Surge in shareholder activism straining investors' resources

The proxy season has triggered a gold rush of activist institutional investors challenging companies. But this swell in corporate governance activity could strain investors' resources, especially related to executive pay issues and shareholder engagements.

Shareholders have been bolstered by recent investment returns in companies in which activists have been involved, said Patrick McGurn, special counsel, Institutional Shareholder Services Inc., Rockville, Md. ISS is a corporate governance and proxy-voting advisory firm.

Activist hedge funds outperformed other hedge fund strategies in 2013, raising the attractiveness of the strategy for new funds and assets, Mr. McGurn said. But hedge fund returns generally lagged the Standard & Poor's 500, he said.

Event-driven activist hedge fund strategies returned 19.1% for the 12 months ended Dec. 31. For the same period, long/short equity hedge-fund strategies returned 16.1%; distressed, 14%; event-driven, which includes the event-driven activist subset, 12.8%; and multistrategy, 7.6%, according to eVestment LLC, Marietta, Ga. The S&P 500 total return, including dividends reinvested, was 32.36% last year.

Michael P. McCauley, senior officer, investment programs and governance at the $174 billion Florida State Board of Administration, Tallahassee, said activism is growing, whether hedge funds or traditional equity portfolios.

“The evidence has really started to accumulate that those types of (activist hedge fund) investment strategies are very effective” for shareholders, Mr. McCauley said.

“The performance record and effectiveness ... have no doubt attracted assets because (the group of activist hedge fund strategies) has done so well. I think the market has responded by creating more funds.”

“It's very clear these types of strategies have really delivered alpha. That's a reflection on the move to increase shareholder rights.”

“It's certainly higher risk with concentrated portfolios,” compared to traditional equity portfolios, Mr. McCauley said.

Activist funds are challenging companies on a number of issues, including balance-sheet matters, business strategy and leadership, Mr. McGurn said.

He expects activists to file contests for board seats at some 35 companies, about the same as last year. He thinks activists could challenge more companies, but reach settlements before proposals are filed.

At Apple Inc., among the activist targets, Carl Icahn and affiliated Icahn funds filed a proposal calling for the company to complete a buyback of at least $50 billion of its shares by Sept. 7 as a way to return to shareholders some of the $146 billion in cash and marketable securities on Apple's balance sheet. The $282.7 billion California Public Employees' Retirement System, Sacramento, is among the institutional investors, opposing the measure.

Shareholders have to gear up to face some 600 more say-on-pay proposals this proxy season compared to 2013, said Mr. McGurn. The reason for the surge is voting on pay policies of the CEO and other top executives come before shareholders this year at companies that have a three-year frequency for voting on the compensation.

These and other mounting issues have put pressure on asset owners' time and talent to devote to corporate governance activity.

“Resources certainly are strained,” said William R. Atwood, executive director of the $14.2 billion Illinois State Board of Investment, Chicago.

At the FSBA, Mr. McCauley said, “Everyone has spent more time on evaluating companies, which I say is a good thing. But at the same time it has stretched resources. It has made things more challenging to provide the same amount of coverage.”

“Engagement has exploded in the last couple of years and I think that will continue in 2014,” Mr. McCauley said. “We're seeing more and more companies reaching out to shareowners to try to talk through issues before the proxy vote,” such as on board member changes and executive compensation.

In all, the Florida board has experienced a 30% to 40% increase in engagements with companies over the past year, Mr. McCauley said.

“We are actually in the process of adding a fourth person to the team,” overseeing corporate governance, because of the step-up in activity, said Mr. McCauley

One of the most active institutional shareholders this proxy season is the Washington-based $1 billion United Brotherhood of Carpenters Pension Fund, along with its affiliated pension funds, whose combined assets total $45 billion.

It targeted 27 companies in the S&P 500, submitting proposals calling for election of directors by a majority vote of shareholders, instead of a plurality, Edward J. Durkin, director, corporate affairs department of the carpenters union, said in an e-mailed response to questions.

Exxon Mobil Corp. is among the targeted companies.

The carpenters' fund withdrew a proposal, filed Dec. 3, after Caterpillar Inc.'s board of directors adopted a majority-vote standard.

Chipotle Mexican Grill Inc., Vertex Pharmaceuticals Inc. and BB&T Corp. each agreed to support such a proposal, leading the carpenters fund to withdraw proposals.

The companies the carpenters fund targeted are among the remaining 13% of companies in the S&P 500 still using a plurality standard for electing directors. The carpenters fund's shareholder proposals over the last several years spearheaded the movement that has transformed the voting standard at most of the companies in the index.

Among other activities this year, the carpenters fund is collaborating with the $52 billion UAW Retiree Medical Benefits Trust, Ann Arbor, Mich., engaging companies — including Bank of America, BlackRock Inc. and General Electric Co. — on the issue of auditor independence.

“This advocacy is not in the form of a shareholder proposal. Company response to the request has generally been positive,” Mr. Durkin said in the e-mail.

Among top shareholder proposals this year, a group of five asset owners teamed up to target 31 companies, calling for annual election of all directors and ending the classified board structure that makes a change of control more challenging.

The group of proposals represents a way pension funds are stretching resources, Illinois' Mr. Atwood said.

ISBI is targeting 11 companies; FSBA five; the North Carolina Department of State Treasurer, which oversees the $83.1 billion North Carolina Retirement Systems, Raleigh, five; the $73.2 billion Ohio Public Employees Retirement System, Columbus, one; and the $400 million Nathan Cummings Foundation, nine.

The investors partnered with Harvard Law School's Shareholder Rights Project, which is coordinating the effort and undertaking most of the costs and engagement effort, Mr. Atwood said.

Last year, 30 of 35 shareholder proposals calling for repeal of classified boards received a majority vote in support, an 85% success rate.

Shareholder resolutions calling for independent chairs of boards of directors are expected to top the list in terms of number of filings, said Mr. McGurn, who didn't have a tally of the proposals so far this season. Companies that could face such a proposal include Boeing Co., Chicago.

The Securities and Exchange Commission on Jan. 21 rejected a Boeing request to exclude an independent chair proposal from its proxy statement, according to SEC documents. Boeing, whose annual meeting typically is in April, hasn't issued its proxy statement yet.

The independent chair issue, was the top filing last year with shareholders voting on 62 such proposals, averaging 32% support, including a high-profile proposal at J.P. Morgan Chase & Co., targeting James Dimon in his positions as chairman and CEO. The proposal failed, receiving 32.2% voting support.

Institutional investors interviewed didn't know if J.P. Morgan would face another challenge on its leadership structure. The company, which typically has its annual meeting in May, hasn't filed its proxy statement yet.

Only six independent chair proposals, all non-binding, last year received a majority of shareholder votes, according to research by the Council of Institutional Investors. None of the companies implemented the proposal.

The $160.7 billion New York State Common Retirement Fund, Albany, filed or intends to file for this season 25 proposals calling for disclosure of political spending, according to the office of Comptroller Thomas P. DiNapoli, sole trustee of the fund. Shareholder proposals on such disclosure are expected to account for the second-most filed resolution this year, as they were last year, when 48 were voted on, receiving an average 23.5% vote in support, according to ISS data. Last year, only one proposal received a majority vote of support.

Proposals calling for shareholder access to proxy statements to nominate directors are expected to have a similar level of 16 filings, as they did last year

Institutional investors regard proxy access as a last resort in overhauling corporate governance, Mr. McGurn said. n