As they enter this proxy season, institutional shareholders can be encouraged by the success they have had in advancing three key reforms in corporate governance: executive compensation disclosure; majority-vote election for directors; and expensing of executive stock options. They deserve much of the credit for this progress.
None is yet a complete victory. The executive compensation disclosure regulations proposed by the Securities and Exchange Commission Jan. 27 still await approval. The effort to win approval of majority-vote election of directors lost significant support when an American Bar Association committee rejected the idea of a sweeping change to state statutes. And while option expensing is now required, it won't necessarily bring uniformity to financial statement comparisons because companies can use different valuation methods.
Such delays and setbacks won't derail reform, but institutional investors must keep up the pressure. Without the undertakings of some major public and union pension funds, beginning in the mid-1980s, many reforms that have been adopted or are under consideration would never have advanced so far.
The pressure from institutional shareholders, together with the fallout from the corporate scandals of recent years and the resulting sweeping Sarbanes-Oxley reform, has led a number of companies to adopt one or other of the reforms without waiting for moves by the SEC, state legislatures or the Financial Accounting Standards Board.
But such corporate action comes about only through continuing shareholder engagement at individual companies and similar tenacity to enlist support from other shareholders.
Institutional shareholders have proven adept at overcoming major setbacks in their efforts to improve corporate governance, disclosure and giving stockholders power that should be theirs in overseeing the corporations they own.
When the proposal to give shareholders direct access to the corporate proxy ballot to enable them to nominate directors faltered at the SEC, some major institutional investors took to campaigning for majority vote for directors. That effort has won support at some companies.
Shareholder pressure helped bring about the SEC proposal requiring greater disclosure of executive compensation. If finally adopted, the proposal will give investors a clearer and more complete picture, in plain English, of the total compensation earned by a chief executive officer and other top executives and directors, as well as key financial relationships among those top officials, significant shareholders and other key people. If the proposal for enhanced disclosure is adopted, shareholders will have only themselves to blame if executive compensation at any company continues to be excessive and out of alignment with shareholder interests and corporate performance.
On the corporate democracy front, the American Bar Association's Committee on Corporate Laws, in a preliminary report, rejected a change to the ABA's model corporate law, a basis for state statutes, to provide for a majority vote. However, it is considering recommending an alternative means that would have to be adopted by companies individually, essentially forcing directors who fail to win a majority of votes cast to resign from the board. Some pensions funds have already been seeking such change before the committee report.
Now that shareholders have begun to achieve some objectives, they have to prove equally adept at bringing about the type of corporate governance structure that will promote improved shareholder performance.
As fiduciaries, pension funds and other institutional investors, particularly those that have been most active in corporate governance, will face increasing scrutiny themselves from their constituents, who see corporate reforms being adopted and now want to see the improved performance to justify the cost.
Activists, no less than corporate management, must realize that companies must be managed in the long-term best interests of the shareholders, and that will most often be in the best interests of all citizens.