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Investors to Directors, ‘Can We Talk?’

What if lawmakers never spoke to their constituents?

Oddly enough, that's exactly how corporate America operates. Shareholders vote for directors, but the directors rarely, if ever, communicate with them.


kieferpix | iStock / 360 | Getty Images

Within the clubby world of directors, communicating with shareholders, big or small, is overtly frowned upon: "We endorse the principle that direct engagement involving directors should not be a routine method of engagement for most U.S. companies and for most investors," according to the Conference Board Governance Center Task Force on Corporate/Investor Engagement.

That's why it was so unusual for the chairmen of at least 1,000 large United States public companies to receive a letter this month from a group of shareholders representing more than $10 trillion in assets with a demand: Talk to us. The letter, signed by representatives of some of the biggest investment groups, including BlackRock, Vanguard and Calstrs, insisted that boards open up.

"Engagement between public company directors and their company's shareholders is an idea whose time has come," wrote the group, known as the Shareholder-Director Exchange. "We believe that U.S. public companies, in consultation with management, should consider formally adopting a policy providing for shareholder-director engagement."

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What was uncommon about the letter was that it came not from activist investors like Carl C. Icahn or William A. Ackman, but from institutional investors that until recently had traditionally always supported whatever a company's board recommended. Now, those investors want a dialogue.

The reason boards have long shunned speaking with investors is multifaceted. Management — the chief executive, chief financial officer and so on — usually have meetings with the company's biggest shareholders. Some directors avoid meetings. worried about speaking with one voice. Most don't consider it their responsibility. Some are anxious about accidentally disclosing sensitive information. A memo to directors on this topic from the law firm Latham & Watkins was explicitly titled "Dangerous Talk?"

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Some chief executives are insecure and don't want shareholders to get too close to their boards for fear they will have undue influence. After all, most directors rely directly on management and their presentations to understand what's going on inside the company and what shareholders think.

And then there is this: "Many top executives seem to think that board members cannot be trusted with such interactions," according to Harvard Business Review. "Yet if directors cannot be trusted to meet with and listen to shareholders, how can they be expected to competently govern a corporation?"

The Shareholder-Director Exchange — which was created by the law firm Cadwalader, Wickersham & Taft and the corporate advisory firms Teneo and Tapestry Networks — has drafted what it is calling the SDX Protocol, a series of guidelines it hopes public companies will adopt and publish to determine when shareholder and director engagement is appropriate.

The guidelines suggest that companies decide under what circumstances a shareholder's request to meet with directors should be granted: to discuss the board's composition or management performance, for example. The point is that companies should decide, in advance and transparently, how they plan to communicate directly with shareholders long before a proxy fight were to develop.

Of course, there is a potential downside to all this transparency: If a board becomes too enamored with a particular view from a set of shareholders, it could lead to short-term thinking that undermines long-term performance.

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A new study by the Institute for Governance of Private and Public Organizations, looking at a series of other studies about the value of activism, determined that "the most generous conclusion one may reach from these empirical studies has to be that 'activist' hedge funds create some short-term wealth for some shareholders as a result of investors who believe hedge fund propaganda (and some academic studies), jumping in the stock of targeted companies."

There is also the problem of unfair access. Large investors might have the opportunity to meet with directors while small retail investors almost certainly never will.

There is, oddly enough, a counterintuitive reason that shareholders and directors don't speak. The shareholders despite saying they want a dialogue, actually aren't interested. According to Tapestry Networks, at a conference, a member of Nestlé's executive board, David Frick, "talked about a program to invite its largest shareholders to meet with the chairman in various cities in the U.S. and Europe. He said shareholders had either declined or simply didn't turn up to the meetings."

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Even so, last year's proxy season showed that only a quarter of the companies in the Standard & Poor's 500-stock index "publicly reported engagement efforts or policies in their proxy statements," according to the Shareholder-Director Exchange.

In the age of activism that is clearly not going away, it would seem that some form of engagement from directors with shareholders — rather than directors simply taking their cues from management — would go a long way toward helping boards work on behalf of all shareholders rather just the most vocal.

—By CNBC anchor and New York Times reporter Andrew Ross Sorkin

Contact US Economy

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