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Paul Hodgson: Does proxy access really ‘destroy value’ as some are claiming?

Some statistics are being stretched too far

I like a good headline myself, but there’s a limit to how far I’ll stretch a statistic.
US free market think tank the R Street Institute recently released a report called Proxy Access: Shareholder democracy or creeping mercantilism?
The title will tell you how it views proxy access, the ability of shareholders to nominate their own directors using the company’s proxy statement: unfavourably. However, the claim that: “Shareholder-sponsored proxy access proposals, which have passed at 39 of the 65 companies that have voted on them in 2015, do not maximize wealth and may have led to $14.6 billion in foregone value for the companies that passed them,” is a stretch for a number of reasons, not least because the calculation of loss is based on just five oil and gas companies.
The use of the word “may” is judicious.
The report sets out with a history of proxy access, starting with the shareholder protection act – Dodd-Frank – granting the SEC authority to set minimum proxy access standards, while not insisting that it do so. However, the SEC went ahead and set standards: Rule 14a-11. These were almost immediately blocked by a lawsuit brought by the US Business Roundtable and the US Chamber of Commerce in September 2010. The SEC lost its case in July 2011. With Rule 14a-11 blocked, the SEC allowed another ruling, Rule 14a-8, that had been sidelined, to be put into practice. Rule 14a-8 allows shareholders to make proposals that would amend a company’s bylaws.
This was considered by many to be a backdoor proxy access ruling, inspiring shareholders to make non-binding resolutions calling for a company’s bylaws to be amended to allow for direct shareholder nomination. The United States Proxy Exchange was set up in November 2011 and its members started filing such resolutions, Norges Bank joined in 2012. But many proposals were challenged and never made it to the proxy statement. Those that did rarely received majority support, until angry shareholders at oil and gas company Chesapeake Energy and Bermuda-based driller Nabors Industries passed resolutions resoundingly, three times in succession at the latter company.

Fast forward to 2015, and the Board Accountability Project initiated by New York City Comptroller Scott Stringer. A total of 108 proxy access resolutions were initially filed, 75 by Stringer alone, in 2015. Companies – Whole Foods being the poster child – reacted to the latest round of shareholder proposals by proposing, or voluntarily adopting, proxy access themselves.Some of these were Stringer targets, and were simply trying to block the resolutions by proposing impossibly high standards for shareholders. But many were not, including General Electric, health care company McKesson Corp, and tax software firm H&R Block. At this point, says the report, 39 of the 65 shareholder resolutions that have been voted on thus far have earned majority support.
Author RJ Lehmann begins his assault on proxy access by citing three academic studies that say abnormally negative returns are associated with any announcement that makes it more likely that proxy access will be introduced. These studies are looking not at the actual introduction of proxy access, just news that the SEC or other body is considering its introduction. However, the periods studied cover 2006 to 2010 when there was so much noise in the market that it would seem difficult or impossible to quieten it down enough to extract meaningful data.
Lehmann then looks at the effects of proxy access resolutions on those companies that had votes during 2015. Most of the companies that approved proxy access proposals are dismissed from the study because, he claims, at most companies the results were decisive and therefore the result must have been known before the vote was actually taken. Since these decisions were obvious, it is put forward, the effects would already have been absorbed by the market before the vote. However, claiming that a decisive vote was predictable and therefore absorbed by the market does not make it true. While it is true that Californian public pension funds CalSTRS and CalPERS declared their support for proxy access early, many large institutional shareholders do not make any declarations of their intent until just before the annual meeting. Some do not announce their intentions at all.
Excluding these “decisive” companies leaves a group of 15, and a further five are excluded because 10 of these 15 are in the energy sector. I’ll return to these five exclusions later.
Focusing on these 10 companies, five of which approved proxy access and five of which didn’t, Lehmann compares their stock price performance on the day of the annual meeting with the stock price performance of an industry peer group – the S&P Energy Select Sector Index. He then finds that five of the companies where proxy access was approved had stock price performance that did not, on average, outperform the index by as much as the five companies where proxy access was denied.

Those five “yes-to-access” companies were the ones who lost the $14.6 billion. Except of course they didn’t actually lose anything, they just didn’t “gain” as much as the “no-to-access” companies.
This hypothesis raises a number of problems. First, it is not clear that the markets knew of, or cared about, the vote results on the day of the meeting. Secondly, measuring the stock price performance on a single day without any kind of longer term appraisal of performance is also problematic. We are not told, for example, whether the stock price of these five companies outperformed or underperformed their peers once news of the vote result had spread further. Thirdly, this is a very small sample – a problem the study recognises. Fourthly, the performance differentials are very, very small, measured in tenths and one hundredths of a percent, and are aggregated. Finally, no attempt has been made to adjust for other performance-related information. Some of these problems are acknowledged by the report which admits: “Obviously, only limited confidence can be invested in this result….”
Because there are no academic studies of long-term performance following proxy access proposals, Lehmann goes on to quote studies of hedge fund proxy fights that show that, where a board has been challenged, long-term performance is lower than peers. But these study periods are between 30 and 50 years ago, and the findings cannot be considered relevant to the modern economic period.
Lehmann then quotes a series of academics who make the same claims as those made by David Katz of law firm Wachtell Lipton in a Harvard blog. These claims denounce proxy access because it will give inordinate power to special interest groups who are intent on achieving their aims regardless of the effect on long-term value. They claim that a ‘proxy access’ director will disrupt a well-functioning board. I have already “refuted”:
https://www.responsible-investor.com/home/article/paul_hodgson_p_access_war/ these claims. Proxy access will not allow activist investors and/or shareholder activists to run rampant when almost all the proposals are being filed by large institutional shareholders and these are the only ones which will benefit since they are the only ones whose holdings may be large enough for them to nominate a director. Hedge funds did not need proxy access to nominate directors or replace a board.
Lehmann finishes the report by drawing a number of conclusions. These include: allowing companies to exclude shareholder proposals that are similar to company proposals – the Whole Foods’ route; preventing the SEC from contradicting state laws (some states do not allow shareholders to amend bylaws); exempting small and medium-sized companies from anyproxy access battles; and even, extraordinarily, a proposal to make all public pension funds defined contribution plans so that the workers can make their own investment decisions, rather than publicly elected officials (and here Scott Stringer, the New York City funds comptroller, is accused of grandstanding).

As Lehmann said earlier: “Moreover, the [proxy access] process provides clear incentives for elected officials – serving in their capacity as administrators of large public employee pension funds – to use the corporate boardroom to effect politically motivated outcomes.” Apart from the fact that not all administrators of public pension funds are elected, no clear evidence is given of any political outcomes, except that Stringer had targeted oil and gas companies, companies with poor board diversity and companies that received shareholder opposition to their executive pay packages. These could as easily be placed under environmental, social and governance concerns as political ones.
But let us return to those other five companies whose votes were indecisive and whose stock price performance was not examined in the report. At four of them the vote was lost: Boston Properties, Domino’s Pizza, SBA Communications and Southern Company. At one, proxy access passed: Monsanto.

The stock price performance of these companies tells us nothing about whether the markets regard proxy access as destroying value. Monsanto’s price dropped on the day of its annual meeting, 30 January, but bounced right back up and over its prior price. Southern Co’s price rose on the day of its annual meeting, 27 May, but then fell again the day after. The stock price for Boston Properties fell on 19 May, its annual meeting date, and continued to fall in the days afterwards and SBA Communications’ stock price fell on its May 21 annual meeting date and continued its slow decline. Domino’s stock price also fell on the day of its annual meeting, April 21, but two days later soared by almost 15 per cent, though I doubt anyone would put that down to a proxy access vote not passing.
In other words, none of these companies’ stock price behaviour tells any kind of story at all about the market’s reaction to proxy access either passing or failing. All the increases and declines were during periods when the S&P 500 index was increasing in value, so no value was destroyed or increased significantly as a result of the votes. As with all governance reforms, any effect is likely to be long-term and based on individual company circumstances. Indeed, if shareholders target underperforming directors and replace them, it is likely to be at underperforming companies and it is almost inevitable that the value of these companies will recover as a result of fresh expertise.

Paul Hodgson is an independent governance analyst.