The Board of Directors is accountable to shareholders and is expected to keep shareholders’ interests in the forefront. Michael Graham explores why certain boards are resistant when shareholders want to nominate their own directors via proxy access.
Although it is no longer GE’s advertising slogan (retired in 2003), it did paint a picture of that company for some 25 years. And just recently GE might again be bringing good things to life, this time in the boardroom by permitting shareholders holding 3% or more of shares to have proxy access in order to nominate their own candidates for directors on the company’s own proxy. This breaks down one significant barrier to shareholder nominations – that being cost. Shareholders have always had the opportunity to nominate their own directors but to do so they need to step up to the enormous expense of producing and mailing proxies to every shareholder. Few would of course, except for perhaps wealthy hedge funds that were intent on waging a proxy war.
Let’s take a closer look at the GE largess and see which shareholders will be able to nominate directors to GE’s board. As of February 2015, GE’s bylaws will allow investors holding a 3 percent stake for three years to nominate directors.
Those GE shareholders who own three percent or more of GE shares are the Vanguard Group, State Street Global Advisors, and the BlackRock Institutional Trust, according to Thompson Reuters.
Some organizations (Whole Foods being one) are trying to get around growing demand by shareholders for proxy access by proposing higher than 3% ownership levels. Zach Oleksiuk, an outspoken director at BlackRock, threw down the gauntlet at an SEC meeting saying provisions that require more than 3% ownership are “… a generally meaningless right for shareholders.” He threatened that Blackrock would vote against directors if this threshold were too high.
Some shareholders may hope and some organizations may fear that the decision made by GE will fuel further demands for proxy access.
So, is proxy access overblown or is there a real problem at many companies with the director nomination process that is looking for (and in the case of GE finding) a solution? Does the director nomination process (when proxy access is unavailable or the thresholds are too high) reinforce boards that are “pale, male, and stale”? And if so, is that really so bad?
In my experience working with hundreds of organizations over 40 years, I have found that most board governance methodologies (the director nomination process being one) are outdated, and incomplete. Executive and CEO compensation (for which the board is primarily responsible) has been under a microscope for some years now, but, like the shoemaker’s daughter or the ugly step child, the relationship between director’s governance and organizational performance has largely been ignored.
Entrenched boards, lack of director independence are two of the problems that proxy access might begin to cure and curing those would improve board effectiveness. Additionally with less entrenched boards and with independent directors, board self-assessment would be increased… thereby becoming more “situational” and better able to address the needs of the organization in our dramatically changing times. Let’s look at these aspects (entrenched boards, lack of director independence, the need for board self-assessment, and the necessity for boards to be situational) and I think we will be able to see how better proxy access might improve directors and therefore board effectiveness.
Many boards today are still quite entrenched, with selection and election processes far from “democratic” or even constructive. Many new (and existing) board members are some form of “insider,” either an organization executive or someone known well by the current board or management. Seldom are there strong competing candidates (or diversity candidates for that matter). As a result, the “election” is essentially won before any votes are cast. Too often, a director’s removal is a condition of age (with “mandatory” retirement most often at age 72, and inching up) rather than on knowledge, experience, contribution or performance. Often, for organizations in a turnaround situation, the board is comprised of the same people who got the organization into the mess in the first place ― or close friends and colleagues.
The board is comprised of individuals (the “directors”) elected by the shareholders for multiple-year terms. Many organizations have a revolving system so that only a fraction of the directors are up for election each year. In that way an organization can better protect itself from a hostile takeover.
Although protecting the organization from takeover might be an admirable goal, academic research suggests staggered boards provide questionable value to an organization. Organizations with staggered boards have been found to have lower value, a greater likelihood of making acquisitions that are value-destroying, and a greater propensity to compensate executives without regard to whether they actually do a good job.
Staggered boards have been an effective takeover prevention device whose time is really come and gone. With more investor awareness and the willingness by key investor groups to propose shareholder votes that would eliminate staggered boards; we predict that over the next 10 years the number of staggered boards to be substantially reduced .
Directors can either be executive directors, perhaps the CEO, CFO or other upper management executives of the organization. Or they can be non-employee directors, again as it sounds, individuals who are NOT employed by the organization in any way other than for their board duties. This non-employee director designation, however, does not mean the director is totally impartial.
For example, in the category of non-employee directors fall “Affiliated Directors”, who are also not employees but may be former employees, the organization’s professional services providers, or family members of an organization executive.
Then there are “Independent Directors”, perhaps seen as the Wyatt Earps of the boardroom (being brave, courageous, and bold) who are not affiliated with the organization, but would hopefully be elected for their business, management and/or industry experience and acumen, rather than their contacts with current members of management and or board members.
Our experience has taught us that a board can have a significant impact on an organization far beyond its governance decisions. So, if board members are selected and elected without considering what they bring in terms of knowledge, experience, and credibility, they could be doing more than just a disservice to the organization and its shareholders.
Organizations at different stages in their life cycles have vastly different needs that impact their short- and long-term business objectives. A company in a start-up phase will have significantly different issues than when it is growing or mature. And most pointedly a company in a turnaround situation needs a unique set of management and governance functions if it hopes to recover. The problem is, although the company may have changed dramatically, it is almost certain (except in the case of a bankruptcy) that the Board of Directors has not.
Ideally, a company would have a situational board comprised of individuals with the appropriate experience to shape and enhance the organization’s value in each stage of the business cycle. During a start-up phase the board should let the company executives determine strategy and operations. Speed and agility with strong executive leadership is the best practice in most start-ups. At the same time during the mature phase of the organization the board needs to contribute more, evaluating proposed strategies and pushing for management to take appropriate risks.
In reality though, boards are far more entrenched. And often for companies in a turnaround situation, the board comprises the same people who helped the company get into the mess in the first place.
Experienced boards know when and how to steward these special situation organizations and the corresponding shareholders investments. It is clear from our analysis of over 1,000 publically listed companies that great governance is situational. It is regrettable that most boards are not.
Directors need to assess how well they are governing both individually and collectively as a board and whether, again individually and collectively, they have the right skills to steward the company. This assessment needs to occur at regular intervals and particularly when economic or business strategy changes occur that may drive the company in a new direction. When board seats become available, candidates should be sought who can help address the company’s specific business issues, not just business issues in general.
Unfortunately, most boards do not effectively self-evaluate often or well, primarily because they have neither the framework nor the tools to do so. Investing the time in this effort, though, could contribute greatly to the company’s overall value.
The effective review of responsibilities and the allocation of individuals to be held accountable for results are threshold conditions too many boards and their advisors skip. Most of these roles, committees, and duties and designs were inherited. That is where we believe there are problems. While the industries and organizations have evolved over the last few decades, their boards have not.
The Board of Directors is accountable to shareholders. The board is elected to keep shareholders interest in the forefront. Where shareholders want to nominate their own directors and boards refuse (or in other ways make this impossible) that can point to a serious breach of the board’s fiduciary responsibility to the shareholders. A “US centric, pale, male, and stale” board in a diverse global economy, just no longer makes sense from the standpoint of governance and accountability.
For more information on board governance read my book Board of Directors Governance and Rewards.