Milberg’s work with institutional clients is based on the premise that good corporate governance is critical to the protection of shareholder assets and the sustainability of a corporation. Institutional investors, by virtue of their large holdings, sophistication, and significant influence over corporate management, are the dominant driver of governance reform.
Through representation of private, public, and labor union pension funds, we understand the governance practices most likely to align management and shareholder interests. Adoption of effective corporate governance policies through institutional investor-led litigation and advocacy may provide the following benefits:
- Greater accountability to shareholders
- Effective monitoring of management’s performance
- Increased transparency
- Effective oversight of board resolutions
- Closer alignment of management and shareholder interests
- Increased productivity and enhanced firm value
- Deterrence of fraud and misconduct
- Robust shareholder participation
In pursuing governance reforms, institutions fulfill their fiduciary responsibilities to individual investors, while serving as leading participants in the modern financial markets.
Shareholder Voting Rights
As owners of public corporations, shareholders must have a role in corporate decision-making where fundamental, long-term corporate changes are at issue. In this regard, the right to vote is an important shareholder asset. In considering the adequacy of shareholder voting rights in the companies in which they invest, institutions should consider issues such as whether shareholders have voting rights in proportion to their economic stake in the corporation; certain classes of stock have “super” voting rights over other classes; and shareholders can approve matters submitted for their consideration with a majority vote.
Transparency of corporate information is also crucial to ensure that shareholders are sufficiently informed in casting their votes. Timely, accurate, and thorough information should aim to apprise shareholders of significant developments that may have a material impact on the value of their investments.
Corporate Elections and the Composition of the Board of Directors
As the elected shareholder representatives, board members are expected to be independent of management. The board of directors must supervise management’s performance and fairly represent the interests of the company’s shareholders. As such, reforming the structure and composition of the board, along with the procedures used to nominate and elect its members, may provide important opportunities to improve the governance of public companies.
In assessing appropriate reforms, consideration should be given to the board member election process, including the nomination of candidates, the applicable voting rules, and the length of directorship positions. Too often, corporate bylaws and policies undermine shareholders’ ability to participate meaningfully in electing board members. In particular, bylaws of many public companies provide for a “classified” (or “staggered”) board, which shields incumbent directors from the risk of removal. A coherent set of governance reforms aimed at reforming the board member election process can often correct such problems, facilitate shareholders’ influence over the board’s composition, and induce incumbent directors to dutifully discharge their fiduciary duties.
Audit, Financial Controls, and Oversight of Financial Management
Effective corporate governance requires strong internal financial controls. Governance reforms should seek to ensure the accuracy of corporate financial statements; the integrity of the internal audit function; regulatory compliance; prompt disclosure and correction of accounting irregularities; and the independence of the independent auditor. Together, these measures promote financial integrity and transparency, exposing public companies to the value-enhancing forces of competition in product, capital, and labor markets.
In considering reforms, institutional investors should consider, among other things, whether the board participates directly in the selection and oversight of the external audit firm to ensure its independence; the board verifies that there are no conflicts or transactions with the company that could impair the firm’s independence; auditors are rotated periodically to ensure continued independence; contracts limit the auditor’s liability to the corporation or require alternative dispute resolution. Reforms in these and other areas may increase the auditor’s independence, thus improving the financial integrity of the corporation.
Executive Compensation Plans
Executive compensation provides a critical tool in influencing corporate performance. Linking pay and performance aligns management and shareholder interests by rewarding management for maximizing shareholder wealth. Executive compensation plans should be designed to promote such alignment, while addressing any concerns unique to the company or individual executives. A compensation committee solely comprised of independent directors may ensure that compensation plans closely link pay with performance.
Executive compensation should reward behavior consistent with the company’s short and long-term goals, while deterring inappropriate risk. A significant portion of executive compensation should be variable and dependant upon performance. “Clawback” features should be adopted so that the company can recoup payments made to executives for performance subsequently found to be based on fraud in which the executive was involved.
Compensation should be fully disclosed to shareholders. Disclosure should include total amounts and types of awards, including full disclosure of how the program is intended to drive performance. Shareholders should also be provided with detailed information on the types of compensation, including options, restricted stock and performance shares, and severance agreements. Close attention should be paid to the exercising, re-pricing, and expensing of stock options and to measures taken upon removal of executives for cause.
Company-Specific Corporate Governance Policies
Although governance reforms may provide shareholders a voice in the management of the companies in which they invest, “one-size-fits-all” measures are bound to produce unsatisfactory results. Optimal corporate governance reforms must account for company-specific attributes and concerns, taking into account the company’s core business strategy, its capital and ownership structure, its asset portfolio, and the various markets in which the company operates.
As corporations and the markets in which they operate grow or change, corporate governance policies must be nimble and dynamic. Public companies should periodically reexamine their policies and assess their suitability and efficacy in light of the changing conditions of the economic and regulatory environment. Continuous attention to governance concerns will ensure that the company best serves the interests of its owners.
Institutional Advocacy to Effectuate Governance Reform
Institutional investors can maximize their impact by pursuing reform on multiple fronts. In addition to effectuating reform through litigation, institutional investors can effectuate reform through shareholder activism and by participating in discussions in the regulatory and policy spheres.
“Internal activism” is an effective way for shareholders to prompt governance reforms through proxy voting and communication with the board. Through proxy voting, shareholders have a valuable asset and a means to communicate with the company and other shareholders. Shareholders should dedicate sufficient resources to elect directors who will represent them on the board. In addition, shareholders should regularly communicate with boards to express their concerns and hold them accountable. They should insist on ongoing dialogue and input on those issues that have a material impact on the value of their investments.
“External activism” offers the potential for long-term market reform. By working with securities exchanges, legislative bodies, regulatory agencies, and industry and trade associations, shareholders can influence the public policy debate and advocate for governance policies, rules, and standards that will enhance corporate accountability and performance.