What are the biggest corporate governance challenges and issues for 2012? I spoke with a number of investors and other governance experts, and here’s what they said:
- Executive compensation will continue in the spotlight.
Jonathan Feigelson, general counsel and head of corporate governance, TIAA-CREF predicts that executive compensation will continue to be a lightning rod issue, especially during such volatile economic times. “In 2011, the expanded availability of say on pay proposals provided investors an alternative avenue to express their views on corporate pay programs and shareholders will most certainly continue to make their views known during 2012.”
Mike McCauley, Senior Officer, Investment Programs & Governance / Florida State Board of Administration (SBA) agrees, and predicts that “in the U.S., year two of say-on-pay will be much more bumpy than 2011, as many investors refine their approach to analyzing corporate compensation frameworks. In response, many companies have made significant changes to their compensation elements, or have plans to do so in early 2012. One of the key points of discussion and review will be a company’s peer group and the dynamic between compensation levels and corporate performance. Advisory services have made revisions to their methodologies, and there will likely be a laser-like focus on some of the more granular elements of compensation design (LTIP metrics, stretch goals, etc.), peer group design, and the quality of advice provided by consultants to compensation committees.”
Rhonda Brauer, Senior Managing Director – Corporate Governance at Georgeson, adds more color. “In the second year in which most public companies will have their shareholders vote on their executive compensation, there are a few factors that should make it even more challenging than in 2011. First, there is a combination of the impact of the “Occupy Wall Street” phenomenon – with its ongoing focus on the 99% versus the 1%, along with the still high US unemployment rate. Second, I have a sense that investors feel that the average vote for say-on-pay was too high last year, that they should have voted against more executive compensation packages and that more companies should have lost their votes. In addition, all companies are going to have to contend with a more complicated and unpredictable ISS pay-for-performance analysis, notwithstanding ISS’s well-intentioned purpose to focus more on the longer term. While all companies should continue to follow best practices in telling their executive compensation stories in the clearest and most compelling way possible, many will face challenges with ISS’s new analysis. There are likely possibilities for disagreement about peer groups and about comparing apples to oranges when comparing a company’s executive pay to the median pay of ISS’s peer group for that company.”
One source noted that when investors assessed the first round of say on pay votes in 2011, companies had the benefit of a general upswing in markets to support pay increases. The more challenging markets of the last year may provide greater differentiation among companies and the pay for performance linkage.
Matteo Tonello, managing director of corporate leadership at The Conference Board, believes that the second year of say on pay in 2012 will provide researchers abundant information to study the actual influence of proxy advisory firms on the voting process. The Conference Board has recently partnered with NASDAQ and Stanford University’s Rock Center for Corporate Governance to investigate the issue and observers can look forward to more on this topic in the coming weeks.
Mike McCauley added that upcoming SEC regulations on claw-back requirements will pose additional challenges to regulators trying to balance the goals of investors with concerns of companies about the difficulties of creating a hard and fast rule. Anne Sheehan, Director of Corporate Governance at CalSTRS, agrees, and notes the significance of corporate governance rulemaking expected from the SEC in 2012 on clawbacks, as well as issues such as disclosure of pay ratios, pay for performance and hedging policies.
Charles Elson, Woolard Professor & Director at the University of Delaware’s Weinberg Center for Corporate Governance, predicts that executive compensation will remain in the spotlight for some time to come. Elson believes that investors will grow more confident in executive pay decisions only when boards clearly demonstrate that they are in fact and by action truly independent of company management, have a real stake in company performance, (e.g., meaningful equity ownership), and, as important, pay is set not by what other companies pay, i.e., peer groups, but how executives actually perform as compared to others.”
2. Corporate political spending will be highly scrutinized.
“Given the 2012 presidential election and the impact of the 2010 Citizens United case removing restrictions on certain corporate political contributions, companies should expect to see an increase in shareholder calls for improved transparency and board oversight of corporate political spending,” said Feigelson, TIAA-CREF.
Brauer agrees. “Shareholder concern about corporate political contributions and lobbying activities will continue to pick up steam in this Presidential election year, as more money is expected to be spent than in any prior election. Shareholder proposal proponents and supporters express concern about whether corporate funds are being spent in a way that is consistent with their companies’ values and not in a way that will risk embarrassing their companies. There are more variations in the 2012 shareholder proposals than there were in 2011. While negotiations continue between proponents and companies, it is too early to tell how many resolutions will actually go to a vote versus reaching a mutually acceptable settlement, as well as how high the average vote may go if there are more settlements and more corporate disclosure is provided. In any case, the general trend is toward more disclosure being posted in easy-to-find ways on company web sites and having thoughtful corporate policies in place on these issues. As has been the case with other significant governance proposals, I expect that the larger companies will take the lead, particularly with the two political contribution disclosure & accountability indices that came out at the end of 2011, rating and ranking the S&P 100 companies. Both indices are expected to expand to the S&P 500 in 2012.“
3. Proxy access will gain steam.
Brauer explains that “after much drama, we are finally seeing institutional and individual shareholders submit both binding and non-binding proxy access proposals. As I expected, the proposals are being submitted to a small number of companies that have significant executive compensation and/or corporate governance issues. Proxy access proponents (including the proxy advisory firms) are generally supportive of proxy access in principle, regardless of the reasons that a proposal may have been submitted to a particular company. However, in the first year of these proposals, there is a sense that the proponents want the proposals that go to a vote to do well, so that the targeted companies appear to be easy targets. As these proposals become more common in future years, certain ownership thresholds and by-law procedures may become more standard, and some companies may take the initiative to adopt or to submit to a shareholder vote their own proxy access by-laws. In addition, proponents will be better prepared to submit more proposals and to withstand the no-action challenges that companies file in an attempt to exclude the proposals from their proxy statements. “
While Elson agrees that proxy access will be a popular ballot item, he questions whether it is the ultimate solution to the shareholder election participation conundrum. Elson believes that “proxy reimbursement, which will appear on a number of ballots this year, is the better approach. It is a self-executing separation of serious from non-serious challenges and is popular with both investors and management because of its simple, easy appeal.”
4. Global convergence of governance practices has begun and will continue to gain momentum.
According to McCauley, “we see a continuation of the trend toward various cross-border actions, comprehensive regulatory benchmarking, and comparative shareowner activism by institutional investors across the globe and in wildly different capital markets. Whether it was the investor outrage shown by non-Japanese investors at the board of Olympus Corporation (not to mention the actions by its former non-Japanese CEO), or bold proxy access filings made by Norges Bank at several U.S. companies, shareowners are increasingly global in their approach to corporate governance and their pursuit of responsible investing. For the first year in its history, the SBA voted more non-U.S. proxies than it did for its domestic holdings, and the focus on developing and frontier markets continues unabated.”
One source noted that for international investors, it is important to recognize the distinctive business culture and standards of local markets, rather than pressing for a single corporate governance model globally. The diversity of approaches taken in different markets can be a great source of inspiration or learning. Say on pay, for example, has played out (and is continuing to play out) differently in different markets with different company/shareholder engagement models.
5. Fundamental concepts such as annual election of directors and majority voting become even more widespread.
According to McCauley, “investors will continue to advocate that boards de-stagger director terms and transition to annual elections. The vast majority of S&P 500 companies have moved away from staggered boards over the past decade, and now many mid-sized companies are likely to make the transition.” CalSTRS’s Sheehan supports this view and explains that CalSTRS sent letters to more than 100 companies this proxy season asking for the adoption of a majority vote standard. These efforts have already met with success at 40 of these companies.
Combined with longer term trends towards more investor-friendly anti-takeover structures, McCauley believes these changes will significantly improve board accountability and the overall quality of corporate governance in the United States.
In addition, McCauley predicts that many U.S. investors will continue to push for bylaw changes affecting true majority voting election procedures. “This governance issue is tied directly with individual director terms. While many investors are agnostic as to the order of adoption, companies which recently transitioned away from staggered boards may be under more pressure from investors to amend their bylaws with a clear, majority standard for board elections (and vice versa).”
Elson believes “there is no compelling rationale for companies to oppose either the annual election of directors or majority voting. Eventually both approaches will end up as the default position, absent some rare and compelling reasons to choose another approach.”
6. Companies continue to face the need to find ways to rebuild trust eroded by the scandals of the past decade.
“Concerns about the responsible use of corporate power remain high in the wake of the financial crisis. Although these concerns have been focused primarily on the financial sector, there is spillover to corporations in every industry. Tough economic conditions, slow job growth, political dysfunction and general uncertainties about the future continue to undermine investor confidence and fuel public distrust (with Occupy Wall Street an example). This in turn intensifies the scrutiny of corporate actions and board decisions, and may skew the regulatory environment in which companies compete. All corporate governance participants – boards, executive officers, shareholders, proxy advisors, regulators and politicians – have both an interest and a role to play in rebuilding trust in the corporations that are the engine of our economy,” according to Ira M. Millstein, Weil, Gotshal & Manges, LLP.
The continued high level of scrutiny of corporate actions means that companies need to act with care and consider the potential ramifications of actions that might have received little attention in a growing economy.
One thing is certain, with respect to corporate governance; we continue to live in interesting times. We can expect that in addition to these issues and challenges, new ones will emerge.
What additional challenges do you expect in 2012?