ISS Governance Weekly: The Power of Protest Votes

From the recent "Governance Weekly" newsletter put out by the ISS:

By Ted Allen, Director of Publications

The resignation of CEO Terry Semel at Yahoo! this week is the latest example of the growing power that investors wield with “withhold” and “against” votes in board elections.

“Shareholders used to be quite reluctant to vote no,” Amy Borrus, deputy director of the Council of Institutional Investors (CII), told Governance Weekly. “Shareholders are becoming more emboldened and more willing to hold directors personally accountable for their performance.”

Semel stepped down June 18, less than a week after at least one director received 34 percent opposition, in part because of a “vote-no” campaign by investor Eric Jackson. The Internet company hasn’t released specific vote totals, but news reports indicate that all board members were elected with at least 66 percent support. That was significantly less than last year, when all the directors received more than 98 percent support.

Jackson and other shareholders complained that Semel’s generous pay package wasn’t justified by the company’s lagging shares, which fell almost 10 percent in the past year, while rival Google's increased by more than 30 percent. In 2006, Semel received an estimated $107.5 million pay package, which included 6 million stock options, according to ISS data.

While the shareholder opposition wasn’t the only reason for Yahoo’s CEO change, the negative votes at the June 12 annual meeting appear to be the final straw that persuaded the board to replace Semel with Jerry Yang, one of Yahoo’s founders. Semel will remain at the Sunnyvale, California-based firm as chairman.

Traditionally, the act of withholding support in an uncontested director election has been viewed by investors as a symbolic protest. While the importance of board elections has increased in the past year as scores of firms, including Yahoo, have adopted majority voting and/or resignation policies, very few directors at U.S. companies ever get more than 50 percent opposition. Last year, just eight directors out of more than 31,000 on corporate ballots failed to receive majority support, according to ISS data.

The vote at Yahoo is further evidence that a significant (but less than a majority) negative vote can prod companies to make management and governance changes. At Home Depot, labor funds and other shareholders withheld more than 30 percent support from 10 directors last year amid criticism of CEO Robert Nardelli's compensation. In January, the company replaced Nardelli and announced several pay reforms.

Last May, the California Public Employees’ Retirement System (CalPERS) and other shareholders withheld 28 percent support from two compensation committee members at UnitedHealth Group. The investors targeted the directors after the health insurance company disclosed that CEO William McGuire held $1.6 billion in unexercised stock options, including options dated when the company's shares were at quarterly lows. McGuire announced his departure in October.

In perhaps the most famous example of a successful vote-no campaign, a coalition of public pension funds and other investors withheld 45 percent support from Walt Disney CEO Michael Eisner in 2004, prompting the board to strip him of his chairman title.

The vote at Yahoo may also persuade other investors at other firms that protest efforts can have an impact. Jackson, who owns 45 Yahoo shares, recalled that his campaign was initially derided by some investors as “futile” and “useless.”

“I do think this is a signal to all shareholders, large and small, that they shouldn't be shy,” Jackson told Governance Weekly. “They should articulate their views.”

Michael Garland, director of value strategies at the CtW Investment Group, which manages labor funds, said a CtW study of 2006 voting found that some large mutual fund companies are starting to vote against directors in certain cases. “It's changing and it's progress,” he noted, which he attributed in part to the funds having to disclose their votes.

Close Vote at CVS/Caremark

In addition to the Yahoo vote, there have been other notable negative votes this season. At CVS/Caremark, Roger Headrick received a 42.7 percent “against” vote amid criticism over his role as a Caremark director in approving the pharmacy-benefits company’s sale to CVS earlier this year. A second director received 33.4 percent opposition.

The CtW Investment Group has called for Headrick's resignation and argues that he would have failed to get a majority of votes cast (which is now required for election at CVS) had uninstructed “broker votes” been excluded. CalPERS has urged the board to “strongly consider” asking Headrick to step down, while CII and North Carolina Treasurer Richard Moore have requested that the company disclose the number of broker votes cast for Headrick.

CVS/Caremark officials, which have said the “broker votes were spread among the votes cast for and against the directors,” have stood by Headrick and not disclosed that number.

CtW's Garland criticized CVS/Caremark for failing to respond to the vote, recalling that Disney's board took action “within hours” of the vote against Eisner in 2004. Given that CVS/Caremark now has majority voting, Garland said the board can't dismiss the vote as a symbolic protest.

“At CVS, the intent was not ambiguous; shareholders knew that they were voting against Headrick,” Garland told Governance Weekly.

Meanwhile, CtW, CII, and other investor advocates are pointing to the close CVS/Caremark vote to build support for a proposed New York Stock Exchange rule to bar broker votes from uncontested director elections. These advocates contend that broker votes are routinely cast in favor of management nominees and “taint the integrity” of director elections.

That rule, which is to take effect Jan. 1, 2008, requires the approval of the Securities and Exchange Commission, which held a roundtable on the issue last month. Borrus of CII said the importance of voting in director elections will only increase if the SEC approves the NYSE rule change. “With the SEC taking action, all these votes on directors will become front and center,” she said.

So far, it’s not possible to determine the full extent of withhold votes this year, since many companies don’t immediately release vote results for specific directors. While firms typically report that every director was reelected, just a few companies provide a detailed breakdown of votes in board elections before filing their quarterly 10-Q reports. Based on the limited results that are available, it appears that many investors are no longer reluctant to use director votes to protest company practices. (On the other hand, some governance observers expect that protest voting will decrease in the future as more firms adopt majority voting and shareholders realize that their votes could bar a board nominee from taking office.)

Compensation Concerns

For the second year in a row, it appears that compensation concerns are generating significant “no” votes. At Occidental Petroleum, six compensation committee members received more than 34 percent opposition amid investor complaints over CEO Ray Irani’s pay package. That negative vote was even higher than last season, when four pay panel members received 20 to 21 percent withhold votes. Irani received a $62 million pay package in 2006; The Wall Street Journal estimated that exercised stock options helped increase his total compensation to $416 million.

Irani also serves on the board at KB Home, where he received 19.3 percent opposition. CalPERS was among the investors that voted against Irani, who chaired the home builder’s compensation committee during a period when stock option grants were improperly dated. Three other directors received withhold votes that ranged from 15 to 19 percent.

Past stock option problems have led to significant shareholder opposition at other companies. At Brocade Communications, investors withheld 42.7 percent support from Sanjay Vaswani, who joined the board in 2004 and now serves on the compensation committee. Former CEO Gregory Reyes went on trial this week on securities fraud charges and is accused of misleading investors about backdated options from 2000 to 2004. Reyes has pleaded not guilty. The company’s board also has not responded to a majority-supported shareholder proposal that seeks to abolish supermajority requirements.

Like Yahoo shareholders, investors have voted against directors at other companies to express concerns that CEO pay doesn’t reflect corporate performance. At homebuilder Toll Brothers, Carl Marbach, who chairs the compensation committee, received a 25 percent withhold vote after the Laborers’ International Union of North America and the Amalgamated Bank mounted a vote-no campaign. The two labor investors complained that CEO Robert Toll received $28 million in 2006, while profits fell almost 15 percent.

At electronics manufacturer Solectron, four pay panel members received more than 26 percent opposition. In 2006, CEO Michael R. Cannon received a 170 percent pay increase, while the company’s shares declined 23 percent.

Failure to Respond to Shareholder Proposals

In recent years, a significant number of shareholders have opposed directors who fail to respond to investor proposals that get majority support. In 2006, directors at five S&P 500 firms received more than 20 percent withhold votes after not acting on majority-backed proposals.

This season, six directors at FirstEnergy received 32 to 42 percent opposition after they failed to implement a shareholder proposal to rescind supermajority voting requirements. That resolution received 73 percent investor support last year and also got majority backing in 2005.
Likewise, two International Paper directors received 25 percent and 38 percent negative votes, respectively, after the company did not adopt annual elections for all directors, as requested by a shareholder proposal that won almost 80 percent support last year.

At Peabody Energy, five directors received 24.2 to 27.9 percent withhold votes after failing to act on a majority-supported proposal that seeks annual elections for all directors.

Other Notable Votes

At apparel marketer Kellwood, Jerry Hunter received a 48.9 percent withhold vote at the company’s June 7 meeting. He was opposed by CalPERS, which questioned his independence and noted that he received a 51 percent negative vote when he last was on the ballot in 2005. Hunter, who serves on the compensation committee, is a partner in a law firm that provided more than $86,000 in legal services to the Missouri-based company last year.

One director at Penn National Gaming received a 36 percent withhold vote, while another had 32.7 percent opposition, according to UNITE HERE, which led a vote-no campaign. The union, which represents hotel and casino workers, opposed three incentive plans proposed by management and criticized the board's maintenance of a “dead-hand” poison pill defense that can't be undone by future directors.

At the New York Times Co., the four directors who are elected by public shareholders received 42 percent withhold votes. Morgan Stanley Investment Management and other investors opposed the directors for a second year to protest the newspaper company’s dual-class equity structure. In 2006, those directors received 30 percent opposition.

Not all high-profile vote-no campaigns received wide support this year. At ExxonMobil, a coalition of 17 institutions, including state pension funds and proponents of socially responsible investing, opposed Michael Boskin, who chairs the company’s public issues committee. While news reports indicated that Boskin received 7 percent opposition, that was less than the 20 percent votes against three compensation committee members last year as investors protested former CEO Lee Raymond's $98.4 million retirement package.

At Verizon Communications, the AFL-CIO and two communications workers' groups waged a vote-no campaign against the compensation committee over the pay received by CEO Ivan Seidenberg. While the company hasn't released specific board vote totals, Verizon did report that all the directors were elected with at least 90 percent support.

Staff Writer L. Reed Walton contributed to this article. Unless otherwise stated, the vote results in this article are drawn from company quarterly filings or press releases.

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