November 2005
Over 80% of U.S. shareholders take the time to vote the proxies that they receive from the companies in which they are invested. That is the good news. The bad news is that evidence shows that shareholders have a strong tendency to vote along with management's recommendations even when it is not in the shareholders' best interest.
You would think that investors would be more critical or questioning of management proposals after the past few years of corporate scandals but that does not seem to be the case. We take a more activist approach to voting our clients' proxies and only vote in favor of proposals that we believe will help increase shareholder value over time.
Most investors vote the proxies of companies they are invested in by following the recommendations of management. Studies have shown they vote "for" management proposals about 90% of the time and "against" shareholder proposals about 75% of the time. What is disconcerting about this fun fact is that the majority of proxies contain management proposals that are not in shareholders' best interest.
When you take the time to examine how proxy statements and the ballots are written, it is not surprising that the results are the way they are. The management proposals can be difficult for the average person to understand and they never contain an opposing view. The ballots themselves tell you how management thinks you should vote. For most shareholders it is easier to trust management and follow their suggestions.
I must admit that when I first got into the investment management business and was given the responsibility for voting clients' shares it was common practice to expedite the process by voting the shares as recommended by the respective companies' management. In this way, we did not have to spend many hours reading the various management and shareholder proposals contained in the numerous proxies that were written in a language that only lawyers would appreciate on issues that, for the most part, I could care less about.
Most investment managers rationalized taking this shortcut by telling their clients that they would sell the stock if they no longer had confidence in management to make sound decisions. In retrospect that was a rather weak argument but it worked at the time.
About ten years ago, the Securities and Exchange Commission (SEC) decided that investment managers who vote clients' proxies should put more thought into the process and actually have formal proxy statement voting guidelines that they can share with their clients. We are also required to keep records of how we voted the proxies in case we are asked. While I was not happy about this new SEC compliance requirement at the time, I came to see the wisdom.
In our opinion, in many public companies management and shareholders' interest are no longer the same. While most CEO's preach about maximizing shareholder value within their company, they sometimes act in a way that does just the opposite.
While shareholders weren't paying close attention they were led by management through the proxy process to institute generous compensation packages for the executives and to protect management jobs with corporate structures and rules that discouraged hostile takeovers or other actions by disgruntled shareholders to try to increase the price of the stock.
Over the last ten years or more, shareholders have approved management proposals that gave company management lucrative annual bonus packages with generous amounts of stock options. Shareholders were told that these incentive programs were designed to align management's interests with their interests; that is, to increase shareholder value (higher stock prices). Who could argue with that reasoning?
Unfortunately, shareholders have not been told that these incentive programs also dilute their equity positions over time by significantly increasing the number of shares the company has outstanding. Many companies have had to spend their cash flow on buying back shares to try to offset some of the dilution of the incentive programs.
Beyond compensation, management also uses proxy proposals to protect their positions within the company especially when the stock price is way off its highs and hostile takeover possibilities become a real concern.
For example, they ask shareholders to vote "yes" on proposals to make it difficult to replace the majority of board members or they propose a "poison pill" that effectively lowers the value of the stock when an outside party accumulates a significant number of shares of the stock. Management tells shareholders that they are looking out for their best interests but these actions speak louder than words.
While the 2002 Sarbanes-Oxley Act has improved corporate governance and held corporate officers and the members of the board of directors more accountable, it is also time for shareholders to do their part and assure that management's interest is in line with that of shareholders.
Investors should spend more time understanding the management and shareholder proposals contained in the proxy statements and not just blindly follow management's recommendations. It might take a strong cup of coffee to get through it but it is well worth the effort.
First of all, they should be on the lookout for proposals that provide excessive compensation in the name of "management incentive programs" at the expense of other shareholders. They should vote against any employee stock option program that increases the number of shares outstanding by more than 2 - 3%, in our opinion. In addition, shareholders should also prevent attempts by management to better secure their positions within the company.
In general, our approach to voting our client's proxies is to examine each issue or proposal included in the proxy statement from an economic prospective whether it is suggested by management or a shareholder. If, in our opinion, the proposal will not increase shareholder value then we just say "NO"!
John W. Gudritz, CFA
john@frontstreet.com