Shareholders are looking to take an increasingly active role in governance. Whether or not they have a literal seat at the table, they are getting closer to the boardroom than ever before. Boards of directors will have to take notice and change their practices to respond.
How are shareholders changing the game?
In recent years, we have seen shareholders put the spotlight on bad governance practices to promote better governance and better boards. Institutional shareholders, organizations like the Canadian Coalition for Good Governance (CCGG) and proxy advisers, as well as so-called "activist" shareholders, have all entered the activist ring to push for greater board independence, majority voting policies and "say on pay" votes. This rise in engagement shows no sign of abating. Indeed, shareholders are becoming more focused in their interventions, and looking for more direct and specific influence on boards.
M&A activism continues to increase, with activists not only pressuring issuers to undertake strategic transactions, but engaging in "bumpitrage" where they seek higher consideration in live M&A transactions. Proxy advisers are also becoming more involved in M&A, asking more questions, doing their own analysis and advising shareholders to vote against transactions. In 2016, ISS advised a negative vote in 6% of the transactions it reviewed—still not a high percentage, but double the rate in 2014.1
The real stories of shareholder influence are now the ones that start and end without any proxy battle.
Even more noteworthy for directors however, are actions by shareholders to get inside the boardroom and influence strategy development and decision-making more broadly. This occurs most obviously when shareholders engage in a proxy contest to include their nominees on the board, both in minority and majority slates. However, the real stories of shareholder influence are now the ones that start and end without any proxy battle because the targets and the activists are able, through dialogue, to reach a mutually satisfactory resolution to address the activist concerns. In fact, the percentage of activist campaigns that resulted in a formal proxy contest in Canada dropped by 23% from 2012-2016.2
One method shareholders are using with increasing frequency to influence the boardroom is tactical voting. Institutional shareholders will register their dissatisfaction by voting "no" on say-on-pay votes or withholding their votes in the election of targeted directors. Shareholders have apparently withheld 20% or more of their votes for 102 directors at S&P 500 companies so far this year, which is the most in 7 years.3 For added impact, institutional shareholders are also often publicizing their negative views: CPPIB recently did so in withholding its vote for the Chair of Bombardier over executive compensation issues; CPPIB and Teachers did so in voting in favour of the dissident slate in the CP Rail proxy vote; AimCo openly criticized Viterra's board renewal process; and the Caisse openly questioned SNC Lavalin's response to its bribery scandal.
Proxy access has become another area of attention for shareholders, first in the United States and more recently in Canada. CCGG is pressing Canadian issuers to implement a proxy access policy designed to allow access to the company's proxy circular, to require an omnibus proxy, and to allow nominating shareholders to solicit proxies, at the corporation's cost, without preparing a dissident proxy circular. Unlike in the United States, proxy access is already enshrined in Canadian corporate law, although it is rarely used and CCGG's policy on proxy solicitation would require securities law changes to implement. Nevertheless, an individual retail shareholder recently made a proposal to implement proxy access at the annual meetings of both Toronto-Dominion Bank and Royal Bank of Canada, on terms that included some elements of CCGG's policy. The proposal was approved by the shareholders at TD and garnered significant support (but was defeated) at RBC, demonstrating there is shareholder interest in keeping proxy access on the agenda in Canada.
Shareholders are also expecting direct engagement with independent board members—and directors have to adjust to this new reality. In all three 2015 cases where the board lost the say-on-pay advisory vote (Barrick Gold, Yamana Gold and CIBC), after the vote the companies focused on shareholder engagement. All three achieved strong approvals on the votes in 2016. The desire for engagement with directors extends even to passive index funds, which consider themselves "permanent" shareholders, making governance a significant issue that they expect to be able to address with boards.
Complexities of evolving shareholder influence
There are benefits to having active owner managers, as demonstrated by the value private equity owners have created following their acquisition of public companies. There is significant appeal to that governance model and investors in public companies are often looking to replicate it by having influence at the board level and a say in strategic direction.
However, shareholders of public companies are diverse and self-interested, with no fiduciary duty to act in the best interests of either the company or other shareholders. No matter how permanent shareholders may consider themselves, they will each have their own investment objectives, trading strategies, or even political or other objectives, that may conflict with value maximization, as illustrated by Mason Capital's recent attempt to block the elimination of Telus' dual class share structure.
As well, shareholders generally act through intermediaries: managers of the institutions that hold the shares for the benefit of the ultimate owners, investment managers, brokers, advisers and other representatives. Their decision-making faces the same potential risks of misaligned incentives (as a result of their personal financial or other incentives) that concern people when directors and officers make decisions for corporations.
Further, shareholder board nominees may not be independent, and there is a risk they may be inclined to advance the nominating shareholder's interests, particularly if the nominee is an employee of the shareholder or is otherwise beholden to it. This issue arises directly when shareholder activists provide compensation to their nominees for acting as a director. These so-called "golden leashes" were a flashpoint when Jana proposed a dissident slate for Agrium, although ISS supported Third Point's nominees to Dow Chemical's board notwithstanding these types of compensation arrangements, and proxy access policies of many U.S. issuers specifically permit these payments if they are disclosed.
Nominee independence may be an issue even if there is no direct compensation from the nominating shareholder. It may be challenging for a nominee to be neutral to the wishes of the nominating shareholder if the director depends on a relationship with the shareholder for other financial benefits or if loyalty is a personal driver. As well, the nominee's acceptance of the board seat may have been based on support of the nominator's agenda for the investment. Committing in advance to an agenda could conflict with the nominee's obligation to come to the board with an open mind and avoid any fettering of discretion.
Ultimately, our corporate governance model rests on boards, not shareholders, overseeing management. It is the board's job to balance the interests of shareholders and other stakeholders in making decisions for the company and Canadian corporate law imposes fiduciary duties on directors to act in the best interest of the corporation in doing that job. Shareholders have no similar role or duty. However, shareholders' opinions clearly matter: if shareholders lose confidence in management, the board will not be able to execute its strategy. In today's environment of rising shareholder engagement, boards ignore shareholders at their peril.
What should boards be doing?
Continuous improvement of your board and your director nomination process
- Renew your board over time. Don't let the board stagnate. Introduce new expertise and experience and a diversity of views to the boardroom by bringing in new members over time.
- Assess your board regularly. Don't rely on fixed terms and retirement policies to provide feedback: move out directors who are not contributing.
- Seek shareholder feedback. Pay attention to and solicit input on board composition and renewal from institutional and other long-term shareholders. Take their views into account and disclose how you have done so.
Engage with your shareholders
- Develop and disclose your process for engagement. The board should develop a process for engaging with shareholders, and disclose that process in the information circular.
- Consider proactive engagement. Don't wait for shareholders to become unhappy. Proactive engagement should be considered in the right circumstances. However, directors have to prepare, or it can backfire.
- Understand your shareholder base. Ask shareholders their objectives for their investment, their time horizon, the composition of their own investors and their investment criteria, and how they measure performance.
- Be prepared. Be prepared to talk about the company's nomination process, director assessment, management succession and executive compensation.
- Be vigilant on matters important to shareholders. These include management performance, executive compensation, accountability, and corporate efficiency.
- Keep an open mind. Avoid knee-jerk defensive responses to negative feedback.
What to avoid
- Don't abdicate. Ultimately the board must make the decision, not simply abdicate to the wishes of particular shareholders.
- Don't make indiscriminate use of defensive measures. Advance notice by-laws can help companies prepare for and manage shareholder board nominations. However, purely defensive measures may backfire. Regulators are unlikely to allow boards to use a voting pill (which triggers if shareholders over a specific ownership threshold agree to vote together) to constrain shareholders from voting in a proxy contest merely because they are acting together. Blacklists in private placements (prohibiting transfers to known activists) have also attracted negative regulatory attention. Concordia imposed this restriction on Cinven in 2015, following a trend that we had already seen in the U.S. Although we expect to continue to see these types of provisions, the staff at the OSC has expressed concern that it could deter shareholder activism.
- Don't simply assume your strategy fits the public markets. Some strategies simply don't suit the public markets or cannot be implemented without a strong controlling shareholder prepared to stick with management's vision. Indeed, far fewer companies today set their sights on an IPO; since 1996, the number of listed U.S. companies has fallen from 7,322 to only 3,6714.
1 Kingsdale Advisors. "M&A Activism: A Special Report," 2017. Available here.
2 Kingsdale Advisors. "Encountering the Evolving Shareholder and Governance Landscape," September 2016. Available here.
3 SS Corporate Solutions, as reported by The Globe and Mail. July 3, 2017.
4 The Economist. "Why the decline in the number of listed American firms matters," April 2017. Available here.
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