Tuesday, May 17, 2011

Director Elections: Majority Doesn't Matter

Diligent investors spend the time and effort required to vote their proxies responsibly. But when it comes to electing directors, the game is rigged against the shareholders: even when the majority of voting shareholders votes against a particular director nominee, the policy of most companies is that the nominee becomes a director regardless!

Consider GTSI Corp (GTSI), a government contractor that has been discussed on this site as a potential value investment. The results of the company's Class 2 directors are in, and they aren't pretty.

Only one of the company's three nominees had more votes "for" than those "withheld", which doesn't express a lot of shareholder confidence in the board. Nevertheless, the two unwanted nominees were still elected to the board! As per the company's proxy statement:

"In the election of directors, votes may be cast in favor or withheld with respect to any and all nominees; votes that are withheld may be excluded entirely from the vote and will have no effect on the outcome of the vote." In other words, there's no reason for shareholders to vote, since the proposed slate of nominees will win the election no matter what!

This process is deemed the "Plurality Vote", whereby the candidate with the most votes wins the job. But this system is designed for scenarios where there are multiple candidates running for limited posts. But in director elections, a company will usually put up for election the same number of nominees as there are positions. This can lead to a situation where only a single "for" vote (even if 99% of shareholders vote "against" or vote to "withhold") is needed to elect a director!

There are some who argue that reforming this system would do more harm than good, however. Certain directors may be very important to the company, and so losing them would leave the company worse off. But can't this be explained to shareholders in the proxy, with shareholders being given the final say? After all, directors are the shareholders' representatives.

Another argument against reform is that the loss of a director could trigger a change in control or another undesired event. For example, if a director is not elected, the company may not be in compliance with rules regarding the number of independent directors.

But a growing number of companies have started to adopt more shareholder-friendly policies that protect for such events while at the same time giving investors their say. For example, Pfizer, Intel and a slew of other large companies have in recent years adopted standards that would see a director offer his resignation if there are more "against" than "fors". The company would then decide to either accept or reject the resignation based on any mitigating circumstances (e.g. a failure to meet minimum independent director standards).

For most companies, director elections are still a farce. Slowly, the tide is turning as companies shift towards a policy that leads to a director resignation if there are more "withholds" than there are "fors". In the meantime, investors who make the effort to vote may be wasting their time.

Disclosure: None


Paul said...

Dude, you never even told us about this!


Saj Karsan said...

ha, no big deal! ;)