Corporate Governance & Executive Compensation 2015 Survey by Shearman & Sterling LLP
2015 Corporate Governance & Executive Compensation Survey – Introduction
We are pleased to share Shearman & Sterling’s 2015 Corporate Governance & Executive Compensation Survey of the 100 largest US public companies. This year’s Survey, the 13th in our series, examines some of the most important corporate governance and executive compensation practices facing boards today and identifies best practices and emerging trends. Our analysis will provide you with insights into how companies approach corporate governance issues and will allow you to benchmark your company’s corporate governance practices against the best practices we have identified.
Shareholder activism is here to stay and well-funded activist hedge funds are setting their sights on bigger targets to generate the outsized returns they and their investors expect. This year, eight of the Top 100 Companies were subject to an activist campaign, up from six of the Top 100 companies in 2014. No company is too large to become the target of an activist, and all public companies should evaluate their businesses in light of the themes activists most frequently pursue, including acquisitions, dispositions and spin-offs, returning cash to shareholders through dividends or share buybacks and modifying corporate governance practices. Additionally, as this year’s DuPont-Trian proxy contest illustrates, a critical element of any company’s defense against an activist is effective engagement with its shareholders.
It is clear at this point that proxy access will remain at the forefront of corporate governance debates in 2016 and beyond. In the 2015 proxy season, we saw a dramatic increase in the number of US public companies that received shareholder proxy access proposals — from just 20 in 2014 to 112 in 2015. We also identified 10 companies that adopted a proxy access by-law or included a management proxy access proposal in their proxy statements. In light of the high degree of focus on proxy access in 2015, in this year’s Survey we analyzed the various approaches taken by this universe of 122 companies as well as the results thereof. Our findings with respect to shareholder proxy access proposals received by, and proxy access by-laws adopted for, the Top 100 Companies are presented in other sections of our Survey.
The separation of the offices of CEO and chair of the board is a corporate governance practice that continues to receive significant attention as shareholders increasingly demand that the chair of the board be independent of management. Yet, at 63 of the Top 100 Companies, the CEO also served as the chair of the board. This year, the most frequently submitted governance-related shareholder proposal at the Top 100 Companies called for an independent chair of the board. Despite the lack of majority support for these proposals, we expect shareholders to continue pressuring boards to separate the two offices.
Women in Leadership
Board diversity matters. Our Survey of board gender diversity, only one aspect of board diversity, shows that achieving gender “equality” on boards is still a long way off. Women held 22% of the total number of board seats at the Top 100 Companies and only two companies have a board where women held 40% or more of the board seats. While increasing the number of women serving on boards continues to be in the spotlight, more needs to be done if there is going to be an increase in the rate at which women are appointed to boards and top executive leadership roles. Women serve as the chief executive officer at only eleven of the Top 100 Companies and as both the CEO and chair of the board at seven of those companies. There is no easy answer to achieving better representation of women on boards and in C-Suites, and nominating and governance committees need to stay focused on and be proactive in accelerating gender balance and increasing all aspects of diversity in leadership roles.
In today’s complex, global business environment, board composition remains an important topic for nominating and corporate governance committees. This complex debate weighs the benefits of director continuity against the needs for fresh perspectives, diverse viewpoints and specialized experience on corporate boards. While mechanisms such as mandatory retirement ages and term limits provide straightforward ways to keep a board refreshed, they do not necessarily take into account whether a director is an effective member of the board nonetheless. Our Survey looks at issues related to average tenure, retirement ages and term limits.
Compensation Disclosure and Practice
In many ways, the compensation disclosures and practices of the Top 100 Companies reflect a “follow the pack” mentality. With the advent of say-on-pay and increased shareholder activism, our review of these companies’ proxies reveals compensation disclosures that are growing in size and incorporating flashier graphics, but in some cases are becoming less distinguishable from company to company.
Some trends we have observed: 52 companies disclosed that they maintained pledging policies in 2013; that number has increased by 58% to 82 by 2015. This increase may partly be a product of the focus on hedging and pledging by proxy advisory firms. Similarly, companies are mimicking each other in the presentation of their disclosures. For example, in 2014, 59 companies provided an up-front “proxy summary” that included key points of the compensation disclosure. In 2015, this number jumped 25%, as 74 companies included an upfront proxy summary. A discussion of good corporate governance practices is included in 54 of these proxy summaries, making it the most prevalent feature. Often, this good governance disclosure is presented through a “what we do” and “what we don’t do” chart that looks very similar from company to company.
The number of Top 100 Companies disclosing their shareholder engagement efforts around say-on-pay in 2015 increased to 77, compared to 62 in 2014 and 45 in 2013. The substance of the disclosure varies, but most companies discuss the number of shareholders contacted nd their aggregate stock ownership percentage, the feedback received and any changes implemented.
The Survey reveals that shareholder engagement can have a positive impact on companies with low say-on-pay approval rates. Of the eight companies that received approval ratings below 80% in 2014, six provided detailed disclosures of their shareholder engagement efforts and the changes made to their compensation programs. These six each received a greater than 80% say-on-pay approval rate in 2015. Of the two companies that did not make disclosures, one company failed its 2015 say-on-pay vote and the second company received nearly 22% lower approval than in 2014.
In July of 2015, the SEC proposed its long-awaited rules to implement Section 954 of the Dodd-Frank Act. The proposed rules would require each listed company to develop and disclose a clawback policy that mandates the recovery of excess incentive-based compensation received by an executive officer when the company corrects erroneous financial data by preparing an accounting restatement. This year, 87 of the Top 100 Companies publicly disclosed that they voluntarily maintain a financial clawback policy, although most of these would not be Dodd-Frank compliant.
Once these rules are finalized, many companies will need to either amend their current clawback policies or adopt a supplemental policy that conforms to the SEC’s requirements. Notably, although the SEC’s proposal does not require misconduct to trigger recovery, 62 of the current voluntary policies require some form of fraud or misconduct to have occurred with respect to the financials before recovery is triggered. Further, although the proposed rules provide the board with almost no discretion in determining whether to pursue recovery once the policy is triggered, nearly all of the voluntary clawback policies in place at the Top 100 Companies permit board or compensation committee discretion or enforcement.
There has been some high-profile litigation in the executive compensation arena. In Calma v. Templeton, shareholders of Citrix Systems, Inc. claimed that the restricted stock units granted to non-employee directors in 2011, 2012 and 2013 were excessive. The Delaware Court of Chancery ruled that pre-filing demand on the board was not required, and the affirmative defense of stockholder ratification was not available to the members of the board. The grants were made pursuant to an equity incentive plan that had been approved by shareholders in 2005. The plan provided that no participant — which included, employees, directors, consultants and advisors — would be permitted to receive more than 1 million shares in any calendar year. The Court held that shareholder approval of the plan did not constitute approval of any action bearing specifically on the magnitude of compensation for the nonemployee directors. As a result, because the directors approved their own compensation and could not rely on the affirmative defense of shareholder ratification, the case will move forward on the merits and the compensation will be subject to an “entire fairness” standard of review.
With similar cases pending against a number of other companies, including Goldman Sachs and Facebook, we expect to begin seeing a change in the level of detail companies provide to shareholders when seeking approval of director compensation.
In the pages that follow, we provide our detailed findings on these and other corporate governance issues.
Shareholder Activism: Are You Prepared?
The last year saw a substantial increase in publicly disclosed shareholder activist activity at the Top 100 Companies, with activist campaigns increasing 33% — from six companies in 2014 to eight companies in 2015. As capital continues to flow into the activist fund asset class, and as the number of single- and multi-strategy activist funds continues to grow, all signs indicate activists will continue to look toward larger targets to provide the outsized returns they and their investors seek.
Shareholder activism takes a number of forms, ranging from non-binding votes on matters such as “say-on-pay” that are required by law, to shareholder proposals included in the company’s proxy statement under SEC Rule 14a-8, to what is referred to as “hedge fund” activism which can ultimately result in a proxy contest and a shareholder vote to replace all or a portion of the company’s board of directors. We have included our observations on say-on-pay on page 44 and shareholder proposals submitted under Rule 14a-8 on page 26. In this section, we provide our observations on hedge fund activism.
DuPont-Trian Proxy Contest – Case Study
The last year was, in many respects, a remarkable one for hedge fund activism. One need not look further than the proxy contest between Top 100 Company E. I. DuPont de Nemours and Company (“DuPont”) and Nelson Peltz’s Trian Fund Management (“Trian”) to understand the potential implications of hedge fund activism today.
Trian first invested in DuPont in mid-2013 and ultimately amassed a position of approximately 2.7% of the company’s stock (24.6 million shares, valued at approximately $1.62 billion at the time of the company’s 2015 annual meeting). As is often the case, Trian approached DuPont privately at first. The hedge fund called for DuPont to, among other things, determine whether to dispose of or spin off businesses, eliminate excess corporate costs, increase dividends and improve management’s accountability.
From the time of Trian’s initial investment, DuPont announced the spin-off of its Performance Chemicals unit (now The Chemours Company), authorized a $5 billion share repurchase program and initiated plans to cut expenses. Despite these efforts, after more than a year of dialogue with DuPont’s management and board of directors, Trian remained unsatisfied and launched its public campaign in September 2014. In January 2015, Trian increased the pressure on DuPont by commencing a proxy contest to have Nelson Peltz and three other nominees elected to DuPont’s board of directors.
If elected, Trian’s nominees would have constituted one-third of the DuPont board — a level of influence well in excess of 2.7% stake in the company. From January until DuPont’s Annual Meeting of Shareholders on May 13, 2015, DuPont and Trian each waged a public relations battle to secure the support of shareholders. Both sides sent documents directly to DuPont’s shareholders, made filings with the SEC, appeared on TV business news programs and even appealed to investors via Twitter.
DuPont eventually prevailed at its annual meeting, with none of the Trian nominees receiving enough votes to be elected to DuPont’s board of directors. Many, including Nelson Peltz himself, credited DuPont with having waged a more effective shareholder engagement campaign than Trian.
The DuPont-Trian saga permits us to make the following observations about hedge fund activism today.
With so much capital under management, activists looking to generate the large returns they and their investors demand require situations in which they can deploy large dollar amounts, even if the percentage of the target’s shares they control is relatively small. DuPont, with a market capitalization of nearly $65 billion at the time of its 2015 annual meeting, was not the only Top 100 Company to be challenged by a hedge fund activist during 2015. Even Top 100 Company Apple, Inc., with a market capitalization of approximately $664 billion at the time of its 2015 annual meeting, was a target. Carl Icahn, who owned less than 1% of Apple’s shares (with a market value of approximately $6.6 billion as of Apple’s 2015 annual meeting), has repeatedly called for Apple to return capital to shareholders through share buybacks, even after the Apple board of directors increased its authorized buybacks to $140 billion in May 2015, indicating plans to return a total of $200 billion to shareholders through share buybacks and dividends by March 2017.
See full survey below.