EY Center for Board Matters Let s talk: governance Special edition 2014 proxy season preview ey.com/boardmatters 1
Proxy season 2014 preview Boards face shifting investor priorities and expectations Proxy season 2014 will see a continuation of many long-standing investor initiatives around board elections and leadership, executive pay, and environmental and social topics. What is new this year is the growing focus by investors on board composition and director accountability. Companyshareholder engagement continues to reshape the governance landscape, drawing investor attention to the boardroom with a focus on the skill sets, track records, diversity and accountability of boards. This emerging dynamic is a move away from check-the-box governance toward a greater focus on board effectiveness, including expectations that companies more clearly explain their governance decisions and approach on key issues. This comes at a time when campaigns by activist investors across companies of a diverse range of size and sector are on the rise. In some cases activist investors are coordinating with long-term institutional investors to achieve a common outcome. These developments raise the bar for proxy disclosures that tell a clear governance story and company-investor dialogues that are ongoing and constructive. This publication examines top areas of investor focus to help boards and management prepare for the 2014 proxy season. These insights are based on conversations among EY s corporate governance team and nearly 40 institutional investors, investor associations and advisors on their governance priorities, as well as our tracking of governance trends and emerging developments through EY s proprietary corporate governance database. 1 Key priority areas for investors this year include: 1. Board composition and renewal 2. Board structure and accountability 3. Sustainability 4. Executive compensation 5. Political and lobbying spending and oversight 1 All data is from EY s Corporate Governance Database and covers the Russell 3000, unless otherwise noted. Data for 2014 is through March 14. EY s investor outreach conversations included asking specific and consistent questions to a broad spectrum of institutional investors, investor associations and advisors. Participants include asset managers, faith-based investors, labor funds, public funds, socially responsible investors, and investor associations and advisors. Investor views vary. The insights provided represent a general, highlevel summary. 1 2014 proxy season preview
Top governance priorities for investors in 2014 Five topics emerged as key investor priorities for 2014 based on EY s discussions with the institutional investor community: board composition and renewal, board structure and accountability, sustainability, executive compensation, and political and lobbying spending and oversight. Investors are raising these topics with companies through a variety of, and in some cases multiple, methods, including letters to directors, submissions of shareholder proposals, discussions with management and board members, and through their proxy voting decisions. 2 About half of the investors tell EY that they generally initiate engagement through a letter, and may subsequently file shareholder proposals if they do not feel their concerns have been heard or addressed. About 22% of the investors raise issues by first submitting a shareholder proposal, though most indicate their goal is to reach some form of agreement without the proposal going to a vote. 1. Board composition and renewal Investors want to know that the right people those with qualifications aligned with the company s strategic goals, stakeholders and risk oversight needs are in the boardroom. They are looking more carefully at board composition, director qualifications, tenure and diversity, along with director succession planning and board refreshment practices. 3 See Spotlight on board composition and renewal on page 5 for a detailed discussion of this emerging topic. 2. Board structure and accountability Many investors continue to push for the annual election of all directors under a majority vote standard and want to see boards with a strong independent chair or lead director. Many companies have adopted these practices, but those that have not and those with lead independent directors who do not have clearly defined, robust responsibilities may be the focus of investor engagement or recipients of shareholder proposals. Annual director elections Majority vote in director elections Independent board leadership 55% 66% 88% 85% S&P 500 S&P 1500 Independent chair Lead director 24% 32% 47% 44% 71% 76% 2 Most investors have several key governance priorities. Priorities are not ranked. 3 See Let s talk: governance: succession planning for the boardroom and C-suite, March 2014 ey.com/boardmatters 2
Top governance priorities for investors in 2014 The campaign for majority voting is fueled, in part, by the few situations where directors who have failed to receive majority support continue to serve on the board often without a clear, reasoned explanation from the company. For most investors, this raises concern regardless of whether the company has majority or plurality voting requirements. In 2013, just 0.3% of director nominees did not receive majority support. Most of these directors appear to continue to serve on the board, though only a handful were at companies with majority voting requirements. Some investors indicate they plan to engage these companies and if they believe their concerns have not been addressed, they may ask for the implementation of proxy access procedures or they may use the media to run vote no campaigns against select directors. Targeted campaigns against directors likely to increase over time In coming years, investor pressure for board renewal may come from vote no campaigns, where investors publicly campaign for other shareholders to join them in voting against one or more directors. These vote no campaigns can occur for a variety of reasons and are a mechanism used by investors to hold board members directly accountable for concerns over governance and oversight. 3. Sustainability Many investors continue to show strong attention to environmental sustainability and human rights and labor conditions, including across a company s global supply chain. Requests for enhanced disclosure, monitoring and management of these sustainabilityrelated risks are growing compared to prior years. Climate change. A number of investors report a renewed sense of urgency around climate change. The risk of stranded assets 4 is at the forefront, with investors asking companies to disclose risk scenario planning and report on potential climate change-related impacts to companies business models. There is an increased push for companies to set, and report on, quantifiable goals for reducing GHG emissions including a focus on financial companies regarding the carbon footprint of their financing and lending portfolios. Proposals on GHG emissions cuts are one of the most commonly submitted shareholder proposals this year, reflecting some investors commitment to seek measurable progress in this area. Investors are also asking for enhanced investment in renewable and sustainable energy sources. Sustainability reporting, including human rights and human capital management, across the supply chain. Investors are asking companies particularly those in the technology and consumer products sectors to report on their suppliers sustainability performance or to require significant suppliers to issue sustainability reports. Companies are also being asked to report on risk assessments that identify and analyze potential and actual human rights risks of company and supply chain operations. Separately, some investors are focused on elevating human capital management as a matter of capital allocation, operational management and value creation. The topic is a broad one, covering employee training and development, fair labor practices, health and safety, and other factors, and includes the company s own employees as well as the employees of third-party vendors. This year, some retail companies are expected to receive letters requesting dialogue on the topic. 4 Stranded assets refers to a potential devaluation of oil and gas companies in connection with regulatory, nongovernmental (NGO) and other efforts to limit GHG emissions. 3 2014 proxy season preview
Top governance priorities for investors in 2014 4. Executive compensation topics Pay continues to command investor attention. More than 2,400 companies with annual say-on-pay (SOP) votes will continue to gauge investor support for their compensation policies and practices, and 2014 will mark the second SOP vote for companies that elected triennial frequencies. Nearly 200 companies received less than 70% support of votes cast on their SOP proposals in 2013. Investors can be expected to closely review those companies to assess pay-for-performance alignment, changes made in response to last year s vote, and whether the company engaged its shareholders for feedback. A growing number of companies are using supplemental pay tables including realizable pay calculations to help explain the link between pay and performance. When such tables are used, investors want to see a consistent approach applied year to year. Even with SOP votes, some shareholders are submitting proposals targeting specific pay practices. This includes efforts to limit the accelerated vesting of equity awards and adopt or enhance executive clawback policies, including asking for disclosure of when decisions to recoup pay have been made. In addition, a group of investors has indicated plans to file a package of shareholder proposals at companies with low SOP votes, including the appointment of an independent board chair, adoption of proxy access, limits on the accelerated vesting of equity awards and a ban on tax gross-ups for senior executives. 5. Political and lobbying spending and oversight A number of investors continue to prioritize requests for enhanced transparency and oversight around a company s political and lobbying expenditures in the absence of Securities and Exchange Commission (SEC) rulemaking on this topic. This year, shareholder proposals seeking board oversight and disclosure of political and lobbying expenditures are the most common in terms of numbers, with more than 120 submitted to companies across a wide range of sizes and industries. The proposals largely focus on indirect expenditures, in which company payments to trade associations and other taxexempt organizations are used for political or lobbying purposes, even if only in part. New variations focus on whether this corporate spending aligns with stated company policies and practices on environmental sustainability. ey.com/boardmatters 4
Spotlight on board composition and renewal Closer attention to board composition and renewal will be a key theme of the 2014 proxy season and beyond. Lack of turnover on boards is raising concern among many investors that board independence may be compromised, groupthink may be stifling boardroom debate, and fresh perspectives may be lacking from strategic discussions. The low rate of board turnover is also seen as a major impediment to progress on board gender diversity. More than half of investors we spoke with indicate they will pay more attention to board renewal in 2014 the greatest focus area for the investors as a group. Almost all of these investors plan to raise the topic in their conversations with companies. A smaller number of investors say they may cast proxy votes against nominating committee members (or entire boards) where boards lack gender diversity. Will you pay closer attention to board renewal in 2014? How do you plan to address board renewal? 18% In certain circumstances Conversations with companies Letters to boards 27% 93% 26% No 56% Yes Using board renewal factors to target companies for engagement 20% Voting against directors if board lacks gender diversity 13% 4 Proxy season 2014 preview
Spotlight on board composition and renewal Investors report that a number of overlapping factors are driving the emerging focus on board composition and renewal: What factors are driving your focus on board renewal? Skillsets Increase diversity 74% 74% Fresh perspective 39% Independence 30% Broader governance concerns 22% Director skill sets and expertise. Investors seek to better understand how director succession planning is tied to the company s strategic plan and specific situation. Is there a thoughtful, ongoing or regular approach for assessing whether the board includes directors whose skills and expertise are relevant to company strategy, challenges and transformation? Investors generally believe the board should be strategically recruiting directors based on a company s oversight needs. Board diversity. Most investors are paying attention to diversity, with particular emphasis on gender. Women hold only 15% of board seats at S&P 1500 companies despite long-standing investor campaigns to enhance gender diversity on boards, the publication of research showing that companies with more female directors outperform companies with few or no female directors, and the emergence outside of the US of quotas and targets to address gender inequality in the boardroom. 5 Fresh perspective and director tenure. In general, investors believe groupthink may stifle boardroom debate and inhibit the introduction of fresh views and insights into strategic discussions. Lack of board turnover also hinders diversification and may raise broader governance concerns. About 10% of S&P 1500 companies have not added a new director in the last five years. Independence and director tenure. Some investors are concerned that director independence may be compromised on boards where a high proportion of directors are long-tenured. The Council of Institutional Investors, a nonprofit association of investors with more than $3 trillion in assets, has adopted a new policy recommending that boards consider an individual director s tenure when determining whether that person is independent. 6 Leading proxy advisor ISS is exploring making tenure a factor in its voting policy for director elections. 7 In some non-us markets, directors with a certain number of years of service (e.g., after nine years in the UK) are no longer considered independent. Broader governance concerns. For some investors, closer scrutiny of board composition and renewal is triggered by other governance factors, such as excessive executive compensation paired with lagging performance, concerns over regulatory compliance or strategic missteps. These situations may result in a closer boardlevel analysis by investors than a company without such challenges. 5 For more information on the progress made to increase gender diversity on US corporate boards, please see Diversity drives diversity: from the boardroom to the C-suite, EY, 2013, and Getting on board: women join boards at higher rates, though progress comes slowly, EY, 2012. 6 More on CII s New Policies on Universal Proxy and Board Tenure, CII, accessed February 2014. 7 ISS Benchmark Policy Consultation, including auditor tenure, EY 2014. ey.com/boardmatters 6
Spotlight on board composition and renewal Considerations for stimulating board renewal Investors are now asking more questions about how a board approaches board composition, including how companies may be using certain mechanisms to ensure regular board refreshment, such as: Term limits/term guidelines. The proxy voting guidelines for most investors oppose strict term limits since they deprive the board of judgment that it should be able to exercise. Many investors consider tenure to be an issue only when a director s performance on the board and key committees is in question. However, some of these same investors may support forced turnover mechanisms, such as term limits, if director succession planning is not transparent and they perceive that the board is failing to regularly refresh composition. Performance evaluations. Ongoing, robust director and board performance evaluations can ensure that individual director competencies are fully understood, recognized and utilized. Evaluations can also create a mechanism for generating strategic board renewal aligned with a company s goals and board-level needs. Having an independent third party help facilitate the assessments can de-personalize the process. For many investors, understanding this process is an engagement priority. Skills matrix. Leading practice for board succession planning includes using a matrix to shape the composition of the board to identify the skills, expertise, attributes and experience necessary to support a company s strategic plan over the short- and longterm. Some identified attributes may apply to all directors, while others may allow for a balanced mix among the board as a whole. The development of a matrix provides an opportunity for thoughtful discussion and observation and allows the board to identify any gaps that need to be filled. 8 How engagement impacts board composition Currently, most company engagement with shareholders includes directors at least occasionally, and some investors indicate they would like to see directors available for engagement more often, especially in cases where specific directors are charged with oversight of the topic in question. 9 Investors want to better understand how a board or key committee thinks through challenging governance areas. Most investors find that proxy statement disclosures and other filings provide only limited insights on board quality and director effectiveness and that engagement can enhance their view into board dynamics and individual director competencies. 8 Key developments of the 2013 proxy season, EY, 2013. 9 Let s talk: governance: navigating the company-investor engagement landscape, EY, Issue 1, January 2014. 7 2014 proxy season preview
Spotlight on board composition and renewal Views from EY s Corporate Governance Dialogue Dinners New paradigm in company-shareholder engagement In February 2014, EY hosted two Corporate Governance Dialogue Dinners, bringing together board members, institutional investors, corporate secretaries, advisors and academics to discuss the 2014 proxy season, with a focus on the rise in board-shareholder engagement, including how this might impact board composition. 10 Participants agreed that engagement is no longer reserved for times of crisis. In this new paradigm, proactive long-term relationship-building between institutional investors and companies which increasingly involves directors presents ongoing strategic opportunities for companies to secure investor support, mitigate potential exposure to activism, and counter check-the-box proxy voting. The traditional company-investor dynamic is changing and this is bringing board composition, among other topics, into the spotlight. Key themes and takeaways from the dialogue included: Boards may gain support through regular engagement with long-term investors, although many boards are not yet engaging at that level. Engaging with shareholders may offset proxy advisory firm views, and engaging with proxy advisory firms may offer benefits as well. Investors expect to have direct dialogue with board members since they elect these directors to represent their interests. As engagement increases, director competencies may include the ability to effectively engage with investors. In terms of managing board renewal, rigorous performance evaluations are preferred to term or age limits. Transparency around the work of the board and clarity around director qualifications are of growing importance to investors. Boards need to have a policy in place regarding director communications that works for them under company-specific circumstances; there is no one-sizefits-all approach. Equity analysts and portfolio managers who are making investment decisions are often not the same individuals evaluating a company s governance and making proxy voting decisions. Including CFOs who typically have long-standing relationships with equity analysts and portfolio managers in engagement conversations about governance and board performance may add useful perspectives that tie into overall company performance and strategy. 10 The discussions took place under the Chatham House Rule. ey.com/boardmatters 8
The overall shareholder proposal landscape While investors are increasingly communicating their expectations around governance through direct engagement and letters to boards, some continue to submit shareholder proposals. EY is tracking around 700 shareholders proposals submitted for 2014 annual meetings. 11 An increasing proportion of proposals are withdrawn as many companies and shareholders reach agreement prior to the proposal going to a vote. So far just under 20% of shareholder proposals submitted have been withdrawn, compared to 15% for the same period last year. Around 80% of these withdrawals have been made in connection with company-investor dialogue and/or company action, compared with 73% for the same period in 2013. These agreements may include implementation of the proposal in part or in full, providing additional disclosure, or a commitment to ongoing dialogue on the topic. Shareholder proposal submissions 1,000 800 600 400 200 0 2012 full year 2013 full year 2013 as of 3/11 2014 as of 3/14 Pending or in proxy Withdrawn Omitted Most common shareholder proposals to date in 2014: 1. Disclosure and oversight of political spending 2. Disclosure and oversight of lobbying spending 3. Report on sustainability 4. Set and report on GHG emissions reduction targets 5. Appoint independent board chair 6. Adopt targeted executive compensation reforms 7. Eliminate classified board 8. Adopt majority vote to elect directors 9. Assess and report on global labor practices/human rights 10. Increase diversity on the board Environmental and social proposals lead Environmental and social topics continue to be the dominant category of shareholder proposals based on the number of proposals submitted. So far this year, environmental and social proposals represent about 55% of total submissions, up from 45% for the same period in 2013. 2014 Shareholder proposal categories Based on proposal submissions 22% Board-focused Environmental and social proposals also represent the leading area for proposals withdrawn in connection with successful company-investor engagement. It is still early in the season, but so far 20% of proposals on environmental sustainability topics have been withdrawn in connection with company action and/or engagement, as mutual agreement is reached. More withdrawals are expected as the season continues following the general trend seen in prior years. For all of 2013, the percentage of withdrawals for these proposals in connection with company action and/or engagement was 45%. 55% Environmental or social 5% Routine 9% Compensation 9% Anti-takeover strategy 11 Through March 14, 2014. 9 2014 proxy season preview
The overall shareholder proposal landscape Enhanced investor focus on the audit committee Some of the largest US companies are being asked to provide enhanced disclosure on the audit committee s role in overseeing the audit firm and how the audit committee supports audit quality. These requests currently are not being made through shareholder proposals but a multi-year letter-writing and engagement campaign. In response, EY has seen an increase in companies voluntarily enhancing the audit committee related disclosures in their proxy statements.12 12 Audit committee reporting to shareholders: 2013 proxy season update, EY, 2013 Conclusion: shifting priorities and expectations It is important for companies and boards to be aware of key areas of investor focus as investor priorities and expectations are evolving and direct engagement is increasing. Companies may benefit from enhanced transparency around decisions and approach on key governance issues, especially as investors move away from check-the-box governance toward a greater focus on board effectiveness. ey.com/boardmatters 10 9
EY Assurance Tax Transactions Advisory About EY EY is a global leader in assurance, tax, transaction and advisory services. The insights and quality services we deliver help build trust and confidence in the capital markets and in economies the world over. We develop outstanding leaders who team to deliver on our promises to all of our stakeholders. In so doing, we play a critical role in building a better working world for our people, for our clients and for our communities. EY refers to the global organization, and may refer to one or more, of the member firms of Ernst & Young Global Limited, each of which is a separate legal entity. Ernst & Young Global Limited, a UK company limited by guarantee, does not provide services to clients. For more information about our organization, please visit ey.com. Ernst & Young LLP is a client-serving member firm of Ernst & Young Global Limited operating in the US. About The EY Center for Board Matters Effective corporate governance is an important element in building a better working world. The EY Center for Board Matters is committed to bringing together and engaging with boards, audit committee members and investors to exchange ideas and insights. Using our professional competencies, relationships and proprietary corporate governance database, we are able to identify trends and emerging governance issues. This allows us to deliver timely and balanced insights, data-rich content and practical tools and analysis to boards, audit committees, institutional investors and others interested in governance topics. Let s continue the conversation. Find out more at ey.com/governance or contact one of the following professionals: Allie Rutherford Center for Board Matters Ernst & Young LLP +1 202 327 7026 allie.rutherford@ey.com Ruby Sharma Center for Board Matters Ernst & Young LLP +1 212 773 0078 ruby.sharma@ey.com 2014 Ernst & Young LLP. All Rights Reserved. SCORE no. CF0075 1403-1219141 In line with EY s commitment to minimize its impact on the environment, this document has been printed on paper with a high recycled content. ED None This material has been prepared for general informational purposes only and is not intended to be relied upon as accounting, tax, or other professional advice. Please refer to your advisors for specific advice www.ey.com Insights on the go 10 2014 proxy season preview Access our thought leadership anywhere with the Center for Board Matters magazine on the Flipboard app. Visit flipboard.com for more information.