There has been much discussion over the last few years about companies adopting a majority voting standard for director elections. And, there has been great progress in this area among large U.S. companies. Some observers have commented that this proactive adoption of majority voting should serve as a signal that no additional shareholder rights or mechanisms are necessary to provide greater board accountability. However, a recent study conducted by The Corporate Library finds that the proliferation of majority voting is limited to large companies, meaning, according to The Corporate Library, that calls to reform director elections should not be so easily dismissed.

Background

One of the fundamental rights shareholders have under state corporate law is the power to elect corporate directors. Influential former Delaware chancellor William Allen wrote in Blasius v. Atlas Corp. that “[t]he shareholder franchise is the ideological underpinning upon which the legitimacy of directorial power rests.” Shareholders have complained, however, that director elections do not impose meaningful accountability because board slates are chosen by the incumbent board and contested elections are exceedingly rare.

Under the corporate law of all U.S. states, the default voting threshold for director election—the one that applies unless the company provides otherwise—is a plurality. A plurality standard means that the director who receives the most votes is elected.

A company can alter its voting threshold by including a different threshold in the bylaws or, less commonly, the charter. The Corporate Library considers a company to have a “majority” voting standard for director elections if the company’s governing documents provide that directors must receive support from holders of a majority of shares voted in order to be considered legally elected.

Some companies retain a plurality standard for election but adopt a corporate governance policy requiring that a director who does not receive majority support must submit his or her resignation. Such companies are described by The Corporate Library as having a “plurality plus resignation policy.” The board has discretion to amend or repeal a corporate governance policy at any time, without shareholder concurrence.

Findings

A recent analysis of director election standards in place at U.S. companies yields a striking finding about the current state of the movement toward change in U.S. director election voting standards. Much of the discussion regarding the move away from plurality voting for directors seems to indicate that the majority voting standard is becoming the norm among U.S. companies. While this may be true for the largest companies, smaller companies are not following their lead.

Nearly half (49.5 percent) of the companies in the S&P 500 have made the switch to majority voting for director elections and another 18.4 percent have adopted the plurality-plus-resignation approach. Less than one-third (32.1 percent) of the S&P 500 companies now use the once-ubiquitous straight plurality standard (plurality without a director resignation policy). This reflects a dramatic change since last year, when more than half of the S&P 500 companies still had a plurality voting standard for director elections.

However, while this dramatic shift at large U.S. companies has garnered much attention, the straight plurality voting standard is still very common among the smaller companies included in the Russell 1000 and 3000 indices. Over half (54.5 percent) of the companies in the Russell 1000, and nearly three-quarters (74.9 percent) of the companies in the Russell 3000, still use a straight plurality voting standard for director elections.

As shown in the charts above, there is a long way to go before the straight plurality standard for director elections is no longer the norm among smaller U.S. companies. Several factors likely explain why such companies have not yet made the change to a majority voting standard:

First, the smaller companies tend to garner less attention from institutional shareholders, activists, and the media. Many of the companies that were among the first to modify their director election standards did so with much fanfare, attracting attention for being on the cutting edge of best practices in corporate governance. For example, when Pfizer first announced its groundbreaking change to a plurality-plus-resignation policy in 2005, much attention was paid to the announcement and the approach became known as the “Pfizer-style” standard for director elections. Because they are not in the spotlight, smaller companies in the U.S. might not enjoy the same kind of public relations boost from making the same changes to their governance practices.

In a similar vein, smaller companies tend to receive fewer shareholder proposals, which are the primary mechanism for pressuring companies to make changes to their director election standard. Although some companies might proactively adopt majority voting without a shareholder proposal (or a credible threat of one), others would likely wait to see if the issue is raised via a proposal before seriously considering a change. (A smaller company that analyzes the data on shareholder proposals might rationally conclude that the likelihood of facing a proposal on majority voting is rather low.)

Another explanation for the differing patterns in director election standards may lie in the ownership structure of companies of different sizes. The Corporate Library has found that companies with smaller market capitalization are much more likely to have concentrated ownership than companies with larger market capitalization. Companies with concentrated ownership are more likely to have controlling shareholders, such as families who own large blocks of shares, and are therefore less likely to be under pressure from their shareholders to adopt best practices.

Conclusion

Whatever the reason for the disparity between large and small capitalization companies’ adoption of majority voting, the fact that many U.S. companies still use a straight plurality standard should be considered when arguments are made that further change to director election procedures is unnecessary. While much progress has been made in this area, shareholders do not have a meaningful role in director elections at a large number of publicly-owned companies in the U.S.

Nearly one-third (32 percent) of the more than 3,000companies in the study said they paid less than $500,000 in board compensationlast year, while on the flip side nine companies paid more than $2 million incash director fees in 2006, including AIG, Honeywell, and Northrop Grumman.Valero Energy, meanwhile, spent more than $30 million on its board, with mostof the pay going to board member William E. Greehey.

“The findings show that, with exception of a few outliers,most companies are not spending an unreasonable amount on their boards,”said Annalisa Barret, the report’s author, in a statement.

The study also reveals that while the practice is unusual,six companies offered their full board a cash bonus based on performance of thecompany. Meanwhile, establishing stock ownership guidelines for directors isincreasing: For the S&P 1500, the prevalence of ownership guidelines jumpedfrom 29 percent in 2005 to 46 percent in 2007.

In a study of more than 2,000 companies, the Corporate Library has found that 126 firms failed to calculate the correct compensation for directors, two of which – Atlas Worldwide Holdings and Aspect Medical Systems – have corrected their errors and refiled with the Securities and Exchange Commission.

Differences ranged from one $1 to more than $125,000, and in some cases only one director was involved; in others, mistakes affected the whole board. Although rounding numbers to the nearest whole-dollar figure could account for some errors, missing columns, ignoring particular data points, and transposing figures accounted for most of the addition problems.

“Why, in an age when you can key numbers into a spreadsheet and use a simple formula to add them with perfect accuracy, did 126 companies have total compensation columns that did not accurately reflect the sum of its table components?” Greg Ruel, research associate at the Corporate Library and author of the report, said in a statement. “How could such basic addition mistakes go unnoticed and uncorrected?”

The figures in the study indicate a need for improved due diligence and a higher level of scrutiny of board financial disclosures to validate accuracy. Sixty-six companies in the study had only one director whose total pay didn’t add up correctly, and the money involved amounted to just more than $950,000.

One of the key elements of the changes required by the Securities and Exchange Commission under its new disclosure regulations was for the Compensation Discussion and Analysis (CD&A) to provide more information to shareholders about the processes for setting pay and awarding incentives. While almost all companies now disclose the metrics they use to award cash incentives, the disclosure of targets or goals is found only in the minority.

“While this represents a huge increase over practice in the past,” Paul Hodgson, The Corporate Library’s senior research associate for executive compensation and author of the report, said in a statement. “It is not surprising that the general lack of disclosure in this area was a key focus of the comment letters that the SEC has been sending to companies.”

The survey examines the full range of disclosures made, from the very detailed information provided by companies such as Electronic Data Systems to the complete lack of disclosure provided by the CD&A of property company Leucadia.

The report is based on the latest filings made by companies in the S&P 500, almost all of them in compliance with the new disclosure

Thereport, like others conducted recently by NERA and Stanford Law School’s Securities ClassAction Clearinghouse, points to another year of increasedlitigation in 2008 and the growing involvement of institutional investors.

Thestudy examines the second-year effectiveness of The Corporate Library’s SCARisk Ratings to identify and predict the probability of companies being hitwith securities class- action suits.

TheCorporate Library’s findings include:

• The most poorly rated companies in mid-2006 were five times morelikely to experience an SCA in 2007, matching the results from The CorporateLibrary’s previous SCA studies.

• CEO base pay and annual bonus levels were more predictive thanlong-term incentives.

• More than 35% of companies in The Corporate Library’s coverageuniverse that were unable to achieve compliance with Section 404 ofSarbanes-Oxley experienced at least one SCA in the past three years.

• Institutional investors hold more than 60% of the traded stock atnearly all companies subject to SCAs.

• Growing numbers of small- and mid-cap companies are being hit withsuits.

“Effective prediction is the only real defense againstsecurities litigation, and that is the primary focus of the presentreport,” said Ric Marshall, chief analyst and author of the study.

Female directors in corporate America earnedmedian compensation of $120,000, based on the most recently available pay data,compared with $104,375 for male board members, The Corporate Library said inits annual director pay report on Wednesday.

At the same time, the study said,women in corporate boardrooms are outnumbered eight to one.

“This makes being a directorone of the few jobs in the U.S.economy where the pay differential is reversed,” between men and women,the study found.

The study found that overall,median total compensation for individual U.S. board members was just over$100,000, based on companies’ annual proxies filed through last month. Themedian increase in total disclosed compensation was about 12 percent comparedwith the year-earlier period, the study said.

The report looked at pay data formore than 25,000 directors at more than 3,200 companies.

The pay increases were driven in part by the addition of previously undisclosed forms of compensations this year, said study author Paul Hodgson, a senior research associate at the Corporate Library.  New Regulatory rules now require public companies to disclose the cost of perks, cash incentives and other elements of total pay for top executives as well as directors. 

The Effect of Compensation Consultants: A Study of MarketShare and Compensation Policy Advice, was released by the Corporate Librarylast week, and focuses on two parts of the effect of compensation consultants:

• The typical pay practices of companies that use particular consultants
• The relationship between the use of a particular consultant by a company and the company’s total shareholder return.

Among other highlights, the study measured CEO base salary.When compared to the median of peers, base salary ranged significantly depending onthe compensation consultant used. Additionally, the report shows that TowersPerrin is the top compensation consultant with a grip on 29 percent of themarket share and employed by more than 400 companies surveyed by the CorporateLibrary.  Coming in second was MercerHuman Resource Consulting, which holds 22 percent market share, and inthird, Hewitt Associates.

“Our findings indicate that compensation consultants areassociated with companies that pay at levels higher than the market median. Thesehigher levels of pay are in general not associated with higher levels ofshareholder return.” — Alexandra Higgins, TheCorporate Library.

Investors have seen compensation consultants play anincreasing role in helping boards set and determine executive and board pay,and the increase in the use of consultants has much to do with increaseddemands for compensation committees to align executive pay with shareholderinterests and comply with new disclosure requirements set for the by theSecurities and Exchange Commission.

“Our findings do indicate that compensation consultants areassociated with companies that pay at levels higher than the market median,”said Alexandra Higgins, author of the report and research associate at theCorporate Library in a statement.  “Further, thesehigher levels of pay are in general not associated with higher levels ofshareholder return.”

The report is available for sale to the general public at theCorporate Library’s website.

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