Why majority should rule

Why majority should rule
When Herb Pinder Jr. first got involved with company boards more than 25 years ago, the identity of directors had more to do with the chief executive officer’s circle of friends than the wishes of its shareholders. “The CEO at company X would get his buddy over at company Y to come on his board and chair the compensation committee, and then the guy at company Y would return the favour,” he says. “It was all very cozy, and it was nice when you got on the circuit, but it was very clubby and inappropriate, both with respect to the law, and ethically.”
The former sports agent and lawyer is president of the Goal Group, a private equity management firm based in Saskatoon, and has been a director at a number of companies, including TSX-listed oil and gas company ARC Resources Ltd., where he currently sits on the board. Things have come a long way since those days, and Canada’s corporations are all the better for it, Pinder says. Increasingly independent directors have redefined their relationship with management, wielding greater influence on the running of the company. “There’s a lot more sunshine on these matters, a lot more news about business, and a recognition of its importance,” Pinder says.

But now directors are facing an uprising of their own, from the people who elect them: shareholders.

In recent years, greater shareholder engagement and the explosion in the importance of institutional investors, who owe a fiduciary duty to their members, has shifted the focus again, from board-management relations to board-shareholder relationships. Investors want more rights, and shareholder democracy advocates like the Canadian Coalition for Good Governance, which was formed in 2003 to represent the interests of institutional investors, are now targeting improvements to the way they elect their representatives on the board.

At times, the complicated system of proxy voting for shareholders can more resemble a third-world dictatorship than a shareholder democracy. As election time rolls around, incumbent directors can relax, safe in the knowledge theirs is the only name on the ballot. Large chunks of votes can inexplicably disappear, many more arrive mysteriously out of nowhere, and protest votes are easily ignored. And the plurality standard that dominates North American corporations gives nominated directors an advantage that the likes of Zimbabwe President Robert Mugabe could only dream of.

Shareholder voters have only two options in uncontested elections for directors. They can either vote for the nominee presented by management, or they can withhold their vote. When it comes to tallying the scores, the withheld votes don’t count against the nominee, but are treated like abstentions. “Any votes that aren’t in support of management basically end up in the trash bin,” says Dan Chornous, chairman of the CCGG’s board. That means directors can win an election without the support of a majority of shareholders. Taken to the extreme, directors need just one positive vote to secure their spot on the board, and since they are usually shareholders themselves, that single vote could be their own.

And at many companies, the board is presented to voters for approval as a slate of nominees, rather than individually, allowing potentially objectionable directors to slip through in the crowd. Almost half of Canadian companies use slate voting, according to Institutional Shareholder Services Inc., a U.S.-based proxy advisory firm, putting it in league with countries such as Jordan, Kuwait, Indonesia, and a number of African countries, where slate voting is still prevalent. According to Chornous, the stage is set perfectly for regulators to step in and reform the system to make it more democratic, with the Canada Business Corporations Act currently undergoing a five-year parliamentary review and the possibility of a national securities regulator still firmly on the horizon. “There is an opportunity for Canada to really get it right. You have this unique alignment, and if it doesn’t happen here, it could be a long time before all those elements line up in a way that you can make effective change,” he says.

The Ontario Securities Commission has answered this call. Earlier this year, it began taking soundings on shareholder democracy issues, including proposals on whether to ban slate voting and mandate majority voting, which would ensure all directors are elected by a majority of voting shareholders, advisory votes on compensation, and the effectiveness of the proxy voting system.

Since 2006, the CCGG has encouraged companies to sign up to its own voluntary majority voting policy. According to a report it issued earlier this year, as recently as 2003, none of the companies listed on the S&P/TSX composite index utilized majority voting. Now about 57 per cent of the issuers on the index have embraced it. But the policy gives boards the discretion to retain board members with more withheld votes than for votes, albeit “only in extreme circumstances, and only really temporarily,” according to Judy Cotte, the CCGG’s general counsel and director of policy development. Should the OSC incorporate majority voting into new rules, she wants to see that discretion removed to give full effect to the shareholder vote. “Ultimately, when the law is changed, we want to ensure that a director who does not get majority votes for, does not get elected, as a matter of law,” Cotte says. “If you get more votes against than for, you’re not wanted, and you should leave.”

She has the backing of the OSC’s investor advisory panel, which is designed to give a voice to investor concerns in the regulator’s policy-making process. The panel’s chair, Anita Anand, who is also a professor at the University of Toronto’s Faculty of Law, says it “seems incomprehensible” that majority voting has not already been adopted, and says the practices of the largest issuers are not necessarily reflective of all companies. “Corporations that are listed on the S&P/TSX index may have majority voting in place but this is unlikely pervasive practice among all listed companies in my view, especially in small- to medium-size firms,” she says. “In our view, there is value in legally mandating certain corporate governance mechanisms, such as majority voting, so that the same practice is implemented by all firms.”

Magna International Inc., recently adopted a majority voting policy, and it will be used for the first time at its 2012 annual general meeting. Directors with a withheld vote above 50 per cent have to resign, but Bassem Shakeel, the company’s vice president and secretary, insists the board must retain discretion over whether to accept the resignation. He says otherwise strong candidates can fall foul of strict guidelines employed by proxy advisory firms, to whom many investors outsource their voting decisions. For example, Shakeel says a proxy advisory firm may suggest a withheld vote for a director who has missed a certain number of board meetings, without taking into account the reasons for the absences. “There may have been a good and valid reason, but the rigid application of the rule could result in a good director who is truly looking after shareholders getting turfed, and that’s clearly not in their best interests,” he says.

Andrew MacDougall, a partner at Osler Hoskin & Harcourt LLP, served as counsel to an Institute of Corporate Directors task force on shareholder democracy. The task force expressed concerns that majority voting could result in failed elections that leave boards without enough directors to function properly. Smaller companies, in particular, could be hit hard by rejected nominees, according to MacDougall, who suggested they be excluded from any rule mandating majority voting. “There’s smaller issuers that are having enough difficulty attracting directors of the calibre they need to be able to take it to the next level. It just adds another impediment or difficulty and a smaller company in growth mode probably doesn’t need that added burden,” he says. “If you get a large withhold vote against, you know there’s something concerning shareholders that is worth investigating, but when you get to majority voting standard, it doesn’t add any more information to the board, it just adds some additional challenges. I
think it’s important that there be an opportunity for the board to reflect on the reasons underlying the majority withhold vote and then make a decision that’s in the best interests of the corporation.”

In any case, MacDougall says majority voting is useless in controlled companies where a majority shareholder is able to appoint the whole board alone.

The CCGG’s Cotte calls the failed election argument a “bit of a red herring” because there are procedures already laid out in the CBCA for the appointment of replacement directors or a special meeting to elect new ones, while Anand suggests that if directors are unable to convince a majority of their shareholders to back them for any reason, then they “should be replaced by others who can.”

Anand acknowledges that majority voting is of little assistance to minority investors in controlled companies, urging the OSC to look into how they can be protected. “A principle of shareholder democracy must take into account the interests of both majority and minority shareholders,” she says.

A number of countries around the world have answered the call for shareholder democracy with an advisory vote on executive compensation and “golden parachute” payments that give shareholders a “say on pay,” and the OSC has also vowed to review the issue with a view to developing regulatory proposals. Legislation in the U.K. and European countries requires companies to give shareholders the vote. In the U.S., the Dodd-Frank Act requires every public company to hold a say-on-pay vote at least every three years. In Australia, legislators gave the vote some teeth by forcing a resolution to remove the entire board when the “no” vote on executive compensation exceeds 25 per cent for two years running. In the Netherlands, the vote is actually binding, but few in Canada are prepared to go that far.

Anand’s panel envisions an advisory vote that enables shareholders to “register their views” on compensation, and open a dialogue with the corporation’s senior management and board that will “likely lead to better and more fruitful exchanges.”

Cotte sees it as a way for investors to let off steam that could actually benefit directors, especially those on compensation committees. “From the corporate perspective, they should embrace this. Say on pay gives shareholders an opportunity to express their view, short of voting against the directors. They can send a signal that the approach to compensation may be off, without actually withholding their vote,” she says. At Magna, Shakeel’s not buying it. “If the ultimate goal is engagement, why do you need this, just engage. Engage in discussions with the board, or the chair of the board, whatever it might be,” he says.

According to MacDougall, Canadian corporations have a strong history of communication and consultation with shareholders, and he says the binary nature of the vote means it adds little to the discussion.

“There’s no useful information that gets conveyed through say on pay other than a bunch of shareholders aren’t happy with the compensation decisions for that year,” he says. “It doesn’t convey what it is that was wrong with the compensation, and it doesn’t do it in a longer-term basis.” He says political and financial crises and scandals have been the spark for say-on-pay votes in other jurisdictions, especially the U.S., and doesn’t believe Canada should merely follow the crowd.

“Where say on pay has been implemented, it’s been implemented as a legislative response by politicians to a public outcry. It’s not been done as a result of a deliberate reflection of what is the right model from a governance perspective. We need to look at this from the Canadian market,” MacDougall says.

Investors here, Shakeel says, also have greater powers to make their voices heard during proxy season than their American counterparts. In Canada, shareholders can issue their own proxy circular containing the names of their own director nominees, or, if they hold more than five per cent of shares, they can ask the management to include the alternative proposal alongside its own materials. “If you already have the ability through other means to make the same point, why do you need another tool to send the same kind of message?” he says.

Pinder says investors shouldn’t be shy of taking the ultimate step of removing a director if they think they’ve got the compensation wrong, comparing the situation to an MP’s relationship with his or her constituents. “When an issue comes up in Parliament, you don’t go back to the people and ask them what to do. You’re elected to do a job, and if they don’t like it, they’ll vote you out,” he says. “If you’re really not happy with the compensation, never mind say on pay, just recommend voting against [the chairman] and the members of the compensation committee. That’ll get their attention real fast.”

But according to the CCGG submission to the OSC, in practice, such drastic measures are “difficult and prohibitively expensive.” It estimates the cost of preparing, mailing, and promoting an alternative slate of directors at a minimum of $500,000. Pinder fears a say-on-pay vote could undermine the role of directors, who are already bound by a responsibility to act in the best interests of the company. “As a director, compensation is about building trust with management that you’re going to be fair. If, at the same time, you have investors saying we don’t trust the directors, because we’re going to vote on what you do, it doesn’t work. If investors don’t trust us, how do you expect management to trust us?”

He sees say on pay as a measure that should be targeted at companies who are suspected of transgressing on compensation, rather than tarring all firms with the same brush.

Shakeel says he’s uncomfortable with the notion that directors, with an intimate knowledge of the myriad complex factors that affect compensation and profitability, could be second-guessed by shareholders whose understanding may be lacking.

“There’s a lot that goes into the structuring of a compensation system. There’s different tools and assumptions you can make, and in the end it’s a matter of understanding how the different tools you apply in a system work to actually create the incentives for the right behaviours in the company. It varies company by company and industry by industry and shareholders aren’t always in the best position to understand all of that and then create decisions or create the pressure for certain decisions.”

Magna’s notoriously generous executive pay packets have, at times, raised eyebrows, but Shakeel says the company’s atypical compensation plan, with its emphasis on direct profit sharing, has been a critical component of its success.

“It has worked very well in terms of incenting the right behaviours towards profitability, which is ultimately what drives long-term value for shareholders.”

Chornous says he was once a member of the director-knows-best camp, but his views have evolved over time. He says where companies have engaged in voluntary say-on-pay votes, it has improved the level and clarity of the company’s compensation disclosure to shareholders. “We establish minimum expectations as owners of the firm for disclosure and transparency, and say on pay lets us say to what degree we think you’ve achieved that minimum standard,” he says.

The entire shareholder democracy argument could be rendered moot, according to Sylvia Groves, unless something is done about the effectiveness of the proxy voting system itself, the third strand of the OSC’s review. “People think they’re walking into a federal election and putting a check mark on the ballot, and you get to count one vote. That’s not what happens. It goes into a huge black hole,” she says. “I think it’s important for shareholders to understand about asking for things like say on pay, and majority voting, but regardless of that, unless your vote is really counting, then having those things really doesn’t mean a lot.”

Groves, a former chairwoman of the Canadian Society of Corporate Secretaries, has firsthand experience with the dysfunctional nature of the process from her time at Nexen Inc., a major Canadian issuer. One tally came in with 20 million more votes than the total number of shares issued.

The issue came to the fore late last year when Davies Ward Phillips & Vineberg LLP partner Carol Hansell released her report, The Quality of the Shareholder Vote in Canada. The 200-page tome identified common problems such as over-voting, empty voting, and a general lack of transparency, in a system largely shrouded in mystery, even for those closely involved. “It’s an issue that’s poorly understood. It seems to be too big for people to get their arms around, because it’s been around for so long, it’s so pervasive, and there’s so many problems,” Hansell says.

The complexity of the system and the sheer number of steps and parties involved increases the chance of technological or administrative error, and can make identifying the source of the error difficult. Hansell’s report details numerous instances of faulty votes, but she says they only tend to come to light when a large shareholder becomes suspicious about whether their own vote was counted, making it difficult to establish how many votes have been affected, and whether they could have changed decisions.

The CSCS has scheduled a Shareholder Democracy Summit for October 2011, at which it hopes to bring together representatives from all of the players in shareholder votes, including issuers, investors, proxy advisory firms, and voting administrators. Groves says it is essential regulators are involved, too, and that they take action to improve. “It does impact how well our markets work,” she says. “Shareholders are not going to invest here if they think they can’t trust the results of our shareholder votes.”

She predicts investor engagement is only going to increase in the coming years, so calls for improved shareholder democracy are not going to get any quieter. The most recent trend has seen web sites like moxyvote.com attempting to mobilize and band together disparate retail investors into a cohesive voting bloc, exerting greater influence on the companies in which they invest. Although she’s a little uncomfortable with the activist language used by some of the sites, Groves says she’s happy to see people taking an active interest in their investments. “Overall I think it’s a really good thing that people are engaged. You really do want your views represented and if you’re not getting a voice, either because you’re not speaking or taking the time, or the companies aren’t doing a good job of communicating with you, I think that’s a loss for companies and for shareholders broadly,” she says.

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