Rob Swystun, Pristine Advisers
It’s time again to look at some trends and potential trends in the financial industry. Investors are continuing to flex their collective muscle and companies appear to be reacting accordingly. Many companies also seem to have learned from the mistakes of the last big recession in regards to raising cash.
Investors Flexing Say on Pay Muscles
First, say-on-pay votes have seen an increase in the “no” category, according to the ProxyPulse report for the 2014 proxy season compiled by Broadridge Financial Solutions and PwC’s Center for Board Governance, particularly for mid-cap companies.
While the percentage of shareholders voting in favor of executive compensation packages has remained unchanged since 2013 at 89%, mid-cap companies saw an increase over last year in the number of executive compensation plans that failed to receive majority shareholder support, as reported by CFO magazine’s Matthew Heller.
This year, 6% (41) of mid-cap companies polled failed to get a majority of votes for their executive pay proposals compared to 3% (18) last year.
Additionally, 13% of companies failed to attain the 70% affirmative threshold looked at closely by some proxy advisory firms—a percentage relatively unchanged from 2013. Overall, 123 plans failed to win majority support in 2014, compared to 104 last year.
Wholesale Board Replacement a Very Real Threat Now
What happened to the Darden Restaurant’s board — everyone getting ousted to make way for activist-backed members — was an anomaly … at least for now. But, could it become the norm?
It may never become commonplace, but it already has caused boards to start adapting their strategies, as proxy solicitor Bruce Goldfarb of Okapi Partners explained in a ValueWalk article by Michael Ide.
Starboard Value LP won a decisive proxy fight against Darden Restaurants, Inc.’s former management when it replaced the entire board with its own nominees. The move was prompted in large part by the former board’s decision to sell its Red Lobster restaurants despite the fact that shareholders largely opposed the plan.
Many shareholders saw this as the board making the sale out of spite and decided to take action by giving the board the boot.
And other boards have taken note of this, according to Goldfarb, as they now realize that it is no longer enough just to placate activist investors with one or two board seats while they continue to run things with minimal input. Investors are becoming more engaged and really want to put together the best possible management they can to run the companies they invest in. If under-performing boards don’t really do something to change things, wholesale board replacements may not be such an anomaly in the future.
The buzz word for most boards nowadays is “proactive,” meaning they actively strive to handle any governance issues ahead of time before the activists start rallying.
“Clients have a heightened interest in how their investors think and behave, in part because investors have also become more dynamic in their dialogue,” Goldfarb says. “We’ve found that the interest level on the corporate side for engagement over the last three years especially has picked up. Some of that has to do with say-on-pay and compensation issues and some of it has to do with the recognition that better communicating plan and strategy can be a way of preempting potentially disruptive election campaigns.”
Buybacks Abound (but may be safer this time around)
Company stock buybacks are at their highest since 2007, when companies spent a record amount repurchasing stocks. At their current pace, buybacks will top $568 billion for 2014, just 4% below the all-time high of $592 billion in 2007, according to the Leuthold Group, a Minneapolis investment firm, reports Dallas News’ Will Deener. Buybacks this year are on pace to be about $100 billion above last year’s total.
Recently, buybacks have usurped dividends as the preferred way to reward shareholders. Over 80% of S&P 500 companies have enacted buybacks so far this year, which is on par with 2007.
When companies announce large buyback programs the price of their shares usually spikes because if their earnings remain constant, fewer outstanding shares will result in higher earnings per share, resulting in higher stock prices.
Companies also prefer repurchasing stock over issuing dividends because if cash gets depleted, a company may have to stop paying the previously announced dividend, which investors don’t like to hear.
Last time buybacks were going this crazy, it helped to usher in that little financial crisis from a few years back.
However, there are stark differences between that time and this time:
- In 2007 companies actually spent more on buybacks than they did on capital expenditures, meaning they weren’t investing in their companies’ future, according to research analyst at the Leuthold Group Kristen Hendrickson. But, that is not the case this time.
– 2007, buybacks amounted to 131% of capital spending with companies spending $140 billion more on buybacks than on capital expenditures and often incurring debt to fund these buybacks
– 2013, buybacks amounted to 84% of capital expenditures and are on pace for that ratio this year
2. Buyback ratios are smaller. Comparing the dollar amount of buybacks with companies’ market capitalization — outstanding shares multiplied by the price per share, what Hendrickson refers to as a buyback ratio:
– 2007, the median buyback ratio for S&P 500 companies that repurchased shares was 4.1% overall and 10.8% for the top 100 companies
-2013, the ratio had dropped to 2.5% overall and 7.2% for the top 100 companies
3. Demand for stock generated from buybacks hasn’t artificially bolstered stock prices enough to affect the current market.
– 2007, buybacks for the typical S&P 500 company accounted for 2.2% of the annual trading volume, according to Leuthold
– 2013, buybacks for the typical S&P 500 company accounted for only 1.4 percent of the annual trading volume, meaning buybacks are not a material factor in either trading volumes or stock prices.
“In 2007 a lot of things got frothy and overdone,” Hendrickson said. “Companies are behaving a little better now. They are making capital decisions in a more disciplined manner.”
So, it seems that while this current buyback frenzy is reminiscent of 2007, it’s just different enough to not be a portent of doom like it was back then. It’s almost like we’ve learned from our mistakes and are doing things differently this time. (Learning from mistakes? There’s something that doesn’t happen everyday.)