Learning from Past Mistakes to Avoid a Proxy Fight
All publicly-traded companies face the risk of a proxy fight with one or more of its current shareholders. In a nutshell, a proxy fight is a situation where two corporate factions (typically the Board/Executive Team vs. an activist shareholder or a group of company shareholders) fight for votes from remaining shareholders in order to effect change in a particular area of governance in the company.
This issue often occurs when a new slate of board members is proposed to replace a group of existing board members by an activist shareholder or group. The new slate of board members are generally individuals who are receptive to the activist shareholder’s views on how to change the company while the existing board members are often resistant to the activist shareholder’s views. Common areas of disagreement that can lead to a proxy fight include: future company strategy, executive compensation, company performance or whether a sale of the company or continuing as a stand-alone company is in the best interest of shareholders.
There are many examples of high-profile proxy fights in North America in recent years including: Proctor & Gamble, Yahoo, Dupont, CP Rail and Crescent Point Energy. However, recent research by Vinson & Elkins LLP has shown that in 2016, 83% of all proxy contests in the United States were at companies with market caps of less than $1 billion, which means that proxy fights are a risk for all size of companies in the marketplace. Even though many of these proxy fights result in unsuccessful vote outcomes for the activist shareholders, they often lead to significant change at companies. For example, Proctor & Gamble ended up appointing activist shareholder Nelson Peltz to its board even though Peltz lost the proxy fight. At Crescent Point Energy, while Cation Capital was unsuccessful in electing new board members, former CEO Scott Saxberg was forced to step down and the company indicated a renewed focus on capital allocation, cost reduction and return on capital employed. All had been promoted by Cation as part of its proxy fight. In a successful proxy fight, Bill Ackman was able to get his slate of new board members elected to the board at CP Rail in 2012, which resulted in an overhaul of management with the hiring of Hunter Harrison as CEO and a renewed focus on driving cost efficiency at the company. The resulting change was extremely beneficial to CP shareholders as its market capitalization has grown almost 300%, while significantly reducing its Operating Ratio under the new strategy and leadership.
The lesson here is not to say whether proxy fights are good or bad for shareholders, but to raise awareness that if you are a board member at a publicly-traded company you need to be aware of the risk and how to avoid getting into this difficult situation. Here are five strategies that can aid your board in avoiding a proxy fight.
Five Strategies to Help Your Board Avoid a Proxy Fight
1. Know your shareholders:
Have a deep understanding of your Top 10, 25 and 50 shareholders. Who are the most active among them? How much of your company’s shares do they own? Do they often vote their shares at your Annual General Meeting (AGM)? Do they follow the voting guidelines or research of a proxy advisory firm (e.g. ISS, Glass Lewis)? Do the shareholders have published voting guidelines on board make-up, corporate governance or executive compensation designs that they prefer? Having the answers to these questions will allow you to understand the potential concerns that shareholders might have with your company and help you address those concerns through your public disclosure or engagement activities.
2. Proactively engage with shareholders rather than react to their views
Seek a dialogue with your Top shareholders and try to engage with as many shareholders as possible either face-to-face or through active communication through e-mail or phone calls. This dialogue will allow you to communicate your Board and management’s story and share why you believe that your strategy and approach are in the best interest of the company. It also provides a vehicle for your shareholders to share their concerns, which allows you to better understand their views and potentially implement certain changes to the Board and management’s plan to address their concerns. If possible, you should try to include your CEO and/or Board Chair in these conversations, so that both the Board and management are hearing shareholder concerns. You must ensure that a consistent message is being presented by the Board and management in any of these conversations to ensure the same story is being told to all shareholders.
3. Monitor your company’s pay-for-performance linkage
Executive compensation has become a lightning rod in recent years for proxy fights when activist shareholders can point to relatively high compensation and relatively low performance over a 3 or 5-year period. It is imperative that the board monitor the relationship between pay and performance and ensure that there is general alignment between the two. While the Compensation Committee and board should be monitoring this alignment on an annual basis during committee/board meetings, another way to demonstrate alignment to shareholders is through the annual proxy circular where a company reports on the compensation for its top five executives. Compensation is required to be disclosed following a rigid format in the Summary Compensation Table, but that does not preclude a company from demonstrating executive pay in other ways using “Realized” or “Realizable” pay calculations. Inserting “Realized” or “Realizable” pay graphics into the annual proxy circular helps to illustrate that what has been paid, or is potentially owed to executives, aligns with the company’s performance even more so than what is disclosed in the Summary Compensation Table. The Compensation Committee and Board should also be monitoring the CEO’s annual performance scorecard to ensure Short-Term Incentive (bonus) payouts align with performance and do not surprise shareholders. The scorecard should also be updated on an annual basis to deal with the evolving strategy and the nature of the company’s operations.
4. Be transparent
Ensure that your company is open with shareholders and is seen as acting in a transparent manner. Often, companies can find themselves in proxy fights and situations where shareholders are unclear on the company’s strategy or why compensation has been structured in a certain way. If shareholders are unclear on the future strategy or do not understand the compensation design, they are more likely to side with the activist shareholder who has a strong vision and strategy for the company with a clear compensation design that makes sense to them.
5. Monitor your Board renewal process
A common theme in many proxy fights is that the Board has become too entrenched in their role and has not done a good enough job at challenging management’s thinking. This issue tends to stem from the tenure of current board members. The activist shareholder may perceive that certain board members lack independence because they have sat on the Board for too long. This perception may not be the case, but it does not stop the activist shareholder from using this appearance to his or her advantage. Your Board should be actively monitoring its renewal process by evaluating the diversity of skill, background, gender and experience of board members – giving rise to the following questions:
- Are there areas where we can strengthen our skills or promote greater diversity in views and experiences?
- Are there board members who are not carrying their weight?
- Is the company moving in a new direction that requires a different set of skills at the Board level?
Being able to communicate this renewal process with shareholders is critical and can be communicated annually through the proxy circular or through providing this information on a company’s website. It will enlighten shareholders to the rigorous process your board follows to ensure it is operating as effectively as it can.
Proxy fights are never fun. They disrupt the company and divert the Board’s and management’s attention away from executing on the company’s strategy and more towards fighting off an activist shareholder. In many cases though, proxy fights can be avoided through better understanding of your shareholders, hearing their concerns and proactively communicating the company’s story so that you can try to deal with any issues before they get out of hand. This strategy requires the company to act transparently; while monitoring the alignment between executive pay and company performance. Annually, the company can demonstrate this transparency through disclosure of the alignment between pay and performance, the company’s compensation design and its board renewal process in the proxy circular. Learning from past mistakes can ultimately help board members weather the storm at their company and hopefully avoid the costly and disruptive nature of a proxy fight.