As 2019 kicks into full gear, companies are preparing for what is sure to be a busy year ahead in corporate governance. With several key events and milestones from 2018 still unfolding, corporate America has had some time to process the changes in governance and adapt to the new landscape. Investors continue to play a critical role in how corporations function and do business, while numerous external factors are altering the way companies approach particular issues, including Say on Pay, the CEO Pay Ratio, board composition and much more.
For its annual report Corporate Governance Outlook 2019, published with commentary partners Donnelley Financial Solutions (DFIN) and Hogan Lovells, Equilar analyzed the proxy statements and shareholder voting results for the 500 largest U.S. public companies by revenue (Equilar 500). The analysis and results of the report shed light on where corporate governance has been and, potentially, where it’s headed in the coming years.
If 2018 was indicative of one thing, it was that shareholders are expressing their opinions at a higher rate than ever, and that is likely to only increase going forward. In 2018, general shareholder rights made up 35.6% of all shareholder proposals at Equilar 500 companies. As a result, companies have become more apt to engage with their shareholders. From 2014 to 2018, companies in the Equilar 100—a sample of the 100 largest U.S. companies—that at least mentioned shareholder engagement in the proxy statement increased by 54%. Additionally, 58.6% of companies disclosed the process of how they engage with shareholders throughout the year, rather than merely stating that engagement happened.
General shareholder rights made up 35.6% of all shareholder proposals at Equilar 500 companies.
One of the primary drivers for this heightened level of effort to engage with shareholders stems from the fact that activist investors have established a daunting presence, particularly as activist campaigns continue to increase in prevalence. 2018 witnessed a number of activist attacks, including one from billionaire activist investor Carl Icahn, who seized control of the boardroom at Sandridge Energy. Other notable activist campaigns from 2018 include activist investor Starboard Value, who launched a proxy fight with Newell Brands citing lackluster performance as the reason. An attack from an investor is certainly something companies want to avoid; however, the key to successfully dodging one of these attacks is getting ahead of the conversation with shareholders, and corporate America appears to be moving in that direction.
“As shareholder engagement becomes more prevalent at public companies of all sizes, companies are increasingly disclosing their shareholder engagement activities in the proxy statement,” said John Beckman, Partner at Hogan Lovells. “Companies traditionally disclosed their engagement efforts in response to a significant issue, such as low support for a Say on Pay vote or significant support for a shareholder proposal. However, detailed disclosure of shareholder engagement activities has now expanded beyond the single issue situations and has become a more standard feature of proxy statement disclosures.”
Going into 2018, the spotlight was cast on the CEO Pay Ratio for a variety of reasons, as it was the first year the ratio was a mandatory SEC disclosure requirement. However, with the amount of pre-disclosure anticipation that stemmed from the ratio, first year disclosures were met with very minimal reaction. Companies went back and forth on what was considered the best methodology to disclose their ratios—whether to be brief or with fine detail—but, ultimately, there was not a definitive “right” or “wrong” way to disclose the ratio. In 2018, the median CEO Pay Ratio at Equilar 500 companies was 168 to 1, while the average CEO Pay Ratio was 271 to 1. Additionally, the median CEO-to-average-NEO Pay Ratio was 2.99, while the average ratio was 3.12 (Graph 1).
Interestingly, there was a greater focus placed on the median employee. “The news of these disclosures is not CEO pay, but rather who a company considers to be the median employee, and what it implies about the company’s business model,” said Ron Schneider, Director of Corporate Governance at DFIN. “Since many companies are permitted to use the same median employee calculation for up to three years, the complexity of calculating year two ratios should be greatly reduced.”
While the CEO Pay Ratio in its first year may be a bit unclear to break down on the surface, when attached to Say on Pay, ratio trends seem to paint a clearer picture. For instance, the median ratio at companies that had a Say on Pay approval in the range of 50–59% was the largest of any bucket at 469.5 to 1, and more than three times the ratio at companies that received at least 95% approval (Graph 2).
Say on Pay continues to have a lasting impact on the corporate governance landscape almost eight years following its inaugural year. While executive compensation packages have been largely accepted by investors, 2018 saw a decrease in the approval percentage that Equilar 500 companies received. In 2018, less than half of companies received more than 95% approval on their executive pay packages, which is 10 percentage points less than the year before. Despite that, 2018 actually showcased the most companies with more than 90% approval for Say on Pay proposals, at 81.6% of companies.
The number of Say on Pay failures nearly doubled from six to 11 in 2018.
Interestingly, the number of Say on Pay failures nearly doubled from six to 11 in 2018. Schneider explained, “This typically means that proxy advisors and investors will look for the company’s responsiveness to the vote which can include post-meeting engagement with investors, evaluation of feedback and perhaps some actions taken in response, such as changes to certain compensation practices that investors and/or proxy advisors objected to, as well as clearer discussion of other perhaps misunderstood or under-appreciated practices.”
In recent years, there has been a movement across boardrooms in America to promote greater diversity, particularly gender diversity. Over the past year, the investor community has placed a heightened emphasis around gender diversity. In February of 2018, BlackRock—the world’s largest money manager—publicly stated that companies in which it invests should have at least two female board members. Michelle Edkins, Global Head of Investment Stewardship at BlackRock, wrote a letter to Russell 1000 companies that have fewer than two women on the board to ask them to disclose their approach to boardroom and employee diversity, The Wall Street Journal reported.
Furthermore, the two major proxy advisory firms—Glass Lewis and ISS—have both updated their proxy advisory guidelines to reflect a greater focus on board diversity. Glass Lewis will now generally recommend a vote against the nominating committee chair of a board that has zero female board members, while ISS plans to enforce the same policy in 2020.
Glass Lewis will now generally recommend a vote against the nominating committee chair of a board that has zero female board members.
On the legislative side, the state of California recently passed a piece of legislation—SB 826—that will require public companies headquartered in California to have a minimum of one female on its board of directors by December 31, 2019. That minimum will be raised to at least two female board members for companies with five directors or at least three female board members for companies with six or more directors by December 31, 2021. Violators of this legislation will be subject to financial consequences.
California is the first state in the nation to pass a mandate of this kind, and, most likely, not the last. The past year has shown exceptional signs of progress, and with California leading the way with an official quota, gender diversity will only continue to become a point of focus in boardrooms across corporate America.
According to the most recent Equilar Gender Diversity Index (GDI)—a measure of gender parity across Russell 3000 boards—there are still 504 boards that lack a female director. As 2019 goes on, there is no doubt that boards that fall into this bucket will face some level of scrutiny from investors. Companies that want to address this issue—and address it thoroughly—must prioritize practices that promote diversity and the value it brings to a boardroom.
“If you want the most talented board, you cannot limit the talent pool,” said H. Rodgin Cohen, Senior Chairman at Sullivan & Cromwell, in a recent interview for C-Suite magazine. “If you want the best board, you need to have a meaningful number of women or else you’re just not getting the best people that you could have.”
Companies are beginning to put more emphasis on their board evaluation process, not just in terms of composition, but also with respect to performance in general. As a result, companies are disclosing their board evaluation processes at relatively high rates. Across the Equilar 100, more than one in four companies disclosed their board evaluation processes—a rate that has nearly tripled since 2014 (Graph 3).
“The process at [many] companies has become a routine ‘compliance’ exercise,” said Alan Dye, Partner at Hogan Lovells. “If undertaken thoughtfully, the self-evaluation process will not be perceived as a demonstration of board collegiality, but instead will lead to both improvements in board processes and a greater willingness on the part of directors to speak candidly at board meetings, particularly regarding strategy, risk and board refreshment.”
There is no question that the governance landscape continues to become more complex, and corporations must react promptly. With these burgeoning responsibilities comes the notion that executives, board members and governance professionals must stay ahead of key governance trends to not only avoid costly pitfalls, but also to reap the benefits of sound governance practices.
Amit Batish is the Editor-in-Chief of C-Suite and Content Manager at Equilar. He can be reached at firstname.lastname@example.org.