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Amy C. Seidel, Partner at Faegre Baker Daniels
One of the hottest governance topics going in 2015 is director tenure. This issue emerged last year when certain institutional investors and proxy advisory firms announced policies focused on director tenure. As we head into 2015, companies and investors will consider questions like “How long is too long?” and “Is the focus on director tenure just another way to encourage refreshment and diversity in the boardroom?”
What Happened in 2014?
- CII announced its view that long tenure can impair independence.
- ISS included director tenure into its Governance QuickScore rating system, whereby long tenured directors (more than nine years, according to ISS) may negatively impact the company’s score.
- State Street announced a policy focused onboard refreshment, indicating that it may engage with companies if the average director tenure is above the market average.
What Does this Mean for Companies in 2015 and Beyond?
In order to avoid scrutiny for director tenure concerns, companies should consider the following:
Break down the tenure of directors. For example, identifying the number of directors serving less than three, three to six, six to nine, and more than nine years may help the board visualize the mix of tenures.
Employ a rigorous director evaluation process. If shareholders had confidence that all director evaluations were honest and constructive, they likely wouldn’t care about tenure. Their real concern is whether each director is holding his or her own weight and making meaningful contributions, and is able to bring diverse perspectives and independent viewpoints to the boardroom.
Refresh the board with relevant experience for the company’s evolving business. Businesses change over time—they may expand into new geographies or product lines, or face new risks. Ensure that the board includes members with experience relevant to the company’s evolving business who bring diverse viewpoints that identify with the company’s diverse constituents.
Amy Seidel is a Partner at Faegre Baker Daniels LLP where she is the head of the firm’s Public Companies and Securities practice area. Her practice involves advising public companies on SEC reporting requirements, stock exchange listing standards, executive compensation issues, disclosure issues, shareholder activism and general corporate governance matters. She also has experience in many areas of corporate representation, including public and private securities offerings, mergers and acquisitions and general corporate counseling.
Greg Lau, Managing Director – Board of Director Practices at RSR Partners
My morning routine typically begins with The Wall Street Journal. And, frankly, I cannot remember the last time an activist investor headline was missing from my breakfast table. But whether you prefer coffee or tea, I think we can all agree that activist investing will be one of this year’s hottest corporate governance topics.
As such, it is high time for boards of directors to take a hard look at how—or even if—they are equipped to go into discussions with an activist. More than 20% of the Fortune 500 has already been targeted. How so? Typically, these activists use direct letters to the board or 14a-8 proposals to incite other shareholders around campaigns aimed at gaining board seats and promoting alternative value maximization strategies.
Now, initiatives to improve shareholder value are indeed a good thing. In the first eight months of last year, activist investors returned an average of 5.9%, according to research outfit HFR, compared with a 3.9% gain for hedge funds generally. In fact, Bill Ackman, head of Pershing Square Capital Management, wrote his investors last August, saying, “The popularity of activism as a strategy has increased due to the potential it offers for substantial returns.”
But typical goals of increasing value and separating disparate business units are not activists’ only aims. As the upcoming presidential election heats up, it is worth noting that, as The Conference Board’s Matteo Tonello and Melissa Aguilar point out in their report Proxy Voting Analytics, “Political spending and lobbying activities, a topic virtually absent from voting ballots until a few years ago, became the most frequently submitted shareholder proposal type of 2014.”
These proposals will continue to gain momentum. According to The Conference Board, during last year’s proxy season, activist hedge funds submitted 39 proposals at Russell 3000 companies, up from 24 proposals in 2013. These proposals, however, only represented 5.2% of the total. But let’s not forget just how powerful these activists can be. Recall last fall when Starboard Value took on Darden Restaurants, convincing shareholders to replace the entire board with its 12-director slate. And Starboard wasn’t even Darden’s largest shareholder.
So just as boards have been beefing up their benches to handle cybersecurity’s ever-evolving challenges, it is important that directors seriously consider adding to their ranks colleagues with the savvy necessary to navigate this new age of activist investing. And if that colleague is already on the board, it is imperative that he or she has the right financial, operating, and communications skill set.
With more than 35 years of corporate governance experience, Greg has deep expertise working closely with chairmen, chief executive officers, and nominating and governance committees on board composition. At RSR Partners, Greg advises the boards of some of the nation’s leading companies on succession planning and director recruiting and also provides compensation and corporate governance consulting. Greg previously served as executive director of global compensation and corporate governance for General Motors, during which he was secretary of the directors and Corporate Governance Committee of GM’s board. He is a member of the board of the National Association of Corporate Directors (NACD) and is a NACD Board Leadership Fellow. He also serves as a trustee of the Committee for Economic Development (CED).
Rich Fields, Principal at Tapestry Networks
Board composition will be a hot topic in 2015. The number of desired experiential, demographic, and personal attributes for most boards has grown substantially. Board composition questions are very company-specific, but industry experience, global expertise, and gender diversity will be of particular interest at many companies.
Shareholder activists have demanded boards bring on more members with industry experience, asserting that industry veterans are better equipped to monitor senior management and the company’s competitors. Expect companies to seek this experience in the absence of activist pressure.
According to Egon Zehnder, international revenue is now 37% of total revenue at S&P 500 companies, up 5.5% since 2008. More than 70% of S&P 500 companies report some international revenue. Foreign nationals and those with significant international work experience—especially in Asia and the Middle East—will be in high demand.
Broad social and political pressure to improve gender diversity will energize efforts to increase the percentage of board seats held by women (roughly 17%) and the number of companies with three or more women on the board (roughly 23%).
Average board size has remained stable, meaning that boards must create space for directors with new ideas and capabilities. Mandatory retirement ages have historically been one route to refreshment, but they continue to trend older (typically 72-75) and are often rendered toothless by exceptions. Major investors are unlikely to hold US companies to tenure-related independence standards like those found in the UK and France, but I think that investors will pay more attention to individual director and aggregate board tenure.
Rich Fields is a Principal at Tapestry Networks. He leads many of the firm’s corporate governance initiatives and leadership networks, engaging with directors of the largest U.S. public companies on topics such as compensation, independent board leadership, audit policy, and board composition. Fields was instrumental in the creation of the Shareholder-Director Exchange and SDX™ Protocol, a practical framework that helps companies and shareholders determine when shareholder-director engagement is appropriate and how to make such engagements more effective. Earlier in his career, Fields was a litigator at Ropes & Gray, where he advised boards on government enforcement and internal investigation matters.
He is also the immediate past president and chairman of the board of the Boys & Girls Clubs of Middlesex County.
Glen T. Schleyer, Partner at Sullivan & Cromwell
I know that we and others have said this in the past, but there’s a good chance that 2015 will be the year that proxy access really starts to gain some traction. This will be the fourth year that shareholders will be permitted under SEC proxy rules to submit proxy access proposals—that is, to propose that companies allow qualifying shareholders to include their own nominees in company proxy statements. In 2012 and 2013, many of these proposals were deemed excludable by the SEC because of drafting errors, and most of those that came to a vote got low support levels. But in 2014, shareholder proponents seemed to have hit upon a successful form of proposal—seeking to give the right to holders of 3% of shares for a 3-year period. This proposal passed most of the time it came to a vote, sometimes by wide margins. We expect to see some private ordering play out in this area in 2015 and beyond, as more companies respond to shareholder proposals by putting forward their own proxy access proposals, with conditions and limitations that the company finds acceptable. In the past few years, we’ve seen special meeting rights and written consent rights develop in this way, particularly at larger companies. Though proxy access has been a slow grower to date, it seems poised for expansion, and companies should be prepared.
Glen T. Schleyer, a partner in Sullivan & Cromwell’s Corporate & Finance Group, advises numerous corporate clients on ongoing public company matters, including SEC reporting, executive compensation, corporate governance, regulatory compliance, and managing shareholder relations and shareholder proposals, as well as a variety of registered and unregistered securities offerings.
Daniel Laddin, Founding Partner at Compensation Advisory Partners
As scrutiny of executive compensation and corporate governance increases, one of the most significant challenges facing Boards is “going against the grain.” Pressure from organizations like Institutional Shareholder Services (ISS) and Glass Lewis has influenced policies on executive compensation to the point where there is increased homogenization of practices, which may not be in the best interest of shareholders. For example:
Relative Total Shareholder Return has become one of the most prevalent metrics in long-term incentives. However, this has come at the cost of driving line-of-sight and linking equity payouts to successful execution of a company’s strategy. While outperforming peer stock performance over the long-term is critical, it may not always be the best metric for incentives, particularly if not balanced with operational or financial indicators of success.
Stock options have become significantly de-emphasized, in no small part due to ISS’s view that they have limited performance linkage. That being said, few vehicles can reward for long-term value creation as well as options. In fact, one could argue that few incentives today provide for a focus of greater than three years versus the 10-year life of options.
Limitations of the Board to exercise its judgment related to incentive payouts. Shareholder advisory groups never complain when a Board chooses to reduce an award, but what if a Committee has strong reasons to increase a payout? Many Committees feel their hands are tied as upside adjustments are frowned upon, even when they may be warranted.
These are just a few examples where outside pressure is influencing executive compensation, and not always for the better. What is most important is to do what is in the best interest of driving value. If that decision includes something that may be “going against the grain,” then the most important thing is for a Board to have a compelling reason for making that decision and communicating it through the CD&A and one-on-one discussions with shareholders.
Dan Laddin is a founding partner of Compensation Advisory Partners LLC (CAP) in New York. He works with Boards and management consulting in all areas of executive compensation, including annual and long-term incentive design, performance measurement, target-setting, regulatory/compliance as well as outside director compensation programs. He has over 15 years of experience working with both private and public companies across industries with a focus in consumer products/services, media, and manufacturing.
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Seamus O’Toole, Managing Director at Semler Brossy
Now is the time for Boards to take a fresh look at their goal setting approach. At the time this was written, the SEC had not provided final rules on the CEO Pay Ratio or clawback requirements. While these topics will be hot in 2015 if final rules are provided, I view goal setting as potentially a more complicated and pressing issue for many Boards.
Increasingly shareholders and their advisors are scrutinizing the difficulty of goals used in pay programs. The recent acquisition of Incentive Lab by ISS suggests this trend is likely to accelerate and become more analytical. External assessments of goal-setting rigor will play a larger role in Say on Pay votes going forward.
There is uncertainty around exactly what frameworks will be used by shareholder advisory groups to assess goals. But given the contextual nature of goal setting, it is likely they will have limitations. As a result, Boards will face significant pressure to provide expanded disclosure on the topic.
Boards will benefit from proactively scrutinizing their approach before others apply the lens. First, Boards should take a fresh look at their process to ensure it is comprehensive and that the right information is available to guide decisions. Second, Boards should review their disclosure to identify opportunities to provide a fuller picture of the calibration process as well as the Board’s analysis of the difficulty of the goals. Boards that don’t act now risk being caught flat footed in the future.
Seamus O’Toole, a principal with Semler Brossy Consulting Group, has served as a trusted advisor on compensation and incentive design issues for both public and private companies for over 12 years. Working with companies of all sizes and across industries including technology, financial services, utilities, and retail, he helps clients execute their strategy through appropriate performance measurement and incentive design, including annual and long-term programs. Prior to joining Semler Brossy, O’Toole founded and ran a technology consulting boutique focused on data and process management and customized application development. O’Toole can be reached at sotoole@semlerbrossy.com.
