The ‘zombie directors’ who lurk on corporate boards

A new analysis by the Council of Institutional Investors reveals how often corporate boards of directors fail to get majority support from investors — but remain on the board. (iStock)

One of the ideas most Americans associate with the concept of elections is that the outcome is decided by a majority vote.

But when it comes to corporate elections of directors, the process sometimes works very differently. The Council of Institutional Investors, a nonprofit association representing pension funds, endowments and foundations whose assets top $3 trillion, released an analysis last week about "zombie directors" — board members who were rejected by a majority of shareholders in annual elections but were still reappointed by their boards to serve. The organization's analysis found that in 2016, 40 of the 44 directors at 27 Russell 3000 companies who failed to win majority support from investors are still holding on to their jobs.

All of those directors serve on boards that have what's called a "plurality" standard rather than a "majority" one. In these, boards only require that directors receive more votes than a competing candidate. Yet since most directors run uncontested, they can win by getting a single vote. And while some of these companies have a policy that says the director must resign if more votes are withheld from them than cast in support, boards can nonetheless decide to reject their resignation and keep them on.

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While it doesn't happen often, it's notable when it does. That's because investors tend to overwhelmingly approve corporate directors — the average vote in favor of directors at S&P 500 companies was 97 percent in 2016, according to proxy adviser Institutional Shareholder Services. Thus failing to get a majority truly stands out, and governance advocates believe companies should take action in these rare circumstances.

"Most companies don’t actually see this happen," Ken Bertsch, CII's executive director, said in an interview. They say "this never happens at our company, so it’s not a problem."

Yet corporate governance advocates believe it remains a problem, even as most large U.S. companies have moved away from it. Over the past decade, investor pressure has prompted many companies to adopt majority voting: Some 90 percent of S&P 500 companies now have it. But among the companies in the broader Russell 3000 index, just over half of companies still have "plurality" voting in the governing documents, either with or without the resignation policy.

Nell Minow, vice chairman of the governance consulting firm ValueEdge Advisers, says policies that allow directors to remain on the board after losing a majority vote hurt investors' capacity to weigh in on how a company is run. "There's no meaningful way for shareholders to hold directors accountable other than the ability to remove directors," she says. "As long as we're still seeing zombie directors continue to serve, it is a problem."

Companies that haven't adopted majority voting tend to defend it, Minow says, by arguing it allows continuity — if too many directors were to lose a majority and be forced to step down, the company's governance could suffer — and that special interests could have too much say in who replaces them. But she doesn't buy it.

"The whole concept of voting is there will be some consequence to it," she says. And if boards put up someone investors don't like as a replacement, "the next year, voters will vote out more directors. There is some muscularity to the system if shareholders can remove directors."

Of the companies in CII's report, most aren't household names. According to the analysis, one director at HubSpot, the marketing software firm that was the target of a satirical book about its corporate culture earlier this year, remains on its board despite not receiving a majority vote this year. At Nabors Industries, the land drilling contractor, three directors failed to get more than half of investors' votes this year after shareholders protested issues including executive pay and their access to nominate directors. The three tendered their resignations, but the board rejected them, saying their resignations were "not in the best interest of the company." It wasn't the first time: Investors withheld a majority of votes from one of the three, John Yearwood, at the company's last four annual meetings, Bloomberg reported in June.

A Nabors spokesman pointed to a lengthy explanation in a company document that was filed with the SEC. It noted "their contributions have helped the company navigate the industry downturn, and the board believes that their continued input will enhance the company’s strategic initiatives in the eventual recovery." A spokesperson for HubSpot declined to comment.

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Boards' willingness to keep on such "zombie directors" is what motivates CII's Bertsch to send letters to the plurality voting holdouts each year, encouraging them to make the switch. "It's pretty effective," he said, "but it's a slow process." Over the past four years, its analysis shows, just 18 percent of directors rejected by investors actually stepped down from boards.

Meanwhile, efforts at the regulatory level haven't been successful. Thanks to intense lobbying by business groups, a provision to eliminate plurality voting on boards didn't make the cut for the Dodd-Frank reform legislation. Yet Minow says in Congressional testimony she has given, lawmakers are often surprised to learn how director elections work.

"You people know what the word 'election' means, but let me tell you what that word means in the corporate context," she says she's told them. "They're dumbfounded to hear you could continue to serve" despite not winning a majority of votes.

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