Agenda - A Financial Times Service

By Tony Chapelle September 24, 2018

Directors and officers who answered Agenda’s third-quarter outlook survey said that ahead of last proxy season, more than anything else, boards and executives talked with investors about strategy.

In fact, “strategy” ranked far above other topics of discussion offered by the survey, with 66% of respondents selecting it in response to a question on common engagement topics. The next most popular topic, “governance issues,” came in next, at 49%. (Respondents could choose more than one topic.) Other subjects that garnered responses from more than 40% of those polled were environmental and social issues and executive compensation. Fewer than a third of respondents said they discussed CEO succession with investors.

About three quarters of the respondents to the poll were board members; about a quarter were executives.

However, the topic of strategy is a broad one.Agenda interviewed several members in the corporate governance community, including two directors, a gadfly investor and a board consultant, to find out what topics are shaping the board-investor conversation on strategy.

For example, the board chairman of Planet Fitness says that last season its investors concentrated mostly on the issue of value creation and how management and the board planned to return that value to shareholders.

Stephen Spinelli, Jr., explains that the board of the fitness chain decided to reduce debt and fund several upgrades via a relatively new financial technique called a whole-business securitization. In a whole-business deal, a company refinances by pledging its revenue-generating assets such as franchise fees or royalties to fund a special-purpose vehicle. That becomes the collateral for securitized notes that investors buy. In August, Planet Fitness issued $1.275 billion in debt to pay off former senior debt, provide working capital, and possibly return capital to equity holders.

“To return value to shareholders, we looked at the nature of our company, which is terrific at generating cash. We decided to optimize our structure by collateralizing the income stream,” says Spinelli, who also co-founded the franchisor Jiffy Lube International.

He claims that especially at a rapidly growing company where value is being created — Planet Fitness shares have doubled in the past year — investors wanted to know, “How is that value going to serve me as a shareholder?” Spinelli says that his management had a very articulate discussion to answer those questions last proxy season with investors and Wall Street financial institutions that would buy the debt. “We used the whole array of communications within the constraints of regulatory requirements. We also had the earnings conference calls. It was a long period of hearing.”

Denise Devine, a director at the Fulton Financial bank and food-freshness company AgroFresh Solutions, typified most respondents to the survey.

“For both of my boards, strategy and growth in conjunction with the economic outlook was the major concern last season. Also, one of my companies is in a regulatory environment, so there are always some questions about that,” she says.

Devine, who is also CEO of FNB Holdings, which markets healthy snacks, says that directors at the boards that she’s on don’t talk directly to investors, but that the discussions with managers largely alleviated shareholders’ issues. Top executives spoke with equity analysts and larger institutional investors by phone and, in a few cases, in person. “For 2019, I don’t see any reason to see anything different. They’ll address questions that most institutional investors have.”

On the investor side, one increasingly visible gadfly says he maintained his focus on a variety of issues, from board structure to compensation to social issues.

Jing Zhaois an individual investor in Concord, Calif., who often owns just 12 shares of companies at which he submits shareholder proposals. A Chinese national, Jing is adamant about human rights in his home country. Proxies are one tool that he uses to affect corporate interaction there. Of the four proposals that he filed and that were voted upon at shareholder meetings this year, two were related to U.S. companies’ policies with the Chinese government. The others sought to reduce executive pay and to split a chairman-CEO role.

At Apple, for instance, Jing requested that the board appoint a human rights committee. His main concern was that Apple should not agree to abide by the Chinese government’s Internet censorship and surveillance policies in order to gain access to that market. Jing claims that with Apple being allowed to operate iPhone stores in China, which is a large source of revenue, “they cannot resist China’s pressure.” Some 6% of Apple shareholders voted for his policy. He has already submitted the same proposal for Apple’s shareholder meeting for next February. A similar proposal at Twitter garnered fewer than 5% of votes.

Jing’s proposal at Tesla was completely different. He wanted the board to separate founder Elon Musk’s roles as CEO and chairman of the board. “Tesla has been a public company for more than ten years so it’s not a startup and it should have more mature corporate governance with an independent chairman. Musk could be chairman if he’s not the CEO or be the CEO if he’s not chairman. After [Musk] issued that Twitter tweet [on Aug. 7] to go private, that verified the necessity of my proposal to separate the functions,” he wrote. The proposal received 16% of shareholders’ support. He says he’s going to repeat that proposal next year as well.

Finally, Jing proposed that Wells Fargo reduce executive pay to fall more in line with the median pay ratio for employees. “This hurts the American economy and the stability of the financial system,” he says.

The bank’s board took his proposal seriously and had senior executives respond personally, Jing says. Over the course of several telephone conversations, Wells officials, who included the associate general counsel, a vice president of policy and a director of investment policy, told him they had already made pay-ratio improvements such as increasing entry-level workers’ pay to $15 plus benefits depending on the area. As a result, they asked him to withdraw the proposal.

“I could not expect every board to fully implement my proposal,” Jing explains. “So, I thought a move to $15 was acceptable. I will not submit a proposal for next year. I do feel their positive attitude is better for communicating with shareholders. Maybe engaging privately, I can get more progress there.”

A board advisor also identifies one major issue that investors will want to discuss next year.

Steve Klemash, the leader of the Center for Board Matters at management consulting firm EYAmericas, says that the conversation around talent has been changing recently. “Boards’ enhanced attention to talent and human capital management is the area that’s different,” he says. “Historically, boards have focused on succession planning of the CEO and the CEO’s key reports. Today, institutional investors are asking, ‘What is your approach to governing culture and talent?”

One reason for that, Klemash says, is that companies have shifted to using a range of different types of employees both onshore and offshore. For example, he notes the ascendancy of the gig or contingent employee, a group that could become as much as 40% of a company’s workforce by 2020. There’s robotic process automation, which consists of bots on a server. And then there’s also the traditional workforce and the virtual workforce.

Meanwhile, intangible human capital, which mostly refers to employees’ know-how, represents about 80% of the typical company’s market capitalization.

“So, boards need to ask what skills their companies need going forward,” Klemash says. “Now that we’re in a knowledge economy, you had better start watching the development of your talent, because that’s how you’re going to move forward in the market environment.”