In search of alignment

Good governance used to be about fixing companies and boards. Then came the rise of the shareholder. Now the ideal lies more in bringing the two sides together in a quest for long-term value. Part 1 of our Special Report on Governance
By Paul Brent

Lines are open: “Boards aren’t guessing what is on shareholders’ minds,” says Yellow Pages chairman Robert MacLellan, “they are listening to it firsthand”

As companies work through the last stages of the 2017 proxy season, it’s tempting to ask what’s changed or improved? A small number of proxy fights are generating headlines and attention as activists take aim at perceived underperformance, while other established companies—step up Postmedia, Bombardier and Valeant Pharmaceuticals International—continue to generate outrage over rising executive pay amid falling results.

It raises the perennial question: are boards doing a better job when it comes to improving governance, relations with shareholders and balancing long-term goals with short-term strategy considering the expanding sub-industry that has grown up around governance?

“Oh I think so, I think that there have been some very significant developments in corporate governance,” says Robert MacLellan, chairman of private equity firm Northleaf Capital Partners. MacLellan, who is also chairman of Yellow Pages Ltd. (TSX:Y), points to, in particular, the recent trend towards more board engagement with shareholders. “Boards aren’t guessing what is on shareholders’ minds, they are actually sort of listening to it firsthand.”

Yellow Pages recently embarked on shareholder outreach that produced some tangible and public results. The company, which is making the painful transition from an analog to digital service, had a quarter in which it reported disappointing earnings and a big write-down. Following that, board members met with the company’s “big three” shareholders who own more than 40% of its shares. At the end of the process, Yellow Pages announced in April that it was adding two U.S.-based executives as nominees to the slate of directors originally named in its original proxy circular sent to shareholders. All were on the ballot in time for the company’s annual meeting on May 10.

MacLellan explains that the new candidates for the board were suggested by hedge fund Goldentree Asset Management, one of the three big shareholders. After a meeting with the chair of the nominating committee and more meetings with shareholders, the duo were added to the company’s slate. “They have both been involved in other directories’ businesses. I think we have got a really good board at Yellow but none of us have had the same level of direct industry experience that they have.”

Not every shareholder outreach effort produces a tangible outcome like Yellow Pages’ has, but it is becoming increasingly common among listed companies. And, typically, the goals go well beyond rectifying immediate performance concerns. There, engagement between companies and shareholders is seen as a way to foster “alignment,” based on the belief that this supports productive governance practices that emphasize long-term value creation over short-termism. “Boards need to get oriented toward a broader range of factors that they consider when making decisions, but shareholders have to give them the space to do that,” explains lawyer Carol Hansell of Hansell LLP.

“FIVE OR SIX YEARS ago it was very unusual for a board to have any direct relationship with shareholders,” says Stephen Griggs, CEO of private equity firm Smoothwater Capital Corp. and a former executive director of the Canadian Coalition of Good Governance. “You fast forward to today and it is a very common thing for boards to regularly discuss with shareholders any issues the shareholders wish to talk about, whether it is compensation issues, general governance, environmental issues, etc.”

The growth in dialogue is credited for the recent, steep decline in the volume of publicly reported shareholder activism. The number of proxy fights in Canada peaked in 2015, fell somewhat last year and has dropped off dramatically since, according to figures compiled by advisory and proxy solicitation firm Kingsdale Advisors (PDF). (Numbers have gone from 55 proxy fights in 2015 to 33 last year and just nine so far this year.)

In a report issued last fall, Kingsdale stated that it was not surprised at the record number of proxy battles in 2015, as say-on-pay votes emerged as a major issue. The firm says that the relative quiet of 2017 conceals a lot of “behind the scenes activism” with only one in three activist situations ever becoming public.

“There are definitely a lot more settlements,” says Hooman Tabesh, executive vice-president and general counsel with Kingsdale. “Part of it is both sides are a lot more sophisticated and I think there is aversion to go to full proxy fights. To the extent that activists have value-creating theses that they are providing, I think that boards and management are more open to it.”

Broadening shareholder engagement from the investor relations team to include management can provide multiple payoffs, Kingsdale argues: it helps win early support in the event of a proxy fight, socializes investors to the company’s long-term strategy and showcases the expertise at the board level and “dramatically increase[s] the confidence shareholders have in the board and in their investment.” It fosters alignment, in other words.

Jonathan Feldman, a partner in the law firm Goodmans, also observes “a lot of behind the scenes dialogue” in the run-up to proxy season. “I think advance notice bylaws give both sides an opportunity to engage in advance and start the discussions on settlements a lot earlier.” The anti-stealth proxy contest measure provides time for management to vet and agree to investor-proposed board candidates. “I think there is a little bit of face-saving that goes on on both sides, but if the result is better people on the boards it is okay for it to be a win-win situation.”

It’s a wonder that any management disputes with shareholders make it to the public arena given the growing industry preaching communication, consultation and compromise. “Law firms are doing it, proxy firms are doing it,” says Feldman. “The really interesting thing is investment banks are now setting up groups, activist practices. Morgan Stanley, UBS, they have now hired people to head up their activist practice and they go in and basically help boards get prepared.”

The growing cadre of consultants advises directors to put themselves in an activist shareholder’s shoes, says the Goodmans lawyer. “Run the same screens that the activists run, figure out what your vulnerabilities are and get ahead of them. Whether it is balance sheet, whether it is operational, know that you are being watched and be proactive. I think it is helping boards be better boards.” (For more insights as to how activists pick their targets—and what sort of Canadian companies might currently be in their sights—see our companion story: “How to think like an activist.”)

Boards can take very different approaches to dealing with shareholder demands, however, even for companies in the same sector. That was displayed earlier this year with the treatment of shareholder requests that the boards of the Toronto-Dominion Bank and Royal Bank of Canada adopt a “proxy access” to allow qualified shareholders to have director nominees included in the company’s proxy circular. The non-binding proposal was approved by 52.2% of the votes cast at the TD Bank meeting but was defeated at the RBC annual meeting, garnering slightly less than 47%.

“The interesting thing is that we have had that remedy for a very long time in our law,” says Andrew MacDougall, a partner at Osler, Hoskin and Harcourt LLP. Even with the availability of proxy access in Canada, it has “rarely been used” he notes. Still, according to an Osler bulletin, the “level of support for the proposal at both of these meetings suggests a degree of interest among shareholders that will ensure that proxy access remains on the board agenda in Canada.”

Voluntary adoption of shareholder-friendly initiatives such as say-on-pay votes goes a long way to alleviating one of greatest potential investor irritants—namely executive compensation. When management allows a say-on-pay vote, it works harder to explain and justify its compensation decisions, says Stephen Erlichman, executive director of the Canadian Coalition for Good Governance (CCGG). “They want to get positive say-on-pay votes and one way they do that is to try to explain in as plain English as they can what boards are doing on the topic of executive compensation.”

The CCGG would like to make say-on-pay mandatory in Canada. Last year a total of 177 Canadian listed companies held a say-on-pay vote, up from 157 the prior year, according to Kingsdale’s figures. One notable say-on-pay management defeat of last year, Canadian Pacific Railway (TSX:CP), resulted in changes to this year’s executive pay motion. This year, too, after a public outcry following the release of its proxy circular, Bombardier (TSX:BBD.B) didn’t even get that far before unilaterally adjusting its executive pay plan.

Tone deafness on executive pay and other critical matters such as board compensation, majority voting and succession planning can be remedied by efforts such as board engagements carried out by the CCGG. The Toronto-based organization advises between 45 and 50 boards a year and has successfully pushed for initiatives such as having the board produce messages to shareholders separate from the CEO.

“We get a very positive reception about that but it is really missionary work, trying to get people to do it,” explains Erlichman. “It is not that they are unwilling to do it, boards are willing to do it because they think it is a good way to communicate with shareholders.”

The organization has not tracked the success of its engagement program, however it can point to a University of Toronto analysis of its history of board engagements. The 2015 study concluded “CCGG engagements had a statistically significant and economically meaningful impact on the likelihood of subsequent adoption of majority voting, say-on-pay, on compensation disclosure and structure, and on incentives.”

According to Hansell, word has gotten out and a great many Canadian directors are now “broadly comfortable” with the idea of engaging with shareholders.

“When engagement was a new thing, it made boards and their general counsel quite nervous,” says Hansell. “But the way in which institutional investors in Canada engage with boards is not confrontational; they’re not looking to catch anybody out. I think they have good, honest, frank conversations and I think they’re fair conversations.”

It’s here again where the argument can be made that engagement and alignment is actually fostering better governance because it promotes long-term value objectives. “I think boards are very much looking for the opportunity to engage on longer-term strategy and risk analysis,” adds Hansell.

She also notes that there is quite a difference in this trend compared to how engagement is progressing between companies and shareholders in the United States. “In the U.S. there is still more tension between what the board does and what the shareholders should be commenting on, or the extent to which shareholders should be expressing a view that is listened to in the boardroom.”

This isn’t to say all Canadian companies are sold on the concept. In its 2016 report, Kingsdale notes that “many companies still continue to drag their heels” when it comes to improving shareholder engagement. It calculates that 40 issuers in the S&P/TSX 60 discuss their engagement with shareholders in their information circular.

However, it also predicts that within the next three years, “virtually all” of the S&P/TSX 60 and a significant portion of the TSX will have an active shareholder engagement program involving their directors. Griggs says the slower uptake among smaller public companies comes down, in part, to simply a matter of not having the resources to readily work with activist shareholders. “It is fairly common for [those] boards to be directly or indirectly hostile towards us,” he says.

Yellow Pages’ chairman MacLellan also cautions that not all activists are right or have plans that will make corporate governance better—especially those with a quick-buck, short-term orientation. But, collectively, their effort to be heard and have influence has been beneficial. “They have made boards think that it is important to listen to shareholders,” says MacLellan, “and I think that is a positive development.”

Hansell offers a longer-term perspective, noting that in the post- Enron years, governance reform was largely focused on making sure boards were positioned to do their job properly; more recently, the focus has shifted to the voice of shareholder. The logical next step is to bring these two forces together, she says. “Shareholders need to understand that while there are overarching themes and values that they can communicate, ultimately they have to put people in place whom they trust and then trust them to do their jobs.”

Sidebar: Can digital hookups overcome hang-ups?

Technology and automated intelligence are enhancing all manner of relationships. Why should companies and shareholders be any different?

While company-shareholder engagement and alignment are emerging as essential elements to enhance governance and long-term value, a persistent blind spot is holding a lot of firms back.

For years, proxy solicitors and other advisers have been urging companies to work harder to identify and connect with the people and institutions that hold their shares. Considering what’s at stake—whether in an activist-led proxy battle or even an advisory say-on-pay vote—“it’s amazing how many mid-cap, small-cap, micro-cap companies…don’t even really know who [their shareholders] are, let alone do any communications with them,” says Jeffry Powell, New York-based CEO of Global Governance Software.

Given this reality, what’s going to be the catalyst for change? Powell, as you might expect, thinks the answer is in technology. Just as board portals have upended the way directors communicate and board documents are shared, his firm is touting the potential of its suite of corporate governance tools, billed as a “stakeholder capital management platform,” to do the same for shareholder relationship management, board effectiveness, compensation design and investor relations strategy.

Considering the sophisticated technology that powers most publicly listed companies’ front- and back-end operations, not to mention the trading and listing of their securities, the lack of automated intelligence in shareholder relations is glaring. But inertia is strong. Powell’s company, the technology arm of Global Governance Advisors, only launched last fall. He says interest is high, but at many companies, until something happens to shake up the status quo, “it is just not necessarily seen as vital to change for the future stability of their organization.”—P.B.

Photography (slider and article) courtesy of Yellow Pages Ltd.

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