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April 03, 2008

Do Your Proxy Votes Really Count?
    by Anne Moore Odell

A new report examines how boards of directors respond to shareholder concerns by adopting or ignoring non-binding shareholder proposals. -- Shareholder proposals are prickly documents. Shareholders have the right to have their concerns heard by the companies they are part owners in. Yet for a non-binding shareholder proposal to get all the way to proxy voters, it has to have been presented to the company's board of directors and basically rejected by the board. Shareholder proposals that have been presented to the board and adopted aren't voted on. Neither is a proposal that is withdrawn after an agreement between the proposal's presenters and the board of directors (which can happen before or after the proxy ballot has been printed).

Please support
our sponsorsWhat happens to non-binding shareholder resolutions after they are voted on by shareholders? It is up to the board to implement or ignore these resolutions, which the board has already usually rejected. Boards of directors have no legal responsibility to act on non-binding shareholder proposals even when the majority of shareholders vote for them, subject to state-by-state jurisdiction.

A new report examines how often boards implement non-binding majority-vote (MV) shareholder proposals and finds that boards are implementing more non-binding proposals than previously. Entitled "Board of Directors' Responsiveness to Shareholders: Evidence from Shareholder Proposals," the report looks at the reasons why boards act on proposals and what are the costs for both the directors and the companies for not responding to shareholders.

The report's authors--Yonca Ertimur, Assistant Professor of Accounting at Duke University's Fuqua School of Business, Fabrizio Ferri at Harvard Business School and Steve Stubben at University of North Carolina at Chapel Hill--looked at 620 non-binding MV proposals that were presented at 273 distinct S&P 1500 firms over the 1997-2004 proxy seasons. The data used were from the Investor Responsibility Research Center (IRRC), which has recorded information on shareholder proposals since 1986. The authors found that the rate of implementation of these proposals almost doubled, from about 22% in 1997-2002 seasons to over 40% in 2003-2004 proxy season.

"While we do not have direct evidence on the boardrooms' discussions leading to the decision to act or not to act on the proposals, our empirical analysis suggests that the major factors affecting that decision are the degree of voting support for the proposal, the influence of the shareholders supporting the proposal, the behavior of peer firms and the type of proposal," said co-author Yonca Ertimur.

The report finds that proposals with higher percentages of votes cast in favor, proposals presented by larger shareholders, proposals adopted by peer firms, and proposals dealing with removing anti-takeover defenses and instituting certain shareholder rights are more likely to be implemented.

Another reason for the increase in implementation of MV non-binding resolutions is that shareholder activism is on the rise, with more shareholders directly addressing the issues of governance and shareholder engagement. Issues such as initiatives concerning directors' election system, expensing of stock options and giving shareholders a vote on compensation have engaged shareholders in recent proxy seasons.

To capture the extent of shareholder pressure exerted on the board, the authors looked at the degree of voting support for the proposals (i.e. the percentage of votes cast in favor of the proposal at the annual meeting) and the influence of the shareholders supporting the proposal. The report states that large institutional shareholders such as CalPERS are more effective at initiating governance changes.

Among MV proposals, shareholder rights proposals have the highest rate of implementation (45% of the cases), followed by proposals that relate to defense and executive compensation (30%). Furthermore, the rate of implementation for defense and shareholder rights proposals has increased significantly in 2003-2004 period relative to the 1997-2002 period.

"We assume that certain type of shareholders (public pension funds, unions' pension funds) have more influence due to their resources (relative to individual investors)," explained Ertimur. "Also, we assume that shareholders with a larger stake in the firm will be able to put more pressure on the board. We also consider another source of direct shareholder pressure on boards: the voting outcome of individual directors' election."

The authors furthermore examine implementation trends across peer companies. They reason that companies that have peers implementing similar proposals will face more pressure to implement non-binding MV proposals.

Whether or not there has been a systemic and structural shift in the way large-cap companies address shareholders, the report's authors think it is too early to tell, although their results are consistent with a structural shift. However, there is still work to be done on governance and board oversight matters.

Ertimur told, "The recent sub-prime crisis suggests there are significant economy-wide governance issues to be addressed, not only in terms of corporate governance, but at the level of market institutions."

Ignoring MV non-binding proposals could be increasingly expensive for firms and for individual directors. The authors looked at other academic literature and at anecdotal evidence to back up this claim. For example, one study finds that directors failing to implement MV proposals have often been targeted by vote-no campaigns. The authors also note that directors who ignore MV proposals often receive a "withhold vote" recommendation by the Institutional Shareholder Services (ISS) (now Risk Metrics), the influential proxy voting service.

"As for firms, those ignoring MV proposals end up on CalPERS' 'focus list' of poor financial and governance performers, receive lower ratings from governance services, such as The Corporate Library, and attract negative press coverage," explained Ertimur. "Our results on director turnover are consistent with it being costly for individual directors to ignore (respond to) majority-vote shareholder proposals."

Shareholder activists will be heartened by the evidence found in this report that indicates shareholder proposals are becoming a more effective mechanism for exacting policy change. The issue of executive compensation, the report notes, has lead to a great increase in the number of shareholder proposals, while, at the same time, there has also been an increase in the implementation of shareholder rights proposals.

Ertimur concluded: "The 'good news' for socially responsible investors is that the higher level of directors' engagement with, and responsiveness, to shareholders on governance matters may translate to proposals dealing with social and environmental issues. The 'bad news' is that a high degree of voting support across shareholders seems a necessary condition for that level of engagement. The challenge for proposals dealing with social issues is to find stronger support across all shareholders."

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