ISS Proxy Advisory Services recently recommended that shareholders of, Provident Financial Holdings, Inc., withhold their votes from the three director candidates standing for reelection to the company’s board because the board adopted a bylaw designed to discourage “golden leashes.” Golden leashes are special compensation schemes offered to dissident director nominees by activist investors. The precise terms of the arrangements vary but in general they provide that, if elected, the dissident directors will receive large bonuses if the company achieves certain goals within an allotted time frame.
The potential problems such schemes pose to the integrity of the boardroom and board decision-making processes are immediately obvious. As pointed out by Wachtell Lipton in a client alert golden leashes:
"undermin[e] Board prerogatives to set director pay and select the timeframe over which corporate goals are to be achieved;
creat[e] a multi-tiered, dysfunctional Board in which a subset of directors are compensated and motivated significantly differently from other directors;
creat[e] economic incentives to take the corporation in the specified direction, and within the timeframe, that would trigger outsized compensation, whether or not doing so would be in the best interests of all shareholders, would engender inappropriate and excessive risk, or would sacrifice long-term value for short-term gain;
open a schism between the personal interests of directors who stand to benefit in the short-term from the special compensation scheme and the interests of shareholders with a longer-term investment horizon;
creat[e] poisonous conflicts in the boardroom by creating a subclass of directors who have a significant monetary incentive to sell the corporation or manage it to attain the highest possible stock price in the short-run; and
introduc[e] unnecessary and problematic complexity and conflicts in strategic reviews and calling into question those directors’ ability to satisfy their fiduciary duties."
On the other side, activist investors argue that such arrangements benefit all shareholders because they incentivize directors to focus on share gains and to ignore activist positions that might harm share value. Further, they suggest that golden leashes will attract better candidates to run for board seats, enhancing the quality of representation for all shareholders. Jolene Dugan of ISS argues that bylaws banning golden leashes are “concerning because [they] could deter legitimate efforts to seek board representation via a proxy contest, particularly those efforts that include independent board candidates selected for their strong, relevant industry experience and who are generally recruited, but not directly employed by, the dissident shareholder.”
Many issues are fueling the fight over the bylaw in question in the Provident case. First, it is a direct example of the growing tensions between companies and activists investors. Second, the bylaw goes further than simply requiring disclosure of third party compensation to directors by banning such compensation outright. In addition it bans all outside compensation to directors or nominees which would prohibit activist investors from compensating individuals for standing for office –a not uncommon practice. Third, while Provident is a small company, several large multinational companies including Halliburton, Marathon Oil, Eastman Chemical and Wynn Resorts have adopted a version of the bylaw.
Finally as with so many issues in corporate law the opposing sides are arguing about the process by which the bylaw was adopted—fighting over process as much, if not more than, as content. The Provident board adopted the bylaw without taking to a shareholder vote and without a “compelling explanation from the board” according to ISS.
Regardless of the result of the Provident vote, it is likely that some reasonable compromise will emerge to address the issue of third party compensation of dissident directors. The precise parameters of that compromise remain to be seen but perhaps a scheme could be devised under which directors could be compensated by third parties for running for office but not thereafter and shareholders would ultimately be given the right to vote on any such arrangement.
Regardless of the vote of the Provident shareholders, the golden leash provision shows the never-ending ingenuity exercised by those in the corporate sphere. For better or worse these types of issues are bound to keep arising.