The GMI Blog

HBS on Sustainability Culture

Kimberly Gladman, Director of Research and Risk Analytics

In a working paper from Harvard Business School, Professors Bob Eccles, Ioannis Ioannou and George Serafeim provide fascinating new research on corporate sustainability.  The authors began by identifying companies that disclosed a set of environmental and social policies in 2003-2005.  They then conducted over 200 interviews with corporate executives to ascertain which companies had already begun to implement these policies internally in 1993. Once they had a set of 90 early adopters, they created a matched sample of companies that had few sustainability policies, but were otherwise similar to the first group in terms of size, sector, growth stage, and capital structure.  Comparing shareholder returns for the two groups, they found that the high-sustainability group outperformed its low-sustainability peers by an annualized 2.3%, on an equal-weighted basis, in 1993-2011.

The authors also demonstrate, based on a statistical analysis of keywords in analyst calls, that high-sustainability companies are more likely to discuss long-term trends and nonfinancial matters with investors.  They study ownership and show that high-sustainability companies attract longer-term investors with more concentrated holdings.  In a section of their paper that was of particular interest to us at GMI, they also show that high sustainability companies also are more likely to have board oversight of sustainability, to incorporate sustainability metrics into executive compensation, and to disclose nonfinancial performance.    We have been tracking these metrics in our subscription product for some time, and were pleased to see this confirmation of our belief that they correlate with good management  (and good investment performance) more generally.

While the study’s performance numbers may be welcomed by many observers as evidence that sustainability pays, the study’s usefulness for active investors may be limited.  As the authors note, few investors have a time horizon anywhere near the 18 years the study spans. In addition, investors may have no way of knowing when a company adopts a set of internal policies;  and even when these matters are disclosed, it may be hard to tell if they are the start of a long-term commitment.  Finally, both sets of companies in the study have what is known as “survivorship bias”--- they include only companies that have survived from 1993 to now.  (As a result, both groups outperform the market.)  It would be interesting to know whether company survival rates differ depending on sustainability.  Does management of social and environmental issues act as a kind of insurance policy, making a company more likely to be around long-term?  Or is sustainability a high-risk, high-reward strategy, which makes you more likely to go bust, but also more likely to excel if you do make it?  These are just a few of the questions this excellent paper raises. (Find it at: http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1964011). 

Not the News Corp News

By Paul Hodgson - CCO and Senior Research Associate

An early entry in our Louis “I’m shocked… shocked to find that gambling is going on here” Renault Weekly Competition is the news that all News Corp’s directors were re-elected and that the management Say on Pay proposal was passed. The 8-K making this shocking announcement is here. No actual voting results as yet, but those might be telling.

Our director election requirement notes say that: “In an uncontested election, each Director shall be elected by a majority of the votes cast.”

So, it’s hardly a surprise, is it? But it might mean that someone apart from the Murdoch Family must have voted for themselves, err…, for the directors, I mean. Oh, no, wait a minute, oh, whatever, it’s basically the same thing. Can’t wait to see those voting results, and find out who else did vote for them.

Successful Activism Dismantles US Takeover Defenses

By Beth Young - Senior Research Associate

An analysis of 2011 shareholder proposals shows companies yielding to activist pressure on takeover defenses. Since 2009, the prevalence of classified boards and poison pills in the S&P 500 has declined; the number of companies that deny their shareholders the right to call a special meeting has also fallen. As these defenses have become less common, the number of proxy proposals on these topics has gone down—probably both because activists see fewer targets, and because companies are more likely to settle with proponents before they print the ballot. Meanwhile, new energy is being directed to the right to act by written consent.

For more detail and statistics, download a free copy of Proxy Season Wrap-Up: Successful Activism Dismantles Takeover Defenses.

Professor Bainbridge is Right on 14-a-8

I have disagreed with Professor Stephen Bainbridge often in the past, so it is a particular pleasure to have an opportunity to side with him on his suggestion for a better approach to shareholder proposals, which must be included in the company's proxy statement if they meet certain criteria specified in Rule 14-a-8. 

The current rule prohibits (or, in the language of the SEC, allows a corporation to exclude from its proxy) a shareholder proposal relating to "ordinary business" of the company.  This makes sense as the purchase of stock does not and should not entitle a shareholder to micro-manage a company.  And it excludes proposals that are not sufficiently related to a company's business, to avoid an obvious waste of everyone's time.  

Bainbridge discusses case law that permits consideration of other than economic significance to determine whether a proposal meets the requirement of sufficient relation.  He proposes instead a standard that should be familiar to anyone who prepares or reads SEC-required disclosures -- materiality.

Courts should ask whether a reasonable shareholder of this issuer would regard the proposal as having material economic importance for the value of his shares. This standard is based on the well-established securities law principle of materiality. It is intended to exclude proposals made primarily for the purpose of promoting general social and political causes, while requiring inclusion of proposals a reasonable investor would believe are relevant to the value of his investment. Such a test seems desirable so as to ensure that an adopted proposal redounds to the benefit of all shareholders, not just those who share the political and social views of the proponent. Absent such a standard, the shareholder proposal rule becomes nothing less than a species of private eminent domain by which the federal government allows a small minority to appropriate someone else’s property—the company is a legal person, after all, and it is the company’s proxy statement at issue—for use as a soap-box to disseminate their views. Because the shareholders hold the residual claim, and all corporate expenditures thus come out of their pocket, it is not entirely clear why other shareholders should have to subsidize speech by a small minority.

I like this idea for its consistency and, well, materiality.  Perhaps the professor will disagree with me, however, when I say that most legitimate shareholder proposals will have little trouble meeting this standard, even the examples he gives of court challenges to company policies that have relatively little cost -- until you factor in costs to reputation and brand.  And materiality should be considered both ways.  The cost of including a shareholder proposal on a proxy card is minimal, the odds of an unwise proposal gaining majority support from the shareholders infinitesimal, and, given that shareholder proposals are almost universally advisory only and need not be followed by the company executives even with a 100 percent vote, the risk of harm is non-existent. 

Regardless, shareholder focus should primarily be on the board and the process and criteria for the selection of directors.  Shareholder proposals on these matters should be per se material.  But a shareholder vote against (or nomination of an opposing candidate) is more effective mechanism for addressing serious concerns of policy or strategy, and that is where investors should focus.

Shareholder Activism at Denny's: No Grand Slam

UPDATE

About two months ago, I blogged on how Denny’s had become a target of certain activist investors looking to right a fledging American franchise.  A proxy fight was mounted by The “Committee to Enhance Denny’s”, a group of investors who collectively account for about 6.5% of Denny’s common stock.  Fed up with Denny’s losing 20 percent of its market share to I-HOP and other breakfast chains over the last five years, dejected over more than $300 million spent in remodeling capital expenditures which have yet to yield quantifiable dividends to shareholders, and annoyed with inadequate marketing messages, the group had sought to replace three current Denny’s directors with candidates of their own.  One of these investors, Jonathan Dash was a guest on CNBC’s “Squawk On The Street” Tuesday. He discussed the need to hold management’s feet to the fire regarding poor financial results over the last seven to eight years as well as issues such as overpricing an inferior food product and promoting to a clientele unlikely to repeatedly patronize the establishment.

The committee was seeking not to just replace any three directors, but the CEO, chairwoman, and former chairman of the board. Following Denny’s annual meeting on Wednesday, the “Committee to Enhance Denny’s” does not believe any of their three nominees were successfully elected to the board based on the information they received, though details may not be made official for another week or so. What’s more, the group appears to be facing litigation from Denny’s for distributing confidential Denny’s Franchisee Association (“DFA”) documents in its effort to persuade shareholders to shake-up the board. The chairman of the DFA questioned the group’s ethics and judgment and accused the committee of obtaining, distributing and misrepresenting materials to further its personal agenda. None of this news has been good for Denny’s shareholders either it seems with shares down more than eleven percent since last Friday.

Greg Ruel - Advisory Services Manager

Jack Bogle on "The Silence of the Funds"

At the CFA Institute conference in Boston this morning, Jack Bogle spoke passionately of the need for institutional money mangers--most of whom, he says, now manage both mutual fund and pension assets--to increase their attention to corporate governance.  Decrying "the silence of the funds," he noted that no mutual fund company has ever filed a shareholder proposal opposed by management. "Never," he stressed. "That's not very often." The Vanguard mutual fund founder also said proxies also need to be more actively voted, especially with regard to "excessive executive compensation." Part of the problem, he said, is that mutual funds have moved from the "own-a-stock" mentality of his youth (typical fund turnover was about 20 percent in 1950) to a "rent-a-stock" model (average turnover today is 100 percent).

He urges a return to a longer-term view. He also recommends the return of Glass-Stegall--although he knows it's an uphill battle--and supports many of the aims of proposed financial regulation. At the same time, he criticizes the lack of specificity of many of the bill's provisions, and the fact that Congress intends to act in June although the Angelides commission won't report back on crisis causes till December.

Finally, he urged funds to take governance into account in security analysis, and says he'd favor a federal statute to clarify fiduciary responsibility (this would cover conflicts of interest and the need to attend to governance issues).

Kimberly Gladman - Director of Research and Risk Analytics

Enhancing Denny’s Three Directors At A Time

A group of activist investors are mounting a proxy fight against the national restaurant chain in an effort to shake up the board and company management. A group calling themselves the “committee to enhance Denny’s”, who collectively own 6.5% of Denny’s shares, are irked by more than just the lagging share price. Namely, that Denny’s has fallen behind main competitor IHOP in the national chain breakfast business, a company which has thrived in recent years relative to Denny’s. The number of customers being served at the more than 1,500 Denny’s stores has declined by nearly 20 percent from five years ago and the company stock price has dropped by more than 50 percent in that span. As such, Investment firms Oak Street Capital Management, Macquarie Futures Inc. and Dash Acquisitions are looking to provide a shakeup to the Denny’s board by nominating their own slate of three directors. To purchase a governance profile for Denny's Corporation, visit our online store.

Among the concerns of the activist group is what they perceive as marketing gimmicks. For instance, Denny’s purchased a superbowl ad  in order to advertise that for a second year in a row they would be giving away free breakfasts nationwide. Jonathan Dash, a member of the “committee to enhance Denny’s”, recently told the WSJ that “Denny’s paid a good amount of money to communicate to the public that they were giving away free food. That was not the best use of their marketing dollars.” This was followed two weeks later by a Denny’s offer of unlimited refills on french fries and pancakes, which sparked public outrage and a company apology when the 150th anniversary of the end of the Irish Famine was used as the basis for a free food celebration. Other problems at Denny’s according to the committee include failure to grow system-wide restaurants, strategic errors, high capital expenditures eliciting no measurable return, and corporate governance issues such as creating a pay for performance system which would better align shareholder and management interests.

Our evaluation of compensation at Denny’s based on its 2009 proxy statement elicited a high concern. The value of awards granted under the company’s long-term incentive plan is heavily dependent on short-term stock price performance. Also, the vesting structure of restricted stock presently lacks meaningful performance hurdles. This leaves the potential for a large increase in the value of the stock award that may be more related to an increase in the value of U.S. equities in general than the skill of management in running the company. It’s clear that the skill of management at Denny’s  is being brought into question, and “the committee to enhance Denny’s” believes the election of their three nominated directors at the 2010 annual meeting may be a jumping off point for making the board and company management more accountable to its shareholders. Denny’s Corporation has set a record date of March 23, 2010 and a meeting date of May 19, 2010 for its upcoming 2010 annual meeting of stockholders. To try Board Analyst and access corporate governance data on Denny's and any of over 3,400 U.S. and Canadian public companies, request a product trial here.

Greg Ruel - Research Associate

Financial Executive Magazine: The Year of the Shareholder

Paul Sweeney has an excellent article in Financial Executive Magazineas a part of its special issue on what's ahead for 2010.  Provocatively entitled "Will 2010 Be the Year of the Shareholder," it opens:

A constellation of forces is coalescing to give investors more clout over such thorny issues as executive pay, the composition and election of corporate boards, board transparency and responsiveness to shareholder concerns....In addition, continued shareholder outrage at overly generous pay packages to top executives — often at poorly performing companies — is further tilting the balance of power.

While Sweeney predicts some pushback from corporate executives, who argue that these pay packages are necessary for retention and to provide incentives,

even a respected source such as the executive search firm Spencer Stuart urges boards of directors to recognize that much governmental and shareholder scrutiny is deserved. “The perceived — or, in some cases, real — disconnect between company performance and executive compensation is fanning the flames of shareholder discontent,” Spencer Stuart notes in its comprehensive 2009 survey on the state of corporate boards. “In light of these pressures,” the report adds, “boards need to be sure they are operating as effectively as possible and have good governance practices in place.”

Sweeney quotes Hye-Won Choi, the head of corporate governance at TIAA-CREF, on the impact of the rule change that eliminates automatic votes in favor of board candidates.  “The end of discretionary broker voting means that management can no longer expect elections to be routine. It will level the playing field. Now the vote will be a clearer expression of shareholder sentiment.”  And he notes that even before this rule change went into effect, the percentage of votes against directors has been rising. 

Through August 2009, 9.8 percent of unopposed director nominees had at least 20 percent of shares voted against them or withheld, a 78-per- cent increase above the 5.5 percent figure in 2008.  The percentage of directors with a majority of shareholders registering opposition to their candidacy tripled, to 0.6 percent in 2009 compared with 0.2 percent in 2008. It may seem a tiny number, but amounts to 84 director nominees at 49 companies.

Sweeney predicts a rise in shareholder resolutions on compensation, governance, and climate change. 

The proxy season, in combination with significant congressional legis- lation and additional SEC rule making, could make the year 2010 among the most historic in the annals of corporate governance. The consultancy Spencer Stuart puts it this way: Events this year “could potentially reshape the corporate governance landscape as dramatically as Sarbanes-Oxley. And just as with SOX, it may take several years before the full impact of the changes becomes apparent.”

Nell Minow - Editor

Warren Buffett Says No to Kraft's Blank Check

Warren Buffett had to give Kraft a lesson today.  Buffett's Berkshire Hathaway is the largest shareholder in Kraft, which is attempting to acquire Cadbury.  Kraft has asked its shareholders for permission to issue 370 million new shares to use as a part of the $16 billion it proposes to spend for this transaction.  The problem with this proposal was that it would have given Kraft executives unlimited authority to change the terms of the deal without coming back to the shareholders for approval.  Berkshire announced that it would vote no.  They don't have a majority stake, but Kraft would not be foolish enough to try to override Buffett, even if they could get the support of the other shareholders.

Berkshire said, “The share-issuance proposal, if enacted, will give Kraft a blank check allowing it to change its offer to Cadbury – in any way it wishes – from the transaction presented to shareholders in the proxy statement. And we worry very much that, indeed, there will be an additional change from the revision announced this morning.”

This seems probable, as there is at least one other possible bidder.  

Berkshire's response is an important lesson for Kraft and for any other corporate executives who think they can get the shareholders to grant them unlimited authority.  It is a lesson in economics about the moral hazard in a deal that allows executives to impose all downside expense on the shareholders.  It is a lesson in fiduciary obligation -- Kraft management was attempting to evade their obligation to their shareholders and Berkshire was upholding their obligation to theirs.  It is a lesson in fairness and logic and judgment and credibility.  We have seen this over and over.  Everyone wants to externalize their risk, and in the past we have made it too easy too often. 

Berkshire's statement concludes that if by the deadline of January 19 it finds the terms of the deal beneficial to Kraft shareholders, it will change its vote to yes.  Will Kraft be able to put together a deal with terms that meet Berkshire's standards of transparency and accountability?  Well, one thing we know is if they don't, the answer from Omaha will still be "no."

Nell Minow - Editor

Playground spat at Children's Place?

A humdinger of a proxy contest has been rumbling on at children’s retailer Children’s Place between the current interim management and the former management such that a committee of concerned shareholders led by former CEO Ezra Dabah has nominated three directors to replace the company’s nominees.

Normally, with a classified board, a corporation could laugh off such challenges, but Mr. Dabah, who has been with the company since 1989, has chosen a year when only the class III directors are being re-elected; three directors and a third of the board, including the recently-appointed independent chair Sally Kasaks. On the other hand the incumbent directors include Mr. Dabah himself, Stanley Silverstein – Mr. Dabah’s father-in-law and another member of the committee of concerned shareholders of the company, and another director Dr. Joseph Alutto who, in a curious turn of phrase according to the 2008 proxy statement “was identified for consideration by the committee by Mr. Dabah” despite the fact that Mr. Dabah does not sit on the corporate governance committee responsible for the nomination of directors. If Mr. Dabah’s new nominees are elected, he would then have potential sway over six of the board’s directors, except that Mr. Dabah has since indicated that if his nominees are elected, Mr. Silverstein will resign. Given the 22% of outstanding stock that Mr. Dabah and Mr. Silverstein say they control, this threat is a very real one.

The mud has been slinging freely and, truly, the company has had its fair share of problems, including an inability to identify a full-time CEO to replace current interim Charles Crovitz. But it has also recently settled two lawsuits – one to do with backdating stock options the other to do with misleading financial statements – in both of which Mr. Dabah as incumbent CEO during the period must have been implicated at least in some fashion. Mr. Dabah is certainly implicated in these issues by the current management. He, of course, claims to be innocent of all impropriety, including securities trading abuses and other corporate governance sins that the current management lays at his door and that it says led to his resignation in 2007. The fact remains that the company’s performance has been relatively disastrous over the last three years. That may be because of Mr. Dabah’s actions prior to leaving rather than as a result of current management’s actions. Current management alleges that the actions it has taken have begun to place Children’s Place on a secure financial footing and cite a 17% increase in stock price in the 21 months since Mr. Dabah’s resignation as well as a number of other core financial successes.

But the share price movement has been anything but constant. In the nine months of 2007 prior to Mr. Dabah’s resignation the share price fell disastrously from over $60 to just over $20 per share. But then after a short rally, it declined even further to just over $15, then climbed, then fell again, then climbed, then fell, and underwent a quick, but small recovery in July that has placed it, well, given the volatility, not that far from where it was when Mr. Dabah resigned.

On the other hand, an impressive array of governance reforms have gone into place since his resignation, including:

• separation of chairman and CEO
• an increase in the number of independent directors on the board
• increased responsibilities and power for the CFO
• a new CFO and a new general counsel were hired
• amendments to several committee charters and to the company’s Corporate Governance Guidelines and improvements in internal policies and procedures, including amendments to Code of Business Conduct, Securities Compliance Guidelines and Related Party Transaction Control Procedures
• an amendment to provide for majority voting in an uncontested election of directors

Mr. Dabah’s criticisms of the company’s official nominees are scathing (as are the current management’s criticisms of him) including the accusation that chair Ms. Kasaks oversaw an 84% decline in stock price as CEO of Pacific Sunwear and another 27% decline in stock price while CEO of Ann Taylor. He cites Malcom Elvey’s lack of retail experience and Norman Matthews’ age – he is 76 – as preventing him from preserving the “youthful, contemporary image unique” to the company.

It is virtually impossible to distinguish the right and the wrong in this contest and the financial data, particularly given current economic circumstances, are anything but conclusive. The annual meeting on July 31 looks set to be a stormy one. Let’s hope that the majority of shareholders get to have a say.

Paul Hodgson — Senior Research Associate