Attack of the zombie director
A look at directors who stay on boards though shareholders oppose them year after year.
by Ron Orol
In May, Steven Roth, 73, chairman and CEO of Vornado Realty Trust (VNO), received a 51% yes vote when he was up for re-election to the company's board.
That doesn't seem like a moment worthy of comment, but what was notable was that it was the first time in five years that any director at Vornado actually had a majority vote in their favor. Two fellow directors up for election in 2015 didn't get the support of the majority of the REIT's investors.
And despite the fact that all nine directors on the REIT's board have failed to win majority support in various elections, they all still serve on the board. Some have lost twice.
What happened at Vornado Realty, which is based in New York and with a market capitalization of almost $18.4 billion, doesn't happen at the vast majority of public companies. But it's common enough that directors who consistently fail to earn the backing of the majority of their institutional investors-and yet remain on company boards-have earned the doubtful honor of being called "zombie directors," by those same investors.
Another recent example includes oil and gas producer Nabor Industries Ltd. (NBR), which is based out of Bermuda and has a market cap of about $3.8 billion. This year, in April, four of seven incumbent directors received majority no votes. Despite that result, Nabors immediately termed them "elected." In 2014, three Nabors directors faced substantial dissent. Two of those directors were subsequently removed from the company's compensation committee, though not from the board. Two directors also received a majority of negative votes in 2013.
Meanwhile, at least one nominee failed to receive majority support at Healthcare Services Group Inc. (HCSG) in each of the nursing home and retirement complex management services company's last four annual meetings. That record got worse when, in May, nine out of 10 directors got majority negative votes.
Vornado, Nabors and Healthcare Services-officials at the companies did not returns call seeking comment-are among the more egregious examples, but they are only the tip of the iceberg when it comes to unelected directors in uncontested elections. And, despite shareholders voicing their displeasure at the ballot box, these poorly performing directors, more times than not, remain on their boards.
In 2015 so far, 70 directors at U.S. corporations have received majority votes of no-confidence, according to ISS Voting Analytics. That's just slightly down from the 74 directors with majority "no" votes for all of 2014. In 2013 there were 114 situations where a majority of investors withheld votes for company board candidates, according to ISS.
And while that may not appear to be that high a figure, the number goes up significantly when companies where directors received a 30% or greater negative vote are included. According to ISS, 406 directors received no votes of 30% or more in 2015 so far. In 2014 there were 503 directors in this category and 554 in 2013. Most governance observers contend that even a 30% no vote demonstrates a sufficient level of shareholder discontent warranting a company's response.
A recent study by the Committee on Capital Markets Regulation, an organization that seeks to provide lawmakers and regulators with policy recommendations, showed that between 2010 and 2014, 85% of directors who did not receive the backing of a majority of shareholder votes were still board members two years later.
They compared that to a control group of directors who did not experience large withhold votes and found that a similar percentage of 91% were still on their boards two years later. The result suggests that the number of directors who resigned because of dissent over their tenure was similar to the number that resigned in the normal course of business.
Institutional investors voicing disapproval through withhold votes is a relatively recent phenomenon-the financial crisis, however, appears to have jump-started the trend.
In 2003, there were only three directors who received a majority no-confidence vote, according to proxy advisory firm ISS. Between 2003 and 2010 there were 218 cases where that happened, but 136 of those, or about 62%, occurred in 2009 and 2010, according to Reena Aggarwal, a professor of business at Georgetown University. In 2009, 557 company directors received more than 30% in negative votes-a particularly strong year for discontent.
Proxy advisory firms are, not surprisingly, are also having an impact on shareholder voting patterns. Aggarwal's study notes that when adviser ISS recommended against directors, on average, 22% of shares voted no. If ISS didn't oppose a director nominee only 3.8% of votes were, on average, withheld, she added.
Olshan Frome Wolosky partner Andrew Freedman notes that the proxy advisory firms will assess a board's responsiveness to any significant negative votes on directors and may recommend the following year that shareholders vote against that director-or even any incumbent board member who fails to accept their resignation.
There can be consequences coming off a large "nay" vote for directors besides being removed from the board. For example, in the case of Nabors, the company kept three directors who received a majority of negative votes because it believed their "contributions" played an important role in the company's "enhanced strategic focus." However, "mindful of shareholder concerns" the company removed two of them from its compensation review committee. One remained on that committee because the company said it wanted continuity on board committees (and he also received the least number of negative votes.)
But even when Nabors reduced CEO Anthony Petrollo's annual base salary and made other changes to executive compensation, shareholders still weren't satisfied. They came back the following year with strong negative votes for the compensation committee directors-the two new ones and the holdover.
Still, Nabors said it kept all failing directors in 2015 because they played a key role in a "strategic review process" and its $2.6 billion deal to merge its well maintenance business with C&J Energy Services Inc. (CJES), a transaction that took two years to complete.
As an interesting side note, Aggarwal's study found that directors who receive high dissenting votes at one company are likely to have fewer board seats at other companies. "Our findings suggest that voting in director elections is an informational channel that helps this market [for directors] operate," the study said. "Our results suggest that dissent by shareholders is consequential and negatively impacts director reputation."
Though companies may come up with various rationales to keep directors who are unpopular with shareholders on their boards, they may soon get another "no" vote-that of the Securities and Exchange Commission. Chairwoman Mary Jo White said at a conference of the Society of Corporate Secretaries and Governance Professionals held in Chicago in June that the regulator could change its rules to mandate more specific explanations about why directors were kept on the board after receiving an unfavorable vote.
While acknowledging that situations where a majority of shareholders withheld votes from directors weren't the norm, White argued that the continued presence of "unelected" directors raises concerns about a company's general responsiveness to shareholders. "If a director receives a majority withhold vote and remains on the board, the company should consider that its shareholders may want to know about that director's service on the board and the decision to let the board member remain," she said.
Harvard Law Professor Hal Scott, who spearheaded the Committee on Capital Markets Regulation study, noted in an interview that in only 18 of 237 cases of directors who lost in plurality voting regimes did the companies provide some disclosure as to why they wanted to keep the director on the board. In majority voting systems in which directors are required to tender their resignations if they don't get a majority vote-resignations that are usually rejected-only two out of 18 cases reviewed, the company offered reasons for retaining those directors.
Disclosure often amounted to a general statement that having the director resign would be detrimental to shareholders, Scott said. "There needs to be a more meaningful explanation about why that director stayed on and the SEC needs to develop a standard to identify what meaningful means."
Timing is also an issue. Though many companies provide an explanation shortly after the annual meeting, Scott said, he often found disclosure happening later. "If the SEC requires more disclosure it should require it more quickly and shortly after the no-vote and board's decision to keep a director on," he said.
Olshan's Freedman added that any move by the SEC to require companies to explain in disclosure documents exactly why that person remained on the board despite the negative vote will only increase the pressure on companies to have them step down.
"Boards will have added pressure to accept the resignations of unelected directors if the SEC requires more disclosure and ISS continues to give negative recommendations in these situations," he said.
Another pressure point may have an impact as well. In recent years, insurgent investors have started pushing companies to shift from plurality voting systems to majority voting regimes for elections. Scott notes that the majority voting regime's requirement that unelected directors at least submit their resignation puts new pressure on boards to act.
"At least with majority voting they have to submit their resignation," he said. "In plurality voting regimes, in legal terms, they didn't lose."