The Wall Street Journal-20080114-Corporate Governance -A Special Report-- Where the Action Is- Forget the audit committee or compensation committee- The new hot seat on boards is on the nominating committee
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Corporate Governance (A Special Report); Where the Action Is: Forget the audit committee or compensation committee; The new hot seat on boards is on the nominating committee
If you can't stand the heat, forget serving on a corporate board's nominating and governance committee.
In addition to setting governance policies and evaluating sitting board members, these committees have the delicate task of finding directors who will fit in well in the boardroom and satisfy both management and shareholders. Now, that work is becoming even more complicated, as activist investors have gained more of a voice in the nominating process and increasingly strive to impose their will on the selection of board members.
Other committees have taken most of the heat from investors in recent years. Audit committees came into the spotlight when the 2002 Sarbanes-Oxley Act made the hiring and firing of a company's outside auditor their responsibility, amid a backlash against corporate accounting scandals. Compensation committees then drew attention, thanks to investors' complaints about lavish compensation packages for executives.
Nominating committees are now headed for the hot seat. The pressure on them is building as new board candidates and incumbents up for re- election increasingly are subject to rejection if they don't win a majority of shareholder votes cast, and as shareholders push for the right to nominate their own board candidates. Richard Koppes, an attorney with the law firm of Jones Day in Sacramento, Calif., who advises boards and companies on governance matters, says he's convinced "it is the next committee in the spotlight." Mr. Koppes also is a director of two public concerns.
The nominating process has been evolving for several years. In the wake of Sarbanes-Oxley, U.S. stock exchanges adopted listing rules requiring nominating and governance committees to be made up wholly of independent directors. That took much of the power in shaping boards away from chief executive officers, who previously had driven the nominating process at most companies. And in many cases it has given more of a voice to shareholders.
"It's really been quite a revolution in the boardroom," says Susan Shultz, a Phoenix-based recruiter for OakBridge Executive Search International Ltd., and nominating-committee chairwoman for privately held Amazon Bank, also in Phoenix. "Now, the CEO often isn't in the loop until the selection process is well under way."
While CEOs usually view other CEOs as ideal directors, nominating committees now tend to cast a broader net, seeking diverse candidates with specific relevant experience, recruiters say. A study by recruiters Spencer Stuart based on corporate data through last May 31 shows that at companies in the Standard & Poor's 500-stock index, some 33% of directors are CEOs and other high-level officials, down from 53% in 2000.
"Consultants are being told [by nominating committees] to widen their searches, and that's a good thing," says William Patterson, executive director of CTW Investment Group, an arm of Change to Win, a Washington-based coalition of labor unions. He applauds nominating committees for looking "beyond the usual suspects" and seeking input from major shareholders, which can solidify support for director candidates and prevent campaigns to withhold votes for an unpopular choice.
American International Group Inc., for instance, now has its nominating committee meet with investors to discuss desirable qualities for directors and to float the names of potential candidates. While disaffected institutional investors had assailed the company in the past, complaining that its board was too beholden to management, Mr. Patterson says that with its new approach the nominating committee hasn't picked any candidates objectionable to labor-union investors. AIG doesn't discuss such matters publicly but it is committed to good corporate governance, says Robert Willumstad, chairman of the board of AIG.
Some nominating committees are going so far as to recruit shareholders to serve as directors. Valeant Pharmaceuticals International enlisted its largest shareholder, San Francisco money manager G. Mason Morfitt, for its board after its nominating committee met with investors to discuss candidates.
"They asked me: 'Who do you think should be on the board?'" recalls Mr. Morfitt. His answer? "Me."
Mr. Morfitt's firm, ValueAct Capital Partners LP, seeks to hold big stakes in a few companies and put its partners on their boards. Mr. Morfitt says ValueAct partners have seats on the boards of eight companies, which is about half the firm's portfolio.
Governance experts say consensus seeking makes sense at a time when many shareholders have a new tool to exert pressure on nominating committees: majority voting. Until recently, nearly all boards were elected by plurality -- those candidates who got the largest number of votes were elected, or re-elected. That meant a board member could be elected with a single vote, since there was rarely any competition for seats. But many companies now subject candidates to the possibility of being rejected or dismissed from the board if they don't win the majority of votes cast by shareholders.
Two-thirds of S&P 500 firms had some form of majority-vote requirement for directors in place by November 2007, up from just 16% in early 2006, says Claudia Allen, chairwoman of the corporate- governance practice at the law firm of Neal, Gerber & Eisenberg in Chicago.
This tool is often blunted, though, because many companies give the board the final say on candidates who fail to win a majority of votes. Shareholders in those cases are able to express their dissatisfaction with a candidate but can't force the candidate's rejection. Ms. Allen estimates that of the companies that have adopted some form of majority voting, only about 38% require the rejection of a candidate who doesn't win enough votes.
For example, at Gen-Probe Inc., a San Diego maker of medical diagnostic tests, the board declined to accept the resignation of board member Mae Jemison last summer after she failed to win a majority of votes for re-election. ISS Governance Services, a proxy- advisory service owned by RiskMetrics Group Inc., had recommended that shareholders vote against Ms. Jemison because she missed two of the board's four annual meetings in 2006.
Gen-Probe's board told major shareholders that it planned to reject Ms. Jemison's resignation, citing her faithful attendance in prior years and her contributions to the board. Abraham Sofaer, who chairs Gen-Probe's nominating and governance committee, cites what he describes as a communications mix-up that kept investors and ISS from receiving an explanation of Ms. Jemison's absences before the vote. Mr. Sofaer says that because Ms. Jemison missed only one regularly scheduled meeting in 2006, and had a pre-existing conflict that precluded her attendance at a rescheduled meeting, "it was clear to me where we should end up."
"I think we dealt with it very responsibly," says Mr. Sofaer. He adds that none of the major shareholders objected to the board's call, and there have been no public protests.
"This is the way the process is supposed to work," says Patrick McGurn, special counsel at RiskMetrics Group. The attention focused on Ms. Jemison's absences should prevent them from recurring, he says, resolving the matter to everyone's satisfaction without ejecting the director.
A proposal by NYSE Euronext's New York Stock Exchange to bar "broker voting" could add a new wrinkle to director elections, particularly at companies with a majority-vote requirement. The NYSE proposal would bar brokers from voting shares they hold on behalf of customers who don't give voting instructions before a company's annual meeting. The Securities and Exchange Commission has yet to act on the proposal, leaving in place votes that typically support a company's chosen slate of directors. Any change, however, could shift the balance of power in future elections.
Broker voting was at issue in a closely watched "vote no" campaign against CVS Caremark Corp. director Roger Headrick, who stepped down in July, citing personal reasons. Mr. Headrick received 56% of votes cast, a level that was reached only because of broker votes, says Mr. Patterson, the CTW Investment Group official -- a contention he stressed to the nominating committee.
CVS Caremark Chief Financial Officer David Rickard disagrees, saying brokers voted uninstructed shares for and against Mr. Headrick. He says campaigns like the one directed against Mr. Headrick are making the job of nominating committees "way more difficult than even five years ago."
Mr. Rickard views the campaign against Mr. Headrick as unwarranted and driven by unfounded claims of stock-option-backdating abuses. Mr. Headrick says that those claims were groundless and that his resignation from the board "had nothing to do with any of this."
Shareholder proxy access -- which would permit shareholders to place names of their own board nominees on company-printed proxy ballots -- could pose other problems for nominating committees. A federal court opened the door to proxy access in a 2006 ruling, saying the SEC failed to adequately explain its position that companies may bar shareholders from considering proxy-access proposals.
The SEC responded last fall by affirming its stance that companies may block shareholders from considering matters related to nominating and electing directors. Further legal wrangling is possible, as some public pension plans are seeking to have proxy-access measures put to a vote by shareholders at Bear Stearns Cos. and J.P. Morgan Chase & Co. Richard Ferlauto, director of corporate governance for the American Federation of State, County and Municipal Employees, says the SEC's action is a flawed, ill-considered move that won't withstand a legal challenge.
All the attention to board elections could start to affect the composition of nominating committees. Despite the growing importance of these committees, directors have often wound up on them by default, not design. Ms. Shultz, the Phoenix-based recruiter and nominating- committee chairwoman, says the nominating committee is "where directors who don't have particular expertise typically end up."
That could change as the limelight requires directors who are comfortable playing a leading role. Says Mr. Patterson: "There's greater conviction that the board matters, and the nominating committee matters, and the nominating-committee chair matters and is key to protecting shareholder value."
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Ms. Burns is a reporter for Dow Jones Newswires in Washington. She can be reached at [email protected].
