The Investor Stewardship Group—a group of the largest, most prominent institutional investors and global asset managers investing, in the aggregate, over $20 trillion in the U.S. equity markets—has developed the Framework for U.S. Stewardship and Governance, a “framework of basic standards of investment stewardship and corporate governance for U.S. institutional investor and boardroom conduct.” The stewardship framework identifies fundamental responsibilities for institutional investors, and the corporate governance framework identifies six fundamental principles that “are designed to establish a foundational set of investor expectations about corporate governance practices in U.S. public companies.” Generally, the principles “reflect the common corporate governance beliefs embedded in each member’s proxy voting and engagement guidelines,” although each ISG member may differ somewhat on specifics. The ISG encourages company directors to apply these basic principles—while acknowledging that they are not designed to be “prescriptive or comprehensive” and can be applied in various ways—and indicates that it will “evaluate companies’ alignment with these principles, as well as any discussion of alternative approaches that directors maintain are in a company’s best interests.” The framework does not go “into effect” until January 1, 2018, so that companies will have “time to adjust to these standards in advance of the 2018 proxy season,” the implication being that failure to “comply or explain” by that point could ultimately lead to shareholder opposition during proxy season. Check out the countdown clock at the link above!
The six principles, along with summaries of the underlying rationales and expectations, are set forth below:
Principle 1: Boards are accountable to shareholders.
Shareholders have a fundamental right to elect directors and hold them accountable. Annual election of all directors, rather than triennial election of classes of directors on classified boards, supports that accountability. Directors who fail to receive a majority of the votes cast in an uncontested election should tender their resignations, and the board should accept or explain in detail the reasons why not. To further enhance accountability, long-term shareholders should be able to make board nominations using proxy access. Because antitakeover measures can reduce board accountability and prevent maximum value realization, directors of companies the charters of which include these measures should explain why their inclusion is in the best long-term interest of the company. Companies should disclose sufficient information about their corporate governance and board practices.
Principle 2: Shareholders should be entitled to voting rights in proportion to their economic interest.
The ISG favors a one-share, one-vote standard—no surprise there. Existing multi-class share structures should be reviewed regularly and provide mechanisms for phase-out at the appropriate time.
Note that at a recent meeting of the SEC’s Investor Advisory Committee, one panelist reported that, when a number of CFOs were asked why they would decide not to go public, at the top of the list was the need to maintain decision-making control. In the private market, another panelist suggested, companies and investors have a kind of unspoken “pact” about long-term strategy. But, said one panelist, the rise of hedge-fund activism in tech and other product-cycle-driven public companies—a relatively recent phenomenon—has fueled concerns among founders and other management that they will be hampered in pursuing long-term strategic goals by activists with short-term perspectives. These companies fear that activity that may have significant long-term payout, but a near-term adverse price impact (e.g., M&A activity, change in product strategy, substantial investment in R&D), will draw scrutiny and intervention from hedge-fund opportunists—hence the recent prevalence of dual-class capital structures, which a panelist characterized as merging some private company benefits into a public company structure. (See this PubCo post.) Here’s a question: if institutional investors would be somewhat more amenable to relatively mild protective measures such as classified boards and other similar protections, might public companies feel less need for recourse to no-vote and low-vote multi-class share structures, which some view as blunt instruments to protect against hedge fund activists? Just a thought….
Principle 3: Boards should be responsive to shareholders and be proactive in order to understand their perspectives.
If a shareholder proposal receives significant shareholder support, it should be implemented or an explanation provided. Boards should seek to understand the reasons for and respond to significant shareholder opposition to management proposals. To understand shareholders’ views, independent directors should be involved in the shareholder engagement process; it is reasonable for shareholders to oppose reelection of directors that “persistently” do not respond to shareholder feedback.
Principle 4: Boards should have a strong, independent leadership structure.
Independent board leadership—an independent chair or a credible independent lead director (with the latter acceptable only to some members) — is essential to good governance, particularly oversight of corporate strategy, assessment of management’s performance, ensuring board and board committee effectiveness and providing a voice independent from management that is accountable directly to shareholders and other stakeholders. The role of the independent board leader should be robust and clearly delineated, with any division of responsibility with the executive chair (if any) determined by the board, periodically reviewed by the board and disclosed to shareholders with an explanation of how the division maintains oversight integrity.
Principle 5: Boards should adopt structures and practices that enhance their effectiveness.
Boards should be majority independent and diverse, composed of directors having a mix of direct industry expertise and experience and skills relevant to the company’s current and future strategy. Diversity includes diversity of thought and background. At a minimum, boards should have fully independent audit, executive compensation and nominating and/or governance committees. In nominating and renominating directors, the nominating committee should assess the candidate’s ability to make an adequate time commitment. Meeting attendance is a prerequisite to engagement and oversight. Directors should aim to attend all board meetings, including the annual meeting, and poor attendance should be explained to shareholders. Directors should be assured access to information from the company and should also seek information from a variety of outside sources (including, for example, outside auditors and mid-level management). The mechanism for board refreshment should be disclosed and should include a regular evaluation process, as well as “an evaluation of policies relating to term limits and/or retirement ages.”
Principle 6: Boards should develop management incentive structures that are aligned with the long-term strategy of the company.
Incentive awards should be driven by short- and long-term performance goals that support long-term strategy. Boards or comp committees should identify these goals, modify them if the strategy changes and explain to shareholders how the goals are linked to long-term strategy and sustainable economic value creation. All extraordinary pay decisions for the NEOs should be explained to shareholders.