By Brian C. Matt, CFA, Director and Global Head of Strategy and Innovation with Ipreo
Institutional shareholders’ voices in the boardroom are more than just a whisper.
Just as board members take the stewardship of shareholder interests seriously, so investors have a stewardship duty and obligation to scrutinise investments under a governance lens.
Some investors take this duty to the level of operational engagement, publicly seeking to change governance practices at a company or filing shareholder proposals. However, a larger and growing contingent of the investment community only seeks to speak its mind once per year through the proxy voting process. The rapid growth of index investing, which is naturally scalable and concentrated, has led to a larger percentage of all shares held by shareholders who are unable to ‘vote with their feet’ by selling shares of companies with unacceptable governance risks. These are the investors who may speak softly 364 days a year, but carry a big stick on the date of the AGM.
Investors’ most direct voice in the boardroom is effected through the vote on director elections, and it’s incumbent on every management team and board to listen to these whispers, particularly before they become shouts. Knowing the composition of the shareholder base and the voting decision makers from each major institutional investor is a first step in the process, but listening to what investors are expressing through their votes is even more important. The statement at the annual meeting may be “director X received only 70 per cent support from investors” but the message may be more specific: “investor Y and Z own 13 per cent of our stock and believe our compensation practices aren’t aligned with shareholder value”.
Investors’ approach to director elections
This thought process occurs globally, but the US market offers us the ability to read investors’ minds through voting data that is released annually, albeit on a delayed basis. US mutual funds are required to disclose their votes cast during the period from 1 July through 30 June via Securities and Exchange Commssion (SEC) Form N-PX, which is made available by 31 August. Additionally, most large investors publicly disclose their voting guidelines and the guidelines from proxy advisory firms may also serve as a way to view the broad ‘standard’ for making director election voting decisions.
Figures two and three give a view of major US investors’ voting with respect to directors; votes from the top 50 US investors by equities under management (EAUM) average 92.7 per cent support for directors on the whole, with some investors even more likely to support the company.
Director voting practices
Rarely do investors vote against a full (non-classified) board – but the fact that these occasions aren’t common is what makes them strong statements when used. Putnam Investments is among the most aggressive in the US, following ISS guidelines closely in voting against the entire board of more than a dozen S&P 500 companies in 2015 for insufficient independence, board size, ignoring shareholder proposals with majority support, or others.
Most investors withhold a vote for a director for a specific reason. Typically, three categories of objection arise: 1) board member conduct; 2) the member’s specific qualifications; or 3) the member’s standing on a particular board committee. ISS and Glass Lewis’ standards have pushed companies toward stronger disclosure on the first category – while not necessarily eradicated, situations of board members missing high percentages of board meetings during a given year have decreased and companies are disclosing greater information on directors’ qualifications to make sure they meet independence standards.
Overboarding – directors sitting on too many boards concurrently – is a common concern in the second category. In a January 2016 study, Ipreo noted that investors Blackrock, J.P. Morgan Investment Management and AllianceBernstein had supported less than 35 per cent of directors that were in the ‘overboarded’ range (six+ boards) in 2015, while TIAA-CREF, Security Investors and Fidelity Management, gave above-average support. The third category, committee membership, may be a bit easier to isolate. Any board committee structure will have committees performing at least three basic functions: 1) overseeing management compensation packages; 2) providing an independent voice in the audit function; and 3) nominating board candidates that will produce a knowledgeable and effective board. Investors will often express their displeasure on any of these functions through a ‘withhold’ vote on either all members of the appropriate board committee, or against the chairperson of that board committee specifically.
Compensation committee
Mandatory say-on-pay voting in some markets has already given shareholders the ability to publicly oppose the company’s pay practices. However, say-on-pay voting is not a requirement for every company, and for some companies the vote may not take place annually. Investors in these cases show their opposition through withhold votes on the compensation committee; Federated Investments, Loomis Sayles, Columbia Management, TD Asset Management and Charles Schwab are a few of the large investors with 10 or more withhold votes on S&P 500 compensation committee chairs in 2015.
Audit committee
Given the public standing of the company’s relationship with an auditor, a withhold vote sends an obvious message. The Enron-era conflicted practices of paying high consulting fees to companies associated with their auditors are generally a thing of the past, but this practice still exists occasionally and attracts withhold votes for those directors associated with the audit. European investors have taken further steps toward reviewing the independence of the auditor relationship, suggesting that auditors that have conducted the audit for a particular company over a long period of time may have lost their independence; investors could present similar demands to US companies in the near future.
Nominating/governance committee structure
In contrast with the audit committee, the withhold vote for the governance committee member is often more difficult to isolate causation. Investors may have a range of reasons to oppose a change to the structure of the board (for example, insufficiently independent, diverse, or qualified boards) and can vote their displeasure in a manner that’s tough to isolate. This is when the relationship between the company and the investor can be leveraged.
Investors are often willing to engage with the company both inside and outside of proxy season and are usually very open in telling companies the issues they have with governance practices. As of 2015, more than half of the S&P 500 disclosed conducting shareholder engagement in their proxy statements – knowing in advance what practices investors want the company to follow in structuring governance may help the company connect the dots from a withhold vote to a reason why.
Whispers to shouts
Shareholders more frequently exercising their rights in the boardroom may have implications far beyond just a few percentage points in an election of an already majority-winning director. As one example, T. Rowe Price Associates recently stated it would withhold votes for governance committee members of US companies with multiple share classes. T. Rowe is also a significant participant in the IPO market, and owns 2.65 per cent of well-known dual-class issuer Facebook’s common shares today, not to mention a greater-than-10 per cent stake in more than 135 companies. While T. Rowe’s move may not single-handedly raise the cost of capital for companies seeking to sell equity, it’s not hard to extrapolate how wider adoption of opposition to poor governance may have a direct and quantifiable impact on the bottom lines of companies in the capital-raising process.
All voting data in this piece was sourced from Ipreo’s BD Corporate Governance tool, which provides a robust set of institutional voting data on corporate governance decision makers, to support corporate secretaries’ and IROs’ interactions with their voting shareholders.
About the Author:
Brian C. Matt, CFA, is Director and Global Head of Strategy and Innovation with Ipreo. All voting data in this piece was sourced from Ipreo’s BD Corporate Governance tool, which provides a robust set of institutional voting data corporate governance decision makers to support Corporate Secretaries and IROs interact with their voting shareholders.
