What trends will heat up the next proxy season and beyond? That’s a burning question for the 80 percent of public companies that hold annual meetings during the first half of the year according to statistics from Broadridge, as well as for those that will wrap up the year later in the fall mini-season. Prognosticating what’s to come this season is no easy task, since proxy season is a complex process.
Sometimes the trends we predict are no more than wishful thinking. To make plausible predictions, we must find empirical clues from shareholder resolutions (hundreds each year), director elections (at thousands of companies each year), and then consider the activity that happens behind the scenes in private dialogue.
Bearing in mind our evidence, we can ask a number of questions:
What new rules will be effective? New requirements will raise expectations during this proxy season.
What proposals were mostsuccessful in 2017? Success (getting more than a 50 percent vote) emboldens proponents, so these issues are unlikely to go away.
What proposals were most frequent in 2017? Even if vote tallies are low, proponents may try again.
What proposals or other actions arebeing planned right nowfor the 2018 spring season—based on survey data and other sources?
After seeking answers, we will conclude with what we think will be hot in the 2018 proxy season.
Clue 1: What new rules or policies will be effective?
Proxy seasons can be shaped by new rules put in place by the Securities and Exchange Commission (SEC), as well as by new voting policies from proxy advisors such as Institutional Shareholder Services (ISS). This spring, a few major developments are notable. First, this is the first year that the pay ratio rule will require disclosure of the ratio between the total pay of a company’s median employee and its CEO (or, alternatively, the median total pay of all the company’s employees, minus the CEO). Despite new SEC guidance on calculation, the results, when disclosed prior to the annual meeting, are likely to spark some shareholder outcry at annual meetings.
A few additional issues stand out based on 2018 ISS Americas Proxy Voting Guidelines Updates. ISS has said that it will support shareholder proposals asking for more disclosure on environmental risk, and its updates point to recent policy changes from the Task Force on Climate-Related Financial Disclosures (TCFD). “The updates to ISS’ climate change risk policy better aligns it with the TCFD’s recommendations, which explicitly seek transparency around the board and management’s role in assessing and managing climate-related risks and opportunities,” the report says. Other proxy season trends may include more support for resolutions opposing excessive director pay and resolutions supporting gender pay equity, as predicted in this recent report from Gibson Dunn.
Clue 2: What proposals were successful last year?
Let’s look at the most successful proposals at the 250 largest companies by revenue throughout 2017 according to full-year data from Proxy Monitor. This source is representative of broader trends because, as noted in Proxy Monitor’s early 2017 overview, shareholder proposals are more common at the largest companies. Moreover, “the companies in the Proxy Monitor database encompass the majority of holdings for most diversified investors in the equity markets, making this analysis appropriate for the average shareholder.”
According to the report, governance proposals seem to take the prize. Fifteen of the 294 proposals at the top 250 public companies in 2017, or about 5 percent of the 294 proposals from investors, received a majority vote. Most of these winners can be called “corporate governance” proposals, rather than social issues. Three were for environmental impact reports (at Occidental Petroleum Corp., Exxon Mobil Corp., and PPL Corp.), but all the rest had to do with governance.
Five proposals were victories for proxy access (National Oilwell Varco, Humana, IBM, and Kinder Morgan, Inc.), five for simple majority voting (Cognizant Technology Solutions Corp., Marathon Petroleum Corp., L Brands, Paccar, and First Energy Corp.) and two were specific governance proposals. Shareholders at CVS Health Corp. voted to reduce required ownership to call a special meeting, and shareholders at ADP voted to repeal a bylaw provision that had been adopted without shareholder approval. That vote happened in November, in the so-called “mini-season” (the one experienced by the 20 percent of companies that hold their annual meeting in the second half of the year).
Clue 3: What proposals were most frequent last year?
Now let’s look at the resolutions proposed most frequently last year. Looking again at the 294 resolutions studied in the Proxy Monitor data, the trends are clear. Classifying the proposals generally into the three categories, we see that social policy, with 164 resolutions, was the most popular proposal category, followed by corporate governance issues at 107. Executive compensation did not draw shareholder ire; only 23 resolutions focused on it, down from higher levels in the past.
Within social policy, the double-digit issues raised across at least 10 companies were environmental (48 issues were proposed—or 52 if you count four “sustainability metrics” proposals), lobbying (38), political spending (13), employment rights (17), gender equality (12), and human rights (12).
Diversity proposals are also notable. Although they were relatively rare compared to other 2017 issues, they showed show signs of growth. There were only three such proposals at major companies the previous year, while there were five in 2017. Furthermore, although they did not propose board diversity resolutions, State Street Corp., a major institutional investor, voted against directors serving on nominating committees for boards without women, and BlackRock also voted no at some boards over the diversity issue.
Within corporate governance, the double-digit issues were chair independence (28 resolutions), proxy access (22), and special meetings (15). Remaining corporate governance issues were introduced at 9 or fewer companies. Although ISS flagged director overboarding as an issue for 2017 and revised its guidelines accordingly, there were no proposals about this last year.
Finally, within executive pay, no particular issue dominated. Various new requirements in pay approval and pay disclosure (say on pay, pay ratio, etc.) have largely resolved this issue.
Clue 4: What proposals or other actions are being planned for 2018?
As of early January 2018, we have little data on shareholder resolutions to be included in 2018 proxy statements. While some companies have already released their 2018 proxies, none of these contain shareholder resolutions. However, we do know what ISS is recommending with respect to shareholder resolutions in the newest revisions to its proxy voting guidelines for 2018.
As reported in the Wall Street Journal on December 22, companies preparing their 2018 proxy statements can expect “continuing pressure from investors to enhance disclosures regarding board composition, climate change risk, and cybersecurity.” The prediction is based on a survey conducted by executive search firm Russell Reynolds. Secondary trends included the usual mix of corporate governance, board composition, and executive compensation.
Of course, shareholder proposals are not the only way to change a company. Instead of submitting a shareholder resolution on an issue, a shareholder can wage a so-called proxy fight by sending investors a separate proxy voting card with an alternative slate of directors, or, in the case of companies with proxy access, by including a dissident slate in the company’s proxy. (There is still no such thing as a universal proxy card that allows investors to mix and match candidates from the nominating committee and dissidents, despite an SEC proposal in that regard.) According to FactSet, 2017 saw 75 proxy fights for board seats. While this is fewer than in 2016—which at 101 proxy fights was a banner year—the battles were waged upon household names: ADP, General Motors Co., and Procter & Gamble Co., among others.
What’s Hot and Why
Here is our short-list of five proxy issues that are likely to appear in 2018.
Pay Ratio. Shareholders will be reading these disclosures for the first time.
Environmental proposals. They have been both frequent and successful in recent times, and because ISS is drawing attention to them again this year.
Governance mechanics. Why? Because they matter. They are rarely discussed by bloggers due to their dry and technical nature, but governance issues continue to be popular proxy issues, with more than 100 last year, and with the highest rate of success (12 wins last year—a strong result since majority votes on resolutions remain extremely rare).
Activism. As Douglas Chia, head of corporate governance at the Conference Board, stated in a recent Equilar report, “public company boards will have their work cut out for them in 2018 with activism continuing to dominate the governance landscape.”
Director compensation continues to gain attention in the corporate governance community. Once one of the most mundane topics of corporate compensation, director pay is becoming the topic du jour as governance experts and current board members alike debate the value of a strong, engaged board of directors, as evidenced by the fact that ISS now assesses director compensation levels on a relative basis using QuickScore, its analysis and rating system for corporate governance practices. All of this prompts the question: What is a quality board of directors really worth?
Total board cost (defined here as the sum of cash, equity, pension value changes, and all other compensation amounts as reported in the director compensation table of a company’s latest proxy statement) has emerged as another way for directors and other stakeholders to evaluate director compensation and to demonstrate the value of boards to shareholders.
Steven Hall and Partners studied the early proxy filings of 100 U.S.-based companies with revenues in excess of $1 billion. The study examined the aggregate amounts of cash, equity, and other compensation paid to directors, as disclosed in proxy tables. Among this year’s early proxy filers, the median increase of total board fees was 7 percent in 2014, bringing the median total cost to $2 million. The movement in pay was driven by a number of factors, including a median increase of 6 percent in equity awards granted, a 2 percent rise in the cash compensation, and an increase in the number of paid directors.
In addition, we found at median:
Total cash payments to directors increased 2 percent to $777,000
Total equity compensation rose 6 percent to $1.1 million
Total board fees grew 7 percent to $2.0 million
Boards were comprised of nine paid directors, up from eight in 2013
Average cost per director increased 5 percent, to $230,000
We also compared total board cost to revenue, net income, and market capitalization amounts to show the minimal financial impact of director fees. At median, total board cost equals 0.05 percent of revenue, 0.66 percent of net income and 0.03 percent of market capitalization. These figures reinforce the notion that the board continues to represent one of the wisest investments of capital, particularly in light of the experience and specific expertise that directors bring to the companies they serve.
Average Cost per Director
Among the companies studied, average cost per director ranged from $78,617 to $410,678 in 2014. Among the companies reviewed, the median increase over 2013 pay levels was 5 percent. The median average cost per director equaled $229,899 in 2014.
According to the study, the mix of pay delivered to directors remained virtually unchanged in 2014. Equity awards accounted for 55 percent of total board cost, up from 54 percent in 2013. Cash compensation decreased as a percent of total board cost to 42 percent, from 44 percent in 2013. Change in pension values increased to 1 percent of total board cost, from 0 percent in 2013, and all other compensation remained equal to 2 percent of total board cost. The increase in pension values is attributable to changes in actuarial assumptions used to value these programs, rather than a shift in approach; pension programs for directors are no longer a part of most pay programs.
Among the 100 companies studied:
Revenues ranged from $1 billion to $183 billion
Median equals $2.9 billion
Median one-year revenue growth equaled 7 percent
Net income ranged from negative $53 million to $40 billion
Median equals $269 million
Median one-year net income growth equaled 11 percent
One-year total shareholder return grew 10 percent
Action Items for Director Consideration
The recent focus on director pay by shareholders and members of the corporate governance community has prompted a number of important changes in the way directors consider and implement director pay programs. First, consider director pay issues on an annual, rather than a biennial or triennial basis. Staying abreast of market movements with small annual adjustments is generally preferable to larger, sporadic jumps in pay. While the ways of delivering pay (cash and equity retainers, meeting fees, and additional retainers for committee service) may vary depending upon the company, directors should focus on total pay per director as well as the total cost of the board. In addition, companies should remain mindful of how pay compares to that of their direct competitors as well as companies in their peer group, as defined by proxy advisory services like ISS.
As it comes time for your company to conduct its annual review of director compensation, we recommend that you consider the following questions:
Is your director compensation program fair and competitive?
Does the program allow you to attract and retain high quality director candidates?
Is the program justifiable to shareholders?
Are modifications to your director compensation program appropriate and reflective of projected market increases and company growth?
How does your director pay mix compare to the pay mix at companies of similar size and/or industry?
Is your program’s structure aligned with the current best practice of delivering at least half of total value to directors in the form of equity? If your program’s equity awards are denominated in shares, does your company account for the total potential volatility in grant value?
To what degree does your company consider total board cost when making modifications to your director compensation program?
For a more detailed analysis on director compensation, look for Steven Hall & Partners’ annual Director Compensation Study due out later this year.
The appropriate length of service by a company director is an emerging issue in corporate governance that yields varying responses among large shareholders, proxy advisors, and directors themselves. Recent board tenure concerns center around a director’s ability to remain independent after extended service, lack of industry expertise and technological familiarity, and poor diversity on corporate boards. Conversely, long-tenured directors can be beneficial because of their deep knowledge of the company acquired through service, the continuity and stability they offer, and their grasp of the historical perspectives that can inform current company strategy. As this issue continues to draw attention from various interested constituencies, corporations should continually assess board composition and consider their current policies on director tenure as shareholders become more attuned to extended service and its implications.
The Current State of Director Tenure in the U.S. and Abroad
No overarching law or regulation currently limits the length of board service in the United States. In fact, few United States public companies address board tenure directly in their bylaws. According to SpencerStuart, approximately 3 percent of company boards in the S&P 500 have specified term limits for directors. Only 17 companies in the S&P 500 set term limits for their directors in 2012, with no company adopting a term of less than 10 years. That same year, board turnover on the S&P 500 reached a 10-year low, reflecting the trend toward directors remaining in their positions.
Mandatory retirement ages are more common. SpencerStuart reports that 72 percent of companies in the S&P 500 have mandatory retirement ages, which reflects a 6 percent increase since 2003. Of those, the mandatory age exceeds 72 in 88 percent of corporate boards. Over the last 10 years, the percentage of boards with mandatory retirement ages of 75 or older has increased from 3 percent to 24 percent, while the percentage of boards with a mandatory retirement at age 70 decreased from 51 percent to 11 percent. Moreover, some U.S. public companies allow boards to waive the mandatory retirement age for directors, which is typically between age 72 and 75, according to David A. Katz and Laura A. McIntosh, authors of Renewed Focus on Corporate Director Tenure.
The lack of term limits and mandatory retirement ages promotes extended board service. Last year, 20 percent of U.S. corporate boards in the S&P 500 had an average director tenure of at least 11 years. The median age of directors was 63.
Director tenure limits are more prevalent outside the United States. The European Commission notes that an appropriate maximum tenure for a director is three terms, or 12 years. The United Kingdom employs the “complain or explain” model, which presumes that directors are no longer independent after nine years of service unless a company can explain why it has determined that a director remains independent after they reach the presumption threshold. France employs one of the most stringent guidelines for independent directors, capping director service at 12 years, though this does not give France the lowest average director tenure in Europe. That distinction goes to Germany, with an average director tenure of five years., Collectively, Europe has relatively shorter board tenures on average compared to the United States, which is 8.6 years. For reference, Spain has the highest average tenure in Europe at 7.7 years. In Asia, Hong Kong does not limit director service, but companies appointing an independent director to serve longer than nine years must employ a separate vote for the director using a special resolution.
Calls for Change
Recently, shareholder advocates have pushed director tenure to the forefront. Institutional Shareholder Services has been visible in highlighting potential issues with corporate director tenure, with its new Governance QuickScore 2.0 program. The product, which uses specific governance factors and technical specifications to rate company governance, takes director tenure into account. According to ISS, “[a] tenure of more than nine years is considered to potentially compromise a director’s independence.” ISS has not disclosed the weighting that each metric will actually have, so it is unknown how much impact long-tenured directors will have on a company’s QuickScore rating.
ISS has yet to alter its voting policy outside of QuickScore such that tenure can lead to a determination that a director is not independent. ISS does urge shareholders to vote against proposals to limit tenure by mandatory retirement ages or term limits, but it suggests shareholders scrutinize the average tenure of alldirectors if their tenure exceeds 15 years in order to promote independence and alternative perspectives.
State Street Global Advisors (SSGA) revised its view on board tenure in 2014 to reflect its support for board refreshment and planning for director succession. According to SSGA’s Head of Corporate Governance Rakhi Kumar, the new policy is “designed to identify companies with a preponderance of long-tenured directors, which may indicate a lack of refreshment of skills and perspectives . . . . [L]ong tenure may also diminish a director’s independence.” Though SSGA does not consider long-tenured directors to be entirely ineffective, SSGA discourages their presence on committees where “independence is considered paramount,” including the audit, compensation, and nominating/governance committees.
SSGA has indicated that it will screen companies based on whether their average board tenure is above one standard deviation from the average market tenure. If a company has a longer-than-average board tenure, SSGA will further screen it for (a) whether one-third of the non-executive directors have tenures in excess of two standard deviations from the average market tenure and (b) classified board structures. Following this screening, SSGA has indicated it may vote against the chair of the nominating committee, long-tenured directors serving on key committees, and/or (c) both the members of the nominating committee and long-tenured directors at companies with classified boards. SSGA, however, has not provided additional details on how it computes average board tenure.
The Council of Institutional Investors supports board turnover in order to guard against a “seasoned board member” losing his or her independence or thinking more like an insider over time. Further, CII’s policy highlights the high salaries that accompany director positions, and how the compensation fails to promote board refreshment. It is estimated that S&P 500 companies pay independent directors an average annual salary of $250,000. Despite an updated policy, however, CII refuses to deem its policy as endorsing a tenure limit, highlighting that removing long-tenured directors “could rob the board of critical expertise.”
Glass Lewis & Co. pushes back on the idea of an inflexible rule limiting director service. Glass Lewis believes such inflexible limits may not provide benefits or returns for shareholders. Its 2014 proxy policy thus reflects the idea that term and age limits are not in shareholders’ best interests, and that there is no evidence of a connection “between either length of tenure or age and director performance.” Nevertheless, Glass Lewis supports “periodic director rotation” through shareholder monitoring to promote fresh perspectives, new ideas, and business strategies. Glass Lewis notes that if a company does have an age or a term limit, shareholders should vote against the board waiving its self-imposed limit absent extenuating circumstances like a merger.
The Effects of Board Tenure Limits
There is no “one-size-fits-all” approach to board tenure. There are merits to imposing board tenure limits at some companies, specifically the potential to promote the independence of corporate directors by limited extensive service. Some directors may also become complacent or out of touch with the company or industry after extensive service. Replacing long-tenured directors may offer a new opportunity for the company to infuse fresh perspectives into the board, whether it may be in corporate strategy or industry expertise. In addition, boards can use mandatory retirement ages or term limits to avoid otherwise unpleasant conversations with directors whom the board believes should retire.
Despite the potential benefits of mandatory director refreshment, there is no strong indication that long-serving directors are not independent, which is the primary concern of those who criticize extended board service. A “one-size-fits-all” approach to term limits or mandatory board refreshment would restrict or remove experienced, knowledgeable board members arbitrarily and create situational difficulties for the company going forward. As noted above, long-tenured directors are often the most knowledgeable about the company and offer stability, particularly during changes in senior management. In addition, at some companies the most long-tenured directors often exercise considerable influence over less-tenured senior management. These factors balance heavily against any strict rule on board tenure. Additionally, term limits offer the potential to interfere with the development of effective collaboration among board members that have developed strong working relationships over the course of their tenures.
It remains to be seen if the increased attention on board tenure will have a significant impact on the corporate governance of U.S. public companies going forward, or if the international trends will be imitated in the United States. Mandatory term limits applicable to all U.S. companies are inappropriate. Rather, companies should continue to have the choice of whether to impose restrictions on board tenure. The important issue, therefore, is how companies make that choice. We suggest a thoughtful consideration of board composition by nominating committees, boards and shareholders on a case-by-case basis that considers tenure, expertise in the particular industry, knowledge about a particular company, diversity, director competency, and the company’s success over the director’s tenure. Boards must also carefully assess their own composition in light of various experiences, backgrounds, skills, and traits that could enhance board performance. Boards themselves, along with input from their shareholders via annual director elections and shareholder engagement, are best equipped to assess whether to retain or remove their own directors, and should not be burdened by a uniform rule that may potentially yield unintended consequences to the detriment of the company and the shareholders.
Steven Haas is a partner in Hunton & Williams’ Richmond, VA, office. He represents clients on corporate governance and M&A matters. He also regularly counsels clients with respect to corporate governance issues and fiduciary duty litigation.