By Holly J. Gregory & Claire H. Holland of Sidley Austin LLP
Corporations create wealth for shareholders and a corporation’s ability to return long-term shareholder value is a key metric for assessing whether the corporation is effective in its activities.
However, corporate contributions to our economic and societal wellbeing extend well beyond shareholder return. By spreading investment risk, corporations facilitate the funding of large-scale entrepreneurial activities that enhance the quality of our lives. They deploy assets and support innovation to produce needed goods and services, provide employment and associated benefits, pay taxes and support social and charitable programmes.
As recognised by The Conference Board’s Task Force on Corporate/Investor Engagement and many others, over the long term creation of sustainable shareholder value requires significant focus on the interests of employees, creditors, suppliers, customers, communities and the environment in which the company operates. Shareholders, boards and management have a common long-term interest in promoting both shareholder value and the societal trust in corporations that is essential to ensuring that regulation does not stifle innovation and rigorous entrepreneurial activity. Corporations can attempt to build relationships and trust with their shareholders by engaging in recurring, open and constructive dialogue regarding shareholder concerns.
Using engagement to restore trust
Trust in corporations, in general, has waned over the last decade in the wake of financial crises and high-profile corporate scandals. Widespread reports of conflicts of interest and some executive pay practices also cause shareholders to be sceptical. Perceived weaknesses in corporate governance can result in new legislation or regulation that may be burdensome or costly for corporations and shareholders, which could upset the capitalist system.
In the current environment, some shareholders are less willing to trust boards to protect their interests and they are pressuring directors to be more accountable. In response, many corporations have adopted governance practices that promote greater accountability, including annual director elections and majority vote standards in uncontested director elections. However, shareholders continue to push for governance and other reforms.
A recent study by the Investor Responsibility Research Center Institute and Institutional Shareholder Services (ISS) determined that, since the advent of ‘say on pay’ in 2011, shareholder engagement efforts have increased by more than 50 per cent. A primary goal of these efforts has been to head off potential opposition to a say-on-pay vote or demonstrate responsiveness after receiving a high level of dissent, but engagement has also focused on various types of shareholder proposals and activism.
Engagement has proven to be an effective tool for releasing tensions with shareholders and attempting to rebuild trust after corporate failures. It allows corporations to understand and respond to shareholder concerns and to explain long-term strategy and the rationale behind corporate decisions. For example, in December 2014, JPMorgan issued a report titled How We Do Business designed to address the concerns of its critical constituencies and repair its reputation after the London Whale trading scandal. The report describes the firm’s ethical values and business principles, its renewed focus on the control environment, its commitment to customers and to transparency and responsiveness with regulators, and its focus on shareholder engagement.
Rules of engagement
Boards and management should consider the practical ‘rules of engagement’ set forth below when planning their shareholder engagement efforts.
Corporations must be well-prepared to engage with shareholders on the following topics and other issues that may be the subject of activist campaigns:
- Corporate strategy and financial results
- Executive compensation
- Corporate governance matters, including shareholder proposals
- Board composition
- Environmental and social issues
- M&A activities
Corporations should continually monitor their shareholder base and changes in ownership. They should identify their top holders (e.g. representing at least one third of the outstanding shares) and determine whether they: (i) rely on proxy advisors, (ii) have established voting guidelines and (iii) have particular concerns about the corporation’s governance or other practices.
Corporations should reach out to the traditional ‘buy side’ that has regular contact with the investor relations department, as well as any governance or other personnel who make proxy voting and governance decisions.
“Trust in corporations, in general, has waned over the last decade in the wake of financial crises and high-profile corporate scandals, like the London Whale”
Typically, members of management will lead the engagement efforts, but it is critical that they be overseen and actively monitored by the board or one of its committees. In some circumstances, the lead director or a committee chair may also be involved in conversations with shareholders. While it is still infrequent, direct involvement in shareholder engagement by directors is becoming more common as recent campaigns have called for it. According to the Guidelines for Engagement published by The Conference Board’s Task Force on Corporate/Investor Engagement, direct involvement in engagement by board members may be beneficial in certain circumstances, such as when “re-establishing company credibility following a period of board or management instability”.
Corporations will be more successful in gaining trust if they establish an ongoing dialogue with key shareholders about their concerns throughout the year, rather than engaging only when they are trying to persuade shareholders to support them on proxy proposals or activist campaigns.
Annual meeting voting results provide critical information about the extent to which shareholders support the board and management. While there is no rigid rule of thumb, a vote that is less than 75 per cent to 80 per cent in favour of a board recommendation on a proposal may indicate a potential issue that requires attention. Contacting key shareholders in the six to eight weeks following the annual meeting to ask how they voted and why is likely to elicit better information than the same outreach six months later.
Shareholders who perceive that a corporation has been receptive and responsive to their concerns may be more amenable to supporting the board and management. Actively listening to shareholder viewpoints provides the board and management with valuable insights into shareholder motivations and priorities, which can inform decision-making.
Shareholders may be more willing to support the board and management on a particular course of action if the board and management have clearly articulated justifications for their decisions. This is especially true for decisions that are controversial, counter to the viewpoints of a large segment of shareholders or otherwise out of line with well-accepted norms of corporate governance or the positions of powerful proxy advisors.
Building relationships with shareholders through increased engagement may have significant benefits such as:
- Understanding shareholder concerns and what drives shareholder voting decisions
- Avoiding, or negotiating the withdrawal of, shareholder proposals
- Achieving greater support for management proposals
- Educating shareholders on corporate strategy and policies
- Promoting long-term stock ownership
- Encouraging long-term shareholders to support efforts to ward off activists with short-term goals
- Fostering goodwill and restoring trust
About the Authors:
Holly J. Gregory is co-chair of Sidley Austin’s Global Corporate Governance & Executive Compensation Practice. Holly counsels clients on the full range of governance issues, including fiduciary duties, risk oversight, conflicts of interest, board and committee structure, board leadership structures, special committee investigations, board audits and self-evaluation processes, shareholder activism and initiatives, proxy contests, relationships with shareholders and proxy advisory firms, compliance with legislative, regulatory and listing rule requirements, and governance “best practice.” Holly played a key role in drafting the OECD Principles of Corporate Governance and has advised the Internal Market Directorate of the European Commission on corporate governance regulation, and the joint OECD/World Bank Global Corporate Governance Forum on governance policy for developing and emerging markets.
Claire H. Holland is special counsel in Sidley Austin’s Corporate & Securities Practice. Since joining the firm in 2003, Ms. Holland has assisted with a variety of public securities offerings and corporate transactions, including public and private mergers, acquisitions and dispositions. In recent years, she has focused her practice on corporate governance matters, SEC disclosure requirements and other federal securities laws issues. Ms. Holland regularly gives advice to public company clients with respect to SEC reporting obligations, exchange listing standards, the requirements of the Sarbanes-Oxley Act and Dodd-Frank Act and proxy advisory firm voting policies. She also advises corporate management, boards of directors and board committees on their corporate governance policies and practices and counsels them on fiduciary duties, takeover defenses, legal compliance and board and committee best practices
FOOTNOTES: 1http://tcbblogs.org/governance/ 2014/08/07/wealth-transfer-versus-wealth-creation/ #more-3496. 2https://conference-board.org/publications/publicationdetail.cfm?publicationid=2708.
*This article has been prepared for informational purposes only and does not constitute legal advice. This information is not intended to create, and the receipt of it does not constitute, a lawyer-client relationship. Readers should not act upon this without seeking advice from professional advisers. The content therein does not reflect the views of the firm.