Canada: "The Curse Of Zombies" Coming To Theatres (And Boardrooms) In Canada

Last Updated: August 28 2013
Article by Anthony Penhale

"Corporate governance: The curse of zombies in the boardroom" appeared in The Globe and Mail on July 24, 2013. The article described a growing phenomenon that illustrates a weakness in corporate governance structures.

What's a Zombie Director?

So-called "zombie directors" are corporate directors who fail to receive a majority of votes in uncontested elections but remain in their seats. They are a consequence (certainly unforeseen) of the adoption of majority voting policies by corporations in response to concerns that plurality voting (the standard Canadian corporate election mechanism) runs counter to shareholder democracy and may lead to the entrenchment of a company's board.

One only has to Google "zombie directors". The number of articles on the topic is now legion. The Council of Institutional Investors, the International Corporate Governance Network and countless corporate and governance blogs are now calling for the removal of zombie directors from boards and urging changes in rules to put an end to zombie directors.

Psychology Today and the Health Medicine Network have weighed in on the issue (see, "'Zombie Directors' The Illusory Rights of Shareholders" in Psychology Todayand "Zombie Directors" on the Health Medicine Network's web page). The situation must be dire!

Where Do They Come From?

Every problem has a solution; and solutions often have their own problems...

Zombie directors spawn from the implementation of majority voting policies, heralded as the cure to the plurality voting system. In a plurality voting system, shareholders do not have the option to vote against a particular nominee for director; instead, shareholders may only vote for or withhold their vote for the individual. Withheld votes do not count and a director needs only one "for" vote to be elected to the board. The plurality system guarantees that every nominee director is elected. And there lies the initial problem.

The solution: moving from a plurality voting system to a majority voting standard through majority voting policies (and thereby making a withheld vote meaningful).

Typically, a majority voting policy provides that a director who receives more "withheld" votes than "for" votes must tender his or her resignation, even though the director has been duly elected under corporate law. Absent exceptional circumstances, the resignation should be accepted by the board. A majority voting policy is designed to ensure that only those directors who receive more "for" votes than "withheld" votes remain on a board.

The move to a majority voting standard brought its own set of problems. Directors who fail to get a majority vote, tender their resignation, and yet still fi nd themselves on the board of the company. In one case, the board actually accepted the resignation and proceeded to appoint the director who failed to get a majority vote in order to fulfi ll the vacancy created by his resignation. See "When Shareholder Democracy Is Sham Democracy" in The New York Times for more examples of failings in the application of majority voting policies.

Only half of directors ultimately step down from a board after failing to obtain a majority of the "for" votes. The data (mostly US) shows that zombie directors are rarely, if ever, retained for what many might consider legitimate reasons: compliance with securities regulations, contracts, corporate laws or a provision of the company's governing documents. See "The Election of Corporate Directors: What Happens When Shareowners Withhold a Majority of Votes from Director Nominees?", a research study conducted by GMI Ratings, and commissioned by The Investor Responsibility Research Center Institute, that examined the causes and eff ects of shareholder opposition to 175 director nominees at Russell 3000 companies between July 1, 2009 and June 30, 2012.

Getting Rid of Zombies?

So, you have a zombie director. What is to be done?

Make no mistake. Majority voting policies are better than the reigning system of plurality voting. They give meaning to a withheld vote by a shareholder. Surely, they improve corporate governance. Must zombie directors be a by-product of that improvement? Not necessarily! Recognition by boards that they can't retain directors who serve without the support of shareholders is required.

We recognize that the decision of whether to accept (or reject) the resignation tendered by a director who failed to obtain a majority of the "for" votes is a matter of the board's fi duciary duties. However, boards should only reject such resignations in exceptional circumstances. And when they do so, boards should explain what those circumstances are. Too often, say corporate governance pundits, this decision is cloaked with the opaque shawl of the best interests of the corporation.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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