"Golden Leashes", and by-laws designed to counteract such arrangements, have provoked significant controversy in the 2013 proxy season, and regulators, proxy advisors, and institutional shareholders have yet to take a definitive position in the debate. This post reviews what will certainly continue to be a hot button topic in 2014.
Compensation by a Third Party
So-called "golden leashes" arise when a shareholder activist privately offers to compensate its nominee directors ("activist directors") in connection with such nominees' service as a director of the target corporation. Arrangements vary but include compensating activist directors who are elected based on achieving benchmarks, such as an increase in share price over a fixed term. Shareholder activists only provide such incentives to elected activist directors, not re-elected incumbent directors.
The Debate
Those opposed to such incentive payments say that they could result in fragmented boards (because only the activist directors receive the incentive payments) and distorted incentives that result in activist directors acting in the interest of the shareholder activists instead of independently and in the best interests of the target corporation.
Those in favour of such incentive payments say that they are necessary to entice high quality candidates to stand for election in contested elections (because activist directors run the risk of being attacked by the target corporation's board) and they aim to link director pay to target company performance, which they say can benefit all investors.
This year, activist investors Jana Partners LLC and Elliott Management Corp. proposed "golden leash" arrangements for their nominees to the boards of Agrium Inc. and Hess Corporation, respectively. Jana was unsuccessful and Elliot settled its proxy fight.
The Use of By-Laws as a Defensive Tactic
As a defensive tactic against golden leashes, some U.S. companies have enacted by-laws that prohibit or limit third party compensation of activist directors in connection with such directors' service as a director of such corporation. These by-laws have proven to be as controversial as "golden leashes".
Recently, Provident Financial Holdings, Inc. (a U.S. bank holding company) went even further by enacting a by-law that not only prohibited compensation of activist directors for service as a director but also prohibited activist directors from receiving third party compensation merely for standing for election as a director of the target corporation (this compensation practice is not uncommon in the United States). In response, proxy-advisory firm Institutional Shareholder Services Inc. ("ISS") recommended that Provident's shareholders withhold their vote for the incumbent directors that were up for election at that corporation's recent annual meeting. Among other things, ISS took issue with the broad by-law (prohibiting compensation even for standing for election) being enacted without a shareholder vote (despite the fact that such shareholder vote was not required under Delaware law).
Expect more Debate in 2014
ISS's position on Provident's by-law is not an endorsement of "golden fee" arrangements generally. We expect that ISS will address such arrangements in 2014, and likely on a case-specific basis.
It's important to note that pursuant to securities laws in Ontario, arrangements or understandings between activist directors and third parties must be disclosed. Canadian regulators have not otherwise taken a definitive position in this debate and may be unlikely to do so.
We are unaware of any judicial consideration of either "golden leashes" or by-laws designed to counteract such "golden leash" arrangements – however, as both practices gain more traction, legal challenges are inevitable.
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