EY 2014 proxy season preview

Let’s talk: governance

2014 proxy season preview

Boards face shifting investor priorities and expectations

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Proxy season 2014 will see a continuation of many long-standing investor initiatives around board elections and leadership, executive pay, and environmental and social topics. What is new this year is the growing focus by investors on board composition and director accountability.

Company-shareholder engagement continues to reshape the governance landscape, drawing investor attention to the boardroom with a focus on the skill sets, track records, diversity and accountability of boards.

This emerging dynamic is a move away from check-the-box governance toward a greater focus on board effectiveness, including expectations that companies more clearly explain their governance decisions and approach on key issues. This comes at a time when campaigns by activist investors — across companies of a diverse range of size and sector — are on the rise.

In some cases activist investors are coordinating with long-term institutional investors to achieve a common outcome. These developments raise the bar for proxy disclosures that tell a clear governance story and company-investor dialogues that are ongoing and constructive.

These insights are based on conversations among EY's corporate governance team and nearly 40 institutional investors, investor associations and advisors on their governance priorities, as well as our tracking of governance trends and emerging developments through EY's proprietary corporate governance database.

1. Board composition and renewal

Closer attention to board composition and renewal will be a key theme of the 2014 proxy season and beyond. Lack of turnover on boards is raising concern among many investors that board independence may be compromised, groupthink may be stifling boardroom debate, and fresh perspectives may be lacking from strategic discussions. The low rate of board turnover is also seen as a major impediment to progress on board gender diversity. More than half of investors we spoke with indicate they will pay more attention to board renewal in 2014 – the greatest focus area for the investors as a group. Almost all of these investors plan to raise the topic in their conversations with companies. A smaller number of investors say they may cast proxy votes against nominating committee members (or entire boards) where boards lack gender diversity.

Investors want to know that the right people — those with qualifications aligned with the company's strategic goals, stakeholders and risk oversight needs — are in the boardroom. They are looking more carefully at board composition, director qualifications, tenure and diversity, along with director succession planning and board refreshment practices.

2. Board structure and accountability

Many investors continue to push for the annual election of all directors under a majority vote standard and want to see boards with a strong independent chair or lead director. Many companies have adopted these practices, but those that have not and those with lead independent directors who do not have clearly defined, robust responsibilities may be the focus of investor engagement or recipients of shareholder proposals.

3. Sustainability

Many investors continue to show strong attention to environmental sustainability and human rights and labor conditions, including across a company's global supply chain. Requests for enhanced disclosure, monitoring and management of these sustainability-related risks are growing compared to prior years.

  • Climate change

A number of investors report a renewed sense of urgency around climate change. The risk of stranded assets is at the forefront, with investors asking companies to disclose risk scenario planning and report on potential climate change-related impacts to companies' business models.

There is an increased push for companies to set, and report on, quantifiable goals for reducing GHG emissions — including a focus on financial companies regarding the carbon footprint of their financing and lending portfolios. Proposals on GHG emissions cuts are one of the most commonly submitted shareholder proposals this year, reflecting some investors' commitment to seek measurable progress in this area.

Investors are also asking for enhanced investment in renewable and sustainable energy sources.

  • Sustainability reporting, including human rights and human capital management, across the supply chain

Investors are asking companies—particularly those in the technology and consumer products sectors—to report on their suppliers' sustainability performance or to require significant suppliers to issue sustainability reports.

Companies are also being asked to report on risk assessments that identify and analyze potential and actual human rights risks of company and supply chain operations.

Separately, some investors are focused on elevating human capital management as a matter of capital allocation, operational management and value creation. The topic is a broad one, covering employee training and development, fair labor practices, health and safety, and other factors.

4. Executive compensation topics

Pay continues to command investor attention. More than 2,400 companies with annual say-on-pay (SOP) votes will continue to gauge investor support for their compensation policies and practices, and 2014 will mark the second SOP vote for companies that elected triennial frequencies. Nearly 200 companies received less than 70% support of votes cast on their SOP proposals in 2013.

Investors can be expected to closely review those companies to assess pay-for-performance alignment, changes made in response to last year's vote, and whether the company engaged its shareholders for feedback. A growing number of companies are using supplemental pay tables including realizable pay calculations to help explain the link between pay and performance. When such tables are used, investors want to see a consistent approach applied year to year.

Even with SOP votes, some shareholders are submitting proposals targeting specific pay practices. In addition, a group of investors has indicated plans to file a package of shareholder proposals at companies with low SOP votes.

5. Political and lobbying spending and oversight

A number of investors continue to prioritize requests for enhanced transparency and oversight around a company's political and lobbying expenditures in the absence of Securities and Exchange Commission (SEC) rulemaking on this topic.

This year, shareholder proposals seeking board oversight and disclosure of political and lobbying expenditures are the most common in terms of numbers, with more than 120 submitted to companies across a wide range of sizes and industries. The proposals largely focus on indirect expenditures, in which company payments to trade associations and other tax-exempt organizations are used for political or lobbying purposes, even if only in part.