RI Quarterly: as proxy access in the US spikes at 52%, have we reached a tipping point?
By Michael McCauley, Senior Officer—Investments Programs & Governance, Florida State Board of Administration (SBA)
Proxy access resolutions have received broad shareowner support and represented the largest proportion of resolutions since 2015. As a result, a dramatic number of companies has moved to implement some form of proxy access, typically adopting the US market standard of 3% share ownership and three-year holding period.
The explosion in proxy access resolution submissions has directly influenced the level and quality of corporate engagement, as well as the dialogue surrounding director elections. This has resulted in numerous companies unilaterally adopting reasonable forms of proxy access, with management-sponsored access items put before investors for approval. Along with several governance features among large capitalisation firms in the US, proxy access is now in place at 52 % of S&P500 companies. This is impressive given that it did not exist in the early 2000s.
Proxy access is now in place at 52% of S&P500 companies. Impressive given it didn’t exist in the early 2000s
Undercutting proxy access
A few companies, however, continue to oppose facilitating shareowner-nominated board candidates. And some enact more restrictive forms that lack one or more components, despite majority support from investors. A small number of companies have included limitations on investors’ abilities to nominate certain types of directors (e.g. prohibit past nominees from being nominated again) and other advanced notice or nominee queuing restrictions. This serves to undercut the effectiveness of proxy access and may substantially reduce its use in the future.
Alongside this, some firms have even attempted to dissuade their shareowners from supporting proxy access proposals. They typically argue there is no need for proxy access because of its perceived costs, concerns surrounding plurality voting, or a general shift away from a board-centric nomination framework.
Many companies also point to recent improvements in their governance practices to minimise the need to adopt proxy access, with most citing their move away from classified boards of directors, adherence to majority voting standards for uncontested director elections, and/or strengthening compensation incentives and related policies.
Proxy access as a special interest?
The board of directors serves shareowners and because proxy access provides shareowners with the ability to have a choice of representatives, such governance mechanisms should be encouraged. In practice, the choice of director candidates has only come when the problems with a company’s board and management vastly outweigh the cost of an expensive proxy contest with one or few owners footing the bill. Reflecting the fact that the number of investor-nominees is limited to a short slate (almost always less than three directors and 25% of the full board), a ‘special-interest’ candidate isn’t likely to win a seat on the board unless a majority of voting shareowners supports them. By definition, any director receiving greater than a majority level of support can’t be viewed as serving a limited or special interest constituency.
The uncertain future of proxy access
For all the corporate adoption and investor resolution activity, there remains an outstanding risk that proxy access won’t live up to the hype. For example, how will shareowners use proxy access? Which investors will play a part: activist hedge funds, long-only institutional investors, retail investors, or a mixture? There isn’t much to help suggest an obvious answer to these questions.
Complicating the situation further, legal challenges from both the corporate and investor sides are almost certain given the lack of precedent, myriad moving parts and multiple requirements.
On 10 November 2016, Gamco Investors attempted to use a proxy access mechanism to nominate a board member at National Fuel Gas Co., ostensibly the first triggering of the director nomination protocol within the US equity market. A shareowner with a 7.8% stake in the company, Gamco's CEO was quoted saying: “We are doing it [nominating a director] on a very friendly basis and only asking for one director.” National Fuel had formulated and adopted a proxy access bylaw in March 2016 that allowed investors owning at least 3% of the outstanding shares for three years or longer to nominate up to 20% of the board of directors. Under the bylaw, shareowners must make certain representations and warranties including: “that an Eligible Stockholder: (i) acquired the Proxy Access Request Required Shares in the ordinary course of business and not with the intent to change or influence control of the Corporation, and does not presently have such intent…”
Ultimately, National Fuel rejected the Gamco director nominee because it did not comply with the terms and conditions set forth in the bylaws. As noted by corporate governance researcher Paul Hodgson, the issue of “intent to change or influence control” is very well defined, and “it means where a shareholder has the intent of effecting a sale of most of the company’s assets or where there is a contested director election”. Gamco's statement did cite an investor resolution to spinoff one of National Fuel's businesses. Dating back to 2011, Gamco previously submitted 13D regulatory filings indicating an intent to possibly influence the firm’s management decisions. Some market observers viewed Gamco’s efforts as more akin to a proxy contest than the true use of proxy access .
Although somewhat anecdotal, the National Fuel experience may be prescient and indicate a larger pattern for activist hedge funds in the future, leading most to maintain their preference for traditional proxy contests. This may be particularly true given the disproportionate role for settlements between activist investors and the boards that they target. For other institutional and retail investors, a more collaborative and structured approach may be needed to inspire the use of proxy access.
The sharp increase in proxy access adoption may well prove to be at a tipping point in the election of directors, but at this point remains an unproven governance feature within the US market.
This is one of the first in a line of articles from the new RI Quarterly. Stay tuned for the next piece on the PRI Academic Network Advisory Committee's new members.