Francis H. Byrd, Co-Leader, Corporate Governance Advisory Practice
Dog Days of Pre-Proxy Access Summer
CalSTRS, the nation’s second largest pension fund, and Relational Investors, reminded us why observers talk of a year-round corporate governance/proxy season, with their announced intention to seek four board seats at the 2011 annual meeting of Occidental Petroleum. The potential short slate contest provides us with some clues about what life in a post-proxy access world might look like.
The issues driving, according to their letter to the company, the two funds are executive compensation and succession planning – not financial or stock performance – as the company has provided excellent returns for investors. Picking up on the results of the Occidental’s Say on Pay vote, CalSTRS and Relational (often seen as an operational activist fund with a focus on improving business operations) believe there is an opportunity to create (or force) change upon Occidental.
Given how much time there is before the company’s 2011 annual meeting (or even the earlier deadline for submitting prospective director nominee candidates) there will be ample opportunity for negotiation between the funds and Occidental. Should those discussions fail to yield an agreement between the parties we may have an opportunity to examine the CalSTRS/Relational director nominee slate for sector experience, financial acumen, enterprise risk management expertise and diversity.
While a majority of Occidental’s shareholders have proven they are concerned with CEO pay, and may be concerned with succession planning as well, it is not clear that they will make a decision to support dissident directors based on those two critical issues alone.
The other interesting point is the teaming up of a public pension fund and an activist (hedge) fund, not something companies are used to seeing, but may see more of in the future. Bear in mind that Relational has had among its clients the funds of the New York City Retirement Systems and CalPERS. The firm has also placed corporate governance issues prominently alongside performance concerns at their portfolio companies. Relational has demonstrated to the activist institutional community that they can ‘walk the walk’ on governance and that has likely provided comfort for CalSTRS in entering this partnership with them.
This is perhaps the rationale for this pairing of funds. CalSTRS’ focus on compensation and CEO and executive management succession at their portfolio companies is widely known and understood. However Relational, as mentioned above, is much more of an operational activist. As many will no doubt remember, Relational sought operational (store closures and the sale of a division) and capital structure changes (share repurchases) at Home Depot. Does Relational see company performance issues at Occidental that are ripe for change and that can result in increased value for shareholders – or is this a pure governance play?
Is this a prelude to the ever-advancing proxy access era, being promised by SEC Chairman Mary Schapiro, or is this a precursor of an evolution in shareholder activism, or is it both? According to media reports, CalSTRS and Relational hold between them 1% of Occidental, far short of the 5% threshold floated in the conference committee and shot down by House Democrats, or the 3% figure being discussed as a compromise. Among those items unclear at this moment is whether CalSTRS and Relational would take advantage of proxy access if the threshold were between 1-3%, or continue their battle with Occidental regardless of their ability to use proxy access.
Lastly, will we start to see more instances of public (and perhaps union) pension funds teaming up with hedge fund activists in order to meet threshold requirements and/or to access analytical (or operational) expertise from hedge funds? This potential contest, at Occidental, and the SEC’s fast-approaching decisions and rule-making on proxy access will help answer these questions.
Early Lessons
There are a couple of early lessons to take away from the presumed Occidental v. CalSTRS/Relational short slate contest.
First, don’t let corporate governance issues – especially on compensation – fester. While Occidental has had a decent relationship with shareholders (their stock performance has been quite strong) investor concerns on pay have also been problematic. While Occidental is a special and singular case, companies, particularly those with weak financial performance relative to peers, need to maintain open lines of communication with shareholders and identify governance concerns or vulnerabilities. The goal should be to limit surprise issues, and be proactive with both your largest holders and the governance influencers like CalSTRS or the NYS Common Fund.
Second, companies where shareholder resolutions have received a majority vote (or between 35%-49%) from investors, but the non-binding proposal has not been acted upon by the board, should take some immediate action to reach out and engage with the proponents. Companies that have ignored such votes in the past – especially if their stock performance has struggled – will be prime targets for short slate campaigns. This also holds true for companies whose directors have been targeted in Vote No campaigns. Substantial withhold votes from directors could also serve as a beacon for activists seeking to run a potential short slate.
Lastly, your Say on Pay vote matters on more than compensation. Many investors, especially the activist institutions, view compensation as a window for judging the quality of board oversight and determining whether a CEO is “imperial”. For example, Moody’s Investors Service, in its examination of governance quality at North American companies, would develop an unfavorable view of board oversight, succession planning and director independence at those companies where the CEO’s total direct compensation was more than two to three times higher than that of the next highest ranking Named Executive Officer (NEO). This was the origin of the now infamous pay equity concept. In short, executive pay reflects on, in the minds of governance advocates, the culture of the firm and the strength of independent director oversight. In that context, a failed Say on Pay vote could be viewed as a signal to an activist that there is at least some lack of confidence in the board and management.
“…let them speak now or…”
We at The Altman Group want to exhort the issuer community to take advantage of the opportunities for comments being provided by the U.S. Securities and Exchange Commission. The Commission has an enormous amount of rule-making to undertake, and on some key issues – Proxy Access and Say on Pay implementation – is planning to have them promulgated in time for the 2011 proxy season.
While we will continue to be active and vocal in representing our opinion on the needs of issuers, whether on aspects of proxy access or the reform of the proxy voting and shareholder communications system, we strongly encourage public companies (especially mid- and small-cap firms) and their advisors to formulate and communicate their concerns to the Commission.
The Dodd-Frank Act provides regulators with considerable latitude in determining the shape of the rules governing both access and SOP. Public company involvement will be critical in assisting Commission staff with gaining a wider perspective of the impact of various regulatory approaches upon the needs of issuers. U.S. capital markets are in the throes of historic, if not revolutionary, changes. Irrespective of what may or may not occur politically, in the mid-term elections or even 2012, much of Dodd-Frank and the preceding changes in the disclosure regimen will remain. The thrust and application of regulatory discretion is what is at stake, and more voices need to be heard from to ensure a better system for both issuers and investors.
