Pass the Mylanta! This Proxy Season Could Be Extreme
from Winter 1999
by Ann Reilly Dowd
Wondering what will give you high anxiety this coming proxy season? Well, if your stock is soaring and you’ve carefully avoided a growing minefield of corporate governance no-nos, probably not much. But if poor performance or shabby board oversight leaves you vulnerable, stock up on antacids. More than ever, shareholder activism is going mainstream, high-tech, and confrontational. If you’re in the cross hairs, 2000 could be the year that proxy season turns into an extreme sport.
At the very least, you can bet that resolutions that won strong voter support last year will be back with a vengeance. Among them: proposals to kill dead-hand poison pills, to eliminate staggered boards, and to require shareholder votes on new poison pills and the repricing of stock options. But what you really need to think about are the new themes, players, and tactics that could take you by surprise. Are you ready?
Hot Themes
EXECUTIVE PAY. “White hot” is how Patrick McGurn, a vice president at Institutional Shareholder Services, describes the increasingly intense spotlight focused on executive pay and stock option plans. Not only are labor and religious groups revving up their campaigns against platinum CEO pay packages, but now joining the critics’ chorus are Wall Street analysts, investors such as Warren Buffett, and even Fed Chairman Alan Greenspan. Their fear: that the explosion of stock options is eroding the quality of corporate balance sheets, particularly in the high-tech and financial sectors where options have been used aggressively to attract executive talent. Says McGurn: “What we’re seeing is a pincer movement of social activists and Wall Street interests on compensation issues that board members can no longer ignore.”
Ironically, the activists’ current complaints are the unintended consequences of earlier victories. Back in 1993, after presidential candidate Bill Clinton had milked the issue with voters, Congress passed legislation requiring that CEO cash compensation exceeding $1 million a year be performance-based. As a result, companies turned to stock and stock options to reward their most valued executives. By 1998, Pearl Meyer & Partners, an executive compensation consulting firm, found that stock options accounted for a record 2% of all stock outstanding at the 200 largest companies in America. At 15 of those firms, options represented more than 25% of all shares outstanding; at Delta Air Lines, Lehman Brothers, and Merrill Lynch, a stunning 50% or more.
So what? After all, isn’t it an article of corporate governance faith that executives should be tethered by golden handcuffs to their company’s performance? Yes, but... respond the critics. At these record levels, they worry that stock and option grants threaten to dilute the holdings of existing shareholders and drain corporate assets as companies dip into cash—or worse yet, borrow—to purchase shares for delivery when the options are exercised. What’s more, since these costs do not have to be written off, they artificially inflate reported earnings. Investor Buffet describes this as “Alice-in-Wonderland” accounting and calls it “outrageous.” Indeed, the Fed estimates that charging these costs against earnings would have reduced corporate profits by one to two percentage points a year over the past five years.
Next year, expect labor pension funds to come back strong with a spate of shareholder proposals designed to align stock options more closely with performance, either by setting the exercise price significantly above the market at the time of the grant, or linking the exercise price to an index. This year, with minimal effort, the AFL-CIO won a stunning 34% vote at Chubb Corp. for a proposal that all future stock option grants to senior executives be tightly tied to relative performance. Next year, AFL-CIO Shareholder Initiatives Coordinator Beth Young promises the union will push more of these resolutions, and with gusto. In addition, she predicts labor activists will be more aggressive in fighting new stock option plans considered dilutive. Last year, Strategic Compensation Research Associates found an “alarming” increase in antagonism against stock option plans: Shareholders defeated a record 15 plans, while 270 were opposed by more than 30% of voters—double the level of opposition just two years ago.
Others will pursue variations on the pay theme. Responsible Wealth, a group of individual investors, is expected to ask companies to establish a cap on executive compensation expressed as a multiple of the compensation of the lowest-paid worker. Its 1999 targets included AT&T, AlliedSignal, Bank of America, BankBoston, Citigroup, Computer Associates, and General Electric. Delta pilots have filed a resolution calling for the company to tie executive compensation to employee satisfaction. Social welfare and religious leaders included a pay element in more than a quarter of their 1999 shareholder proposals. For example, several resolutions linked compensation for tobacco executives to progress in fighting teen smoking. While none passed, they succeeded in creating the negative publicity that no director relishes.
More likely to succeed will be proposals aimed at increasing the independence of directors on compensation committees. At the AFL-CIO’s Executive Paywatch website (www.paywatch.org), the labor federation lists 27 firms, including Callaway Golf and Hyperion Solutions, at which the CEO or a business associate of the CEO sits on the compensation committee that sets the chief executive’s pay. At another 26, including Coca-Cola, Nike, and Sara Lee, Paywatch claims compensation committee members include people doing business with the company.
Besides pushing the Securities and Exchange Commission to require more extensive disclosure by compensation committee members, Young predicts the AFL-CIO and its labor allies will be filing shareholder resolutions demanding greater board independence. Among other things, they will urge companies to adopt the Council of Institutional Investors’ tough standard of independence, which prevents anyone with connections to the company beyond his or her directorship from sitting on compensation, audit, or nominating committees.
ENVIRONMENTAL ISSUES. When Sister Pat Daly talks, CEOs shiver. In the past, the 43-year-old Dominican nun has taken busloads of environmentalists to pray at Superfund sites, lobbied Detroit to produce an 80-mile-per-gallon car, and, during the days of apartheid, helped convince U.S. companies to leave South Africa. Next year, she will be one of the leaders in a growing war against companies that belong to the so-called Global Climate Coalition, a group of oil, chemical, and utility firms organized to debunk the concept of global warming. Led by a Washington, D.C.-based group called Ozone Action, Sister Daly’s campaign will file shareholder resolutions at more than a dozen companies, asking them to disclose the extent of their businesses’ reliance on fossil fuels and what they are doing to reduce that dependence. The top target will be Exxon, which Daly calls “a dinosaur.” Others on the activists’ hit list include Texaco, Chevron, Allegheny Energy, Southern Co., CSX, General Motors, and Ford.
Even hotter will be the issue of genetically modified seeds and crops, which already has created a consumer and government backlash in Europe. Next year, for the first time, a coalition of social, religious, and environmental activists spearheaded by the Interfaith Center on Corporate Responsibility will be writing letters and pushing shareholder resolutions at dozens of U.S. companies. Their goal: to halt the production of bioengineered products until further testing determines their safety to humans and the environment. Chief among the activists’ targets are seed producers Monsanto and DuPont, food processors Kraft and General Mills, and major supermarket and restaurant chains. “Last year, 75% of infant formulas made in the U.S. included genetically engineered soybeans,” says Sister Daly. “How many mothers knew that? We need full disclosure.”
GAY RIGHTS. Proposals to increase the number of women and minorities on corporate boards have long been proxy season staples. But next year, expect a new twist to the diversity theme. Gay and lesbian groups are gearing up to insist that companies adopt nondiscrimination policies regarding sexual orientation, an effort that could conceivably affect everything from hiring and firing to benefits and even the makeup of boards. This year, McDonald’s, Chrysler, Johnson & Johnson, and American Home Products adopted nondiscrimination policies after the Pride Foundation threatened to file shareholder resolutions. Other targets, including General Electric and Exxon, were less responsive. Next year, expect Pride, the Interfaith Center on Corporate Responsibility, and other socially responsible funds to target six to 10 more companies.
Facilitating such resolutions is a landmark SEC interpretation regarding which shareholder proposals corporations must include in their proxies. In 1998, the agency reversed its earlier Cracker Barrel decision that had deemed workplace issues “ordinary business.” As a result, explains Meg Voorhes, who tracks social and religious resolutions for the Investor Responsibility Research Center: “More equal opportunity and discrimination resolutions came up last year. Those resolutions did very well, and we will likely see more next year, particularly on gay and lesbian rights.”
New Players
HEDGE FUND MANAGERS. Hedge funds take positions in underperforming companies, agitate for change, and pocket the profits if the stocks rebound. Now there are signs that the managers of more traditional hedge funds, and a few mutual fund managers as well, are getting into the corporate governance game. “It’s almost becoming something akin to arbitrage,” says Patrick McGurn. “The same people you used to see buying a company when it was in play because of a merger are now turning to corporate governance to ratchet up their returns.”
In August, Julian Robertson of Tiger Management, a New York City hedge fund, announced in SEC filings that he would push US Airways management to consider changes, including a merger, sale, or recapitalization, to boost the company’s flagging stock value. In September, Reynolds Metals was put into play partly because of pressure from disgruntled shareholder Highfields Capital Management, a Boston hedge fund. Likewise, Greenway Partners leaned on Venator Group (formerly Woolworth) to restructure by seeking board seats, albeit unsuccessfully. Calpers, the giant California public employee pension plan that has long been a leading voice for corporate governance reforms, recently announced that it would invest $100 million in hedge funds whose goals it shared.
As for mutual funds, Michael Price, who manages a mutual fund group owned by Franklin Resources, helped facilitate the 1996 merger of Chase Manhattan and Chemical Bank and the 1998 sacking of Sunbeam’s CEO Al Dunlap. More recently Peter Langerman, the value-minded manager of Franklin Templeton’s Mutual Series Funds, announced in September that he would seek two board seats at the beleaguered Commercial Federal Corp., an Omaha-based savings and loan. Even Oakmark, a value fund known for its quiet presence, has been making a ruckus lately, calling for the sale of Dun & Bradstreet, one of its poorest performers. Behind the scenes, Vanguard and Heartland Advisors also have lobbied for corporate changes at underperforming companies in which they invest. Says Scott Fenn, executive director of the Investor Responsibility Research Center: “The fact that hedge funds and mutual funds are jumping on the corporate governance bandwagon is a vote of confidence that the state pension funds and other activists are on the right track and that corporate governance reforms can boost returns. Expect to see more of this.”
STUDENT ACTIVISTS. Not since the campus-led campaign against investment in South Africa in the early 1980s have colleges been so alive with anti-corporate zeal. Rallies, teach-ins, and sit-ins at colleges including Harvard, Yale, Duke, and the University of Michigan have turned up the heat on companies such as Nike, which, critics charge, use foreign sweatshop workers to manufacture clothing sold in the United States. This year, student activists at the University of Washington, Stanford, and Harvard have called for their universities to divest their interests in companies that are most resistant to addressing the threat of global warming. Fired up by their successes, a group of student activists at Yale has formed a nationwide coalition, called the Student Alliance to Reform Corporations, or STARC, whose goal is “to empower the socially responsible investing campaigns now active on more than 50 campuses and to spark the creation of many more.” Says STARC founding member Jonah Zern, a 21-year-old environmental policy major at Cornell University: “Corporations are run by white guys who aren’t exposed to the rest of society. Now they have a way of seeing that people and the environment are suffering as a result of their greed.’’ Watch for student groups to align with environmental, religious, and labor groups behind shareholder resolutions on issues ranging from global warming to bioengineered “Frankenfoods,” foreign sweatshops, and workplace discrimination both at home and abroad.
FOREIGNERS. Shareholder activism is going global. This year, Calpers and Lens announced a new alliance with the giant United Kingdom pension fund Hermes, which manages $2.8 billion in assets in the United States. Beginning in 1999, Hermes agreed to follow Calpers’ lead in voting its U.S. proxies. In addition, Hermes’ corporate governance executive, Michelle Edkins, says the fund will look for U.S. partners to push similar proposals. Among her biggest concerns: excessive CEO pay in the U.S., which Edkins says is inflating U.K. executive pay and undermining shareholder value. Also on her worry list: the quality and independence of directors. Noting that other U.K. funds are considering a similar foray into U.S. shareholder activism, Edkins adds: “I think it’s the beginning of a trend.”
Likewise, U.S. activists are looking abroad for underperformers. Calpers and Lens will vote their U.K. proxies with Hermes. Others will go it on their own. For example, while New York City hedge fund operator Guy Wyser-Pratte is launching a global corporate governance fund to invest in underperforming U.S. companies, he is particularly eyeing Europe, where he sees a plethora of opportunities. Says Lens’ principal, Nell Minow: “This international thing will just be a monster.”
Power Tools
BINDING RESOLUTIONS. Frustrated by corporations that ignore shareholder resolutions, institutional investors such as the State of Wisconsin Investment Board (SWIB) most likely will continue to file binding resolutions that, unlike typical resolutions, actually change the bylaws of the corporation. In 1999, IRRC reports, 43 binding resolutions were attempted, many of them pushing for shareholder approval of new poison pills or the repricing of underwater stock options. Of the 15 that made it to a vote, eight won a majority, though only four passed because of tough requirements for bylaw changes. Expect more binding resolutions next year. There’s also bound to be more legal wrangling, since companies have decided to sue over the validity of such bylaw changes—and activists such as SWIB have proved they are willing to fight back.
THE INTERNET. Of all the new weapons available to corporate governance activists, the Internet is the scariest. Consider the tale of disgruntled investors in bankrupt United Companies Financial Corp., a Baton Rouge lender, who met on a Yahoo message board. Led by Martin Stoller, a professor of organization behavior at Northwestern University, the dissidents organized themselves into a powerful bloc of vote-flexing shareholders. As a result, a bankruptcy court that put them high on the list of creditors likely to get paid. “The Internet holds an almost unimaginable untapped power to change the way corporate governance has been done,” Stoller told the Washington Post. “The Net has the power to replace the illusion of shareholder rights with the reality of it. It’s the great democratizer.”
And activist institutions are accelerating the trend. The Council of Institutional Investors, which represents major activist pension funds such as Calpers and SWIB, posts on its website the names of companies that, for two years in a row, have ignored shareholders’ proposals. Meanwhile, Calpers is using its website to publicize proxy voting decisions for its top 100 holdings, and soon will e-mail updates to interested individuals. And of course, the AFL-CIO’s Paywatch website is integral to its plan to build individual shareholder opposition to excessive CEO pay.
Indeed, the rise of the individual shareholder activist is just beginning. In 1999, proxies representing 5.4 billion shares were voted on the Internet, up more than fourfold in one year, according to Electronic Data Systems, the leader in electronic proxy voting. Over the next decade, experts expect the share of votes cast on the Internet to explode. Toss in the demographic shift in the retail investing population to the more skeptical baby-boom generation, and the result could be utterly transforming. “By leaps and bounds you will see the radicalization of the corporate voting process,” predicts McGurn of Institutional Shareholder Services. Although small investors traditionally have been relatively loyal to management, McGurn says shareholders who vote on the Internet are much more likely to vote against the corporate brass. “The Internet is a forum that is, on balance, anti-corporate. You’re always just a few clicks away from a critic’s site or a chat room where group psychology can easily take over. It’s the Wild, Wild West out there. Yet companies are, by and large, defenseless. Ninety-nine percent of investor relations sites have nothing on corporate governance,” he says.
