activists were miffed that the company
had ignored a 2004 shareholder proposal to repeal its poison pill.
Filling
seats left empty as a result of majority voting can be done in various
ways. Boards themselves can elect replacements, who then stand for
election at the next annual meeting. Attorney Ira Milstein, the
governance expert at Weil Gotshal & Manges, likes the Pfizer
approach—namely that a company should be required to convene the
shareholders and elect replacements within 120 days. The Council of
Institutional Investors wants replacements elected by the shareholders
within 90 days.
Until those seats are filled, a
company may well be in the awkward situation of having a board that is
at odds with the requirements of Sarbanes-Oxley. “Most of the
committees are three-person committees,” says Dan Dalton, “and if you
lose one person, you’re out of compliance.”
Activists
are already gearing up for the 2006 proxy season. The Carpenters &
Joiners union has filed a nonbinding proposal to elect the directors of
uniform manufacturer Cintas Corp. by majority vote. The American
Federation of State, County and Municipal Employees has submitted a
similar proposal at the Morgan Stanley investment bank.
Even the Business Roundtable, no fan of majority voting, expects companies to continue changing their governance guidelines voluntarily. Says Dalton: “Taking the high ground when the cost is modest is a good risk for these companies. They don’t want the plumbers and steamfitters showing up at their doors.” That could throw a wrench into their business.
