Corporate Secretaries And Governance Professionals Proxy Votes That Build Value: PROXY Governance , Inc., Takes Portfolio Manager's Approach To Proxy Analysis With Aim Of Increasing Long-Term Corporate And Shareholder Value

Friday, April 1, 2005 - 01:00

[Editor's Note] Increased SEC regulation and a new public focus on corporate governance have expanded the market for proxy advisory and voting firms.The newest of these is PROXY Governance, Inc., a wholly-owned subsidiary of the Internet-based brokerage and financial services technology firm FOLIOfn, which was founded in 1998 by former SEC Commissioner Steven M.H. Wallman.PROXY Governanceis making a name for itself on the basis of its company-specific approach to proxy analysis and the quality of its research.
To gain a better understanding of PROXY Governance 's services and unique methodology, we talked with the firm's Managing Director for Policy James P. Melican.Prior to joining PROXY Governance, Jim was Executive Vice President of International Paper Company where he directed the company's legal, corporate secretary and investor relations functions, as well as other administrative and operating units.Jim has been a recognized expert on corporate governance for two decades.He served on the American Bar Association select committee that contributed to the American Law Institute's Principles of Corporate Governance.He also was Co-Chairman of the A.B.A.'s Corporate Governance Committee and a member of the Committee on Corporate Lawstask force that wrote and published the last three editions of the Corporate Directors' Guidebook.He is a former member of the Lawyers' Advisory Committee of the New York Stock Exchange.

Editor: Jim, how is PROXY Governance different from the other firms in this marketplace?

Melican: I think three things are most important in setting us apart from other proxy advisory firms.The first is our mission, which is increasing long-term shareholder value.The second is our company-by-company approach to proxy analysis.We don't believe that specific proxy issues should always be voted in the same fashion, because there is no specific set of corporate governance initiatives that are - or are not - inherently beneficial to all shareholders, of all companies, all of the time. Proxy proposals have to be judged in the context of each specific company's performance, its board structure, its executive compensation structure and other factors

The third distinguishing characteristic of PROXY Governance is our commitment to avoiding conflicts of interest in all of our operations.We do not sell consulting services. We do not market special research or other services to short-sellers, whose interests are opposite those of pension plan participants, mutual fund shareholders and others whose financial goals are tied to the growth of long-term shareholder value.We also are unique in that we have established a Policy Council of outside experts who provide oversight of our policies and voting recommendations.These are individuals who are recognized for their expertise in corporate governance and disclosure issues, their independence and their integrity.

Editor:I think most proxy advisory firms would say that their goal was to help increase shareholder value.How are you different from the others in this respect?

Melican: Our difference is in how we define what does increase shareholder value, and what doesn't.We believe Warren Buffet framed this issue very well this spring in his annual letter to Berkshire Hathaway shareholders.He basically said proxy advisory firms have "focused on minutiae" and ignored the questions that really count.

We think what really counts is increasing corporate value, because we recognize that the corporation is the true engine of shareholder wealth creation.We make proxy recommendations that are designed to support the growth of overall corporate value, because we believe that increasing corporate value is the best and surest way to increase value for shareholders, pension plan participants, employees, communities and all of a corporation's other constituencies.

Unfortunately, most other proxy advisory firms don't think of shareholder value in these terms.They tend to think of it in terms of "shareholder power" - how individual groups of shareholders can gain "power" over corporate management groups on an issue-by-issue basis.We think that vision is awfully short-sighted.It fails to recognize the reality that, when the pie gets bigger, everybody gets a bigger piece.

Editor: So, how does your vision of what really "counts" in the effort to increase shareholder value translate into a proxy analysis methodology?How do you decide what voting recommendations best serve the interests of shareholders at a given company?

Melican: The best way to describe it is to say that we take a portfolio manager's approach to proxy analysis.Our bias is corporate performance, and we use the portfolio manager's standard tools for performance measurement.We look at each company individually, and we evaluate its performance - not in a vacuum - but relative to peer companies in its industry.We also measure whether a company's performance has improved or deteriorated relative to this peer standard over the past three years.In other words, has the company been building or diminishing shareholder value?Of course, our analysis also takes into consideration any issues, such as accounting misstatements or lack of management oversight, that might cause us to question whether the board or management are exercising adequate control over the company.

Editor: How does this portfolio manager's approach steer your decision-making on specific issues?For example, if a company is having performance problems, do you always deliver a recommendation to vote against management's slate of directors?

Melican: No, definitely not.If a company has had a limited period of underperformance, barring other issues, I think it would be quite unusual for us to recommend a vote against management's slate of directors.In a case when a company's financial performance has been consistently below peers, we examine whether a board has focused on changing the direction of the company.We would look for a change in management, or a change in business strategy.

Editor:Executive compensation is a big issue this spring.How does your portfolio manager's approach work on this issue?

Melican: We use a "pay-for-performance" model to evaluate executive compensation.Our analysis is based on a total executive compensation measure, including cash, as well as equity and other compensation.We use this measure to evaluate the CEO's compensation relative to the compensation of CEOs at peer companies.And then, of course, we consider the CEO's compensation level relative to the corporation's performance.We also perform the same analysis using the total compensation, as a group, for the named executives in the proxy.

We think the total compensation that a corporation is paying to its entire senior executive team is very important because we believe this is the group that bears the most responsibility for the corporation's performance.

Editor: How does PROXY Governance's methodology lead you to look at the issue of declassifying boards?

Melican: If the concern is that a staggered board might be used as an anti-takeover device, we look at the circumstances of the company. For example, is its market capitalization such that the possibility of an attempted hostile takeover is minute, or are its assets mostly people rather than physical assets, which also decreases the likelihood of an attempted hostile acquisition.Hostile takeovers are not an everyday occurrence, and 95% of the time we think there is a value in having a staggered board of directors who are empowered to act on behalf of shareholders without unduly worrying about a CEO's wishes or feelings because those directors have terms of office thatextend beyond one year or less.

Editor: How about the issue of splitting the positions of chairman and CEO?

Melican: If a company led by an individual who holds the combined offices of Chairman and CEO has been performing well, and if we see no excessive compensation or other issues that have come to be associated with the notion of an "imperial CEO," we would see no compelling rationale for voting to split the positions.On the other hand, in the case of a company that consistently has been underperforming, and in which other measures are out of line, we might advocate separating the positions to free the board to push for quicker and better solutions to the company's problems.

Editor: Jim, to what kinds of organizations are you targeting your services?

Melican: We are providing our services to the full range of fiduciaries: corporate defined benefits plans, institutional investment managers, public and union pension funds, mutual funds - in short, any entity which votes proxies.

Editor: Aren't most corporate defined benefits plans outsourced to investment managers who in turn make their own selections of proxy advisory firms?

Melican: That's currently the case, yes,but whether the corporate employees who have been designated as fiduciariesmanage its defined benefits plan assets internally or contract out the management, theyshould be concerned about how the assets in its plan are being voted.Are they being voted in the interests of long-term value growth that will truly benefit the plan participants?Or, are they being voted in the interests of outside groups who have their own agendas and are focused on "flavor-of-the-month" proxy issues?Every corporation with a defined benefits plan should consider that question carefully, as opposed to taking a "hands-off" attitude and preferring not to know how the shares in the corporation's portfolio are being voted

Editor: Let's say a corporation is concerned about how its pension plan assets are being voted by investment managers.What can it do to ensure that long-term value growth is the yardstick that is being used to vote the proxies of the stocks in its fund - especially considering ERISA requirements?

Melican: If an investment manager - either inside or outside of the company - is purchasing an externalproxy advisory firm's recommendations,he or she should seriously considersubscribingto PROXY Governance's reports and recommendationsto gain a second point of view on proxy issues.That is completely appropriate, because an investment manager should have the benefit of a broad spectrum of thinking on these issues to ensure responsible voting on behalf of plan participants.

Companies using an outside investment manager also can take the voting of the shares back in-house.This doesn't have to be a difficult or burdensome process.The corporation can form a committee to establish voting policies that might include, for example, members from the Corporate Secretary's office, HR and Finance.It also could include retirees, who would provide important perspective on the real needs and concerns of the plan participants.The committee could, in turn, subscribe to an advisory service like ours, either as a benchmark against which to compare their own policies or to rely on as a source of voting recommendations and voting agency services.

Editor: Is your universe of covered companies expansive enough to meet the needs of most defined benefits plans?

Melican: Absolutely.We currently cover the S&P 1500 Composite Index, plus the publicly held companies in the Fortune 500.We also have an agreement with the highly respected UK-based firm, Pensions & Investment Research Consultants, which gives us the ability to provide coverage of more than 1,000 European companies.This summer, we will add coverage of the Russell 3000 companies, as well as fully-automated voting agency services.PROXY Governance intends to be, without question, a full-service provider, and we will respond to the needs of our subscribers.

For more information about PROXY Governance's services, management and Policy Council, go to,