June 9, 2006

Fewer Companies Maintain Defenses

From the ISS “Corporate Governance Blog“: “For the first time since the mid-1990s, the proliferation of takeover defense features at major U.S. corporations has begun to slow, and several defenses are now in decline, according to a new study by ISS’ Governance Research Service (GRS).

For example, the study found that active “poison pills” are in place at barely more than half of the surveyed companies. Given this trend, maintaining a pill may soon no longer be considered “standard practice,” along with classified board structures.

The 2006 edition of the Corporate Takeover Defenses (CTD) study surveyed corporate control features at 1,925 public firms as of the end of 2005. As in previous years, the biennial analysis finds that the most prevalent defenses remain blank-check preferred stock, advance notice requirements, golden parachutes, classified boards, and poison pills, each of which is found at a majority of the firms tracked.

Remarkably, though, the proportion of companies with an active poison pill or a classified board declined for the first time in many years, along with several other defenses once thought to be impregnable. The proportion of firms with pills (also known as “shareholder rights” plans) dropped from 55.1 percent two years ago to 51.2 percent.

Although shareholder proposals requesting companies to redeem poison pills or put them up for investor approval routinely receive support from a majority of voting shareholders, companies have traditionally been reluctant to comply with such requests. At least 119 of the companies profiled have taken action to eliminate their poison pills in the last five years, however, and others have amended their pills to institute “shareholder friendly” features such as Three-Year Independent Director Evaluation (TIDE) provisions or qualified offer provisions to assuage shareholder antipathy toward those defenses.

Another of the most effective takeover defenses, staggered election of directors, remains the fourth most popular defense, but the prevalence of classified boards also declined for the first time this decade, from 59.7 percent of the companies (as of the 2004 CTD edition) to 56.4 percent. Growing opposition to staggered board elecÂtions by institutional investors has made it more difficult for corporations to justify them, and requests for the repeal of classified board structures continue to be one of the most numerous and most popular shareholder proposals. In 2005, such proposals received support from an average of 63.2 percent of votes cast.

The last few years have seen sizeable jumps in the number of management proposals seeking repeal of staggered board bylaw or charter provisions. Clearly, investor pressure to eliminate this takeover defense is finally driving real change. Nevertheless, many companies continue to enter the public market with staggered boards, which they assert enhances stability and continuity of the board, and these typically require significant effort to declassify. The supermajority vote requirements often needed to repeal or amend classified board provisions–usually 80 percent of outstanding shares–have hindered some companies from eliminating their staggered board structures. All but one of the 22 such proposals voted on in 2003 in the study universe received enough votes to “pass,” however, as did all but four of the 46 proposals in 2004 and three of 45 proposals in 2005.

What’s more, these changes are occurring in a fairly robust mergers and acquisitions market, which began to rise again after 2002. Despite some evidence that growth through mergers often fails to deliver higher returns, acquisitions–both friendly and hostile–remain a key component of many companies’ growth strategies. Institutional activists and value investors continue to utilize shareholder proposals and proxy fights to inspire change at under-performing companies, and recently hedge funds have emerged as new players in instigating governance changes through often hostile advances. Proposed Securities and Exchange Commission rules that would permit companies to post proxy statements on the Internet, rather than requiring them to mail the statement to shareholders, are expected to boost the incidence of proxy fights, since costs to provide proxies would drop for dissidents as well as issuers.

Several other defenses that were popularized in the 1980s continue to lose ground, the study found. The ratio of companies with fair price provisions, for example, peaked at 33.2 percent in 1993, but has continued to fall since and now stands at just 19.2 percent (compared with 19.8 percent at the end of 2003). Similarly, the proportion of companies requiring supermajority vote requirements to approve mergers, which peaked at 18.1 percent in 1993, shrank to 14.9 percent as of 1997. Prevalence of this provision reached 15.5 percent at the end of 2001, but then dropped to 14.6 percent by the end of 2005.

Other Defenses Are Less Common

Meanwhile, the pace at which companies are erecting barriers against proxy contests and enacting rules to maintain tight rein over shareholder meetings has slowed to a crawl. The percentage of companies that have adopted provisions to limit shareholders’ right to call special meetings, which doubled in little more than 10 years, from about 24 percent in 1990 to 49.5 percent as of the end of 2001, stands only slightly higher, at 49.7 percent, as of the end of 2005.

By the same token, the proportion of companies that restrict shareholders’ right to act by written consent in lieu of a special meeting–which increased dramatically from about 35 to nearly 44 percent between 2000 and 2002 and rose another 3 percentage points by 2004–increased just 1.4 percentage points in the last two years to 48.2 percent. Typically, proposals to change these shareholder rights are put forth in bundled resolutions with a merger, reincorporation, or restructuring, which shareholders are more likely to approve than stand-alone restrictive resolutions, so it appears that fewer companies are now requesting these changes.

Another provison that remains on the rise, though its proliferation has slowed, requires shareholders to give advance notice of an intention to present director nominations or other motions from the floor. This feature, virtually unheard of in the early 1990s, has become the second most prevalent defense; nearly 81 percent of firms now have advance notice provisions, up from 77 percent two years ago. As of 1995 (the first year they were tracked), these notice requirements were present at only about 44 percent of the companies examined.

Executive Protections Continue to Spread
Golden parachutes–executive severance arrangements contingent on a change in corporate control–have been a popular management retention tool for many years, and their prevalence increased significantly in the past two years from 73.4 percent to 77.6 percent. The terms of these typically generous severance agreements vary considerably, but most of those packages provide for payments based on three years’ salary and bonus, acceleration of stock options, and sometimes other incentive compensation and extra pension credit. Because most companies now consider golden parachutes to be critical components of compensation packages, and shareholder approval of them is not required, these arrangements have continued to spread. This trend has occurred despite the fact that investor activists concerned about excessive severance payments, sometime dubbed “pay for failure,” have made anti-golden parachute proposals a cornerstone of their proxy season campaigns, with increasing success.

While most companies continue to maintain strong defenses against hostile shareholder action and to guard against perceived unfair and abusive actions by dissident groups, the findings in this year’s study signal that the most potent defenses have peaked for the time being.

Meanwhile, shareholders and activists continue to monitor companies and their boards to ensure that takeover defenses are being utilized properly. In the last few years, shareholder proposals to eliminate classified boards and supermajority vote requirements and to eliminate or allow a shareholder vote on poison pills have garnered average support of more than 50 percent at U.S. companies each year, and the message appears to be finally getting through to corporate management and boards.”