December 31, 2013

A trend to watch in 2014, particularly given the recent strength in equity markets and the disappearance of easy gains, is the push for differentiated board compensation. Evidently concerned, or even spooked, by the activities – and successes – of growingly prominent and large activist funds, several dozen North American companies have moved to amend corporate by-laws and board of directors charters to render impossible the ability of an activist fund to offer incentive compensation to their own director nominees. In effect, some activist funds have favoured paying their director nominees bonuses for work on behalf of the activist fund’s agenda – these payments coming above and beyond other director compensation.

Corporations – in many cases backed by traditional institutional investors – have recoiled at the idea citing a clear lack of alignment of interest. A director has a fiduciary interest to act on behalf of the company and all of its shareholders, not merely those paying a bonus above and beyond director compensation. The “establishment” argument (if we can term it thus) would run that whilst there are clearly cases where interests and motivations of two groups with different compensation schemes may align, so too there may be cases where they clearly conflict. In short, this line of reasoning holds, clarity of purpose and interest at the board level is a good thing, and that this in no way impedes meaningful discussion of strategy.

Equally, many institutional investors feel that the activist funds – the two most pertinent examples of which are Elliot Management (which lost in a fight to provide incentives of this type at Hess) and Jana Partners LLC (which took a much-publicised run at imposing this scheme, and other demands, on Canadian fertiliser-maker Agrium) – are overstepping the mark and trying to dominate board compensation structure. These institutional investors wish to retain that right for themselves. For example during the Jana battle The Canada Pension Plan Investment Board refused to support Jana (which was the largest shareholder at ~7.5%) noting in its decision to support management “[Jana Partner’s] nominees do not represent the best alternative for optimising long-term value creation, particularly in light of Jana’s proposed director compensation structure.”. Agrium was blunter, calling Jana’s proposals “Trojan Horse Tactics”.

Interestingly Institutional Shareholder Services, a consultancy that provides widely-followed advice on proxy battles and other shareholder votes, split the difference between Jana and Agrium and its institutional supporters: it argued in favour of electing 2 of Jana’s 5 nominees.

Long-time activist investor Carl Icahn has recently re-opened the argument, arguing in the Financial Times (30 December 2013) “Why is it all right for a company to give directors … all kinds of perks, yet if I find a Nobel prizewinner who is going to really help a company it is not all right for me as a holder of a lot of stock to give him a share in my profits?”. In the same vein he argued that entrenched boards of directors may act to stymie a takeover merely to protect their (presumably comfortable) existences.

We expect to see this debate intensify in 2014.