The Conference Board Governance Center Blog

Dec
08
2014

Maintaining Integrity: Golden Leashes Back on the Board Table

By Donna Dabney, Executive Director, Governance Center, The Conference Board

On November 20, 2014, Dow Chemical Company entered into a settlement agreement with Third Point, a New York based hedge fund, to increase the size of its board and add two directors retained by Third Point as advisors. Dow had previously rejected Third Point’s nominees because of a “golden leash” pay plan which would entitle Third Point’s nominees to significant compensation from Third Point for their service on Dow’s board. According to proxy disclosures filed by Third Point, each of Third Point’s two nominees would receive $250,000 for agreeing to serve as a nominee, and each would receive an additional $250,000 payment if appointed as a director, which would be invested in Dow stock. In addition, each nominee would receive two additional cash payments from Third Point based on the appreciation of approximately 396,000 shares of Dow common stock following October 2, 2014. The first stock appreciation payment would be calculated in connection with the average selling price of Dow’s stock during the 30 day period prior to the third anniversary of service on the board, and the second payment on the fifth anniversary. The incentive compensation reportedly was not contingent on Third Point continuing to own Dow stock over this period.

Third Point acquired a 2.5% stake in Dow in January 2014 advocating for a spin-off of the company’s petrochemical businesses.  According to FactSet, Dow took several actions to increase dividends, expand its share repurchase program and sell assets to raise cash to buy back more shares, but these actions did not satisfy Third Point, which announced on November 13 that it intended to launch a proxy contest.  A week later, Dow entered into a settlement agreement with Third Point forestalling a proxy contest and agreeing to nominate Third Point’s nominees with the disputed pay plan in place.

Last year when similar pay plans were proposed by activist hedge funds, there was a considerable amount of discussion and concern about the propriety of such payments, but there has not been a similar reaction to the Dow/Third Point case.  In one case in 2013, the proposed nominees waived their rights to incentive compensation after push back from institutional investors (Hess and Elliott Management,) and in another case the activist was unsuccessful in its efforts to place its nominees on the board (Agrium and Jana Partners).  What is the difference in public reaction now?

In the Hess/Elliott case, Elliott reportedly agreed to pay each of its nominees $50,000 to agree to stand for election plus it planned to pay its successful nominees $30,000 for every percentage point Hess stock outperforms a group of peers over three years.  If Hess stock outperformed its peers by 10% over that period, the Elliott-nominated directors would each receive $300,000 from the hedge fund in addition to their regular board fees.  These directors could have made millions (up to an unlikely maximum of $9 million) if Hess were sold for a large premium within two years.  The incentive to break up Hess as advocated by Elliott would make it more vulnerable to a takeover and a larger potential incentive payment for the dissident directors. Hess objected to the fees because they would incentivize Elliott’s directors to take short term actions that may not be in the best interests of the company or the shareholders as a whole.  This argument apparently was persuasive to Hess’ longer term shareholders at that time.

In the Agrium/Jana case, Jana took the position that Agrium should spin off its retail-distribution business and distribute the cash to its shareholders.  Jana reported that it paid $50,000 to each nominee and in addition, each of its nominees to the Agrium board would receive a percentage of Jana’s net profits based on an increase in Agrium’s stock price. In its letter to shareholders, Agrium had this to say about the Jana pay plan:

JANA’s Dissident Nominees: Bought and Paid For?

It is important to note that JANA’s dissident nominees have agreed to accept special incentive payments from JANA for serving on Agrium’s Board. These payments are structured to incentivize short-term actions, even if they are taken at the expense of greater long-term value. This kind of “golden leash” arrangement is unheard of in Canada and raises serious questions about the independence of JANA’s nominees, and their ability to act in the best interests of all shareholders.

Professor John C. Coffee, Jr. of Columbia Law School analyzed the Hess and Agrium situations in an April 29, 2013 article entitled: “Shareholder Activism and Ethics: Are Shareholder Bonuses Incentives or Bribes?” concluding that while special bonuses to selected directors are not inherently unlawful nor fraudulent if full disclosure is made, these pay arrangement raise serious corporate governance concerns.  He points out the following issues:

  • Timing conflicts. Special pay incentives encourage those directors who receive them to take short term actions that may not be appropriate for the company.
  • Risk appetite. Directors with incentives to boost stock price quickly may be more inclined to take risks to boost stock price such as by leveraging the company. The Dodd Frank Act restricted incentives for executives at major financial institutions precisely because such compensation was thought to have led to the short term incentives that produced the financial crisis.
  • Directors have a fiduciary obligation to the company and all of its shareholders, yet special compensation paid by one shareholder may unduly influence a director to act in that shareholder’s interest at the expense of other shareholders and the company’s interests as a whole.
  • Conflicts of interest. Compensation can give rise to a conflict of interest that induces a director to subordinate his or her own judgment to that of the institution paying the director.

In short, third party incentives create a fragmented board and create a shift towards both the short term and higher risk.  Is this the direction business should be going?

About the Blogger:

Donna Dabney, Executive Director, The Conference Board Governance Center

Donna Dabney, Executive Director, The Conference Board Governance Center

Donna Dabney joined The Conference Board as Executive Director, Governance Center, in August, 2012. In her current position, Donna leads The Conference Board’s efforts in the areas of corporate governance and sustainable value creation. Prior to joining The Conference Board, Donna was Vice President, Corporate Secretary and Corporate Governance Counsel of Alcoa Inc. and she participated for over 15 years in board and committee meetings of Alcoa and Reynolds Metals Company. As part of her work with the Alcoa Board of Directors, she gained experience with sustainable development in the Amazon region of Brazil. Donna is a member of the board of directors of American Forests, the oldest national conservation organization in the U.S., the New York Advisory Board of the Society of Corporate Secretaries and Governance Professionals and previously served on the board of a public/private consortium promoting development in Richmond, Virgina.



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