It’s shareholder meeting season, which means the proxy votes will be rolling in. As corporate boards receive these results of shareholder votes, a framework on how to respond may be helpful. After all, these days corporate ballots may include shareholder proposals on any issue of social significance, without regard to its significance to the company, from animal rights to zoning. Moreover, there are no rules in this area of advisory shareholder votes, leaving it to the board’s judgment whether a proposal should be deemed passed and what action, if any, should be taken.
In theory, the shareholder proposal process is simple and valuable. Shareholders communicate priorities to boards, such as severance packages for directors or rewarding employee safety records, and boards benefit from hearing their views. Proponents provide written explanations of their proposal for fellow shareholders and boards deliver a written response. At its best, the board gains information from what is in effect a non-binding referendum on the contending positions.
Neat as it sounds, the reality is more complex and the value less certain. For one, proposal topics now cover the waterfront, from those intertwined with a company’s business, such as product categories at a drugstore chain, to those wholly outside it, such as abortion at a bank. In addition, constituents increasingly use the proposal process for parochial aims—anyone holding $25,000 worth of shares for one year (or $2,000 for three) can require a company to present its proposal.
A further complication: shareholders have diverse voting practices. Large index funds follow general guidelines on how they vote on designated topics for all companies while active stock pickers focus on investee companies rather than topics. Institutions exercise far more voting power than that exercised by a company’s individual and employee shareholders, although the corporation’s performance may be more important to the latter.
Without rules to help interpret voting results on shareholder proposals, boards must evaluate them through the perspectives of their fiduciary duties, accountability to shareholders in annual elections, and reputations for faithful corporate stewardship.
Starting with duties, directors must make decisions in good faith, with full information, and using independent business judgment. They may not act based on their personal views on the topic of a shareholder proposal, but only in the honest belief that they are acting in the best interests of the corporation and its shareholders, taken as a whole—which would permit rejecting a proposal even if voted for by an overwhelming percentage of shares.
On the other hand, most director elections now are by majority vote and directors rejecting landslide proposals run the risk of being ousted the next year. Today’s majority voting in director elections is new in the past two decades, a change from the historical practice of director elections won by a mere plurality of the vote. It would therefore be reasonable for directors to make a majority vote their baseline in determining what percentage to recognize as “passing” a shareholder proposal.
Director reputations are influenced by their discharge of duty and accountability, as well as broader manifestations of integrity. Directors do well to act with conviction on behalf of the corporation, and explain their positions publicly, even when disagreeing with powerful forces pushing other interests. To the contrary, catering to the whims of small blocs of shareholders—say implementing a proposal that passes with only a 20% vote—may damage a reputation not only of the director but of the corporation.
With those perspectives in mind, consider a framework to assess shareholder proposal voting results. Start with the easy cases. The simplest rules of thumb might be: if more than 90% approve a proposal, adopt it, but if less than 10% approve, reject it. Absent special reasons, such rules are likely consistent with legal duties, majoritarian elections, and reputational stakes.
Switching to the hardest cases, consider votes down the middle, split near 50%-50%, or those within the ambit of a split vote, perhaps 66% to 33% either way. It’s possible to declare rules of thumb in these cases too—requiring a majority to win. But a bit more analysis of the votes and subtlety in the response may be valuable.
First, count the number of shareholders (not just shares) voting each way. This gives a different and additional perspective on weighing contending interests. Since institutions with large stakes invariably vote while many dispersed individuals with small holdings do not, it is common for proposals to carry a greater percentage of shares than number of shareholders. Adding that data point can be illuminating, particularly in cases where a proposal is approved by a majority of the shares but opposed by a majority of the shareholders.
Second, follow the common practice when tallying shareholder votes to exclude those of large block shareholders. Doing so offsets the effects of concentrated voting positions where the raw vote is carried by a small number of large holders. For example, the three largest index funds control some 25% of the vote at many companies; examining the vote by excluding their shares would reveal the preferences of a larger cross section of shareholders.
Third, a director would do well to classify the substance of the proposal and calibrate the required voting threshold accordingly. Topics run from investment issues (like dividends) and governance power (staggered boards) to social issues which may intertwine with the company (say selling tobacco products) or those extraneous to it (abortion). With such classifications, it would be reasonable to use ascending threshold percentages for a vote to be deemed passed. To illustrate without being prescriptive, thresholds could be 51% for investment issues, 61% for governance, 71% for intertwined social topics and 81% for extraneous ones.
Fourth, directors should appreciate that a company has a range of responses available, not a simple binary of acceptance or rejection. With this in mind, a board could adapt a sliding scale voting threshold here as well. For one, a proposal the board sees as unworkable as proposed might be modified to a form acceptable to its supporters and the company alike, an effort that may be warranted for proposals with as little as 40% of the vote in favor. Also, shareholder proponents unable to attract a critical mass of votes often settle for other terms, such as meeting with directors to discuss the topic, a courtesy the board might grant with as little as 33% of the vote in favor (though some vocal shareholder proponents suggest a threshold for that as low as 20%).
Finally, and above all, whatever the vote and whatever the analysis under a framework such as this, boards must evaluate each proposal on its merits, considering the potential benefits and drawbacks of implementation to the company and its shareholders and how the proposal aligns with the company's overall strategy. All voting outcomes—perhaps even those that are 90% to 10%—must be assessed solely in terms of the best interests of the corporation. That is why these are non-binding votes and why corporate policy is set by the board, not shareholders. Accordingly, the board must carefully and loyally consider each proposal and voting outcome and should communicate its assessment and rationale to the shareholders. As shareholder proposals proliferate, using a framework such as this one can help directors in both the analysis and the outreach.
Please feel free to contact Lawrence Cunningham, Special Counsel at Mayer Brown, to discuss further.
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