When Shareholders Speak Their Minds
A large proportion of shareholder proposals contested by firms receive support from other investors when put to a vote.
Bottom Line: A large proportion of shareholder proposals contested by firms receive support from other investors when put to a vote.
In an era when corporate responsibility has increasingly come into the spotlight, shareholder activism is gaining importance and attention. In particular, equipped with the Securities Exchange Act of 1934, shareholders can call for fellow investors to vote on certain demands made of a firm’s management and board of directors.
Researchers have suggested that this type of shareholder activism has the potential to effectively facilitate changes in firms’ policies, strategy, and governance structure.
Conversely, the act allows companies to appeal to the Securities and Exchange Commission (SEC) in an attempt to prevent proposals from appearing on the firm’s proxy statements, which set the agenda for annual shareholder meetings. And quite often, that’s exactly what companies do, according to the first empirical study on the number of shareholder proposals contested by firms.
To be sure, companies may have legitimate reasons to try overruling frivolous or impractical recommendations. But managers may also have less benevolent intentions, trying to block proposals because they threaten those managers’ position in the company or challenge an all-too-comfortable status quo in the executive suite.
The authors’ findings suggest that there’s a sizable disconnect between what proposals investors think are important and what proposals management finds to be useful, because many contested proposals, once up for a shareholder vote, are clearly supported by the majority of shareholders despite the company’s attempt to quash them.
The authors assembled a database of all shareholder proposals that the SEC had reviewed from 2003 through 2013, during which time about 350 to 400 proposals were contested each year by companies. And they found that almost 40 percent of the submitted proposals were challenged by management. These addressed a wide range of topics, including antitakeover measures, executive compensation packages, shareholder voting rules, and the environmental and social issues facing the firm.
About 72 percent of the time, the SEC agreed with management and suppressed proposals. Shareholder recommendations are usually turned down because they violate the law, are based on false or misleading information, or interfere with the company’s ability to conduct regular business operations. But what the SEC views as beyond the scope of shareholder influence one year can change the next. For example, in 2009, the SEC reversed its position on proposals regarding CEO succession: Whereas issues surrounding succession had previously been viewed as an ordinary part of doing business, in the wake of the financial recession and several scandals that rippled through the business community, the SEC decided that succession should be treated as a matter of governance on which shareholders should be able to voice their opinion.
Also in 2009, the SEC’s Division of Corporation Finance announced that over the past decade, it had received an increasing number of proposals addressing environmental, financial, and health concerns, and that staff members were “concerned that our application of the analytical framework…may have resulted in the unwarranted exclusion of proposals.” This suggests, the authors write, that “while some proposals appeared at one point as ‘fringe’ proposals that could be rejected as simply being an individual grievance, regulators are now beginning to pay attention to these concerns.”
When put to a vote, the researchers found, 19 percent of contested proposals won the approval of shareholders. If this total seems low, consider that only 25 percent of proposals that weren’t challenged by companies were sanctioned by investors. The closeness of these two numbers suggests that contested proposals can’t all be written off as impractical or frivolous ideas advanced by the odd minority shareholder.
In fact, although regulations require that shareholders need hold only US$2,000 of stock or 1 percent of a firm’s share capital to venture a proposal, the authors found that in the vast majority of cases, contested proposals were put forth by shareholders with a much larger stake in a company. The average submitter of a challenged proposal owned about $9.6 million in stock, or 1.6 percent of outstanding shares, the kind of investment normally associated with such institutional entities as pension or hedge funds — hardly the sort of marginal or fringe shareholders that could merely be looking to stir up trouble.
Firms that are larger, that carry more debt, or that have a higher number of directors, and firms whose CEO also acts as board chairman are more likely to receive proposals from shareholders, as are those with plummeting stock prices and lower returns on assets, according to the authors. All of which suggests that investors are more likely to try facilitating changes at underachieving companies or those with what appears to be a bloated leadership structure. In turn, these same types of firms tend to be most likely to reject shareholder recommendations, underscoring a clear tension between the priorities of management and those of investors, especially at struggling companies.
But proposals don’t have to go to a vote. Many firms elect to negotiate with shareholders instead — and this course of action tends to become more popular once the SEC rules against the exclusion of a proposal from a proxy statement, the authors found. But it’s a sensible approach for a firm seeking to limit the scope of such a proposal or reputational harm that might occur if a controversial proposal comes up for a vote.
There’s a disconnect between what proposals investors think are important and what proposals management finds useful.
Take the case of Chipotle. The organization PETA (People for the Ethical Treatment of Animals) demanded in a shareholder proposal that the Mexican restaurant chain start buying chickens from suppliers that followed more humane policies than its traditional suppliers. Chipotle contested the request, but the SEC allowed it to proceed. A negotiation followed, and the bulk of the proposal was implemented. After negotiations PETA said that it buys “small amounts of stock; just enough to be able to submit shareholder resolutions…Our resolution called upon Chipotle to buy chicken from suppliers that used less cruel methods. They agreed to do just that in exchange for us withdrawing the resolution.”
As the above example points out, although shareholder proposals are not binding, they can exert considerable influence over a firm’s strategy and operations, and investors are waking up to the idea that proposals can have an effect on a company even if they don’t receive a formal vote.
Source: “What Else Do Shareholders Want? Shareholder Proposals Contested by Firm Management,” by Eugene Soltes, Suraj Srinivasan, and Rajesh Vijayaraghavan (all of Harvard Business School), April 2016, Harvard Business School Working Paper No. 16-132