FINAL UPDATE: No One Wants Director Say-on-Pay

Well, our lonesome effort to improve how shareholders influence BoDs failed miserably.

Recall we proposed a hard-hitting corp gov idea, in which company shareholders would approve BoD compensation (below). If the BoD fails to win a majority vote, then the company can't pay them. We call it "doubly-binding":

• we submitted a bylaw amendment, rather than a precatory proposal
• the bylaw provides for a binding shareholder vote, rather than advisory, as with current executive say-on-pay votes.

The corp gov debacle at TSLA inspires this. It settled its huge director comp lawsuit with an agreement to put director pay up for a shareholder vote. Long-time corp gov activist John Chevedden submitted it to thirteen of his portfolio companies for the 2024 proxy season.

Eight of the companies sought no-action relief from the SEC. Seven received it; based on this result, we expect the last one will, too.

Five of the companies included it on the AGM agenda and proxy statement. All AGMs have now occurred. The average vote in favor was about 2% of the shares voting.

We never put together a shareholder proposal before, so didn't really know what to expect. Now we understand a little better, and based on this experience we find the process kind of screwed-up. So, we offer some observations about what happened. The parties to this absurd process mostly just puzzle us.

Companies

Well, ok, companies don't puzzle us. All thirteen opposed it, with elaborate statements claiming all manner of dire consequence from shareholders voting on the pay of their elected representatives.

We met with staff from most of the companies. We didn't expect any to say, "wow, this is terrific, glad you brought it up, let's do it right away," and of course none said anything close. They asked a few routine and a couple of probing questions in brief meetings. None offered a compromise, say a precatory proposal or advisory vote on director pay. Based on the AGM voting results, evidently they didn't need to.

On the other hand, all of these companies claim to embrace progressive corp gov. We expect them, and almost all companies, to win a DSoP vote, at least based on the experience with executive SoP. It seems like a layup to conduct this vote each year as a commitment to responsive corp gov, and a way to quiet prospective corp gov critics.

Shareholders

These parties might think a little harder about their commitment to advanced corp gov.

We talked with a number of investors about the idea before we submitted our proposals. We received mostly neutral reactions, so perhaps no one wanted to comment before they saw a live example. One stewardship head of a big index fund said "I really hate this idea” but didn't explain why. This should have told us something.

After we submitted the proposals, we corresponded or talked with the stewardship departments from the top five or six index funds; we all know who they are. A couple thanked us for the explanation of the proposal. Based on the outcome, none voted for it, and none said whether they did or why. We'll look later this year to see exactly how they did vote.

Proxy advisors

We figured out what veteran proponents know well - it's not easy to work with these firms. Sure, they receive hundreds of proposals each year in the US alone. They must read and research each, and then write and disseminate a recommendation. They seem to make it at least a little harder for a shareholder to work with their system than they do companies.

We did talk with ISS and Glass Lewis, and explained our proposal and rationale. We diligently kept them updated as we submitted proposals and worked through SEC no-action requests.

We requested a copy of their recommendation. ISS sent us one company's out of five, with a friendly note that they don't typically provide these to proponents. Glass Lewis provided nothing. Aside from the one ISS report, we don't know the recommendations, although we assume they advised clients to oppose the proposals at each company. Both ISS and Glass Lewis offered to sell us copies of the reports, though.

ISS and Glass Lewis have an elaborate process for responding to companies. They have procedures for companies to submit data and rebut proposals, and share copies of a company's report with them in advance of a vote. They have updated recommendations based on company input. Proponents have no such access.

Proxy advisors have no bigger fans than us. We think they provide an invaluable service to shareholders confronting an increasing number of novel and arcane proposals. We wish they would work with proponents the same way they work with companies.

SEC

The SEC is about as inscrutable as the proxy advisors. Proponents have long complained about terse no-action letters, which affirm a company's argument with no further explanation. The SEC offers no opportunity to discuss a proposal or understand the staff's rationale.

Some confusion arises from the differences in the SEC's response to substantially similar proposals. Six of the companies argue the bylaw amendment would violate state law. The SEC agrees and granted no-action relief. Earlier, we addressed this argument (below).

One company argued it constitutes micromanagement. The SEC agreed with this, too, which truly puzzles us. We fail to see how a shareholder vote on whether to pay their elected representatives infringes on ordinary, day-to-day business operations or is overly prescriptive. The proposal specifically allows the BoD to design the structure and amount of compensation. Shareholders would then vote on what the BoD devises. Unfortunately, we don't have the opportunity to ask the SEC what they mean, and thus design a better proposal for next time.

Ourselves

We bear responsibility for this outcome, too. Some confidants advised we submit a precatory proposal, merely asking the BoD to consider the idea. Others suggested we accept an advisory vote, similar to the current executive say-on-pay vote. We're stubborn and idealistic, though.

We thought shareholders would welcome the opportunity to express views about a BoD beyond empty complaints to a nominating committee or a feckless "vote no" campaign. We thought proxy advisors and the SEC would embrace or at least not object to a corp gov innovation that could prevent other companies from trying the same stunts as the TSLA BoD. Boy, we got that wrong.

Look, shareholders don't owe us anything, much less an explanation why they voted against the proposal. Yet, we thought we put together something that should matter to investors interested in improving corp gov materially. We thought we interacted with them in an appropriately discrete and civil manner.

We'd like to understand why they "really hate" the concept. We still don't know whether they have too many proposals to vote on, are happy with the current ways to object to directors, or don't want to provoke companies by supporting something as forceful as a vote on director pay.

Wait 'till next year, it seems.

UPDATE: Doubly-Binding Director Say-on-Pay

A few weeks ago we explained how director say-on-pay works, and why companies need it (below). We submitted proposals at twelve (now thirteen) companies to implement it. Here's an update on how it's going.

As a reminder, the proposal addresses one of the most egregious conflicts on BoDs today: directors design and approve the structure and amount of their own compensation without any oversight from the shareholders they represent. The proposed bylaw amendment provides a degree of oversight, in the form of a shareholder vote.

The comments we received largely favor the idea. Companies assert they compensate directors fairly and reasonably, so why do we need this now? As TSLA shareholders learned the hard way, while things might look fair and reasonable now, they might not remain that way.

Votes at five companies

Of the twelve companies, five will include it on the AGM agenda and in the proxy materials:

NiSource (NI)

• proxy statement (proposal 5., p. 78)
• our rebuttal
• AGM on May 13.

PayPal (PYPL)

• proxy statement (proposal 6., p. 112)
• our rebuttal
• AGM on May 22.

Fortiv (FTV) included it in a preliminary proxy statement (proposal 5., p. 93). We will submit a rebuttal once the company files a definitive proxy statement. Alphabet (GOOG) and Devon Energy (DVN) indicated they will also include the proposal. Neither have published a proxy statement yet.

Eight others

Six companies sought no-action relief, which the SEC granted. The companies asked to exclude the proposal based on a potential technical violation of Delaware law, among other grounds.

The proposal limits the votes of directors as shareholders on their own compensation. It follows the structure of the TSLA directors comp litigation settlement, in which TSLA directors will not vote as shareholders on their own compensation. State statute and case law say little about how directors can vote as shareholders on conflicts like this.

The six companies obtained separate legal analyses from state corporate counsel. The lawyers delivered a narrow interpretation of statute and case law that arrives at an opinion that so disenfranchising directors as shareholders potentially violates state law. SEC staff relied on those opinions in granting no-action relief. Of the six, five have a Delaware domicile, and one Delaware firm provided four of the opinions, mostly identical, nice work if you can get it.

It's good practice to exclude directors' own shares from a director say-on-pay vote, but hardly essential. We won't do that again.

We await the status of the proposal at two other companies. Shareholders have started voting at NI and PYPL, so let us know what questions and comments you might have.

Doubly-Binding Director

Say-on-Pay

The TSLA board comp case was vastly interesting and even some fun. I learned a lot about Delaware Chancery Court, figured out how to navigate the befuddling File-and-Serve system, and visited Wilmington to argue our objection to the proposed settlement. I had a terrific time talking with Ron Orol at The Deal about the experience.

You'll recall the proposed settlement provided for TSLA shareholders to vote on director pay. We objected because it arguably did not require directors to abide by the vote result.

As we wait for Chancellor McCormick to issue her opinion on the settlement, which we hope will include an order for the parties to amend its terms to incorporate the substance of our objection, we ponder what else might happen. Does director say-on-pay make sense only at TSLA, or could it help shareholders at other companies?

We decided to find out. As far as we know, no other company has tried this before.

Also, we've long thought about ways for shareholders to improve our limited authority over directors. Awhile ago we wrote an essay about the foundations of that limited authority, as a sort of novel and confounding agency problem. It pointed toward compensation as a critical point between shareholders and the BoD. It's as pure a conflict as we find anywhere: BoDs design and approve their own pay with no oversight from the shareholders who elect them and whose interest they should represent.

As we studied the TSLA settlement, we quickly understood it represented a real live example, at a significant US company, of what we first envisioned only theoretically. It could launch an entire new way for shareholders to influence directors.

Thus, we developed a shareholder proposal for director say-on-pay. Long-time governance activist John Chevedden took an interest in it, and offered to submit it at some portfolio companies. Thus far two indicated they will include it on the 2024 AGM agenda and proxy statement. We await the result of the SEC no-action process at ten others.

Doubly-binding

As we have noted before, we have minimal experience with shareholder proposals, and we find it curious in many ways. In particular, we think shareholders can improve on the longstanding practice of merely suggesting a company consider a corp gov change. Thus, we structured the proposal as an actual bylaw amendment, rather than a resolution urging a company to adopt a bylaw amendment.

The subject lends itself to a bylaw term. Most US companies have a bylaw section that allows the board to pay itself. Thus, we drafted a straightforward amendment to that section. The language falls well within the 500-word limit the SEC allows for shareholder proposals, and permits a persuasive supporting statement.

If shareholders approve the proposal, then they amend the bylaws. The company must implement it.

Further, we wrote the bylaw term to provide for a binding vote on director pay. The current executive say-on-pay vote is of course advisory; it merely expresses only shareholder sentiment. The director pay vote will literally approve what pay directors receive. If the company fails to win that vote, then directors ... well, don't get paid (more below).

Three easy steps

The proposal provides for approval in three steps:

• Company discloses BoD comp in advance of the upcoming fiscal year
• Company submits the disclosed comp to a shareholder vote
• A majority of shareholders voting need to approve whatever comp is disclosed.

A BoD can design and recommend, in whatever structure and amount it wishes, in whatever detail it wishes, its desired compensation. Unlike in the TSLA settlement, the proposal imposes no requirements on the process that a BoD must follow to design that compensation. It's a pure vote on whatever the BoD wants it pay itself.

The TSLA settlement excludes directors from voting, as shareholders, on their own pay. It prevents CEO Musk from voting his 13% of TSLA shares in favor. The bylaw amendment can include this. It makes the shareholder vote even cleaner, so directors absolutely cannot approve their own pay.

Suppose a company loses the vote? A few companies asked us what happens then. Aside from the obvious problem that it must have performed badly enough that shareholders don't want to pay the directors, we can think of a few choices.

• Directors serve without pay, which is not as crazy as it sounds; executives almost always serve on a BoD without pay, employees of company shareholders frequently decline director pay, and some activists compensate independent directors themselves.
• Re-do the disclosure and vote with a revised pay plan that can win shareholder approval.

We rather like the idea of a shareholder vote with this kind of impact. It should gain the attention and loyalty of directors quite well.

What's next?

We wrote a brief explanation of the proposal and why it makes sense in this year's Proxy Preview.

We submitted the proposal at 12 companies. Two already indicated they will include it on the AGM agenda and in the proxy statement. We will update everyone as companies publish their proxy materials.

Of course, amending bylaws is frequently difficult, as many have supermajority voting rules for shareholders to amend bylaws. (The 12 companies all follow a simple majority rule.) We talked to a few shareholders that object to a bylaw amendment, and instead timidly prefer a precatory proposal. Or, some of them want only an advisory vote on director pay, rather than a binding one. These shareholders might wish they had this bylaw term in place when one or another portfolio company develops some of the corp gov headaches that we see at TSLA.

For further information, or to discuss a specific activist situation, please contact:

Michael R. Levin

m.levin@theactivistinvestor.com

847.830.1479