Institutional Shareholder Services Inc. ("ISS") has
now formalized its position on director compensation bylaws. In
short, ISS has adopted the position that a board that adopts a
bylaw provision prohibiting directors from accepting third-party
compensation for board service has infringed on the right of
shareholders to elect directors of their choosing, which ISS
considers to be a "material failure of governance" that
may result in an "against" or "withhold" vote
recommendation in respect of the reelection of the company's
director nominees.
While we recognize that ISS has recently taken steps in the right
direction on other topics, particularly by revamping the
quantitative component of its approach to executive compensation,
we think that this voting policy is misguided and misses the
serious governance issues raised by compensation schemes offered by
some dissident shareholders to their nominees—depending, of
course, on the structure, these compensation schemes can be
divisive at best and contrary to basic tenets of fiduciary duties
at worst.
Of course, it is well established that boards may adopt bylaws that
set forth qualifications for directors. Moreover, it is difficult
to understand how bylaws designed to prevent conflicts of interest
in the boardroom and to ensure that directors are not beholden to
third parties with special interests are a governance failure.
One-time payments to dissident nominees for agreeing to run on a
slate have long been accepted and are not prohibited by carefully
crafted bylaws. However, special compensation arrangements,
especially those tied to short-term stock price gains, paid by a
dissident shareholder for ongoing board service simply cannot be
reconciled with a director's fiduciary duties of loyalty to the
corporation and its shareholders generally.
As the 2014 proxy season unfolds, we expect that some companies
that have adopted these bylaws will repeal them, while others will
submit them to a vote of shareholders or take no action and
withstand a possible withhold vote campaign. (Notably, the
directors of Provident Financial were reelected despite ISS's
negative voting recommendation.) We continue to believe that
director compensation bylaws serve legitimate corporate interests,
and hold out hope that shareholders will support reasonably crafted
director compensation bylaws that permit the payment of a one-time
"candidacy fee" designed to fairly compensate an
insurgent's nominees for the time and effort involved in
participating in a contested election.
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