As another year of shareholder meetings comes to a close, the real work is just beginning. While very few companies are likely to fail their Say on Pay vote—typically about three-quarters of the S&P 500 not only passes, but also receives more than 90% approval on executive compensation from their shareholders—there are a host of other long-term issues facing companies that they will have to address in the coming shareholder engagement season.
Companies were no stranger to shareholder concerns this past year, and some estimates put the number of activist campaigns launched in the U.S. at approximately one per day in 2015. According to a 2016 Davis Polk report, aggregate assets under management for activist investors range from $120 billion to more than $200 billion. In other words, these campaigns can’t be considered small special interests looking to make big noise.
Though the intent of many of the recent SEC rules and regulations has been to increase corporate transparency and shareholder rights—undoubtedly a positive thing for all constituents—some are concerned that this has upset the balance of power. The changes over the past few years have put high demands on boards and management not only to perform well in the face of added scrutiny, but also to appropriately predict and communicate proactively how company performance will play out in both the short- and the long-term.
All of this upheaval has resulted in companies reaching out more to their shareholders. In 2011, just 2% of the S&P 100 disclosed shareholder engagement, increasing to 55% in 2015, according to Equilar research. In the S&P 500, the number of companies disclosing shareholder outreach has doubled, reaching about one-third of that larger index. (Table 1)
On paper, the solution to the tension among companies and their various constituents seems simple: Carefully assess and address all potential shareholder concerns. The application, obviously, is not so straightforward, and writing about outreach in the proxy statement means very little if it doesn’t produce better results and investor relations in real life. Companies must address performance issues and make changes in order to show shareholders return on their investment, and that process starts by engaging with shareholders proactively after annual meetings to understand the hot-button issues and potential trouble spots.
Here are several ways companies will have to prepare for shareholder engagement in the second half of 2016.
Many expect the SEC to follow through on the proposed rules from Dodd-Frank regarding pay versus performance disclosures this year. While ideally this would make pay for performance universally understandable and easily digestible, it creates further challenges for companies who want to show other definitions of pay and performance, of which there many, in relation to their specific strategies and goals.
According to Equilar research, 252 companies failed their Say on Pay votes at least once within the last five years, and among those, nearly 25% (63 companies) saw their CEOs resign—the average time frame being within a year of the shareholder meeting. In other words, no matter what they disclose, companies will need to prepare to defend their pay practices and respond to any negative feedback immediately.
Because the SEC’s CEO to employee pay ratio shines a spotlight on income inequality, companies must be prepared to contend with the media and the general public on this issue. Aside from the logistical and cost challenges incurred when this rule goes into effect for the 2018 proxy season—some estimates have put the cost to corporate America at $1.3 billion in the first year and an estimated $526 million each year thereafter—the concept of a uniform figure applying to all companies complicates this issue when it comes to communicating the reasons.
As one attendee of Equilar and Nasdaq’s recent Compensation Committee Forum put it, in the first year companies will be worried about the “four-digit pay ratio,” (i.e., a ratio higher than 1,000:1), unions will love it and use it for negotiations, the media will use it to sell papers and magazines, and a lot of sound bytes will get amplified. But in the near term, investors won’t be able to tell very much until they have a longitudinal view on how it changes year over year and affects executive compensation.
The intended consequences would bring more equitable and transparent pay practices at the executive level and from board compensation committees. However, there will also be a ripple effect to corporate communications strategies both internally and externally, which could distract them from shareholder engagement on this issue.
Boards need to be prepared to effectively communicate how they are assessing, recruiting and refreshing their boards on an annual basis, down to the specific candidates they are bringing to the ballot. As the potential for board turnover increases, companies are under pressure not only to replace directors, but also to replace directors with the right people. The SEC has even weighed in on gender and racial diversity on the board, calling it “a priority for 2016.” Boards can expect to see more and more calls from their stakeholders and the public at large to add diversity to their ranks as a signal of better corporate governance.
Diversity in the boardroom is not limited to gender and ethnicity, and it’s not about increasing numbers for the sake of doing so. The concept of “cognitive diversity” is gaining traction, as companies require new skillsets and professional trade skills in order to meet the changing demands of today’s corporate environment.
There’s also no way around it that many individuals in the current generation of executives and board members are on the cusp of retirement. Among S&P 500 companies that have a mandatory board retirement age, the most common is 72. A recent Equilar study found that 45% of all S&P 500 directors are over the age of 61, and another 15% are older than 70.
If boards aren’t prepared with the right executive and director candidates when a succession situation arises—whether due to an emergency, directors forced out through a proxy fight, or for a strategic reason as board members reach age and term limits—they will be facing significant challenges as the pool of qualified director candidates comes in higher demand over time.
The uptick in shareholder engagement amidst the increase in shareholder activism is a fine balance for companies, who may want to avoid extended exposure to calls for quick decisions on short-term strategic planning. The irony is that in order to avoid this, they have to go out proactively and make sure that their strategic vision is clearly communicated to all their shareholders, especially those that have long-term interests. Even though activism is on the rise, many, if not most, investors are aligned with companies in seeking long-term gains, not just quick returns, and partnering with allied shareholders can help mitigate disruptive forces.
The challenge is finding time with those allied shareholders, many of whom are busy being engaged by other portfolio companies. As an example, a major institutional investor told attendees of the Equilar and Nasdaq Compensation Committee Forum that his firm may meet up to 1,000 companies this year, up from about 800 in 2015, but that would still only account for one-quarter of the companies in which they invest.
Corporations consistently prepare to deal with unpredictable elements in the economy, and boards are attuned to managing risk for a host of issues. The case of shareholder outreach is no different. The era of activism may represent a shift in process, but it doesn’t have to mean a change of strategy. Straightforward, clear and consistent communication with respect to company goals and expectations among all stakeholders—directors, executives, investors and employees—is more critical than ever.
Dan Marcec is C-Suite’s Editor-in-Chief and Director of Content at Equilar. He can be reached at dmarcec@equilar.com.