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Practice Management > Compensation and Fees

Constructive Engagement

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It’s a well known that investors love steady returns and hate surprises. With more media scrutiny of Wall Street than ever and news reaching investors at the speed of light, shareholders are quick to examine what’s going right and wrong with their investments. Furthermore, they expect accountability from those companies they have invested in.

This increased scrutiny has included a focus on the once-clubby corporate board room, after several high-profile corporate bankruptcies and other troubles brought intense public and government examination of how business operates in the United States. And, as a result, a large number of corporations have moved to demystify their policies and bring in more outsiders to their leadership.

Today, many investors believe that better corporate governance translates into better investment returns and shareholder value. They believe a strong corporate governance program can lessen risk and enhance results. “Proxy proposals [are] another avenue to create shareholder value,” says Peter Vanderlee, portfolio manager with investment firm ClearBridge Advisors of New York, an affiliate of Baltimore-based Legg Mason.

And corporations are on the same page as well. Many publish the full details of their corporate governance programs. Plus, the market has seen the rise of services such as those provided by RiskMetrics Group of New York, which specializes in independent analyses of corporate governance practices.

What makes up a good corporate governance program? Good communication, strong disclosure practices and constructive engagement with investors, explains Patrick McGurn, special counsel with RiskMetrics Group.

Where there’s transparency, investors are more comfortable and confident about their holdings, and often companies and senior management are able to weather rough times more easily than when firms and their corporate governance practices are opaque, experts say. Where there’s opacity, troubles can be exacerbated, McGurn notes. “The way out of darkness with all companies has been to bolster corporate governance practices,” he says.

In the early part of the decade, investors and corporate leaders awoke to the hazards of weak oversight by boards. As Enron, WorldCom and others stumbled, investors saw billions of dollars of value vanish. Investors, impressed by the stellar returns of these firms realized a need to more closely examine how corporations were being run and earnings were being achieved.

Those high-profile collapses led to what RiskMetrics’ McGurn called a “once in a generation … wave of reform in corporate governance.” And corporate governance reform has now become widespread.

Take, for instance, the way corporate boards are created. Years ago, some corporate boards were largely hand-picked by CEOs. Today, independent nominating committees are becoming the norm. This is just one of many changes in corporate governance that have materialized recently.

A Say on Pay The hot topic for 2008 is “say-on-pay voting.” With say-on-pay, investors get a chance to voice their opinions about corporate compensation plans. For the most part, say-on-pay votes are non-binding. Still, shareholders want these measures.

If shareholders were to give a thumbs-down on a compensation package, “Nothing would have to happen, because it is non-binding” explains Vanderlee of ClearBridge Advisors. However, it might be disadvantageous for a board to ignore dissatisfied investors. “I would submit that if the majority of shareholders are voicing displeasure, it is an issue the company should address.”

Insurance firm AFLAC, for example, has voluntarily decided to submit to say-on-pay votes. Plus, a majority of telecom giant Verizon’s shareholders voted to have the firm start allowing say-on-pay votes starting in 2009.

Indeed, executive compensation has become a major corporate governance issue, but not because shareholders are necessarily upset with the level of compensation now given to executives. Rather, some investors are troubled by large payouts when a firm is doing poorly, say corporate observers. Investors want to make sure that both pain and gain is shared among a company’s different stakeholders, and some investors groups have actively embarked on a quest to further align executive compensation with shareholder’s interests.

Sorting out executive pay is a thicket that isn’t necessarily easy to clear. Compensation programs are often set up to meet tax and accounting needs, rather than to fit in with corporate strategies. Still, the Securities and Exchange Commission is starting to take a hard look at executive compensation.

Some compensation programs tie executive bonus payments to a firm’s performance within its peer group, and these plans may stipulate that the bonus is only paid if and when the firm outperforms its group. If there’s no out-performance then the bonus isn’t paid.

But, if this encourages too much risk taking, for instance, it may lead to questionable results. In other words, it could have “a number of unintended consequences that can be detrimental to shareholders,” says Vanderlee. In other words, new corporate governance programs have to tread carefully into such uncharted territory.

Leadership ContinuityWith the rise of independent nominating committees, corporate boards are taking a greater role in ensuring that CEO turnover doesn’t weaken the corporation in any way. Take the highly publicized departure of former GE CEO and Chairman Jack Welch. Many investors feared that with Welch’s departure, the halo of GE’s leadership might be negatively affected.

But, incoming chief executive Jeff Immelt foresaw that, McGurn notes. In a dramatic change from the Welch era, Immelt undertook a massive overhaul of GE’s corporate governance practices, in the process adopting many progressive practices. The result? GE was able to “turn around declining investor expectations and put (the firm) back on the road where there’s lots of investor confidence,” explains McGurn. “Immelt knew that’s what the market wanted to see.”

Boards of DirectorsRelations between boards and investors have certainly warmed over the past few years. “What we are seeing is constructive engagement,” McGurn says. Boards are more open to investor input and are increasingly willing to meet, discuss and even negotiate with activists.

One reason boards may be more engaged with investors is that investors are demanding more of a say in how directors are elected. For instance, some directors must be elected or retained by a majority vote. Historically, many directors ran unopposed, and if they received a single vote would be retained. About two-thirds of S&P 500 firms have some sort of majority voting program in place.

Also, the rise of corporate governance committees and nominating committees have given boards more independence. As a result, boards are less attached to senior management than they once were. Indeed, a number of firms have split the jobs of chairman of the board and chief executive officer.

Campbell Soup Company of Camden, N.J., endeavors to incorporate and epitomize the best of many of these practices. It has “every governance principle you that you can imagine,” says Leonard F. Griehs, vice president of investor relations. The firm has split the chairman and CEO jobs for years, he notes. It has active nominating and corporate governance committees, and its shareholders have an active voice in how the firm is run.

Green, Social IssuesEnvironmental issues have become a staple of shareholder proposals. And, in recent years, companies and shareholders are more in sync with the push for corporations to become being environmentally friendly.

Once, shareholder proposals calling for such “green” measures were authored by environmental activists. Today, more and more of these proposals are instead coming from pension funds and institutional investors, notes Mary Jane McQuillen, director of socially aware investments with ClearBridge Advisors. In addition, they are crafted in such a way that is complementary with the firm’s business plan, she says.

Green issues can’t be taken lightly, says Vanderlee, and have “the potential to be a mainstream topic.” They affect both the long-term health of the community and the long-term viability of corporations, experts point out.

Along these lines, firms are seeing more shareholder interest in social responsibility. At Campbell, the company is developing its first corporate social responsibility report, according to Griehs.

The push for such a wide-ranging document, which touches on topics from environmental impact to corporate giving, aligns with shareholders’ growing interest in corporate citizenship. “I think shareholders are not looking for companies to not do harm, but rather what they are doing to improve the community and area in which they operate,” he explains.

Corporate governance is “an intangible asset,” says Campbell’s Griehs. When practiced well, it helps ensure a corporation’s existence, “and [it] does it year after year.”

Clifton Linton is a Bay Area-based writer specializing in energy markets and investing.


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