What the proxies tally: a rising tide of activism: the voting both last year and this year shows a stiffening resolve by shareholders to press boards on several fronts, including executive pay, corporate performance, board representation, and investor confidence.

• Author: Melican, James
• Position: PROXY REPORT

THE 2007 AND 2008 PROXY SEASONS have been characterized by a rising tide of shareholder activism, spurred on both by a concerted effort to require boards to dialogue with shareholders on executive compensation issues and by the increasing willingness of hedge funds and other activist investors to mount board challenges. The 2008 season is, as this article is written, still in its early stages. But even before the spring meetings peter out, it is evident that the weakening economy, the collapse in the housing market, the subprime mortgage debacle, and the tidal wave of credit-related losses at major financial institutions have combined to stiffen the resolve of a number of prominent shareholders to hold directors responsible--not just for what they regard as flawed executive compensation policies, but also for failure to rein in the excessively risky bets made by company management.

"Say on Pay"

In 2007 we saw a vastly increased number of shareholder resolutions seeking an advisory, nonbinding vote on executive compensation. Some 50 of these were voted on (others were withdrawn for various reasons). Of that number, eight received a majority of the votes cast; in total, the average level of support was 42%. Aflac warded off a shareholder resolution by being the first to announce that it would seek such an advisory vote. A handful of other companies--all but one of which were among the eight companies where the resolution got a majority vote last year--have since announced that they will also implement the advisory vote mechanism. They are (as of this writing) Verizon Communications, Par Pharmaceuticals, Blockbuster, and RiskMetrics (a newly public company that acquired and has since integrated what was formerly known as Institutional Shareholder Services, or ISS).

The major distinction between last year and this is that, in 2007, the "say on pay" concept was generally regarded as an initiative of AFSCME (the American Federation of State, County and Municipal Employees). By contrast, this year other shareholders that are widely thought of as more centrist and less confrontational are also actively promoting the advisory vote concept. For example, TIAA-CREF is the proponent of such a shareholder resolution at PepsiCo and Johnson & Johnson. It is hoping that, if several large and highly regarded companies were to opt for the advisory vote, others, including those whose compensation policies might be less transparent or more suspect, will feel constrained to follow suit.

The proponents insist that they are not trying to micromanage board compensation policies; rather, they are attempting to encourage dialogue between the board's compensation committee and shareholder representatives on the one issue on which they feel company management has an inherent conflict of interest. They also contend that the existence of an advisory vote may tend to stiffen the backbone of board members confronted by excessive compensation demands from an overly aggressive or greedy CEO. They point out that an advisory vote on compensation is now standard practice in the United Kingdom, Australia, Sweden, and the Netherlands (where it is binding). In addition to AFSCME and TIAA-CREF, other traditionally active shareholders such as the AFL-CIO and CalPERS are supporting the shareholder resolutions, as are proxy advisory firms RiskMetrics (formerly ISS) and Glass Lewis. The Council of Institutional Investors (CII) has also been strongly supportive.

Those opposed to an advisory vote also cover a wide spectrum, ranging from some trade unions such as the United Brotherhood of Carpenters (UBC), to large institutional investors such as Barclay's Global Investors (BGI) and organizations that represent business interests, notably the Business Roundtable and the U.S. Chamber of Commerce. At this point at least, virtually all the corporations that have received such a resolution are opposing it.

While the opponents' reasons vary widely, a common argument is that, even with the SEC's enhanced executive compensation disclosure regulations, shareholders cannot have the same level of understanding as do board members sitting on the compensation committee of the various needs and objectives of the corporation, which could vary significantly from year-to-year, or even, in unusual circumstances, with in the year. They would contend that the details of how the CEO's compensation package is structured should be left to the compensation committee to decide, with the caveat that, if the shareholders don't like the result, they have the option of withholding their vote from compensation committee members who are up for election. They argue that in an era when, particularly among the larger companies, some form of majority voting has generally been adopted, withholding votes from a director is an immediate and much more potent message than...