Cumulative Voting

Discussion

Background

Cumulative voting allows shareholders to amass, or cumulate, their votes for one or more directors on the ballot. Each shareholder is entitled to as many votes as are equal to the number of his or her shares multiplied by the number of directors to be elected, then he or she may cast all of such votes for one nominee or may distribute them among two or more nominees at his or her discretion.

For example, consider a company with a 10-member board and 500 shares outstanding. The total number of shares that may be cast is 10 x 500, or 5,000. In this case, a shareholder with 51 shares (10.2 percent of the outstanding shares) would be guaranteed one board seat because all votes may be cast for one candidate. This provision facilitates the election of minority representatives to the board and can be particularly significant in proxy contests where dissident candidates are seeking election to the board.

The power of cumulative voting is diluted at companies with classified boards. Because only one-third (in the case of a board divided into three classes) of the directors stand for election at any one time, it takes three times as many votes for a shareholder's choice for director to be guaranteed a board seat. In the example above, 151 shares (30.1 percent of the outstanding shares) would be required to guarantee a board seat if the company had a three-class board.

Fewer than 10 percent of S&P 500 companies currently provide for cumulative voting, although most companies have the option of using cumulative voting if provision is made in the charter permitting its use.

Cumulative voting is a corporate governance tool that shareholders can use to protect their interests. It is a means of giving shareholders access and influence over director elections. Supporters of cumulative voting argue that it ensures that holders of a significant number of shares may win board representation. However, while cumulative voting can be a cornerstone in the protection of shareholder rights, the need for cumulative voting can be offset by a different mix of safeguards that protects shareholders' rights in the nomination and election of directors.

Critics charge that cumulative voting promotes special interest candidates who may not represent the interests of all shareholders. Also, directors have emphasized the need for a "collegial" board in order to encourage candor.

In recent years, many companies with cumulative voting policies have sought shareholder approval for charter amendments to eliminate this practice. At the same time, some shareholder rights advocates have sponsored proposals to permit cumulative voting at companies that do not use it. However, most of these proposals have failed to gain majority support, typically garnering between 20 and 35 percent of votes cast, unlike proposals to submit poison pills to a shareholder vote or to declassify the board, which now often command majority support. Cumulative voting resolutions in 2007 received an average of 33.5 percent support.

One of the reasons why cumulative voting proposals have failed to gain greater support may be the nature of the firms targeted by shareholders. Companies that receive these proposals tend to be larger firms that already have a number of good governance provisions in place. And despite the failure of these proposals to achieve majority approval, shareholders tend to submit these same resolutions to the same companies year after year.

Although cumulative voting was the standard practice in the early 1900s, it has become increasingly rare. According to ISS’ database, about 290 companies in the U.S. allow for cumulative voting.

Advantages of Cumulative Voting

• Cumulative voting supports the interest of minority shareholders in contested elections--by concentrating their votes, they can elect a dissident nominee to the board;
• It is a low-cost method for institutional investors to get representation on the board, when compared with waging a proxy fight;
• It is quick--it all takes place in one election cycle; And
• It guarantees the dissident candidate will be put to a vote (similar to a proxy fight), as opposed to merely suggesting candidates to the nominating committee and relying on them to decide if they wish to nominate him or not.

Disadvantages of Cumulative Voting:

Cumulative voting is not universally seen as a benefit for investors. It has several drawbacks:

• Depending on the particulars of the company’s charter/bylaw, proxies tendered by shareholders that vote FOR director nominees can be re-allocated by the company. For example, many proxies explicitly state that persons named in the proxy card will allocate the votes to elect the largest number of management nominees as possible;
• It overturns the rule of one share, one vote, and the rule of the majority. Some institutional investors oppose it on principal;
• It lacks transparency: votes can be manipulated to force outcomes; and
• It is operationally difficult: electronic voting does not allow for it.

Evolution of the ISS Policy on Cumulative Voting

Before the advent of proxy access and the majority vote standard, ISS would examine specific governance factors as an acceptable alternative to cumulative voting including the following:

• Majority voting threshold in director elections, including a carve-out for plurality in contested situations;
• Annually elected board;
• Two-thirds of the board composed of independent directors;
• Nominating committee composed solely of independent directors;
• Confidential voting; however, there may be a provision for suspending confidential voting during proxy contests;
• Ability of shareholders to call special meetings or act by written consent with 90 days' notice;
• Absence of superior voting rights for one or more classes of stock;
• Board does not have the right to change the size of the board beyond a stated range that has been approved by shareholders;
• The company has not under-performed both its industry peers and index on both a one-year and three-year total shareholder returns basis, unless there has been a change in the CEO position within the last three years; and
• No director received WITHHOLD votes of 35 percent or more of the votes cast in the previous election.

Even though these factors did not directly address vote standards, the rationale was that if the company showed evidence of board independence, impartiality in the nominating process, and accountability to shareholders, this was sufficient to offset the need for cumulative voting.

We have re-examined our policy in light of the introduction of proxy access and majority voting reforms that directly address the voting process. A majority vote standard ensures board accountability in uncontested elections. In contested elections, similar to cumulative voting, proxy access allows shareholder access to the ballot without a veto from the nominating committee, but unlike cumulative voting, it also requires majority support to elect such directors. The introduction of proxy access and majority voting serve as an effective counterbalance to cumulative voting as they directly address the voting process and help ensure board accountability to shareholders.

Majority Vote Standard: A majority vote standard, in combination with a plurality standard in elections with more nominees than seats, and a director resignation policy to address post-election results, has emerged in the last few years as a catalyst to make director elections meaningful rather than merely symbolic. In 2007, ISS Governance Services added it to the list of factors considered as an alternative to cumulative voting. One could argue that boards elected under such a majority vote structure are sufficiently accountable to shareholders and that this structure alone is an acceptable alternative to cumulative voting. Indeed, ISS supports management proposals that bundle or condition the adoption of majority voting with the removal of cumulative voting.

Although majority voting is meaningful in uncontested elections, it can potentially serve as an anti-takeover mechanism in contested elections. Cumulative voting, on the other hand, is meaningful primarily in contested elections. Also, while majority voting and cumulative voting are not totally incompatible, it is certainly possible (and permissible) in an uncontested election for a company to override a withhold/against campaign against a director by cumulating votes for that director.

Proxy Access: Proxy access combines both minority representation and rule by the majority in a two-step process. The minority representation arises in the nominating process: generally, access-related shareholder proposals call for investors representing 3-5 percent of outstanding stock to be able to nominate a director. However, rule by the majority is still safeguarded: to actually elect that director to the board requires more shareholders to vote for that nominee than a management nominee. This avoids some of the objectionable parts of cumulative voting. Also, a SEC draft rule on access considered in 2007 did away with the “triggering” events that were in a 2003 SEC draft rule (e.g., ignored majority-supported shareholder proposals; 35 percent withhold levels on directors) that made shareholder dissatisfaction with the board require two election cycles to address. However, the future of proxy access is uncertain. The SEC decided in November 2007 to allow companies to resume omitting shareholder access proposals. Nevertheless, issuers may still adopt their own proxy access bylaws.