The hottest issue in U.S. corporate governance and investor relations right now is majority election of directors.
Plurality voting for directors is the prevailing rule today throughout the United States. Essentially all state corporate statutes provide that, unless stated otherwise in a corporation’s charter, nominees receiving the most votes, up to the full number of seats open, are elected – even if a majority of votes cast is not in their favor. Plurality voting is intended to ensure continuity of the board.
Many shareholder activists believe plurality voting does not adequately permit shareholders to express disapproval. Votes withheld have no real effect. In an uncontested election, each nominee in the board’s slate will still be elected so long as he or she receives at least one affirmative vote, even if a majority of votes are withheld. If directors must receive an affirmative majority of votes cast to be elected, then withheld or negative votes will have real meaning.
In 2003, the SEC proposed a new rule that would have given 5% shareholders of U.S. public companies the power to nominate their own director candidates in the company’s proxy materials under certain circumstances. The SEC has not moved forward with this “shareholder access” proposal, but its introduction prompted renewed interest in majority voting as a means of giving shareholder disapproval real teeth.
Shareholder activists, led by the Council of Institutional Investors and labor union pension funds, have flooded larger public companies with letters and formal shareholder proposals requesting boards to initiate amendments to their charters necessary to implement a majority voting regime for directors. In 2005, 55 formal shareholder proposals calling for majority election were voted on, receiving an average of 43% vote in favor (with 13 garnering majority favorable votes). Shareholder groups predict over 100 such proposals being voted on in 2006.
In June 2005, Pfizer Corporation announced that its board of directors had taken a different approach. Rather than adopt majority voting by charter amendment, the Pfizer board simply adopted a corporate governance principle requiring any nominee who receives more votes withheld than in favor to submit his or her resignation. Pfizer’s board governance committee would then decide whether to accept the resignation. In the face of increasing pressure from activists, dozens of other large public companies have followed the Pfizer example and adopted director-resignation governance principles. Some shareholder groups maintain that Pfizer-type governance principles do not go far enough, arguing (among other things) that boards may choose not to accept the tendered resignations or may simply rescind a principle without consulting shareholders.
Nevertheless, in November 2005, Institutional Shareholder Services announced that, although it generally supports proposals calling for majority election, it would consider opposing such a proposal in the future if the company in question had adopted formal governance principles offering a “meaningful alternative” along the lines of the Pfizer approach. In light of this ISS policy, experts believe many U.S. public companies will eventually adopt formal governance principles as a means of avoiding the disruption and cost of shareholder proposals – especially after it becomes clear over the next year what precise features and conditions will be required to satisfy ISS.
In December 2005, however, the SEC staff refused to let Hewlett-Packard omit a majority election proposal from its proxy under Rule 14a-8 on grounds that the proposal had been “substantially implemented” by H-P’s previous adoption of a Pfizer-type governance principle.
Activists have also called for states to change the default rule in their corporate statutes from plurality to majority. In response, the American Bar Association Committee on Corporate Laws, which is responsible for the Model Business Corporation Act (adopted as the corporate statute in more than half the states), has studied the question and, in January 2006, published a preliminary proposal for changes to the Model Act. The proposal would not change the Model Act’s plurality default rule. It offers, however, a bylaw amendment (that may be adopted unilaterally by either the board or shareholders) providing that a director nominee receiving more votes withheld than in favor would generally serve no more than a 90-day transitional term. Other proposed amendments would make clearer the statutory basis under the Model Act for Pfizer-type governance principles.
It is too early to tell how the majority election issue will play out, but it seems clear that it is not going away. The 2006 proxy season should go a long way toward indicating whether Pfizer-type governance principles or something akin to them but contained in a bylaw (like that announced by Intel in January 2006) or something else altogether will be the direction of the future. It will take considerably longer to see whether shareholder activists will be successful in changing U.S. corporate statutes.
In the meantime, it is crucial that IR and legal personnel work together to keep the board informed on majority election issues.
This article originally appeared in the NIRI Virtual Newsletter.