The whos, whats and whys of this year's proxy season
When it comes to corporate governance, many shareholders are strictly foul-weather friends. In a market that has turned sour, questions of executive and board performance assume an urgency that these same inquiries lack when stock prices are steadily climbing, regardless of the makeup of the board or how lavishly CEOs are compensated.
'What's interesting about this year's proxy season is the amount of activism from investors we're seeing,' says Bruce Goldfarb, senior managing director at Georgeson Shareholder, the Manhattan-based proxy solicitation firm. 'We're seeing shareholders who in the past were investing more passively, such as the large institutions, become more active and vocal in their dealings with companies.'
As unlocking shareholder value becomes a growing concern for money managers, new players are entering the fray. This year, for instance, the New York City Employees' Retirement System and the State of Connecticut's pension funds stepped up to the plate to sponsor shareholder resolutions about executive compensation. 'Given the volatility of the markets,' says Goldfarb, 'a way for investors to actively manage their investment is to become vocal and involved. This is a way to have impact vis-a -vis a non-actively-managed stock picker.'
Although activism is on the rise, most proxy watchers agree that no single showdown seized the lion's share of attention during this year's round. As usual, several hostile takeover bids are on proxy ballots this year. Weyerhaeuser Company is trying to acquire Willamette Industries and the Royal Dutch Shell Group is bidding for Barrett Resources. Board seats were also being contested. A good example, according to Goldfarb, is the bid by Sam Heyman, who runs International Specialty Products, for board seats at Hercules.
Instead of a single proxy contest, it was one issue - executive compensation - that took center stage. First and foremost in the minds of shareholder activists are the astronomical executive compensation and severance packages so many CEOs command.
'The major trends continue to be shareholders pushing boards for increased accountability and heightened concern about executive compensation packages,' according to Richard Ferlauto, managing director of Proxy Voter Services, a Rockville, Maryland-based division of Institutional Shareholder Services. 'Executives are still drawing options windfalls or revising their plans to draw options windfalls, even with falling stock prices.'
Heads I win, tails you lose
One sign of just how closely executive compensation is being monitored is the AFL-CIO's expansion of its PayWatch web site (aflcio.org/paywatch). The site provides data on compensation packages awarded to CEOs at S&P 1500 companies last year. Highlighted there are e-campaigns aimed at Bank of America, Conseco, and Sprint, three companies that are all deemed serious offenders when it comes to runaway CEO pay. During this proxy season, all faced shareholder proposals on performance-based stock options, the repricing of underwater options, golden parachutes and increased disclosure.
'There is a lot of focus on compensation this year and particularly on efforts by companies to reprice underwater stock options,' according to Jamie Heard, CEO of Proxy Monitor, a Manhattan-based firm providing a proxy voting advisory service to institutional investors.
Rosemary Lally, editor of Corporate Governance Highlights, which is published by the Investor Responsibility Research Center (IRRC) in Washington, DC, also describes executive compensation as the year's hot topic. She suggests Bank of America, which 'got hit really hard with executive compensation resolutions this year,' is one of the key votes to watch. On its PayWatch site, the AFL-CIO says CEO Hugh McColl received a cumulative total compensation package worth $95.6 mn in the five years from 1996 until 2000, even though the company's stock underperformed the S&P 500 by 34 percent under McColl's stewardship.
Early voting results show that compensation proposals have the potential to garner strong support this year. A Sprint resolution, which was jointly sponsored by the International Brotherhood of Electrical Workers' pension fund and the New York State Common Retirement Fund, asked the telecommunications giant to limit the repricing of executive stock options without prior shareholder approval. Sprint allegedly allowed executives to obtain more than $1 bn in stock options and even replaced executives' stock options that were no longer exercisable after the company's stock price plummeted.
Support for the anti-repricing resolution at Sprint was an unprecedented 46 percent. 'I was expecting it to be high,' says Ferlauto, 'but frankly I wasn't expecting it to be that high.' He attributes the large vote to outrage about the increased use of options repricing in general, and a sense that Sprint had manipulated the system by reaping the tax advantages of waiting just over six months (in this case, six months and a day) to begin repricing. 'This,' says Ferlauto, 'is a very clear message not only to Sprint, but to all companies considering repricing, that shareholders are vehemently opposed to that kind of manipulation of options programs.'
Perhaps more than any other form of executive compensation, options have become a lightning rod for shareholder discontent. 'Because of the decline in value in technology stocks and the market decline generally, a lot of options are underwater,' says Heard, 'and companies are trying to figure out what to do about it. For many shareholders, the idea that executives should get new options just because the value of their old options has declined makes the use of options a heads-I-win-tails-you-lose kind of proposition.'
The repricing of executive options clearly undermines the original intent, which was to create an incentive for executives to outperform certain specific metrics. But basic fairness is just one side of the options coin; the other side is dilution. 'It's becoming clearer to many of our clients that the widespread use of options as a compensation device is very costly to shareholders,' says Heard. 'The fact is that options dilute the value of the shares of everybody else.' He continues, 'I think we're in the midst of rethinking the idea that the very liberal use of stock options is a good one.'
If executive stock options are failing to live up to their promise, the next question - one posed on many proxy slates - is how to motivate executives more effectively. Ferlauto points out that there's a trend toward pay-for-performance measurements and that several 'shareholder resolutions request that some portion of future pay either be indexed to the company's peer group or set at a premium price - something substantially higher than the market price.' One of the major pay-for-performance votes this year is taking place at Office Depot. Ferlauto notes that 16 percent of the largest businesses already have performance hurdles in place.
Finally, another aspect of runaway executive pay - namely, over-generous severance packages - has also garnered increased attention this proxy season. 'Many CEOs, after running the stock price of the company into the ground, left with very large pay-outs,' complains Ferlauto.
He notes that proposals about severance pay appeared at Albertson's, CSX, McKesson HBOC, Ogden Corporation, Qwest Communications, Sierra Health Services, Sprint and Verizon.
Similarly, the International Brotherhood of Teamsters submitted a proposal to place a cap on severance packages at Bank of America; in its supporting statement, the Teamsters noted that CEO David Coulter, upon retiring from Bank of America, was granted a salary of $1.25 mn and a bonus of $2.5 mn each year for five years, as well as stock worth $14.2 mn and pension benefits for life of almost $5 mn annually. Fortune magazine characterized Coulter's severance package as 'so rich that you had to wonder how long Coulter would stick around.'
None of these resolutions against executive compensation are necessarily expected to command a majority of the vote. In 2000, for instance, Lally notes there were 16 executive compensation proposals and the average vote was 8.5 percent. Goldfarb suggests that a quarter of the vote or better is significant, and Ferlauto agrees: 'Any vote above 10 percent sends a very clear message about shareholder dissatisfaction to companies. And I'd imagine that lots of these votes would be at least 20 percent this year.'
Some upsets on the executive compensation front were scored before annual meetings even got rolling. The State of Connecticut withdrew a shareholder proposal about executive pay when HealthSouth adopted a new compensation policy making 25 percent of shares in a stock option grant performance-based. Denise Nappier, the new treasurer for the State of Connecticut, considers shareholder activism 'a core component' of her funds, says Ferlauto, and therefore the pension funds submitted shareholder resolutions for the first time in five years.
Most results from this proxy season won't be known until after this issue of Investor Relations has gone to press since most votes are cast in April, May and June. Moreover, there's a general trend for the meetings to be held later in the year. While some companies are very forthcoming and make it their policy to publicly reveal the vote totals, others wait and publish results in their next 10Q.
This proxy season, there were a few emerging issues that might gain momentum in the coming years, according to Heard. Along these lines, he points out that the Securities and Exchange Commission (SEC) is now requiring companies to disclose information about the fees they pay auditors in their proxy statements.
'There's a concern,' Heard explains, 'that companies that pay large amounts to their independent auditors for non-audit services could be compromising the independence of the auditors. That's getting some scrutiny for the first time since we now have the information for the first time.'
Although the question of auditor independence was far too new an issue to feature among this year's shareholder resolutions, Heard says he advised clients to withhold votes or vote against the approval of auditors when the levels of fees paid for non-audit services were extraordinarily high. 'My guess,' he says, 'is that the auditors will be approved because most shareholders look at it as a routine item, but I think there will be much more scrutiny than in the past.'
In the years to come, experts anticipate that the numbers of executive compensation proposals will grow, and that these proposals will be aimed not just at household-name companies, but also at some much smaller-caps. While shareholder proposals typically are made at large companies, 'Some of the worst practices you see take place at small companies,' Heard suggests. 'Their boards are much weaker and tend not to be as independent as bigger ones.'
Dot-coms could be considered the worst offenders on this score. Not only are their boards populated by venture capitalists in a hurry to cash out, but they aren't subjected to the same numbers of outside directors and arms-length oversight that older, established companies have in place. 'A year ago,' says Heard, 'the feeling was that the dot-com world was a new paradigm and that shareholders didn't need to have the same oversight and accountability they had at other companies. Time has proven that that was an incorrect position. If anything, there was a need for more oversight and accountability.'
One notable 2001 proxy trend, according to Proxy Monitor's Jamie Heard, is the number and sophistication of proposals concerning genetically modified foods. Last year, church groups asked a handful of consumer goods companies to ban their use of genetically modified ingredients in their products. But they didn't have much success. This year, says Heard, shareholder proposals are far more reasonable and either request that products using genetically modified ingredients be better labeled or that the use of such foods be studied.
Specifically, says Heard, church groups associated with the Interfaith Center on Corporate Responsibility (ICCR) have asked Hershey Foods to consider the feasibility of phasing out the use of genetically engineered foods. Resolutions at Albertson's, General Mills, Procter & Gamble, The Kroger Company, Sara Lee, Quaker Oats and PepsiCo asked these companies to disclose any genetically modified ingredients on their labels. 'Usually,' says Heard, 'these types of proposals don't pass, but if they got in the neighborhood of ten percent support that would be viewed as something the companies ought to be looking at seriously.'
Heard emphasizes that Proxy Monitor's interest in the genetically modified foods debate is grounded in a desire to protect shareholders' economic interests. 'When companies are selling products to consumers and consumers lose faith in the integrity of the product, it's not good for the companies. So we think it's a very risky business practice for food and grocery companies to not take seriously the widespread public concern about genetically-modified foods.'
Another important proposal, says Heard, was submitted to Exxon-Mobil asking the board to perform a study on the potential environmental damage that would occur if drilling began in the Arctic National Wildlife Refuge. This issue recently became politically charged when President Bush indicated that he would support drilling there.