Index funds control 20 percent of total equity mutual fund assets in the U.S. and that makes them a powerful block of voters at proxy time. While they are passive investors, they are active voters, and that can create a dilemma for companies that have a significant percentage of index fund investors. This gives rise to the frequent question, “How can we influence these passive investors, who are essentially immune to investor relations communications efforts, yet have the power to vote large blocks of our stock?”
For insight on this issue, we spoke to Ron Schneider, Director of Corporate Governance Services at RR Donnelley Financial, who shared the key findings from their 2015 Survey of Institutional Investors, Deconstructing Proxy Statements – What Matters to Investors?
The bottom line: The proxy statement may be the only investor communication document passive investors will read and is therefore one of the few opportunities to communicate directly with this important audience. However, according to the Donnelley survey, most proxies are too long, too difficult to read and, when drafted with only the SEC in mind, often do not address voters’ most fundamental questions.
“Investors want companies to communicate and explain rather than simply disclose,” Schneider told us. “This represents a significant opportunity for many companies to improve the clarity and effectiveness of their proxy statements. Since investor relations is responsible for a company’s ongoing investor messaging and direct communication with shareholders, they are best positioned to help integrate this story into the proxy and are playing a bigger role on the proxy development team. The choice is clear: either you can deliver your story directly and clearly to your institutional proxy voters or you can allow their vote to be influenced by third-party proxy advisory firms.”
With help from our friend Ron Schneider, we have outlined some emerging best practices every company should consider:
Remember that context matters. In a best practices proxy statement, more space is devoted to voluntary disclosure (i.e. not mandated by the SEC), and driven by storytelling that creates a narrative and business context for the institutional proxy voter. The goal is to educate these voters, who are governance generalists and not portfolio managers or equity analysts, and therefore are not likely to know much about your company. These proxy voters work in a compressed time frame of a few months at most – from the time a company files its proxy until its annual shareholder meeting – and carry the responsibility of voting hundreds or even thousands of portfolio company proxies in the best interests of their investors with limited information or management access.
Given the time crunch and heavy work load, these voters do their best to make informed decisions; however, in the absence of clear and compelling information provided by the company, they will vote as recommended by ISS or another proxy advisory firm. This elevates the proxy statement to the primary opportunity to educate this audience about your business, create context between business strategy and outcomes, and present your case for any proposed initiatives.
A critical question your proxy must answer is: How do these proposed initiatives support the company’s growth and value creation strategy? The answer to this question should align with the investor story you tell analysts and portfolio managers in earnings calls and investor meetings. In short, you should repurpose your investor relations messaging for your proxy statement.
Include a cover letter to highlight the most important information. Many companies are including cover letters to deliver a strong opening to the proxy statement, to educate passive and less knowledgeable investors about their companies, to frame the opportunities and challenges the business faces, and to make their case for key governance and proxy measures right up front. These cover letters are also a forum to address issues such as board accountability, investor engagement and transparency. Here is an example from the Prudential Financial, Inc. 2015 Proxy Statement.
The cover letter is an opportunity for a newly public company to establish its identity and corporate objectives, for a business in transition to lay out long-term initiatives and tracking metrics, or for a company facing industry headwinds to explain how factors out of its control are impacting performance and returns. The cover letter can be a personal and persuasive way to focus the proxy voter on the company’s most important messages during proxy season.
Seize the opportunity to establish your corporate identity. Adopt the point of view that the proxy voting team probably doesn’t know your company well, so establish your identity right from the start. This is especially important if your company is relatively small and unknown, your company name is not as well-known as your brands, or your company is in the midst of a strategic shift. Schneider cites as an example MondelÄ“z, a global snack food company that spun off from Kraft Foods under the new name. The 2014 proxy is MondelÄ“z’s second since the divestiture. “A quick look at the front and back covers reveals a very creative showcasing of the group’s major brands, revenue category breakdown, global footprint and high-level strategic messaging,” Schneider said. The proxy cover is consistent with the visual brand used in the 10K wrap and annual report, reinforcing the corporate identity.
Remember that executive compensation is still the central corporate governance issue for both investors and management, and context is critically important in the Compensation Discussion and Analysis section of the proxy. According to the Donnelley survey, investors are still deeply dissatisfied with compensation disclosure. What’s missing? The analysis. Companies must do a better job of explaining how growth strategies translate into operational results, how these results relate to executive and incentive compensation, and how the comp committee arrived at their decision. “Proxy voters know compensation is a complicated subject and they don’t want to second guess the board,” said Schneider. “They have one primary question they want answered: How does pay incentivize leadership to support the company’s strategy?”
Be sure that all messages in this vital section of the proxy align with the story you have been telling the investment community. Also, be aware that on January 1, 2017, the U.S. Securities and Exchange Commission will enforce the rule that requires a public company to disclose the ratio of CEO compensation to the median compensation of employees. This disclosure will be required in 2018 proxies.
Put a spotlight on your board and remember diversity relates to more than gender. Board composition is also a hot button and may require you to think through different ways to measure diversity. Gender and ethnicity are not the only measures of diversity. Age and director tenure are important considerations because today’s board needs a continual refreshing of skills. New directors should bring the critical skills that help companies manage rapid growth, changing business models, new technologies, or emerging threats such as cyber security. In its 2015 proxy statement, Splunk, Inc., a mid-cap company that makes big data analysis software, provides a Director Dashboard. A series of three simple pie charts delivers key information in a clear and accessible format.
Use graphic design as a vital tool in your proxy communications. Today’s proxy statement relies on visual design and graphics to simplify and explain complicated information and illustrate key information such as board composition, executive compensation, and peer group analysis. Good design engages readers, drawing them into the document. To describe a process, put it in a timeline. To call out best practices, use a checklist.
Check out RR Donnelley’s Guide to Proxies for a host of outstanding examples for improving your proxy.
RR Donnelley Financial Services provides technology and expertise to help companies create, manage and deliver accurate and timely financial communications to shareholders, regulators, and investors. RR Donnelley files 160,000 client submissions annually with the SEC and produces critical documents for regulatory compliance and business transactions. A single point of contact at RR Donnelley helps you stay on top of the dynamic regulatory landscape and manage the logistics of your critical financial communications. For an assessment of your current proxy and opportunities to take it to the next level, or to arrange a call with Ron Schneider of RR Donnelley, contact Niklas GyllÃ¶ at firstname.lastname@example.org or 213-620-7556.