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The dictionary offers two definitions of "gadfly." First is any of various types of insect that bite or annoy livestock. Second is a person habitually engaged in provocative criticism of existing institutions. Neither definition is particularly flattering. The impression is of a parasitic bloodsucking irritant. But in the corporate world, as in the evolutionary scheme, gadflies have a vital, value-adding role.
The Gilbert brothers have been referred to so often as "corporate gadflies" that it has almost become a permanent part of their name. Since 1932, the Gilberts have submitted shareholder resolutions on topics like executive compensation and the location of the annual meeting. Indeed, if not for the Gilberts, shareholder gadflies would have no sting; it was the efforts of the Gilberts which persuaded the SEC to enact the rules governing shareholder proposals in 1942. Before the Gilberts became involved, companies did not have to put shareholder proposals to a shareholder vote. Management did not even have to allow shareholders to speak at the annual meeting. It was corporate gadflies who made the whole system possible.
Now, of course, proposals submitted by shareholders who have held at least one percent or $1000 worth of stock for a year must be included in the company's proxy materials (as long as they relate, but not too closely, to the "ordinary business" of the corporation). The proposals must be put to a shareholder vote. Shareholders can even speak at the annual meetings. But the shareholder proposals are (in almost every case) precatory only. Even a majority vote is not binding. The SEC frequently requires shareholders to redraft proposals to make them explicitly precatory, if it has not been made sufficiently clear in their original form.
And the spacious reach of the "ordinary business" exclusion for proposal subject matter has kept the resolutions on the fringes of corporate activity. The SEC has permitted shareholder proposals on issues like the company's dealings with South Africa or loans to Chile or SDI, but not proposals to assess a percentage of a company's criminal fine among the responsible executives, to establish an ethics committee of the board chaired by an outside director and to establish a board committee to develop and promulgate a code of corporate conduct, to permit shareholders with substantial holdings to use the proxy statement to present one or more nominees for election to the board and to disclose of negative votes by directors on matters considered by the board. Until very recently, it has not permitted resolutions on executive compensation. Its recent reversal opens up one of the most significant new subjects in corporate governance since the shareholder proposal rules were first promulgated.
Once the resolutions are filed, shareholders are also very limited in what they can do to encourage other shareholders to support them. A member of the United Shareholders Association was surprised to find that his plans for a tea party at his home, to explain his proposal to a dozen other shareholders, was in violation of the SEC's solicitation rules. Any communication to more than 10 shareholders must be cleared by the SEC before it can be circulated, a time-consuming and expensive process. Once it has been cleared, the shareholder still faces the daunting task of figuring out who to send it to. In theory, companies must either provide a shareholder list or mail the material to shareholders themselves. But in either case, the person sponsoring the proposal must pay the costs, which can reach hundreds of thousands of dollars. It is all but impossible to get a majority vote; it has occurred less than a dozen times, and in at least one of those cases the company refused to comply with the proposal anyway. These are some of the obstacles that keep shareholders who want to express views or concerns in the "gadfly" category.
And yet, even with this limitations, shareholder activism has made a real difference. A recent study by the well-respected Wilshire Associates shows annual net gains of as much as $137 million, based on stock price changes at 27 companies targeted with shareholder proposals by the California Public Employees' Retirement System (CalPERS). CalPERS, with assets of $65 billion, has been one of the leading institutional investor gadflies.
From 1988-1991 CalPERS sponsored 42 shareholder proposals at 27 companies. The proposals included cancelling poison pills (a device for defeating takeovers), creating shareholder advisory committees, and ammending excessive compensation packages. In half of these cases CalPERS was successful, either through majority votes (3) or settlements (18). One of the study's key findings is that even proposals that do not get a majority vote may add value if investors believe management "got the message" and will act on their own as a result. The study notes "a pattern of proposals, defeated in the first year, but settled in a subsequent year" as support for this conclusion. And this activity has quite a ripple effect. Corporations observe the level of shareholder support for certain resolutions and adjust their own proxy proposals accordingly. John Wilcox, head of the proxy solicitation firm Georgeson, says that corporate management is often deterred from taking actions that have led to expressions of shareholder disapproval at other companies, whether votes in favor of shareholder proposals or against management-sponsored proposals.
In other words, gadflies add value. The market values a company with effective governance provisions, accountable management, and active shareholders more highly than one without. By using the proxy process to implement these provisions, a gadfly realizes value for all shareholders. And these changes do not happen without the influence of shareholders; management won't implement such provisions by themselves since their own self-interest favors entrenchment.
Shareholder resolutions are not the gadfly's only avenue of recourse. CalPERS achieved a significant victory last year by withholding its votes for the board of directors at ITT's annual meeting, to demonstrate their objections to CEO Rand Araskog's 103 percent increase in a year when his company's profits declined 18 percent and its total shareholder returns were outperformed by 83 percent of the S&P 500. CalPERS, USA, and others objected. ITT responded with substantial changes to its compensation plan: future stock options would limit the ability of executives to exercise most options until the stock price had risen at least 25 percent, and a new bonus program would tie cash bonuses to improvements in the company's return on equity. Thanks to gadflies, Rand Araskog is this year's Most Improved Player in the compensation game, and shareholders will no longer bear the cost of inordinately large bonuses.
Other companies have responded to criticism on executive pay. General Dynamics scheduled a special meeting to get shareholder approval for substantial changes in the pay package that gave its executives double their salary for a 10 day rise in stock prices, after pressure from shareholders -- and a visit from "60 Minutes." Institutional investors and members of the United Shareholders Association have successfully negotiated improved compensation changes at several of companies, confidential voting and other changes at dozens of others.
Individual gadflies like the Gilbert brothers and Evelyn Davis are still going, and they often have the support of the institutional investors as well. Last year, Robert A.G. Monks ran as an independent candidate for the board of Sears Roebuck. His campaign, more symbolic than hopeful of success, cost him $250,000. But so ferocious was Sears's response -- they slapped Monks with a lawsuit to prevent him getting a shareholder list, removed three company employees from the board to increase the number of votes he needed, and budgeted $5.5 million to keep him off -- that the shareholder community was stimulated into action, and Sears was forced to make some changes. In late 1991 Sears settled a lawsuit which, in part, accused management of overreacting to the Monks challenge. The company agreed to add three outside directors to their board by 1994, to expand the size of the board's nominating committee, to have an outsider as the chairman of the nominating committee, and to appoint trustees of the employee fund who are not also members of the board. It was Monks' campaign that highlighted the problems caused by Sears' failure to have governance provisions like these in place. (ADD STOCK PRICE--including drop after he declined to run this year.)
The Monks campaign also raised questions about Sears's future as a conglomerate. Monks called for a study of the value to be gained by divesting Sears's financial and insurance services - Dean Witter and Allstate. While refusing to consider such a move Sears did disclose for the first time that Goldman Sachs had advised them that more value could be realized (as much as three times more) by spinning off these subsidiaries. If Sears wants to continue as a conglomerate, it will have to find a way to produce that value for shareholders.
Gadflies have played an increasingly important role in environmental issues. Concern for corporate treatment of the environment following the Valdez spill led to the articulation of the Valdez Principles, ten goals that a signing corporation vows to uphold. They include a commitment to protection the biosphere, wise use of energy, and increased disclosure. Requests to report on the issues covered in the principles were filed as shareholder proposals at twenty-five companies. Sixteen corporations, including Chevron, Mobil and Texaco adopted a toned-down version of the principles without forcing a shareholder vote. At other companies where the proposal did go to a vote including Amex, Exxon and Union Pacific -- between nine and seventeen percent of the shareholders supported the measure. This was an astounding turnout for a social proposal. At Exxon the 9.5 percent support for the Valdex principles represented 74 million shares. The visibility of the Valdex Principles initiatives led the industry to adopt its own standards (distributed on recycled paper), and disclose more information about its efforts.
Shareholders cannot and should not play a direct role in establishing corporate strategy and direction. The consequence of their limited liability is a limited agenda. But they can play a vital role in establishing meaningful accountability for corporate officers and directors. That is why we have the proxy system in the first place. Without gadflies, we would have to rely on corporate raiders for accountability, a group shown to be not only highly imperfect but easily thwarted. Some shareholder initiatives will be insignificant, even detrimental, but overall, the benefits outweigh the costs.
Gadflies, then, have a vital role in corporate behavior. Shareholder action, even when unsuccessful, can add value, promote more accountable management and air important social issues. Often it takes time and effort to get any positive response from a corporation. But never forget that however small the shareholder and however big the corporation, in the end the gadfly gets the animal to move.