The lost art of communication

Last summer, when Pfizer announced that its directors would meet ‘face-to-face’ with representatives of the pharmaceutical giant’s largest shareholders to discuss executive compensation and other board performance issues, the governance community sat up and took note. Many praised Pfizer for its openness, a few groused that the invitation-only event left retail and small investors in the cold, and Martin Lipton, co-founder of Wachtell, Lipton, Rosen & Katz, sent his clients a now famous memo calling this ‘another example of corporate governance run amok.’

Although private meetings among executives, directors and shareholders have taken place with greater frequency over the past five years, semi-public forums like the one Pfizer initiated are rare. Pfizer’s historic October 24 meeting wasn’t, however, the first of its kind. Kenneth Langone, Home Depot’s co-founder and chairman of the nominating and corporate governance committees of the board, invited shareholders and other guests to participate in a ‘town hall’ in September 2007. Meanwhile, companies facing stock options backdating and other governance-related problems, like UnitedHealth Group and Comverse Technology, have invited shareholders to sit on advisory groups with board members.

The trend for more open communication, probably involving face-to-face meetings, between shareholders and board members will likely continue. Rich Ferlauto, director, corporate governance and pension investment for the American Federation of State, County and Municipal Employees, or AFSCME, says that he’s in discussion with a number of fairly large and well-known companies about holding similar events in the near future.

Meanwhile, Roger Raber, former CEO and president of the National Association of Corporate Directors, observes that enormous progress has been made in shareholder/board relations. Over the past five years, he’s found that directors have become increasingly interested in finding ways to regularly interact with investors. ‘We’ve made a real quantum leap,’ enthuses Raber.

Pfizer welcomes open dialogue
Pfizer’s October meeting lasted a full day, says senior vice president, corporate governance, associate general counsel and corporate secretary, Peggy Foran, and directors ‘participated in a listening role since their primary objective is to grasp what is on the minds of investors.’ Foran clearly considers the exercise a success: ‘The objective of the meeting was achieved: candid, private and open dialogue with shareholders.’ Although Foran anticipates that similar meetings will occur, no future dates had been set at the time of writing this article.

TIAA-CREF, which was present at the Pfizer meeting, praised the effort, noting Pfizer’s bravery in being one of the first companies to go down this route. Although the identities of shareholder participants were confidential, Hye-Won Choi, TIAA-CREF’s new head of corporate governance, notes that portfolio managers, governance professionals and lawyers from Pfizer’s largest institutional shareholders were all represented. ‘Though we had not met before the meeting,’ says Choi, ‘what struck us was that we spoke with one voice about the major issues such as compensation based on performance and managing for the long term.’

Even some shareholders and opinion-makers who weren’t invited – like Ferlauto – applaud Pfizer for taking this step. He points out that this type of meeting has historically been avoided either because companies plead a lack of resources (executives and board members are overtaxed) or because of a general fear of the unknown. The latter is what Ferlauto calls ‘the Marty Lipton view – we just can’t let the barbarians through the gate.’

Stephen Davis, a fellow at Yale University’s Millstein Center for Corporate Governance and Performance, describes the Pfizer meeting as ‘a highly effective experiment in how to bring boards and shareholders into closer alignment.’ Although Davis was not present at the actual meeting, he has since spoken with many of the principals who were in attendance, and is in the process of producing a policy briefing due out in June on how boards and shareholders might find better ways to communicate.

‘In most of corporate America, boards and shareholders don’t talk to each other very often. Shareholders often think boards are on a tangent and not looking out for the investors, whereas boards think shareholders have horns and have no earthly idea how to run a company.’ He continues: ‘To have a face-to-face, high-level encounter turns out to do wonders for dispelling these myths.’ 

Legal hurdles
In November 2006, UnitedHealth created a shareholder nominating advisory group, after an independent investigation into the company’s stock options granting practices spurred the company to bring on five new board members within three years.

The five-member shareholder nominating advisory group consists of four shareholders and one representative of the medical committee, explains Dannette Smith, corporate secretary at UnitedHealth. So far, three meetings have been held, with another planned for early 2008. The meetings are attended by the chairman of the board, the CEO, Smith, the chairs of the nominating and corporate governance committees, the chief legal officer and an outside search firm assisting the board with identifying new directors. 

Before shareholders signed on to participate, many legal matters had to be resolved, says Smith. First off, shareholders didn’t want to be seen as acting in concert because they might be deemed to beneficially own each other’s shares, and they didn’t want to lose their passive investor status under regulation 13-G. What’s more, they needed assurance that they weren’t taking on any fiduciary duties by participating in the nominating process. Smith says that these concerns were addressed in the formal description of the group, which is posted on the corporate governance section of the company’s website.

More daunting, still, were the Regulation FD concerns. Here, says Smith, ‘We told them we have the affirmative obligation to make sure that we don’t give you any material, non-public information.’ Topics on the agenda are carefully reviewed and tend to be strategic so they don’t veer into Reg FD terrain. ‘You end up erring on the side of caution,’ says Smith. ‘If there’s a question mark, you don’t have the discussion go that way.’

Ferlauto believes that Reg FD issues are manageable because shareholders ‘want the focus of these meetings to be on director effectiveness, which is not material to a particular look at financial performance,’ he says.

Investment banker Gary Lutin, who created the Shareholder Forum program to foster greater shareholder/company engagement on thorny issues, also believes Reg FD need not present an impediment to shareholder/director communication. ‘The only thing directors can report is their personal opinion, and wisdom would suggest they don’t do that,’ he says. ‘Really, you can’t expect a director to do anything other than listen to you.’ And listening doesn’t violate Reg FD.

Who listens and who talks?
Even though companies and shareholders are more open to the idea of frank discussion, there are many hurdles outside the legal and regulatory arenas. Semi-open meetings with shareholders raise fairness issues, and that’s where tempers tend to flare. Who’s invited and who’s not, who speaks and who listens, and even who does the inviting and when the meeting is scheduled can become highly controversial matters.

Last year, Langone invited ‘fellow shareholders’ to meet with members of the company’s nominating and corporate governance committees. The event, held at the Grand Hyatt Hotel in New York on September 21, 2007, was billed as a discussion ‘of our director nominating process and considerations we use for identifying, interviewing and selecting new board members.’ The invitation specified that the format would be ‘an open town hall.’

The first bone of contention was the invitation process. Ferlauto says that after several meetings with Langone in which the possibility of such a meeting was raised, the date and time were decided upon without consulting the key constituents. As a result of this process, Ferlauto couldn’t attend and instead had to send a representative.

‘From what I gather, that meeting was not a give-and-take discussion. Langone talked, [others listened]’ explains Ferlauto. That said, he did laud Home Depot for its willingness to meet personally with shareholders. ‘The town hall meeting came out of shareholder efforts post-Nardelli and some direct discussions with the board about ways of improving shareholder communications,’ says Ferlauto. ‘Although the meeting itself wasn’t satisfactory, it emanated from direct discussions with shareholders [and the intent was right].’

According to one attendee at the Home Depot town hall, who declined to be named, ‘It seemed to be a bunch of softball questions from sell-side analysts who had been personally invited by Langone.’ The attendee lamented the lack of real dialogue and said that Langone and the other directors mainly spoke, repeatedly exhorting the audience: ‘Trust me, trust me.’ 

A spokesman for Langone declined to comment beyond pointing out that Langone is ‘one of the single largest shareholders of Home Depot, and as a co-founder of the company, he has a strong vested interest in Home Depot’s success.’

Inevitably, the guest lists for shareholder/board events generate some buzz – and size is one objective cut-off. According to 13-Fs for the third quarter of 2007, Pfizer’s five largest investors were Barclay’s Global Investors, Axa, State Street, Vanguard and Franklin Resources. Lutin calculates that Pfizer’s top ten investors for the third quarter of 2007 accounted for 25.4 percent of outstanding shares. He also notes that the 13-Fs list 1,369 institutions investing in Pfizer in total.

How a company crafts its guest list reflects its aims. ‘If you’re interested in pure voting results, getting your top 25 together is the smart way to do it,’ says Lutin. ‘If you’re interested in [getting a broader] range of views, it’s not. Inviting only the largest investors cuts out the AFSCME public pension coalition and those with concentrated portfolios who really pay attention.’ He continues: ‘Think of the hedge fund or the individual who’s got half his life savings invested and doesn’t have a chance to express his views.’

A proliferation of communication models
Holly Gregory, a partner specializing in corporate governance at Weil Gotshal, believes that last year’s ‘say on pay’ debate gave rise to a consideration of greater board/shareholder engagement. Rather than simply having a binary yes or no vote on something as nuanced as executive compensation, some companies saw the benefits of eliciting shareholders’ views. ‘In the UK, where they have say on pay, it’s led to more discussion between boards and shareholders,’ she says. ‘Some boards have said, Let’s skip the advisory vote and go straight to the thoughtful discussion.’

Last year, after Aflac voluntarily embraced say on pay, Foran, Ferlauto and Timothy Smith, a senior vice president at Walden Asset Management, assembled a working group dedicated to discussing this issue; companies like Intel, Tyco, Schering-Plough, American International Group (AIG), Colgate-Palmolive and Bristol-Myers Squibb also participated.

Although Ferlauto acknowledges that the working group wasn’t exactly a shareholder/board meeting, he calls it an example of the ‘different kinds of conversations’ taking place on governance issues today. ‘The next logical step emanating out of this working group is to establish dialogue directly with compensation committees,’ he says.

Another model for more open dialogue is Lutin’s Shareholder Forums. Since 1999, Lutin has put together forums where issues are aired and a range of opinions freely expressed. So far, he’s tackled topics like executive compensation at Verizon and analyst access to information at Amazon, a timely conversation that contributed to the Reg FD movement and the reconciling of pro forma numbers with US GAAP.

Yet another offshoot of greater shareholder/company engagement are corporate governance roadshows, something that Pfizer and other companies have started to arrange. Davis supports this idea, noting it’s a useful way to learn about shareholder discontents that might someday erupt into contentious resolutions if they’re not satisfactorily resolved.

Since 2002, Nexen, based in Calgary, Canada, has held a week-long corporate governance roadshow, observes Sylvia Groves, assistant secretary and manager of the governance office. ‘The most valuable part of the roadshow is the relationship-building that goes on,’ says Groves. When Nexen had a problem after some audit committee members went outside independent listing requirements, Groves felt comfortable calling the NYSE to discuss the situation. ‘We don’t want to be the company that phones the law firm, and then the law firm phones the stock exchange on a no-names basis,’ she says.

Paul Schneider, research director for the Canadian Coalition for Good Governance, praises the corporate roadshow concept as ‘an opportunity to talk about more philosophical issues.’ He points out that Nexen’s initiatives have been proactive, noting that too often ‘companies only do these kinds of things when they’re trying to right the ship, so to speak.’

What lies ahead?
Companies and shareholders alike seem cautiously optimistic about changing their historic relationship – for the better. ‘I think we’re moving into a new era,’ says Gregory. ‘Both boards and shareholders are more receptive than ever before to having some level of real engagement.’ Now that activist shareholders have been successful in pushing a reform agenda, she points out ‘there really is interest in lessening tensions and finding more cooperative modes of communication. Some managements and boards are interested in reaching out to the largest shareholders and saying, Let’s sit down and talk.’

Ferlauto agrees. He notes that even before the first formal public meetings of 2007, groups of shareholders and directors regularly met in private to discuss issues of concern, running the gamut from director nominations to compensation issues.

In a perfect world, Ferlauto would like to see meetings, once or twice a year, with the chairs of key board committees and shareholders. Ideally, he’d also want ‘an unstructured agenda where any party could raise issues they want to ask.’

New relationships take time, though, and Ferlauto welcomes everything from directors holding town halls to the semi-open meeting held by Pfizer. ‘The next generation of corporate governance will really be about the types of shareholder communications that get established,’ he concludes. ‘The relationships between shareholders and the board really let shareholders understand and have some ability to evaluate the job that the board is doing.’

Foran also sees this type of communication as the way forward, saying: ‘I believe this was one of the single most useful information gathering exercises we have ever conducted. It is easy to find a lot of reasons not to conduct this type of face-to-face meeting, and Reg FD is certainly one of those, but in the end there are more good reasons to do it. The opportunity for shareholders to see first hand that directors are well informed and actively involved is invaluable. We plan to conduct more of this style of meeting in the future.’