What if lawmakers never spoke to their constituents? Oddly enough, that’s exactly how corporate America operates. Shareholders vote for directors, but the directors rarely communicate with them.
Within the clubby world of directors, communicating with shareholders is overtly frowned upon: “We endorse the principle that direct engagement involving directors should not be a routine method of engagement for most US companies and for most investors,” says the Conference Board Governance Center Task Force on Corporate/Investor Engagement.
That’s why it was so unusual for the chairmen of 1,000 large US public companies to receive a letter this month from a group of shareholders representing more than $10 trillion in assets with a demand: Talk to us. The letter, signed by representatives of some of the biggest investment groups, insisted that boards open up.
“Engagement between public company directors and their company’s shareholders is an idea whose time has come,” wrote the group, known as the Shareholder-Director Exchange. “We believe that US public companies, in consultation with management, should consider formally adopting a policy providing for shareholder-director engagement.”
What was uncommon about the letter was that it came not from activist investors like Carl Icahn or William Ackman, but from institutional investors that until recently had traditionally supported whatever a company’s board recommended. Now, those investors want a dialogue.
The reason boards have long shunned speaking with investors is multifaceted. Management usually have meetings with the company’s biggest shareholders. Some directors avoid meetings, worried about speaking with one voice. Most don’t consider it their responsibility. Some are anxious about accidentally disclosing sensitive information.
Some chief executives are insecure and don’t want shareholders to get too close to their boards for fear they will have undue influence. After all, most directors rely directly on management and their presentations to understand what’s going on inside the company and what shareholders think. And then there is this: “Many top executives seem to think that board members cannot be trusted with such interactions,” according to the Harvard Business Review. “Yet if directors cannot be trusted to meet with and listen to shareholders, how can they be expected to competently govern a corporation?”
The Shareholder-Director Exchange – created by law firm Cadwalader, Wickersham & Taft and the corporate advisory firms Teneo and Tapestry Networks – has drafted what it is calling the SDX Protocol, a series of guidelines it hopes public companies will adopt and publish to determine when shareholder and director engagement is appropriate.
The guidelines suggest that companies decide under what circumstances a shareholder’s request to meet with directors should be granted: to discuss the board’s composition or management performance, for example. The point is that companies should decide, in advance and transparently, how they plan to communicate directly with shareholders long before a proxy fight were to develop.
Of course, there is a potential downside: if a board becomes too enamoured with a particular view from a set of shareholders, it could lead to short-term thinking that undermines long-term performance.
A new study by the Institute for Governance of Private and Public Organisations determined that “the most generous conclusion one may reach from these empirical studies has to be that ‘activist’ hedge funds create some short-term wealth for some shareholders as a result of investors . . . jumping in the stock of targeted companies.”
There is also the problem of unfair access. Large investors might have access small investors almost certainly won’t.
Lack of interest
There is, oddly enough, a counterintuitive reason that shareholders and directors don't speak. The shareholders, despite saying they want a dialogue, actually aren't interested. According to Tapestry Networks, at a conference, a member of Nestlé's executive board, David Frick, "talked about a programme to invite its largest shareholders to meet with the chairman . . . He said shareholders had either declined or simply didn't turn up to the meetings."
Even so, last year’s proxy season showed that only a quarter of the companies in the S&P 500-stock index “publicly reported engagement efforts or policies in their proxy statements,” according to the Shareholder-Director Exchange.
It would seem that some form of engagement from directors with shareholders would go a long way toward helping boards work on behalf of all shareholders rather just the most vocal.