Controlled Companies in the Standard & Poor s 1500: A Follow-up Review of Performance & Risk Webinar: Review of Research Findings and Q&A Thursday, March 31, 2016 at 1:00pm ET Investor Responsibility Research Center Institute & Institutional Shareholder Services (ISS) 1
Agenda q Introductions q Research Review q IRRCi Perspective q Q&A 2
Webinar Logistics Attendees in listen only mode. Questions encouraged. Type using the Question function, answers following report overview. You will receive email with replay link. Report at Share info on social media - @irrcresearch and @issgovernance Audio issues, contact GoToWebinar @ 1-800-263-6317. 3
Speakers Edward Kamonjoh Report Author and Head of U.S. Strategic Research & Analysis Institutional Shareholder Services Jon Lukomnik Executive Director Investor Responsibility Research Center Institute 4
About Investor Responsibility Research Center Institute Not-for-profit established in 2005 Funds, disseminates objective, unbiased research on range of issues at intersection of corporate responsibility, investors informational needs Academic & practitioner research examining capital market context that impacts how investors, companies make decisions Annual research award with two $10K awards More than 40 research reports available at no charge 5
About Institutional Shareholder Services The world s leading provider of corporate governance solutions to the global financial community Clients include asset managers, asset owners, hedge funds, & banks ISS offers governance services, investment services and securities class action services More than 900 employee across 17 global offices 6
Study Universe S&P 1500 Composite Index as of Jul. 31, 2015 105 Controlled companies as of Oct. 25, 2015 78 firms with multi-class capital structures 27 firms with a single stock class o Firms with an owner of 30 percent or more of the voting stock were deemed to be controlled In 2012, 114 Controlled companies 79 firms with multi-class capital structures 35 firms with a single class of stock 7
Key Findings The number of controlled firms has dropped over the last three years Multi-class stock structures with differential voting rights remain preferred control mechanism Controlled companies ü Growing in size ü Generally underperform ü Have less diverse boardrooms ü Feature longest director tenures ü Refresh their boards less frequently ü Have less financial expertise on the board ü Have larger related party transactions ü Compensate their CEOs significantly more 8
High-Level Trends The number of controlled firms in the S&P 1500 dropped ~8% percent between 2012 and 2015 Control mechanism of choice? Multi-class stock structures with differential voting rights Control Type 25% 40% Board election class- voting via multi- class stock Super- voting multi- class stock Controlled companies concentrate in three sectors 35% Control Concentration Single- class stock significant shareholder 31.4% 12.4% 16.2% 40% Consumer Discretionary Industrials Consumer Staples Other 9
Ultimate Survivors Multi-class stock controlled firms built to last 100% of all controlled firms prior to 1960 50% controlled before 1990 Average age more than double that of controlled single-class stock firms Single-class stock controlled companies tend to have limited shelf-lives 50% controlled after 2000 (vs. < 20% of controlled multi-class stock companies) ~3X more firms became controlled after 2010 relative to multi-class stock companies. 10
Wider Portfolio Shadow Controlled companies double in size Average market capitalization jumped from $8.3 billion in 2005 to $20.6 billion in 2015 and median market capitalization increased from $1.45 billion in 2005 to $2.8 billion in 2015 Controlled Company Size Grows The average and median MARKET CAPITALIZATION for the study s universe of controlled firms just about DOUBLED over the study period 2005 2015 11
Does Control = Superior Perf.? Controlled companies generally underperform Average TSR, revenue growth, return on equity, and dividend payouts over one-, three-, five- and 10-year periods Outperformed on ROA Mixed results for ROIC (marginal outperformance except for 10-year period) EBITDA Growth (underperformed in short-term & outperformed over longer-term periods) Balance sheet metrics 10 Year Metrics 6.9% 8.5% 7.4% 7.7% 12.8% 7.8% 9.8% 11.7% 11.3% 5.2% 4.9% 5.6% 7.3% 7.9% 7.8% 15.5% 43.0% 30.5% 34.5% 37.4% 53.5% TSR Revenue Growth* ROE* Dividend Payouts* ROA ROIC EBITDA Growth* % Ctrl- d Firms % Non- Ctrl- d Firms % Ctrl- d Multi- Class Stock Firms 12
Volatility: No Consistent Diff. Controlled firms have highest long-term share price volatility Average volatility higher (vs. non-controlled firms) over one- and 10-year periods Lower volatility over three- and five-year periods Stock Price Volatility 27.5% 37.9% 27.2% 21.5% 25.6% 36.3% 27.9% 23.1% 25.7% 36.4% 22.5% 26% 1 Yr 3 Yr 5 Yr 10 Yr % Ctrl- d Firms % Non- Ctrl- d Firms % Ctrl- d Multi- Class Stock Firms 13
Director Diversity Deficit Controlled companies feature less diverse boards Women and minority directors less common Boardroom Diversity 63% 59.5% 43% 21% 21% 17.4% 17.7% 30% 21.5% 16.6% 9.5% 10.1% 0 WOB 2 WOB 0 MOB 2 MOB % Ctrl- d Firms % Non- Ctrl- d Firms % Ctrl- d Multi- Class Stock Firms 14
Prolonged Director Tenure Controlled companies have longest director tenures % of firms where board members average at least 15 years of board service is more than 17 percentage points higher than at non-controlled firms. Extended Tenure (15+ Years) 55% 54% 43% 42% 35.5% 21% 19% 23% 7.7% Long Tenure (10+ Years) 50%+ of Board 33.3%+ of Board 25%+ of Board % Ctrl- d Firms % Non- Ctrl- d Firms % Ctrl- d Multi- Class Stock Firms 72% 64.2% 75.7% 79% 75% 82.4% 47% 39% 48.6% 50%+ of Board 33.3%+ of Board 25%+ of Board % Ctrl- d Firms % Non- Ctrl- d Firms % Ctrl- d Multi- Class Stock Firms 15
Fewer New Faces Controlled companies have less board refreshment New Nominees (0 Yrs of Board Service) 79% 75.7% 69.7% 2% 3.7% 1.4% 24.3% 18% 18.9% 31.1% 26% 29.7% 25%+ of Board 10%+ of Board 5%+ of Board 0% of Board % Ctrl- d Firms % Non- Ctrl- d Firms % Ctrl- d Multi- Class Stock Firms Recent Nominees (1-3 Yrs of Board Service) 84.4% 79.4% 78% 79.7% 72% 71.6% 31% 39.5% 24.3% 27% 25.7% 16.4% 25%+ of Board 10%+ of Board 5%+ of Board 0% of Board % Ctrl- d Firms % Non- Ctrl- d Firms % Ctrl- d Multi- Class Stock Firms 16
Financial Expert Deficiency Controlled company boards feature fewer financial experts and more executives Financial Expert Prevalence 64% 63.5% 57.4% 27.2% 4% 6.1% 2.7% 18% 17.6% 14% 16.2% 9.2% 50%+ of Board 30-49% of Board 10-25% of Board 0-9% of Board % Ctrl- d Firms % Non- Ctrl- d Firms % Ctrl- d Multi- Class Stock Firms Professional Director Experience 34.6% 36% 31.5% 25.6% 23.6% 21.5% 13.8% 13.2% 13.1% Executives Retired Professionals Financial Services % Ctrl- d Firm Board Seats % Non- Ctrl- d Firm Board Seats % Ctrl- d Multi- Class Stock Firms 17
Elevated Executive Pay Controlled companies with multi-class stock structures award significantly higher average CEO pay (most recent fiscal year) CEO Pay 3X higher than at single-class stock controlled firms CEO Pay > 40% higher than at non-controlled firms Average CEO pay at all controlled companies is 19% higher than at noncontrolled firms Controlled single-class stock firms CEO Pay is less than half the broader market average Avg. CEO Pay $10,936,769 $9,137,340 $7,683,392 $3,739,055 Controlled: Single- class Structure Non- Controlled Controlled Controlled: Multi- class Structure 18
Shareholders Subordinated? Controlled companies sport less shareholder friendly governance features 81.6% 67.1% 66.3% 60.1% 52.4% 53.8% 59% 60.3% 55% 58% 20% 18% 26.6% 24% 37.4% 20.3% 38% 33.3% Avg. Board Indep. Majority Vote Std. Written Consent Special Meetings Classified Boards Supermaj. Vote Reqs. % Ctrl- d Firms % Non- Ctrl- d Firms % Ctrl- d Multi- Class Stock Firms Board Elections ü Less independence ü Less voice Action Between AGMs ü Rights favor controlling parties ü Narrower avenues for change Fort Defenses ü Control assured ü Backup unnecessary 19
Investor Viewpoints Majority of institutional investors surveyed make distinctions between controlled and non-controlled firms when making investment decisions and/or proxy voting decisions 114 investors conservatively representing $4.2 Trillion in AUM were surveyed ~65 percent of investors responded to the survey question 56% of survey respondents indicated they make distinctions between controlled and noncontrolled portfolio companies ü Compensation ü Takeover defenses ü ü ü ü Board composition Director independence Related-party transactions Stock ownership guidelines Majority of survey respondents do not make distinctions based on control mechanism A number of investors, however, stated that control via super-voting shares is more problematic than control via majority ownership 20
Recent IPOs Number of controlled recently public firms on the rise The proportion of controlled firms has, however, dropped. ü 7% of controlled firms feature multi-class stock (vs. 11.8% in 2012) ü 16.8% of entities with a controlling shareholder (at least 30 percent ownership) have a single class of stock (vs. 16.5% in 2012) ü Median market cap still > 2X that of non-controlled firms ü Imprimatur of less shareholder friendly governance features still evident 2015 2012 Ownership Type Controlled Non- Controlled Controlled Non- Controlled # Firms 110 352 48 122 Median Market Capitalization $970.9 million $445.5 million $617.8 million $322.4 million Avg. Board Independence 57.0% 73.6% 60.4% 75.3% Written consent Prevalence 44.5% 9.9% 45.8% 4.9% Material Weakness Prevalence 1.8% 0.9% 6.3% 4.2% 2015: n = 462 2012: n = 170 21
IRRC Institute Viewpoint Comprehensive, detailed report Universe of single class controlled / multi-class controlled / not controlled Performance / Risk Balance sheet information Governance data Alignment Market participant views Want to focus on multi-class share controlled companies That's where the controversy is Council of Institutional Investors just last week called for ending multi-class IPOs Proponents claim structure allows boards and managements to focus on long-term value creation Opponents claim structure insulates just serves to protect/entrench boards and managers 22
IRRC Institute Viewpoint Multi-class companies are "built for comfort" Boards are materially less independent: 66.3% independent directors at multi-class companies vs. 81.6% at noncontrolled firms Boards are very long-tenured with little refreshment 66.3% of multi-class companies have boards with an average of at least 10 years of service vs. 36.8% at non-controlled companies Diversity Similar percentages of women on multi-class company boards (16%) as noncontrolled company boards (16.5%), but 59% of multi-class company boards have no minorities vs 43% of non-controlled company boards Executive pay Multi-class control companies pay their CEOs an average of $10.9 million, compared to $7.7 million for non-control companies. 23
IRRC Institute Viewpoint Multi-class shares are not built for performance Performance is corporate-specific and time specific. No evidence that dual-class, multi-class shares have a structural advantage. Makes sense: Some organizations thrive under pressure and others when comfortable Multi-class shares generally, but not always, underperform TSR: Underperform 1 and 10 years, virtual tie 5 years, outperform 3 year Revenue growth: Underperform all time periods ROE: Underperform all time periods ROIC: Outperform 1-, 3- and 5-year time periods, underperform 10-year time period Volatility: No consistent difference 24
IRRC Institute Viewpoint Issue for external investors is that if things go wrong, traditional remedies not available. Therefore, multi-class controlled companies contain different, and arguably more, contingent risk for external investors The key is: Will you get paid for taking that risk? Situation argues for fundamental investors to dig deep and understand Control structure Controlling entity: Is it a skilled, benevolent dictator/ capital allocator or an insulated entity with little at risk? 25
Type your question using the Question function. We will read questions aloud, speakers will respond. 26
Contacts Jon Lukomnik Executive Director IRRC Institute +1.646.512.5807 jon@irrcinstitute.org @irrcresearch Edward Kamonjoh Head, U.S. Strategic Research & Analysis ISS +1.301.556.0392 edward.kamonjoh@issgovernance.com www.issgovernance.com 27