Corporate captains have been brought up short by the impact on this year's proxy round of the IRAA
Separating tobacco business from consumer products divisions? Labour issues? Compensation? Staggered boards? Secret ballots? Golden parachutes? All these were likely to be on the proxy agenda in 1995, but until the season got under way it was anyone's guess which would be the hot issues for this year's round.
Now, with the season in full swing, it's clear that the issue attracting most attention is that of non-employed directors' pensions. 'There are about 20 proposals to do with directors' retirement plans this year,' notes Jamie Heard, of Institutional Shareholder Services, the governance advisory firm based just outside Washington. 'Most of them, interestingly, are being submitted by individuals rather than by institutions.'
Many of those individuals are filing their proposals under the wing of the IRAA, which is this year's other talking point. The old United Shareholders of America, the umbrella organisation for individual shareholder activists which shut up shop last February, has been superseded by this new force, the Investor Rights Association of America. And it's been the group making most of the noise in this year's proxy round.
Although the IRAA has been behind many proposals on directors' pension benefits, it's by no means a single issue pressure group. Indeed, it could well become a serious force for under-performing companies to reckon with, especially those with over-protective management structures. Founded by president Bill Steiner, who was chair of the USA's New York chapter, the IRAA has had some notable successes already. Steiner and Tom Flanagan, a stockbroker in Great Neck, New York, are the two most active IRAA members and they are pretty satisfied with the way things have gone so far.
'We've submitted 60 proposals this year,' reports Flanagan. 'And I believe that's more than any other organisation in any other year.' More importantly, many mainstream institutions voted in favour of IRAA resolutions, often advised to do so by organisations like ISS. As a result, they typically achieved votes in the 35-45 per cent range. 'Now that we have the proven backing of institutions, we might get funding next year to expand our activities,' notes an optimistic Flanagan. 'We're hoping to file 100 resolutions next year.'
Despite this support, Flanagan points out that, unlike the investing institutions, his group cannot exploit the SEC's freed-up communications rules - at least not unless it files with the SEC. In any event, it simply doesn't have the resources to set about calling up all the shareholders - or paying someone else to do so. That doesn't seem to have inhibited IRAA's success too much, however. 'We've actually won in two cases, so far,' notes Flanagan. 'Both were proposals to eliminate staggered boards: one at Stride Right, the shoe company; the other at Liz Claiborne, where we got 63 per cent of the vote in mid-May.'
It was on this issue of classified boards that the IRAA submitted the bulk of its proposals this year. But the subject creating most of the buzz was that of directors' retirement benefits, on which it filed resolutions at some 20 companies, including GTE, Warner-Lambert, Merck, Johnson & Johnson, Bell Atlantic and Champion International. Apart from helping to push this issue right to the top of the activist agenda, the IRAA claims some specific victories. 'We put in a proposal on retirement plans for outside directors at Alexander & Alexander, for example, but it decided to get rid of the plans itself in advance of the annual meeting,' says Flanagan. The company claims to have had the issue under review well before the IRAA's proposal came along, but Flanagan clearly has his doubts about this.
Other companies have been prepared to negotiate. 'Managements are willing to talk to us. We explain that we want to eliminate management entrenchment devices, and they do listen,' says Flanagan. His group has focused its efforts on four issues in all this year. In addition to the 40-plus filings on classified boards and directors' retirement benefits, it has made nearly a dozen submissions on golden parachutes. 'We believe these should either be eliminated or put to a shareholder vote. They remove any incentive for management to perform.'
The fourth IRAA issue for this year has been the independence of directors, although this accounted for less than a handful of proposals. 'But next year we intend to put up specific proposals to the effect that outside directors should have a minimum of half their compensation in stock; and that they should have to hold the stock for at least three years.'
This broadens the issue out to director compensation and consulting fees generally, a debate in which interest was fuelled by the shenanigans at companies like WR Grace this year. WR Grace's 1995 proxy statement showed just what a fine time directors could have. Former CEO J Peter Grace Jnr had such a staggering list of benefits that even the most cynical of corporate critics were surprised. Apart from his $5mn lump sum paid on retirement in 1992, the proxy statement listed direct financial benefits which included consulting fees of $50,000 a month; a $1 mn a year pension; insurance policies worth even more millions; and further cash to cover tax obligations.
In addition, Grace - who has since died - had a free apartment, as well as nursing, a cook and security services to go with it; and free use of both a limousine service and corporate aircraft. Then there was the funding of business ventures for his son. And the consulting fees for five non-employee directors, who were typically collecting $200,000-$600,000 a year, with additional sums being paid to their own consulting firms in some cases.
The company's CEO and president JP Bolduc departed back in February, either because he sexually harassed female members of staff or because the board disagreed with him about the need to disclose details of the company's use of funds on Peter Grace and his son, depending on who you believe. But this is a story in its own right, with numerous sub-plots and ramifications.
In fact, it may yet have a happy ending: the new CEO and chairman, Albert Costello, stepped ably into the breach of a potential shareholder revolt at the meeting on May 10, just ten days after his appointment. Costello said his immediate priority was to resolve the issue of the sale of subsidiary National Medical Care, seen by many as the best way of quickly increasing the company's value. He seemed to satisfy most shareholders. A threat by some to withhold votes for re-election of four directors resulted in just 19 per cent using this means to show their displeasure - not insignificant, but fewer than could reasonably have been hoped for a few weeks earlier.
Grace wasn't the only company in this particular firing line. Kmart's CEO Joseph Antonini was fired in March following shareholder pressure; and Morrison Knudsen CEO William Agee was also forced out by angry shareholders - to name but two.
But in terms of the broader context of this year's proxy season, the particular events at WR Grace served to focus attention on corporate largesse and its implications for conflicts of interest, throwing up the specific question of whether 'outside' directors who are being paid consulting fees can seriously fulfil an independent supervisory role, keeping management in check. 'They are bound to start thinking like employees and rubber-stamping management plans,' contends Tom Flanagan, 'instead of thinking like shareholders.'
This question seems likely to be taken up further in coming years, with the IRAA probably continuing to take a lead. 'There's a strong trend under way now - we're just seeing the beginning of it but I think it will accelerate,' says Heard. 'We're going to see directors being paid more in stock and director retirement programmes being phased out. There will also be a trend away from directors serving as paid consultants, as this kind of compensation is increasingly seen as misaligning the interests of directors and shareholders. When pay is directed more towards stock, shareholders see a greater alignment of interests.'
But compensation has not been the only issue on this year's agenda: out of the 500-odd proposals on the ballot, the Investor Responsibility Research Center says most were on governance issues, with compensation ranking second.
'Many of the big institutional investors who have been major activists in the past are still interested in corporate governance,' says Heard. 'But they are finding that they don't need to use shareholder proposals as much as they used to. They have better options for pressing their points, generally by going to top management or the board.'
This change has been evident ever since institutions got the hang of the implications of the 1993 changes to the proxy rules. Since then, they have been able to work together to put pressure on companies to change their ways, with the result that companies have been more willing, year by year, to resolve contentious issues before they reach the annual meeting stage.
Take the New York-based College Retirement Equities Fund (Cref), the $65 bn variable annuity arm of TIAA-Cref, the world's largest pension fund (with $136 bn under management). Cref submitted 26 resolutions at the beginning of the 1995 proxy season, but had withdrawn most of them by the middle of May, following successful negotiations with the companies involved.
Cref's resolutions focused on three governance issues this year. The first of these is the issue of 'blank check' preferred stock, the special class of stock whose voting, dividend or other provisions are determined without shareholder approval. Ten of Cref's proposals addressed blank check preferred stock, but at the time of writing it was only expected to come to a vote at four: Burlington Northern, Colgate Palmolive, Mobil Corp and Phillips Petroleum. The others were all withdrawn.
At Texas Instruments, for example, Cref had asked the company to adopt a policy of seeking shareholder approval before placing such stock with any person or group, except where it was for the purpose of raising capital or making acquisitions in the normal course of business. Texas Instruments' board duly adopted a resolution that substantially met this demand. 'We were pleased that the management responded constructively to our concern, and that positive results were obtained for Texas Instruments' shareholders,' John Biggs, chairman of TIAA-Cref, acknowledged.
The second issue raised by Cref - at some 15 companies - sought the introduction of active policies at the companies concerned to find qualified women and minority candidates for nomination to their boards, with a view to creating more diverse representation of race, age, gender and experience.
By the end of March, ten of these had been withdrawn following satisfactory agreements with the corporations targeted. Another dropped by the wayside when the company was taken over; and one was omitted from the proxy on technical grounds. It went to a vote at Federal Paper Board Co Inc, at Shared Medical Systems, and at Nucor Corp. The latter fought back aggressively, attempting to exclude the proposal by raising objections to the SEC, which Cref in turn contested. The SEC found in Cref's favour so the resolution went ahead.
Cref's third issue was the adoption of secret ballots for voting, but this was filed at just one company which, as in so many cases nowadays, agreed to implement confidential voting rather than see the issue be put to the test at the meeting. But the tactic of talking with managements to try to win change through negotiation undoubtedly relies heavily on the threat - explicit or implicit - to fight hard on the issue if it does come to a vote, especially by rallying support among other institutions with whom they are now free to discuss voting plans.
And that, in turn, becomes a more effective threat as proposers increasingly succeed in garnering more support. 'Each year we see a slight increase in the level of support that some of these corporate governance shareholder proposals receive,' says Bill Crane, chief executive of Georgeson & Co in New York. 'And I would say that this year it's at an all-time high, as far as the percentage of shares that companies are seeing being voted in favour of stockholders' proposals. There's been enormous support, particularly for proposals to eliminate staggered boards, which does put pressure on management.'
The growing numbers of votes against management may result in part from the freedom institutions now have to speak to each other and encourage support from their brethren. 'But you also have to attribute some of the sponsors' success to ISS and similar organisations making voting recommendations,' says Crane. These firms have growing client numbers, so more institutions are reviewing what they have to say. 'It's not that their clients necessarily follow them 100 per cent of the time,' Crane adds. 'But proxy voting during the meeting season is an overwhelming task for institutions nowadays. They may have hundreds or even thousands of stocks in their portfolios, with most of the proxy statements concentrated in April and May. That means it's very difficult to analyse each one in respect of the individual companies. It's much more efficient to rely on outside firms to analyse them and make voting recommendations.'
Crane believes the other factor behind the increase in votes against management is the growing tendency for institutions to fix firm voting policies, from which they will rarely diverge. 'If, for example, an institution has established a position that it will vote to declassify a board whenever the opportunity arises, it will do that automatically. It is then very hard for a corporation to go and persuade that institution to make an exception in one particular case,' says Crane.
Corporations - especially underperforming ones - are also having more difficulty these days getting executive compensation through. Proxy statements now have to include peer group information, showing relative performance and remuneration, which makes analysis much easier for institutions and their advisers. As a result, proxy firms now get more work in advance of the season, advising companies on how institutions are likely to vote on their compensation plans. 'We were doing a lot of this kind of work back in January, February and early March, advising companies on how to structure their plans to make them acceptable,' says Crane. 'We assess the likely voting results either on the basis of information given to us directly by institutions in conversations with them, or by ascertaining their criteria through analysing and reviewing their past voting patterns.'
One effect of all this off-stage activity - the pre-meetings analysis and behind-the-scenes negotiation - has been a reduction in recent years in the amount of front-of-house fireworks that once typified the annual proxy round. But as this season was drawing to its close, the indications were that there would end up being more proxy fights this year than last. Given the propensity for last minute settlement, however, that may change in the final few weeks of the season.
What is indisputable, on the other hand, is the continuing growth in mergers and acquisitions activity - among companies of all sizes - which has been building since the last quarter of 1994. 'It's really busy this year,' confirms Stan Kay of Mackenzie Partners Inc, in New York. 'There have been lots of small proxy fights and a few bigger ones - like US Shoe and Luxottica, or Teledyne and WHX.'
The latter began at the end of last year when Los Angeles-based diversified manufacturer Teledyne rebuffed a bid from steel company WHX at $22 a share in cash and stock. Teledyne's chairman described the offer - worth a total of $1.2 bn - as a 'non-starter' and the company subsequently adopted a poison pill. Meanwhile, WHX reduced its sights from an initial goal of seeking to win control of all seven Teledyne board seats, going instead for just two. These were to be occupied by WHX chairman Ronald LaBow and one other nominee.
The battle came to a head at Teledyne's annual meeting at the end of April, which left both sides able to claim partial victory. 'The interesting thing about it was that Teledyne's Californian base meant it was subject to cumulative voting rules,' says Kay. In this case, that meant that if WHX could secure just one vote over a 12.5 per cent threshold, it would be able to accumulate the votes and harness at least one board seat. 'Cumulative voting makes it much easier for insurgents, provided they have at least some support,' notes Kay. Indeed, Teledyne was defended by Mackenzie Partners and it also won the support of ISS, which advised its clients to vote to re-elect existing board directors. Nevertheless, WHX succeeded in getting one seat, achieving around 17 per cent of the votes.
This is just one of a long list of fights this year, indicative of the significant upturn in M&A activity. Crane notes that his firm ha been involved in some 20 tender or exchange offers already this year. 'I think it's being driven by the opportunity to make acquisitions at a time when companies are looking for growth,' says Crane. 'With the financial fine-tuning of the early 1990s, we saw companies restructuring and reducing debt, down-sizing, spinning-off businesses that weren't very profitable, and so on. Now they are looking for growth opportunities and they are focusing on acquisitions as the most efficient way of achieving that.'