Innovation comes in many forms, whether that means transformative technologies, groundbreaking discoveries or new ways of approaching business challenges. In the boardroom, driving innovation may not be the first thing on the agenda considering the board’s key role in risk oversight and mitigation. In order to fulfill fiduciary duties to shareholders, directors are required to consult management and ensure that business objectives are in line with short- and long-term growth—not just chasing the next big thing. This may even mean they have to rein in their executives at times.
Yet, the board’s role as shareholder fiduciary does not preclude their motivation to innovate, and, in fact, it pushes them not only to consider all possible outcomes from management proposals, but also to pivot in order to suggest alternatives. In an age of activism and shareholder engagement, the investor’s voice has grown stronger, and as a result boards are looking for new and better ways to communicate company value creation to these stakeholders. That’s where boards have the opportunity to be creative and innovate.
“The primary challenge boards face is to demonstrate measurable progress in addressing issues that have become increasingly important in recent years, particularly the composition, competence and responsiveness of the board,” said Alan Dye, Partner at law firm Hogan Lovells, who, along with several partners, contributed commentary to the recent Equilar report, Executive Compensation and Governance Outlook 2017. “The company’s progress on these issues, particularly the board’s ability to oversee corporate strategy in an increasingly global and competitive environment, has a direct bearing on the risk that a company will have to face an activist investor.”
Boards are looking for new and better ways to communicate company value creation to investors.
The power and influence of shareholders on compensation practices and corporate governance has risen over the years, partially in connection with the Dodd-Frank reforms. Consequentially, companies are doing more to understand demands of their shareholders. Active shareholder engagement, whether through soliciting feedback or outreach programs, has become an effective method for conveying information and creating dialogue between parties. Even more frequent over the last few years is the disclosure of engagement programs, providing the company a chance to listen to their shareholders’ main concerns, and an opportunity to show how the company reacted and adapted to these vocalizations.
In 2012, 95 companies disclosed some form of engagement with shareholders or investors, whether through outreach programs or feedback solicitation. By 2016, that number more than tripled, with 324 companies disclosing some form of shareholder engagement. These figures translate to a dramatic increase in the prevalence of shareholder engagement disclosures, from 20.1% of S&P 500 filings in 2012 to 66.1% in 2016—a 228.9% increase (Graph 1).
“Any company can say they ‘engage’ with their shareholders, but providing proof is what ultimately makes a difference,” said Molly Doran, Director of Advisory Services for Labrador, who also contributed to the Equilar report. “This information should outline the topics discussed with shareholders and the outcomes of such discussions—some companies have even included a graphic to illustrate year-round engagement.”
Companies are doing more to understand demands of their shareholders.
Variable trends in shareholder proposals shed more light on the progress that boards have made. Over the past five years, there has been a steady increase in the number of social and environmental proposals—for which there are few mandatory disclosure regulations—while compensation and board management proposals have decreased, Equilar found. In 2016, there were nearly 200 shareholder proposals around social and environmental topics, vs. just 49 on compensation, with those categories trending in opposite directions (Graph 2).
“The trend in shareholder proposals over the past five years has demonstrated the increased interest in, and presence of groups focused on, social topics including political contributions and lobbying, the environment, and other social policy matters such as human rights and diversity,” said Alex Bahn, Partner at Hogan Lovells. “This trend may be attributable, in part, to the as-yet-unsuccessful efforts of certain stakeholders to convince the SEC to adopt new disclosure requirements concerning social topics.”
Bahn noted that many proponents for social policy issues from year to year will continue to enter proposals, even where broad stockholder support is unlikely. As a result, the number of increasing proposals is not a reflection of company adoption.
The proposal categories on the downslope may be partially attributed to clearer and more meaningful disclosure. Following the mandates from Dodd-Frank and Say on Pay, companies have become to be more transparent around executive compensation in response to enhanced scrutiny from shareholders and proxy advisors.
The question is whether this will extend to the other categories. Dodd-Frank is expected to be under heavy scrutiny from the Trump administration, and with that, there is uncertainty in the future of executive compensation disclosures—particularly the CEO pay ratio. Though a ruling was passed in 2015 that would require all public companies to report the ratio of their CEO pay to that of a median employee, which will be mandatory in proxy statements filed for fiscal years beginning after January 1, 2017, just one S&P 500 company has disclosed this information thus far, Equilar found.
Hard and fast SEC disclosure rules that have been proposed on pay for performance, clawbacks and hedging restrictions still hang in the balance, but already, more than 90% of companies include some kind of information on these topics, according to the Equilar report. In addition, don’t expect Say on Pay to go anywhere any time soon.
“Say on Pay revolutionized the way companies engage with their shareholders on executive compensation matters and became a referendum for shareholders to express their views on how executives’ pay relates to the company’s performance,” said John Beckman, Partner at Hogan Lovells.
Over the past five years, there has been a steady increase in the number of social and environmental proposals while compensation and board management proposals have decreased.
While these compensation-related disclosures seem to be entrenched, the question will be what happens to governance-related proposals and topics championed by outgoing SEC Chair Mary Jo White. Already put through in Fall 2016, a proposal for a universal proxy ballot is on the books, with the comment period ending as this issue goes to print. The universal proxy would allow investors to vote on board of directors elections from one ballot inclusive of both shareholder- and management-proposed candidates.
While the prospects for that proposal passing are in flux, the shareholder right to nominate directors, otherwise known as proxy access, has become significantly more prominent in recent years. Equilar found that there were 116 proxy access proposals in 2015 and 2016, after a total of 25 in the previous three years. Furthermore, there were a total of 62 approvals in two years vs. 10 the previous three (Graph 3). Meanwhile, the number of management proposals for proxy access jumped from 6 to 16 from 2015 to 2016. As a percentage of total proposals, management accounted for 31.4% in 2016 vs. 9.1% in 2015.
With proxy access, activists have a new tool to nominate their own candidates.
“By now, most public companies either have had interactions with shareholder activists or are preparing to have them, and may be able to work constructively with activists on board composition including specific potential independent director candidates,” said Hogan Lovells’ Beckman. “With proxy access, activists have a new tool to nominate their own candidates and we are just beginning to see this used. Companies would be well-served to objectively evaluate board composition in advance of outside pressure to do so.”
The other big question up in the air is what happens with board diversity, as Chair White had begun to advocate for more clear disclosure on this. Calls from shareholders have reached a fever pitch in terms of adding diversity and increasing transparency in board recruitment processes as well.
The change in administration does leave one to wonder whether these initiatives for formal disclosure will fall by the wayside under whomever takes the reigns at the SEC under President Trump. And at this point, meaningful disclosure in these areas is still scant. In 2016 proxy statements, while about three in five companies said they considered racial and ethnic diversity when assessing board candidates, just 13% actually disclosed the composition of their boards in these terms.
“As companies began voluntarily disclosing information on board diversity, an interest in further disclosure was sparked,” said Doran of Labrador. “As shareholders demand clearer explanations of how the board is aligned with business needs, companies will focus on communicating this link by highlighting board diversity and risk oversight. It is important to remember that credit can’t be given if the information isn’t there.”
Dan Marcec is the Editorin- Chief of C-Suite. For more information on Equilar data and analysis, please contact him at firstname.lastname@example.org or visit equilar.com/knowledge-center.html.
Director of Advisory Services