The Activist Investor Blog
The Activist Investor Blog
Investors Paying Directors? Have At It.
Now, why would an investor would pay a director to serve on the BoD of a portfolio company? Especially when companies already pay directors? Probably to recruit outstanding candidates to run against incumbents, and align company and director incentives. But, that decision and its rationale remain the prerogative of the investor and the director.
But, whether they can do so, and whether the company can restrict investors from doing this, is quite clear: investors can, and companies that restrict this are wrong. These restrictions not only limit the candidates that investors can recruit to a BoD. They can also limit how portfolio managers can serve on a company BoD, and require disclosure of PM salary and bonuses. Shareholders can and should punish companies and BoDs that seek to restrict these arrangements.
By paying directors, we mean incentive payments, say based on the share price performance of the company. Shareholders typically reimburse director candidates for expenses, and also indemnify candidates for legal liability. This year, we saw some innovations in this practice:
❖Two investors agreed to novel incentive compensation plans for director candidates.
❖In response, companies began to adopt a bylaw amendment that prohibits directors from accepting incentive compensation from shareholders.
❖Then, investors began to vote against directors that approve such a bylaw amendment.
It started at Agrium and Hess
First, in November 2012 JANA Partners, the hedge fund run by Barry Rosenstein, nominated five directors (including himself) for the BoD at Agrium, the Canadian fertilizer company. JANA disclosed, clearly and in a bit of detail, that it would pay the four other directors a total of 2.6% of the gain in the value of its stake in Agrium. It did not specify the period of time over which JANA would calculate the gain.
Then, in April 2013 Elliott Associates, the hedge fund run by Paul Singer, nominated five directors at Hess Corporation, the US energy company. Elliott disclosed, clearly and in more detail, that they will pay each candidate $30,000 for each 100 basis points of alpha, measured over a three year period, with reference to a benchmark portfolio of 15 other energy companies, and limited to 300% of excess return.
Both JANA and Elliott paid each candidate $50,000 to serve as a nominee, and agreed to customary indemnification terms. None of the JANA nominees won election, while Elliott settled with Hess such that the company added three of Elliott’s candidates to the BoD.
This is not new, either. Investors have created incentive pay structures for directors at various times in the past.
Marty Lipton (who else?) Gets Involved
Around the time of the Hess annual meeting, Wachtell, Lipton shopped a bylaw amendment that limits significantly how shareholders can compensate directors. Seeing as most states allow companies to set forth director qualifications, it adds to these qualifications a restriction that only the company can compensate a director for BoD service.
The Wachtell formulation provides an exception for indemnifying and paying someone to serve as a nominee. (This would permit JANA and Elliott to pay the $50,000 fee.) It also provides an exception for a “pre-existing employment agreement” between a director and his or her employer, presumably the investor. This latter exception may prove very problematic (more below).
ISS reports that as of November 2013 at least 33 companies have adopted some form of this bylaw amendment.
Investors Fight The Bylaw
Provident Financial, a small California bank holding company, adopted the Wachtell bylaw verbatim in July 2013. The BoD did so without a shareholder vote.
In advance of the company’s November 2013 annual meeting, ISS issued a strongly-worded recommendation to clients to vote against the three directors on the Nominating and Corp Gov Committee. ISS reasoned that Provident adopted an overly-broad restriction, which also prohibits investors from compensating BoD candidates. It also objected to the BoD adopting the bylaw amendment without a shareholder vote.
Shareholders did reelect the three directors, yet with only about two-thirds of the vote cast in favor, considerably lower than what they had received in prior votes.
Investors are Right, and Can Pay Directors Anything
One legal scholar argues that this bylaw is illegal under Delaware law. We hope he is correct, but the legality is besides the point.
We object to any limitation on well-disclosed pay arrangements between investors and directors. While it took a strong and correct position, ISS did not go far enough in its advice.
The JANA and Elliott arrangements, and others like them, make perfect sense. An investor compensates directors, out of their own funds, for appreciation in a position, following a detailed formula that the investor discloses in full. One could not ask for a better alignment of investor and director interests.
Suppose, though, that a shareholder pays directors in ways that may present a conflict. Say, the investor rewards directors to sell the company to the investor at a fire sale price. Setting aside the obvious breach of fiduciary responsibility, disclosure of the arrangement leaves it to shareholders to decide if they want directors to work that way. As ISS argues:
The proper forum for assessing an individual's suitability for board service is the election process. If investors are concerned with a candidate’s compensation arrangements, they are free to express their concerns at the ballot box.
Who can argue with that sort of private ordering?
More practically and importantly, this bylaw also limits how PMs can serve on the BoD of a portfolio company. It exempts:
any pre-existing employment agreement a candidate has with his or her employer (not entered into in contemplation of the employer’s investment in the Corporation or such employee’s candidacy as a director).
This troubles us greatly. Suppose:
❖A CIO asks a PM to serve as a candidate for a portfolio company BoD
❖They agree to a bonus plan for that role that includes customary incentives for appreciation in the position value
❖Shareholders elect the PM to the BoD.
Seems to us that under this realistic scenario, the Wachtell bylaw precludes the PM from serving on the BoD. At the very least, it requires the investor and the PM to disclose their internal compensation arrangements.
We think that investors (and ISS) should oppose these bylaws unconditionally. Not because they pertain to BoD candidacy in addition to BoD service. Not because they allow only nominal expense reimbursement and legal indemnification. But, because they interfere with investor rights to nominate and compensate their representatives to portfolio company BoDs, including the right to nominate their own employees in this very important capacity.
Tuesday, December 3, 2013