Flexing Corporate Muscle

Third Quarter 2012
Corporate Board Member
by Brendan Sheehan

Every proxy season brings new trends to light. This year, governance observers have witnessed the rumblings of dissent with public companies that are finding their voices and speaking out against a longtime nemesis—proxy advisory firms.

Unheard of only two years ago, some companies are responding publicly, in no uncertain terms, to negative vote recommendations from the likes of ISS and Glass Lewis. “Companies seem to be more willing now than they were 18 months ago to publicly disagree with ISS and other advisers,” explains Francis Byrd of Laurel Hill Advisory Group.

The numbers tell the story. At the end of May, a total of 52 companies had filed supplemental proxy materials in response to ISS complaints about compensation practices. That is more than double the number of companies that had done so at the same time last year. Of the 52 public supplemental filings so far this year, exactly half were in regard to peer group selection by the proxy adviser.

Not only is there a dramatic increase in the number of companies speaking out, but the language being used has become stronger and more specific. Moreover, in some cases, the forum is changing. In the past, companies might just reach out privately to select shareholders. Today, there is far more public conversation utilizing the media to tell the company’s story.

“We see [the supplemental filing] as an outflow of information generally, and an outreach to investors. It is something that companies need to do,” says Byrd.

One reason a company might consider a supplemental filing is to address potential conflicts or errors present in advisory firm recommendations and to put those recommendations into the correct context.

That may mean refuting publicly, or pushing back on information that is coming out of the proxy advisory firms. Companies need to place compensation information, for instance, in the context of what the board believes the company needs to do to “properly incent executives and to attract and retain senior leadership, while also meeting strategic and operational goals,” offers Byrd.

The big question today is why are companies feeling more confident about taking a public stand in refuting ISS and Glass Lewis? It could be a case of safety in numbers.

Or, as Brad Robinson of Eagle Rock Proxy Advisory Services suggests, some companies may simply feel their back is against the wall and they have no choice but to take action.

“In the day and age of greater responsibility to shareholders and greater consequences when shareholders are unhappy, it is just a natural extension of the current environment,” Robinson explains. “There are more avenues for investors to hold boards accountable, and the consequences can be quite serious. Thus, I see that companies really have an obligation to address those issues—they have to be prepared to tell their story in a way that is going to resonate with the shareholder group.”

Furthermore, he continues, “Companies are increasingly concerned about how they are perceived in the media and also among investors. That means that they have to respond to negative vote recommendations, especially when it is on the highly charged issue of executive compensation.” In many ways, he concludes, “Doing nothing is worse because then you are not part of the conversation and not explaining the facts as you see them.”

Boards are also becoming more knowledgeable—and knowledge is power. They understand their shareholder base better than they did a couple years ago, and this allows them to communicate their strategy more effectively. This also allows them to have a much better understanding of what investors are going to be responsive to, giving them the confidence to speak out.

“You should start with the investors that you think are not so heavily wedded to advisory firm analysis and can be convinced of the board’s thinking on the particular issue,” advises Byrd. This knowledge only comes through in-depth analysis of the shareholder base and how they use various voting services, she says.

Identifying which shareholders are rigid ISS followers and which ones only use the analysis for research purposes is also important. Several major institutional investors, for instance, have voiced concern about the methodologies used by advisory firms.

Companies that have spoken out recently include retailer JCPenney, which took issue with the peer group ISS used for its compensation comparison of the company, as well as hotel chain Marriott, which made a similar public filing regarding peer groups. Marriott criticized ISS for omitting its two main rivals—Hyatt and Starwood—from the peer group it used for the pay-for-performance analysis. Ironically, Marriott itself appeared in the peer group ISS used for Starwood. Qualcomm, Walt Disney, and Piedmont Natural Gas have also had public debates with advisory firms on this issue.

Where this will lead is yet to be seen, but at least for now, it’s clear companies are beginning to refute voting advice that they feel is inaccurate, misleading, or lacking in context. As governance issues in general, and compensation issues in particular, continue to be highly scrutinized, you can expect more public debate about the merits of proxy analysis and vote recommendations. It seems likely that the pendulum has swung, and companies will no longer be sitting on the sidelines and letting others control the conversation.