At the general meeting of Tesla Inc. on June 11, 2019, two management proposals seeking to introduce shareholder-friendly changes to the company’s governance structure failed to pass, despite both items receiving support by more than 99.5 percent of votes cast at the meeting. To get official shareholder approval, the proposals needed support by at least two-thirds of the company’s outstanding shares. However, only 52 percent of the company’s share capital was represented at the general meeting; based on turnout alone, there was no possible way for the proposal to pass.
As strange as the voting outcome at Tesla may seem, it is not a very unusual result. Every year, dozens of proposals are not considered to be “passed,” even though they receive support by an overwhelming majority of votes cast at the meeting. Supermajority vote requirements may be responsible for a large portion of these failed votes with high support levels (62 percent of instances since 2008). However, using a base of all outstanding shares for the vote requirement is an even more common corresponding factor (92 percent of instances). The increase in failed majority-supported proposals in recent years can be directly attributed to the change in the rules pertaining to the treatment of broker non-votes.
Vote requirements in the U.S. can be mindboggling to anyone unfamiliar with governance practices and proxy voting. This article provides an overview of some important factors to consider when assessing proxy vote results and meeting agendas in general. We highlight the following key takeaways:
- Vote requirements vary significantly by proposal type. Mergers, share issuances, and changes to the bylaws typically require support by a percentage of all outstanding shares, while the outcome of most other proposals is determined based on votes cast.
- Supermajority vote requirements are very difficult to remove, and they make it very difficult for companies to implement governance reform and shareholder-friendly governance practices.
- Broker non-votes can play an important role in determining a voting outcome, as they often make up a significant portion of the company’s outstanding shares, and they are excluded from most proposals, except for routine times, such as the ratification of auditors.
- The plurality vote standard remains common practice at small-cap firms, as approximately 72 percent of non-S&P 1500 Russell 3000 companies continue to employ the practice. Only 29 percent of companies with a plurality vote standard have a director resignation policy in place.
Framing the Problem: Key Voting Concept Questions
There are three key questions that investors should ask to have a firm grasp on vote requirements at U.S. meetings:
- The voting base: What will the denominator be to determine an item’s passing or failing?
- The vote standard: What’s the difference between a plurality, majority, or supermajority requirement?
- Broker non-votes: How do they factor into vote results, and how has that changed in recent years?
The following sections will address each of these questions.
Vote Requirement Base
Voting base refers to the denominator of the vote result figure – to determine the proportion of supporting votes, are the “For” votes divided by “For” and “Against” votes, or are “Abstain” votes included, or is the denominator the total number of outstanding votes eligible to be cast? To make matters even more complex, vote requirements may vary by company, by state of incorporation, and even by proposal type on different items on the same proxy ballot.
Individual states typically have default provisions for the vote requirements to pass a resolution, but companies can adopt their own voting thresholds based on provisions in their bylaws. Changes to the charter and bylaws, approving business combinations (such as mergers), and share issuance authorizations typically require approval by a percentage of shares outstanding.
Advisory votes on compensation, shareholder proposals (which are also precatory in nature), equity compensation plan approvals, and auditor appointments are generally based on votes cast, with an almost equal split between companies that count abstentions as cast votes compared to companies that only count votes “For” and “Against.” Thus, in many instances, abstentions are considered as votes cast, even though they do not represent sharers voted. Abstentions play a minor role in vote results on management proposals, and they are not expected to significantly impact a voting outcome. On average, less than 0.3 percent of votes are cast as “Abstain.”
However, until recently, abstentions appeared much more frequently at environmental and social shareholder proposals, making up to approximately 15 percent of all votes cast on such issues in 2010. By 2019, as investors have integrated ESG into their stewardship framework and have examined social and environmental issues more closely, the rate of abstentions on these proposals has dwindled to a record-low of 1.3 percent of votes cast so far in 2019.
Vote Standard: The Proportion of Votes Required to Pass
Once the base is set, the next key item is the vote standard – that is, the proportion of votes required to be cast “For” a proposal to consider it as passed. In this arena, there are three key concepts: a simple majority vote standard and supermajority vote standards; and – in the specific case of director elections at some companies – a plurality vote standard.
A supermajority requirement establishes that a proportion of greater than 50 percent (calculated using the vote base as defined by the company) is needed to consider a ballot item passed. These supermajority requirements often are pegged at numbers between 55 and 80 percent. Making matters more difficult, supermajority vote standards are often linked to voting bases of all outstanding shares and votes.
Simple majority vote standards represent exactly what you expect: half (plus one) of all votes cast should be cast “For” a ballot item, though that half is based on the denominator set by the vote base. Of course, there are strange implications of this: for instance, using the entire share capital as the base for approving a resolution raises the approval bar significantly – it’s in effect a “supermajority in disguise.” For example, a proposal with a vote requirement of a simple majority of shares outstanding at a company with the median vote turnout of 80 percent of shares outstanding would require approval by approximately 62.5 percent of votes cast at the meeting.
Once put in place, a supermajority vote requirement is very difficult to remove, due to the factors discussed above. To remove the supermajority vote requirement, a company would need to change its articles or bylaws, where the voting requirement threshold is normally based on votes as a percentage of all outstanding shares. At companies with significant shares held by brokers and not instructed, it becomes especially difficult to pass a resolution. From June 2018 to May 2019, 29 percent of management requests to reduce the supermajority vote requirement failed, even though they were supported by management, and they received a median support rate of 98 percent of votes cast.
Among companies that have supermajority vote requirements in place, approximately half apply voting thresholds between 55 percent and two-thirds of outstanding shares, while the other half use thresholds of more than two-thirds of outstanding shares.
Ownership structure plays a vital role in determining the impact of a supermajority vote requirement. In certain instances, a supermajority vote requirement is considered beneficial to minority shareholders. For example, at controlled companies, a supermajority vote requirement may ensure that significant decisions are not made unilaterally by the controlling shareholder (depending on the stake of the controlling entity). According to ISS data, approximately 37 percent of controlled companies had supermajority vote requirements for the amendment of bylaws or charter (compared to approximately 60 percent of non-controlled companies), while only 10 percent of controlled companies have supermajority vote requirements to approve a merger (compared to 15 percent of non-controlled companies).
Director election proposals are also based on votes cast, but they form a separate category, as many companies continue to employee the plurality vote standard in the U.S., which allows for directors to be elected by receiving a minimum of a single vote in favor, irrespective of the opposition, since votes not in favor are “withheld.” A growing number of companies that use the plurality vote standard have introduced a “director resignation policy.” This mechanism provides that, if a director fails to receive support by the majority of votes cast, they are required to submit their resignation to the board, and the board can decide whether to accept or reject the resignation. While the so-called “plurality plus” standard increases the level of accountability at boards, it does not ensure that shareholder concerns are always addressed. Based on ISS Analytics data, approximately 29 percent of companies with a plurality standard for director elections currently apply a director resignation policy. And, in some of those cases, boards have exercised – either explicitly or implicitly – the option not to accept an unelected director’s resignation.
To vote shares held by a broker, the beneficial shareholder needs to provide the broker with instructions on how to vote the shares. If the beneficial owner fails to provide voting instructions, the broker can vote on behalf of the beneficial owner on “routine” proposals. Until the end of the previous decade, brokers were able to submit these so-called uninstructed votes on several proposals, including director elections, certain article amendments, and the ratification of auditors. In 2010, brokers could no longer vote uninstructed votes on director elections and say-on-pay votes. In 2012, the NYSE updated its definition of “routine” proposals further to exclude certain corporate governance proposals, such as the declassification of the board, the reduction of supermajority vote requirements, and the adoption of the majority vote standard for the election of directors. With the exclusion of broker non-votes, it became more difficult to approve these resolutions, even with management’s support, as the trend depicted in our first graph and this year’s Tesla vote illustrates.
Broker non-votes can make up a significant portion of the company’s share capital. Based on ISS data for vote results from June 2018 to May 2019, the median broker non-votes accounted for approximately 9 percent of the shares outstanding at U.S. companies. Broker non-votes typically represent shares held by individual investors. In the case of Tesla, broker non-votes accounted for 28 percent of the company’s outstanding share capital in 2019. Therefore, a high percentage of broker non-votes can significantly increase the likelihood of a “non-routine” management resolution (including proposals seeking to improve governance practices) failing to pass at the meeting.
The 2012 NYSE updates did not change the “routine” classification for proposals dealing with the appointment of auditors. Therefore, brokers can vote uninstructed shares at these proposals, and the relevant votes also count towards quorum. Even though no laws or regulations require the appointment of auditors to be approved by shareholders, most U.S. general meeting includes this resolution as a routine item, which allows companies to ensure that quorum is met.
Managing the Potential Challenges of Vote Requirements
Understanding a company’s vote requirements in the context of its ownership structure can help investors address potential governance risks. Two of the biggest challenges for implementing governance reforms are supermajority vote requirements and a significant number of shares held by brokers that are typically not instructed. Understanding these dynamics can potentially make it easier to engage with companies, so that they may improve their governance before it becomes too difficult. For example, it may be easier for younger companies to remove supermajority vote requirements at their earlier stages, when ownership is relatively concentrated and fewer shares are held by investors who do not vote their shares. In addition, to promote greater accountability at the board, investors may engage with companies about their voting standards for uncontested director elections and monitor the vote results of director elections and companies’ responses to low support levels. A good understanding of the implications of vote requirements and a pro-active engagement with companies will likely help manage governance risks before it may be too late or too difficult to do so.
This post comes to is from Institutional Shareholder Services. It is based on the firm’s memorandum, “An Overview of Vote Requirements at U.S. Meetings,”dated June 21, 2019.