This article, the first in a two-part series looking at diversity in the boardroom, is drawn from ISS' 2006 Board Practices/Board Pay study.

Board diversity has received increasing attention from institutional investors in recent years. This year, activist investors continue to press companies to add women or minorities to their boards. Church groups and social investment funds have so far filed board diversity resolutions at 15 companies including Bed, Bath & Beyond; CBS; Overseas Shipholding; and, for the second year in a row, at Torchmark, asking each to "publicly commit itself to a policy of board inclusiveness."

While support for the proposals has historically been modest--11.6 percent of votes cast supported the Torchmark proposal in 2005, and 10.2 percent this year, for example--some corporate governance experts believe that the engagement of different views and perspectives on diverse boards is fundamental to achieving board effectiveness, and so investors have continued to focus on diversity.

Companies, meanwhile, remain opposed to efforts to promote diversity, noting they agree with proponents' arguments but disagree with the process. Bed, Bath & Beyond, for example, asked shareholders to vote against the resolution, arguing the proposal was "inappropriately restrictive, would unduly limit the Company in its selection of Directors, would involve cost in time and effort without any commensurate benefit and would, therefore, be detrimental to the best interests of the Company and its shareholders."

Notably, Monster Worldwide management took the unusual step this year of making no vote recommendation on a diversity proposal. Vote results from the June 7 annual meeting are not yet available.

Trends
As might be expected, larger U.S. companies have more diverse boards. S&P 500 companies are almost twice as likely to have a woman or a minority on the board than small-cap companies. Overall, only 12 percent of all directorships are held by women, and only 10 percent are held by members of a racial or ethnic minority group, according to data gathered by ISS' Governance Research Service from 1,269 companies in the S&P 1,500 that held their meetings between Jan. 1 and July 31, 2005. The data are largely based on proxy filings for fiscal 2004.

Moreover, only 1.2 percent of directorships are held by minority women, suggesting that few companies use this approach in responding to calls for increased diversification. The opportunity for diversity on boards may be hindered by the lack of diversity in the executive suite, where most companies recruit their directors. Less than one percent of all directorships are held by female CEOs, and the same holds true for minority CEOs. Because so few women and minorities hold top executive positions, companies often are competing for the same individuals to fill board vacancies.

Given the recent reforms requiring increased director independence, there has been speculation that companies would recruit women and minority directors in higher proportions than in years past. As women and minority directors tend to be more independent than their counterparts (89 percent of women directors and 86 percent of minority directors are independent), some observers predicted that women and minority directors would be sought out to meet the new independence requirements. It appears that this may be somewhat true only in the case of women. Fifteen percent of directors that have been added to boards in the last year are women, but minorities account for only 5 percent of these new directors.

In addition to the new independence requirements, disclosure laws adopted in late 2003 by the Securities and Exchange Commission now require increased disclosure concerning the director nomination process. Companies must now disclose: the criteria used by the nominating committee to screen nominee candidates, including shareholder recommendations; the qualifications the nominating committee believes company directors, or a given director, should have; the nominating committee's process for developing and considering nominees; the source of each of the board's nominees, including the use of third parties to identify potential nominees; and the nominating committee's policy with regard to the consideration of shareholder recommendations, among other things.

Traditionally, boards have often relied on the relationships and knowledge of current board members in recruiting new directors--a process that has perpetuated the all-white, all-male board. The new disclosure rules, by putting pressure on the nominating process, held promise to open the door to increased diversity. However, the overall percentages of women and minority directors has remained stable amid the implementation of the nominating disclosure and independence reforms.

Female Directors
The overall proportion of female directors increased by 1 percentage point from 2004 to 12 percent in 2005 (as reported in 2004), indicating the recruitment of women to boards has increased very slowly over the past six years (in 1999, women accounted for 9 percent of all directorships). Women are significantly more likely to serve on the boards of larger companies. Fifteen percent of all directors at S&P 500 companies are women, compared to 8 percent at small-cap companies.

Overall, however, 70 percent of the study companies had at least one female director as of 2005. Though the incidence of boards without any women directors has varied slightly from year to year, the general trend has been for more boards to include at least one female. Company size is clearly correlated to female representation on the board--the larger the company, the more likely it is to have at least one woman director. Nonetheless, mid-cap companies have seen the biggest jump since 1999, when only 59 percent of the companies in that index had a female director.

There is a clear correlation between company size and the incidence of female directors. This also holds true when size is measured in terms of revenue: 98 percent of companies with revenue of $10 billion or more had at least one woman director on their boards; conversely, only 43 percent of companies in the smallest revenue band (less than $500 million in revenue) had at least one female on the board. The proportion rises along with revenue, to 59 percent for companies in the $500 million-$1 billion band, to 74 percent in the $1 billion-$3 billion band, and to 84 percent in the $3 billion-$10 billion band.

The percentage of companies including women on their boards varies considerably by economic sector. Firms in the utilities sector are the most likely to include at least one woman on the board, although more females hold directorships overall in the consumer discretionary products sector. Conversely, companies in the energy and information technology sectors are the least likely to have women serving on their boards and also have the lowest percentage of female directors overall.

It does appear that companies are trying to recruit female directors. Based on analysis of directorships over 2004-2005, 15 percent of those who were new to the board during the period were women, versus 11 percent among those directors who were already serving prior to 2004. The rate of females to the board appears to be greater than the existing female representation on boards, indicating that adding female directors is a growing trend. The study found that at least 24 companies (five more than last year's list) have at least four women on their boards. Among those were Albertson's, New York Times, and SBC Communications, which each had six female directors.

Attributes of Female Directors
Women directors are more likely to be independent from the company where they sit on the board than directors generally. Eighty-nine percent of directorships held by women are classified as independent, as compared to 72 percent of directorships overall, and only 69 percent of directorships held by men. Only 7 percent of women directors were considered affiliated, versus 12 percent of male directors. These differences between the general independence levels of male and female directors underscore the failure of new independence rules to stimulate substantial diversity on the board, however. While 93 percent of the female directors who first joined their boards in the last two years are independent, they represent only 16 percent of all the new directors during that period.

Few women directors are employees at firms where they sit on boards, reflecting the small though growing numbers of women in top executive positions. Only 66 women are employees of the company where they serve on the board, representing one-half of a percent of directorships overall. Twenty-four of these women are CEOs of their firm, with the highest proportion represented in the consumer discretionary sector.

June 29, 2006

Walking the Talk: Big Box Retailers Commit to Review Energy and Climate Performance
Submitted by: Doug Cogan, Deputy Director of ISS' Social Issues Service

In light of the annual meeting today at Bed, Bath and Beyond (where certain BBB shareholders have submitted a proposal requesting that the company report on its response to rising regulatory, competitive, and public pressure to increase energy efficiency), the below article on energy and climate performance is an interesting and timely read...

Walk into any Home Depot or Lowe's department store and you're sure to find hundreds of Energy Star(R) appliances. But what if you're in the market for an energy efficient "Big Box" retailer or real estate investment trust? Soon investors will have information to help shop for those, too.

Thanks to a new shareholder campaign, The Home Depot in Atlanta, Ga., and Lowe's in North Wilkesboro, N.C., will report in coming months on their strategies and progress to make their operations more energy efficient and less harmful to the environment.

Simon Property Group in Indianapolis, Ind., the nation's largest shopping mall company, and Liberty Property Trust of Philadelphia, Pa., a real estate manager with more than 700 office and industrial properties, also have agreed to disclose such information in response to recent shareholder requests.

Together, these four companies manage nearly 600 million square feet of building space.

Focus on Energy Management

The impetus for these disclosure requests comes from a group of environmentally minded investors who see a connection between these companies' ability to control energy costs and their own bottom lines. They know that property managers play a critical role in shaping the nation's energy demand and greenhouse gas emission trends. According to the Environmental Protection Agency, 70 percent of all U.S. electricity use and 40 percent of total energy demand is consumed in residential and commercial buildings.

With energy prices and concerns about global warming on the rise, more attention is being focused on how companies are controlling their energy costs. However, few companies in the buildings sector report on their energy use and energy management strategies in their annual reports, securities filings or on their corporate websites.

So, starting in 2005, shareholder proponents led by the Nathan Cummings Foundation, the New England Yearly Meeting of Friends Pooled Funds (Quaker) and the Sierra Club Mutual Funds started filing shareholder resolutions with major homebuilders and commercial property managers, asking them to assess "rising regulatory, competitive, and public pressure to increase energy efficiency" and report to shareholders.

Their efforts got a boost in October 2005, when Wal-Mart made a major announcement that it would invest $500 million a year in technologies to reduce its stores' greenhouse gas emissions by 20 percent within seven years, mainly through energy efficiency measures. Wal-Mart is the world's largest Big Box retailer, with 3,800 stores in the United States and 6,000 worldwide.

As Wal-Mart CEO Lee Scott explained at the time, "If you had told me 12 or 18 months ago that we would be doing a focus on the environment, I would have told you that that would be a good public relations campaign, nothing more. But the truth is, the more we learned, the more opportu-nity we saw for Wal-Mart."

Apparently, Wal-Mart is not alone. The Home Depot and Lowe's arrived at the same conclusion four months later. Having received energy efficiency shareholder proposals for their 2006 annual meetings, they agreed in February to issue detailed reports on their energy management programs in exchange for having the resolutions withdrawn. Lowe's report is due in September 2006. The Home Depot will issue its report in February 2007. (Download file to see a comparison of energy efficiency commitments made by Wal-Mart, The Home Depot and Lowe's.)

2006 Proxy Season

Altogether, 10 homebuilders, commercial property managers and Big Box retailers received energy efficiency shareholder proposals for the 2006 proxy season. With four withdrawal agreements and exclusion of one proposal by the Securities and Exchange Commission, five of the resolutions are expected to come to votes. (Download file)

Support for two proposals at companies whose annual meetings came early in the year were modest. Only 5.5 percent of the shares voted were in favor of the proposal at homebuilder D.R. Horton in Fort Worth, Tex. At Whole Foods Market, a natural foods chain in Austin, Tex., which has pledged to purchase all of its energy needs from wind power, making it the largest private buyer of renewable energy credits in the United States, just 8.9 percent of the votes were cast in favor of the energy efficiency proposal.

At Standard Pacific's May 10 annual meeting in Irvine, Calif., however, the homebuilder saw support for its shareholder proposal soar to 39.3 percent. That vote was the highest ever for an energy efficiency or global warming proposal.

Other resolutions are pending at Bed Bath & Beyond in Union, N.J., and at homebuilder Centex in Dallas, Tex., whose annual meetings are scheduled during the summer.

REIT Disclosures

Of the two retail estate investment trusts that ne-gotiated withdrawal of their shareholder proposals, one already has made good on its pledge to increase its disclosure on energy efficiency. Simon Property Group added three paragraphs to its annual Form 10-K securities filing, issued on March 31, 2006.

Under the heading "Energy Costs Conservation," Simon reported that it began monitoring and benchmarking its energy consumption in 2003 and started "a process to assess energy efficiency across our enclosed mall properties." This effort grew into a comprehensive strategy to improve energy efficiency in 2004, when the company launched its "Energy Best Practices Program."

Simon Property Group expanded its energy monitoring efforts in 2005 with a web-based tracking tool for managers, which allows them to review energy use and trace costs in real time. In 2004 and 2005, Simon cut its overall electricity use by 6.8 percent compared to 2003 levels. The savings avoided more than 84,000 metric tons of CO2 emissions, or enough to power nearly 10,800 U.S. homes for a year, according to EPA estimates.

In 2005, Simon Property Group also was named a finalist for the Platts Global Energy Award for Industry Leadership. The National Association of Real Estate Investment Trusts gave the company its Bronze Leader for the Light Award, which is awarded in collaboration with EPA. Simon was the only REIT to receive this award in 2005.
Liberty Property Trust also plans to expand its reporting on its energy efficiency programs in its next Form 10-K filing. In a memo to proponents from the New England Friends, James Bowes, the company's general counsel, said that Liberty "would provide, in reasonable detail, a discussion of the projects and steps undertaken" in 2006 "in furtherance of these efforts, and would also include, to the extent reasonably practicable, quantitative measure of the success of these efforts."

As in other discussions with other companies, the proponents want Liberty to be able to document how its energy efficiency programs are affecting its financial performance and industry competi-tiveness. In 2007, the company will open a new 57-story office tower in Philadelphia, Pa., for which it is seeking Gold Certification under the U.S. Green Building Council's Leadership in Energy and Environmental Design ("LEED") program.

Also 'Walking the Talk'

Given the progress made in recent months, share-holder proponents believe their campaign to promote energy efficiency in the buildings sector has "legs" that will extend into future years. They also now have backing from some of the nation’s largest institutional investors. The California Public Employees' Retirement System and TIAA-CREF, for example now routinely support shareholder resolutions that seek systematic disclosure of energy use and energy management strategies by homebuilders and property managers.

These funds are themsleves major property owners and are finding that they, too, have to "walk the talk" when it comes to achieving energy savings. CalPERS owns approximately $5 billion of core real estate that includes investments in office, retail, industrial and apartment properties. Its board has set an energy reduction goal of 20 percent in these properties over the next five years.

"Besides collecting information [on energy use], we will strongly support shareowner resolutions at individual companies to address environmental impacts," said Chuck Valdes, Chair of CalPERS Investment Committee in March 2006. "In the long run, we believe it's possible to do well in business by doing what's good for the environment."

To read about the energy use commitment by the three big box retailers plus view the 2006 energy efficiency shareholder resolutions, Download file

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June 27, 2006

In Memory of Ginny Rosenbaum
Submitted by: Rosanna Weaver, Governance Research Analyst

Corporate governance at its essential core is an attempt to measure and understand some hard to codify items. Ginny Rosenbaum, who died early last Thursday after a long battle with cancer, knew that precision, consistency and accuracy were the tools needed for such measurements. The balance of power between the trinity of management, board, and shareholders may rest on such arcane details as whether broker non-votes are counted in the tally of a particular resolution, or whether the company has erected an insurmountable hurdle to keep shareholders from calling a meeting. Ginny knew that details mattered and was passionate about getting them right.

When Ginny first interviewed at IRRC in 1976, if you wanted a proxy you needed to visit the SEC to get it. Thirty years later, with "corporate governance" now a household term turning up in PowerPoint slides everywhere, Ginny was still reading proxies. No one was better at finding the critical, and most hidden details. An intern commented last week that much of what Ginny did - still, and by her own choice - was "grunt work." In many ways it was, but Ginny's pleasure in "getting it right," and her understanding of the larger context, gave it great value.

In her honor and memory we commit to doing our best to get the details right.

We invite you to use comments on this blog to share memories of Ginny, which we will forward to her family.

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June 26, 2006

Listing Rules Tilt Level Playing Field
Submitted by: Geof Stapledon, Managing Director of ISS Australia, and Martin Lawrence, Lead Analyst of ISS Australia

ISS Australia's Geof Stapledon and Martin Lawrence had a piece published in the Australian Financial Review on why the Australian Stock Exchange (ASX) listing rule exception should be removed. We welcome your comments on the ASX listing rule.

Listing rules tilt level playing field
Geof Stapledon and Martin Lawrence. Geof Stapledon is managing director, and Martin Lawrence lead analyst, of Institutional Shareholder Services, Australia.

22 June 2006
Australian Financial Review

Stock exchange shareholders suffer at the hand of the ASX itself, write Geoff Stapledon and Martin Lawrence.

The merger of the Australian Stock Exchange and the Sydney Futures Exchange highlights an inequity in the way ASX listing rules apply to mergers and scrip-funded takeovers.

Due to a little-publicised exception in the rules, only the target company's shareholders get to vote on mergers. Despite often having their shareholdings diluted materially, the bidder's shareholders don't get a vote. At the moment it is the shareholders of the ASX - of all organisations - that are faced with being diluted, without any right to vote on the deal.

The shareholders who reportedly forced the ASX board to install Robert Elstone in place of Tony D'Aloisio as chief executive of the combined entity were, in fact, SFE shareholders. This is because only its shareholders get to vote on the merger. ASX shareholders stand to be diluted by between 35 and 40 per cent if the merger is implemented.

That they aren't getting to vote on the deal appears to be inconsistent with the long-standing ASX listing rule that puts a cap on dilution by requiring shareholder approval if a board wishes to increase the equity on issue by 15 per cent or more in any 12-month period.

The reason why no meeting of ASX shareholders is required is a long-standing exception in the listing rules for shares issued under an off-market takeover bid or under a merger by scheme of arrangement. The ASX-SFE deal is a merger by scheme of arrangement. There is also an exception for shares issued (for example, under a placement) to fund the cash consideration for a takeover bid or a merger by scheme of arrangement.

What is the justification for denying the bidder's shareholders the right to vote on a scrip bid or merger that materially dilutes their equity holdings? The answer is not obvious.

Why should a dilutionary issue of shares to facilitate a full takeover or merger by scheme of arrangement receive special treatment, compared to a dilutionary issue of shares to acquire a major asset?

To take an extreme example, Alinta's proposed bid for AGL would have resulted in Alinta shareholders being diluted to about 25 per cent of the merged entity - without any opportunity to approve this massive dilution. Alinta's management wanted to structure the bid as an AGL scheme of arrangement, voted on solely by AGL's shareholders.

In the context of the ASX and the SFE, it could be argued that, at the same time their percentage shareholding is diluted, ASX's shareholders become investors in a larger enterprise.

The transaction results in them having a smaller percentage of a larger pie - which in an ideal world will leave them no worse off.

But that still leaves unanswered why SFE shareholders get to vote while ASX shareholders get no say on an equity issue that dilutes them by up to 40 per cent - and which will have major consequences for the value of their shares.

Some may point to the fact that institutional investors are often shareholders in both the bidder and the target. And some may argue that an extra meeting is an unnecessary extra expense although, given the costs of most mergers, any extra costs are unlikely to be material.

Requiring shareholder approval for scrip bids or for equity raisings made to fund scrip bids may reduce the attractiveness of such types of bids. Critics may say it would simply lead to an expansion in the use of debt-funded takeovers (given few companies are in the position to make major acquisitions from existing cash reserves) that require no shareholder approvals. But the credit rating implications of overreliance on debt would probably act as a brake on any such trend.

The fundamental issue is whether shareholders get to approve dilutionary share issues, a principle already firmly (if, it seems, only partially) embedded in the listing rules. After all, if a merger or acquisition is likely to increase shareholder wealth, there would appear to be no reason for the bidder company's board to fear putting it to shareholders. The listing rule exception should be removed.

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June 23, 2006

ISS Introduces Options Backdating Information Center
Submitted by: Sarah Cohn, Director of Communications

There are now dozens of companies under investigation for potentially backdating stock option grants and the list of companies coming under scrutiny seems to be growing daily. To keep investors informed on this fast-moving issue, Institutional Shareholder Services (ISS) has launched an Options Backdating Information Center. To visit the site, please click here.

To read the latest Governance Weekly article on the options controversy, please continue reading.

Options Spark Global Concern
By Ted Allen, Director of Publications

The U.S. stock options timing scandal is attracting the interest of pension funds in Europe and Australia, which along with U.S. pension funds and other investors have filed more than 70 lawsuits against at least 25 firms.

Darren Robbins, a partner with the law firm of Lerach Coughlin Stoia Geller Rudman & Robbins in San Diego, told the Associated Press that the pension funds are "completely beside themselves and outraged over the self-dealing that has gone on."

Robbins said he is bringing 34 cases on behalf of 350 to 400 pension funds. "The damages total in the tens of billions of dollars," Robbins told Red Herring, a technology industry magazine, noting that he would seek to recover for the market value that investors have lost after companies disclosed option probes.

As part of any settlement, Robbins said his pension fund clients are going to seek the replacement of directors who allowed the backdating of grants as well as the ouster of executives who profited from those options. "That's their position," he told Red Herring. "They're just not going to accept it. These companies are owned by investors, primarily pension funds. These people are owners and not the employees."

Among the investor plaintiffs are the New South Wales Treasury, which filed a lawsuit against American Tower in Massachusetts.

More than 50 firms had disclosed internal, regulatory, or criminal probes into whether the timing of option grants was manipulated to maximize executive compensation. This week, Delta Petroleum said it received a subpoena from federal prosecutors for records on its option grants since 1996. In addition, Progress Software delayed filing quarterly results as it completes an internal review of option grants. On June 21, Altera announced that it will restate 10 years of earnings. Nine other companies have said they will restate results to account for option grants, according to Bloomberg News.

Around the world, investors and regulators are taking a closer look at corporate option grants and other executive compensation practices. David Tweedie, chairman of the International Accounting Standards Board, said European securities regulators are looking at the option timing issue. "We're looking very closely at what's happening here, and we'll also have to do something about it too," he said in an interview with Bloomberg News. "We've got exactly the same problem."

In Australia, mining firm Oxiana disclosed on June 20 that it had mistakenly undervalued options granted to executives and directors by about A$1 million, The Australian newspaper reported. Oxiana's chairman agreed to review the company's options after its remuneration report received a 46 percent "no" vote in April. Most reports have received less than 10 percent opposition since Australian firms started submitting their remuneration reports to non-binding shareholder votes in 2005.

In France, securities regulators are probing stock sales by senior executives at EADS, which occurred before its Airbus unit announced jumbo jet production delays that caused the company's shares to fall.

Questions at Home Depot, Microsoft
Back in the United States, two industry leaders have acknowledged irregularities in how they used to date option grants. On June 16, The Wall Street Journal reported that Microsoft awarded stock grants to employees at monthly lows from 1992 to 1999. A spokesman for the software giant said the practice was legal and did not constitute backdating because the grant prices were set at the lowest price in the 30 days after the grants. Microsoft disclosed in 1999 that it was ending that practice and took a $217 million charge. According to the Journal, Microsoft's practice may have violated accounting standards then in place that required companies to book expenses for "in-the-money" options.

Also on June 16, Home Depot disclosed three instances before December 2000 where executives received stock options with exercise prices that were below the market price on the day they were approved. The company has faced recent investor criticism over the pay received by CEO Robert Nardelli. Ten directors received "withhold votes" of more than 30 percent at the home improvement retailer's May 25 annual meeting.

"It's very disturbing," Charles Elson, director of the John L. Weinberg Center for Corporate Governance at the University of Delaware, told Bloomberg News. "It's a particularly damaging disclosure vis-à-vis their relationship with shareholders."

Another concern is that shareholders may end up paying the taxes and penalties owed by executives who received improperly timed options. In a June 15 filing, Brocade Communications said it will pay $3.32 million to executives and employees who received options that are under scrutiny. The company said it has offered to cancel the options or to raise their exercise price, and then pay the employees the difference in cash. One executive will receive a $581,812 payment, Bloomberg reported.

"Were the options designed as an incentive or a reward?'" Elson told Bloomberg News. "If they were designed as an incentive, there is no sense in reimbursing'" employees and executives for taxes due.

Earlier this month, the California Public Employees Retirement System urged 24 companies to fully disclose their option grants and "to refrain from using any company resources to satisfy the tax and legal liability for executives implicated for wrongdoing related to the backdating of options."

Meanwhile, a new survey by consulting firm Watson Wyatt shows that large majorities of both directors and institutional investors want U.S. firms to move toward the greater use of equity incentives that vest only after performance goals are met. More than four out of five corporate directors and two-thirds of institutional investors surveyed by Watson Wyatt said they would prefer performance vesting, but they disagree on what performance metrics should be used.

"Directors and institutional investors want to see performance vesting, rather than time vesting, on both options and shares,'" Ira Kay, Watson Wyatt's global director of compensation consulting, told Bloomberg News. "They're much harder to earn because there's a greater likelihood of forfeiture."

The Watson Wyatt survey included 50 institutional investors and 50 directors. While they differed on how to determine severance payments, 79 percent of directors and 85 percent of investors agreed that the U.S. compensation model has hurt corporate America's image. For more on that survey, click here.

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June 21, 2006

Growing Support for Majority Vote Proposals
Submitted by: Sarah Cohn, Director of Communications

Shareholder support for proposals seeking majority voting in director elections has averaged 47.3 percent support at 80 meetings this season. Last year, those proposals averaged 44 percent at 60 firms. This season, majority vote proposals received an average of 54.5 percent approval at 33 meetings where companies had not previously announced board election reforms such as a director resignation policy. Support was lower at firms with director resignation policies such as the one at Pfizer and over 90 other firms, averaging 42.1 percent at 47 meetings this season.

To see the results so far this season, Download file

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June 20, 2006

Sudan Divestment Moving to Targeted Approach
Submitted by: Nancy Coelho, Senior Director of Marketing

No one disputes the facts about the horrific genocide occurring in the Darfur region of Sudan. However, deciding how to influence change in this troubled region has been the source of significant debate, resulting in a variety of divestment strategies among many states' public pension funds as well as many college and university endowment funds.

ISS has been working on this issue since 2001 and has worked with many public pension funds, colleges and universities to meet the regulatory criteria of their respective states. ISS has also worked with student leaders who have been very successful in getting the issue on the agenda at Trustee meetings and state legislatures. What is significant about the students' approach is their thoughtfulness in recommending a targeted approach to divestment by making a distinction between companies that are financially benefiting the Sudanese government versus those that are benefiting Sudan's citizens.

By taking a more targeted approach to divestment, institutional investors have the flexibility to pursue the most effective approach that balances their funds fiduciary obligation to their shareholders while also influencing change in the Sudan region.

A recent story in the Chronicle of Higher Education discusses this move to a more targeted approach regarding Sudan Divestment. To read the story, Download file

We welcome your comments on the Sudan Divestment movement.

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June 19, 2006

Looking back at the 2006 French Proxy Season: Use of Poison Pills
Submitted by: Catherine Salmon, Research Manager, France

In March 2006, a new law on hostile takeovers of French companies was issued in application of an EU directive and proposed by the French finance minister Thierry Breton. The changes were seen by the market as a direct result of the country's growing protectionism.

Following this new law, companies subjected to a hostile bid would be able to issue free warrants convertible into shares at a potentially discounted price to existing shareholders. These poison pill measures can be used only if approved by shareholders at a general meeting, by a simple majority. Since April 2006, 15 companies, including big names such as Suez, Bouygues, and Compagnie De Saint Gobain, have requested shareholder approval for the issuance of free warrants during a takeover.

The resolution was approved by 55% of Saint Gobain shareholders and 63% of Suez shareholders. This means that in both cases, the resolution would have been rejected had an extraordinary majority been required. In Bouygues, 49.7% of which is held by three strategic shareholders, 85% of votes were cast in favor of the resolution. But based on the 59.7% quorum participating in the meeting, this corresponds to only 50.5% of total voting rights in the company.

Another recurring agenda item since April 2006, consists in authorizations to the Board to issue shares in the event of a public tender offer. This is a takeover defense with respect to the Law of Reciprocity (as for issuances of free warrants). It was submitted to shareholder approval by 15 companies as well, all small caps except for Bouygues.

Currently, we are not aware of any of these resolutions being rejected by the required simple majority. What are your thoughts on economic nationalism as an answer to globalization? We welcome your comments.

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June 16, 2006

Investors Seek Answers on Options
Submitted by: Ted Allen, Director of Publications, and Subodh Mishra, Managing Editor

The California Public Employees Retirement System (CalPERS) and the Council of Institutional Investors (CII) have asked companies to explain how they determine the timing of stock option grants and to disclose if their executive pay practices are under investigation.

In addition, the AFL-CIO has sent letters to the compensation committee chairs at Countrywide Financial and seven other firms, asking them to disclose if any option grants were improperly timed and to adopt new safeguards.

More than 45 companies now face criminal, regulatory, or internal investigations into whether they backdated or otherwise manipulated the timing of stock option grants to maximize compensation for senior executives. Among the latest firms to disclose probes include: Macrovision, Meade Instruments, Monster Worldwide, Broadcom, Equinix, Applied Micro Circuits, and Cyberonics. Comverse Technology, Michaels Stores, Asyst Technologies, and Semtech have delayed filing financial reports as their option practices are investigated. In addition, investors have filed more than 60 lawsuits against more than 20 companies, according to Bloomberg News.

Backdating "can have a pernicious effect on executive compensation," Ann Yerger, CII's executive director, wrote in her June 12 letter to companies. “By giving an executive an instant paper profit, backdating undermines the purpose of options, which is to motivate executives to act in ways that lift the stock price. For this reason, the Council believes that except in extraordinary circumstances, long-term incentive awards of options should be granted at the same time each year."

CalPERS, in its June 7 letter to 24 firms, urged directors to:

--Conduct an independent investigation into backdating allegations.
--Publicly disclose all findings from both internal and external investigations.
--Develop and disclose in public financial statements and proxy statements a new board policy for the determination of all option grant dates.
--Refrain from using any company resources to satisfy the tax and legal liability for executives implicated for wrongdoing related to the backdating of options.
--Commit to have the company's external auditor ratified by shareowners annually.

CalPERS sent its letter to: Affiliated Computer Services, Altera, American Tower, Analog Devices, Brooks Automation, Caremark Rx, Comverse Technology, F5 Networks, Jabil Circuit, KLA-Tencor, Maxim Integrated Products, McAfee, Meade Instruments, Medarex, Openwave Systems Power Integrations, RSA Security, SafeNet, Semtech, Sepracor, Sycamore Networks, Trident Microsystems, UnitedHealth Group, and Vitesse Semiconductor.

"Stock option backdating potentially threatens the credibility, governance, and performance of companies," Russell Read, CalPERS' new chief investment officer, said in a statement.

AFL-CIO Secretary-Treasurer Richard Trumka, in his June 13 letter, urged compensation committees to grant options on predetermined dates that are at least 30 days from earnings announcements, to set grant dates independently from executives, and to avoid granting options for executives and directors at the same time. He also urged firms to consider replacing options with stock grants that vest after performance goals are met.

The labor federation also sent its letter to Occidental Petroleum, American Express, Cardinal Health, Eli Lilly, McGraw-Hill, Proctor & Gamble, and U.S. Bancorp.

On June 7, the AFL-CIO called on the Securities and Exchange Commission to address stock option grants as it finalizes new executive compensation disclosure rules. The CFA Centre for Financial Market Integrity, in a May 30 letter, urged the SEC to require the disclosure of:

--The compensation committee's meeting dates for the preceding year.
--The dates when the committee plans to make share-based awards.
--Whether any grants were made on other dates.
--Whether any grant dates were selected to take advantage of the pending release of material information.
--Whether any executives were permitted to select or recommend grant dates for their options.

"The intent of these disclosures is to enable shareholders to hold boards accountable for improper behavior," the CFA Centre noted.

Regulators and Lawmakers Respond
The widening scandal has attracted the attention of regulators and senior lawmakers. On June 8, SEC Chairman Christopher Cox said his agency will require firms to "release all information related to their [stock option] decisions," including the rationale for those grants and dates when the options were priced, according to news reports. Cox said the new pay disclosure rules should be in place by next year's proxy season.

"We expect this to be written in plain English so every investor can understand it," Cox said in a speech to the New York Financial Writers Association. "No shareholder should need a machete and a pith helmet to find out how much the CEO makes."

Two senior lawmakers have also called for action. U.S. Senator Richard Shelby, chairman of the Senate Banking Committee, expressed concern that backdating would undermine investors' "belief in the integrity of the marketplace. Transparency and integrity are keys to capital markets."

"If you're backdating stock options . . . that's fraud," Shelby told reporters on June 8. "And we should punish people who do that."

U.S. Senator Charles Grassley, who chairs the Senate Finance Committee, said he hoped that the SEC and the Justice Department "are taking a hard look at this practice."

"I've asked the Justice Department to let me know whether the tax laws on the books are adequate to rein in and prosecute stock option backdating. If the tax laws are inadequate, I want to beef them up," Grassley said in a June 13 press release.

To review the CalPERS letter, click here:

To read the CII letter, click here.

To review the CFA Centre's letter to the SEC, click here:

To see Senator Grassley's statement, click here:

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June 15, 2006

Corporate Governance Hits the Weblogs
Submitted by: Rosanna Weaver, Governance Research Services Analyst

Does the topic of corporate governance resonate outside the confines of the world of corporate secretaries, pension fund activists and academics? Evidence that it does can be found today on DailyKos, a democratic blog that bills itself as the most highly trafficked blog on the internet. According to Sitemeter.com the site receives an average of over half a million visits per week, and has had 3.5 million visits in the past week. The blog includes a feature in which members can write essays, known as diaries, and readers can vote on the one they consider the most important or relevant. The number one recommended diary this morning wasn't about Karl Rove or the Iraq war but about the fact that Home Depot directors didn't attend the company's annual meeting. By 11 o'clock more than 225 comments had been added to the diary titled, "Why What Happened at Home Depot's Annual Meeting Matters," and while many discussed the political leanings of executives at Home Depot or the quality of service at the big box hardware store, several offered interesting thoughts on director independence, executive compensation and implications of corporate governance to the larger political picture.

Click here to read more.

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Investors Focus on Pills, Pay Disclosure as Japan's Proxy Season Begins
Submitted by: Subodh Mishra, Managing Editor of ISS Publications, and John Taylor, Principal Researcher, Japan Governance Research Services

With Japan's proxy season set to get under way next week, market observers are abuzz over this week's arrest of shareholder activist Yoshiaki Murakami, who admitted June 5 to engaging in insider trading.

The 46-year-old Murakami, whose $3.5 billion MAC Asset Management reshaped the governance landscape of the world's second largest economy, is best known for launching the first-ever hostile takeover by a Japanese company when he targeted real estate firm Shoei in 2000.

Since then, MAC, whose stated mission is to promote and unlock shareholder value through effective corporate governance, has been the bane of many old-guard corporate managers who fear the fund will target their cash reserves and non-core assets by forcing them to raise dividends, buyback stock, or sell off assets.

Near-term fallout from Murakami's arrest will likely include tougher shareholder disclosure requirements, The Wall Street Journal reported. Japan's Diet is expected to pass a bill later this month requiring professional investors, brokerage houses, and banks to report to authorities within two weeks of the date at which their holdings exceed 5 percent of a company's outstanding equity. Currently, those types of investors have three months to file such disclosures, the newspaper reported, thus leaving many corporate share registers exposed.

Meanwhile, shareholders likely will focus on Japanese companies adopting "poison pill" takeover defenses without shareholder approval, as well as investor efforts to improve pay disclosure.

Domestic and foreign funds have increased their pressure on corporate boards that adopt poison pills with shareholder consent. As reported in the April 21, 2006, issue of Governance Weekly, Japan's influential Pension Fund Association (PFA) will vote against incumbent directors at companies that adopt pills without seeking shareholder approval of such provisions. The PFA manages 12 trillion yen ($104 billion) in assets, 4 trillion yen of which are invested in major domestic, exchange-listed corporations. While the association's investments represent only a small fraction of Japanese corporate pensions, it acts as a manager of last resort for insolvent funds.

The PFA is calling on companies to provide a full description of their plans and to put them to a shareholder vote. The association has set four conditions for supporting any poison pill, but those standards still leave the PFA with significant discretion that may invite corporate lobbying:

Management must provide "adequate explanation" of how the defense would be "useful" in boosting long-term shareholder value.

The firm must seek advance shareholder approval of the pill plan's details.

The pill plan must clearly spell out what would actually trigger the action to dilute a raider's position, as well as conditions that would preclude such action, "such as oversight by a committee of non-executive directors."

Any plan must have a two- to three-year sunset provision.

Similarly, Japan's Pension Fund Association for Local Government Officials (PAL) is opposing "poison pill" defenses adopted without a shareholder vote.

Without targeting specific companies, PAL is publicly urging its external equity managers to vote against the election of directors at firms where boards have formally adopted poison pill defenses.

Some foreign fund managers also have voiced concerns over board-adopted pills and may vote against directors at companies where shareholders are not given a vote.

"Hermes will on an individual basis deal with companies that have adopted a pill without shareholder approval," Makoto Seta, Asia-Pacific associate director of corporate governance at Hermes Pension Management, told Governance Weekly. A Hermes affiliate is a part owner of ISS.

Seta cautioned that votes against directors would be a last option, and that decisions to do so would be based on: what type of pill was adopted (with "dead-hand" features, for example); whether a threat of acquisition was real or perceived; and the fund's past dealings with a company. Hermes is looking at roughly 50 companies in its portfolio that have adopted pills without shareholder consent, though not all would be engaged, Seta said.

Enhanced pay disclosure also will be a focus of shareholders this proxy season. In a move similar to its proposals to Sony in the past four years, the Kabunushi Ombudsman (or "Shareholder Ombudsman") coalition proposes to amend the articles of association to require disclosure of the individual compensation of each of the five highest paid members of Sony's board of directors. The proposed bylaw would require the firm to include these details in the financial report that accompanies the annual meeting notice sent to shareholders (or to their local custodians in Japan, in the case of foreign shareholders) each year. Sony has long been seen as a governance trailblazer in the Japanese market.

The coalition's earlier proposals fell short of the 67 percent required for passage, but they did receive 31.2 percent of votes cast in 2004, and 38.8 percent support in 2005. While Sony has never agreed to amend its articles, the firm has voluntarily provided more compensation details in its proxy circular than the legal minimum, unlike the vast majority of companies in Japan.

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June 14, 2006

The Trifecta
Submitted by: Bruce Carton, Vice President of Securities Class Action Services

As stated in this press release last week by the SEC, the disbursement of $750 million to Bristol-Myers Squibb shareholders began on Thursday, June 8. This $750 million includes (1) $150 million BMS paid to settle the SEC's case against it, (2) $300 million BMS paid to settle a related securities class action, and (3) $300 million BMS paid in a deferred prosecution agreement with the U.S. Attorney's Office in New Jersey to address the company's criminal liability. The combined $750 million in funds from the SEC case, civil action and criminal case is being distributed all at once to shareholders who filed a claim last year with the claims administrator--The Garden City Group--in the BMS securities class action settlement.

As a result, we have what I believe to be the first claims filing "trifecta"--civil, SEC and criminal settlement money all rolled into one giant distribution. Shareholders who filed a timely proof of claim in the BMS securities class action settlement will actually receive a share of $750 million, not just the $300 million from the civil settlement. Conversely, shareholders who fail to file a claim in the BMS civil settlement miss out on the money from that settlement, as well as the additional $450 million from the SEC and criminal settlements.

The moral of the story, as usual: File those claims.

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June 13, 2006

Stocks Options, Directors and Accountability
Submitted by: Bill Mackenzie, President of ISS Canada

I see a stock option problem surfacing in Canada. Resource companies, buoyed by high resource prices, are stock option gold mines not only for management, but also directors. It seems that some directors at some of the smaller resource companies have seen fit to grant themselves ever larger option packages. Although non-executive director compensation has topped the $100,000 mark at some of Canada's largest companies, we are seeing some packages, driven by stock options, top $500,000 and even $1 million at some smaller ones.

For example, non-executive directors of Yamana Gold received a grant of 1.5 million Yamana options in 2006. Averaging 300,000 options per non-executive director, with an exercise price of just under $10, these options had a Black-Scholes value in excess of $1,000,000 per director at the time of grant. By the time we obtained the proxy circular, they had an intrinsic value of nearly $1 million per director. There was nothing in the proxy circular to support unusual board activity that would merit such an exceptionally large compensation package, which had mushroomed from that of the previous year. Unfortunately, there are others like Yamana.

What this means is that the concept of accountability needs to be reinforced with many boards. The language of Canadian proxy circulars with regard to directors' stock option compensation invariably reads "the company granted options to directors..." as if there were some superior being "the company" that was there to deal at arms length and look after shareholder interests. Is this what "independence" has come to mean? How independent are directors that pay themselves such fees?

Does casting a withhold vote punish these mega-grant directors? With our plurality system, they get elected. Usually even publicly filed vote results disclose that directors were elected "by show of hands" at the meeting, so even the embarrassment of a high withhold vote by proxy is unlikely to be felt outside the boardroom. Fortunately, we have the press, who are merciless on perceived abuses. Yet the press will not win the battle if shareholders are standing silently on the sideline.

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June 12, 2006

Investors Sue Firms Over Options
Submitted by: Ted Allen, Director of Publications, and Rosanna Landis Weaver, Governance Research Analyst

As federal probes into corporate stock option grants widen, investors have filed 45 lawsuits against UnitedHealth Group (UHG) and more than a dozen other U.S. companies, alleging that the timing of option grants was manipulated to maximize compensation for executives.

On June 6, Securities and Exchange Commission Chairman Christopher Cox said the growing number of firms that are reviewing their option granting practices is "of serious concern to the commission." Investors also are calling for the agency to take action. On June 7, the AFL-CIO urged the SEC to address option grants as it finalizes new executive pay disclosure rules. Cox appears receptive to that idea; he told reporters that the agency's new rules "will improve our ability to deal with this issue," but he did not elaborate.

So far, at least 34 companies have disclosed criminal, regulatory, or internal investigations in option grants, according to Bloomberg News. Fifteen executives and directors, including five CEOs and three general counsels, have quit or been fired.

Shareholder activists and academics have long speculated that some corporate executives were timing their option grants to occur before the release of good news that would spur market gains, a practice sometimes referred to as "spring loading." One indication that many of these anomalies are more likely based on backdating is the fact that the number of such statistically improbable gains fell sharply after the Sarbanes-Oxley Act (SOX) went into effect. One SOX provision implemented by the SEC reduced the reporting period for many executive transactions including option grants from 45 days after the end of the fiscal year to two days after the transaction.

Accounting and tax rules stipulate that an option with an exercise price below the market value of the stock on the (actual) grant date constitutes a discount-priced option. If a company's grants are determined to have been discounted without proper disclosure and accounting, the firm could face significant tax penalties and may have to file a restatement. Most stock incentive plans provide that the option price is set at the stock's fair market value on the grant date, so determining a grant and then setting the exercise price at an earlier date would violate the terms of the plan. One of the investor lawsuits against UnitedHealth characterized the practice as the "equivalent of picking the lottery numbers after they have been announced on the evening news."

Earlier Investor Doubts
Most of the companies being probed are small companies that have relied heavily on options. In many cases, it appears that shareholders had concerns about company option programs prior to the recent regulatory scrutiny, as evidenced by above-average shareholder opposition to specific option plans. In 2004, shareholders expressed greater opposition to management-sponsored equity incentive proposals at several of the companies that are under investigation, according to data compiled by ISS' Governance Research Service.

At CNET Networks, which announced May 24 that the SEC had begun an investigation into the company's option practices, 44.5 percent of votes cast opposed the firm's 2004 option plan, despite the fact that CNET's dilution level was less than at industry peers. This negative vote was significantly higher than the average 24.6 percent opposition to option plan proposals at S&P 1,500 firms in 2004.

In 2004, 41.9 percent of votes cast opposed an equity plan at Renal Care Group, which recently received subpoenas from prosecutors about its option granting practices. Boston Communications, identified by The Wall Street Journal as a company where statistical analysis of options grants showed suspicious patterns, also received above-average opposition to its 2004 option proposal with a 34.3 percent negative vote.

At F5 Networks, 46 percent of votes opposed the company's 2005 option plan, which exceeded the 25.5 percent average shareholder opposition that year. On May 18, the company announced it had received a grand jury subpoena for documents related to option grants since 1995.

Companies with questionable option grants may have other accounting problems, according to two finance professors whose research helped spark the recent media and regulatory scrutiny of option grants. Erik Lie, a finance professor at University of Iowa, and Randall Heron, a finance professor at Indiana University, said investors should look more closely at the other accounting practices of those firms.

"This sends a signal that management is willing to fudge numbers for their own benefit and they might be willing to play other accounting tricks," Heron told Bloomberg News.

Lie estimates that at much as 10 percent of all stock options granted in the decade before August 2002 were backdated. For more background on option backdating, see Lie's faculty Web site here.

Investor Lawsuits
In the lawsuit against UnitedHealth directors, a group of pension funds allege the board allowed UHG chairman and CEO William McGuire to "dictate his own compensation through the secret manipulation of the company's stock option plans" for almost a decade. Public pension funds from Ohio, Connecticut, Minnesota, Louisiana, Florida, and Mississippi have joined that lawsuit, which is pending in federal court in Minnesota.

"We claim that UnitedHealth's CEO and other executives secretly bled the company with the board's blessing," Connecticut Attorney General Richard Blumenthal said in a May 31 press release. "Connecticut demands an immediate halt to this illegal, immoral practice and return of ill-gotten gains to the company, as well as damages for stockholders."

The lawsuit, which includes both class action and derivative claims, contends that UnitedHealth's directors "completely abdicated their fiduciary responsibilities" to shareholders, leading the company to overstate its earnings and issue misleading financial statements since at least 1997.

The Ohio and Connecticut pension funds are represented by the law firm of Grant & Eisenhofer, while Bernstein Litowitz Berger & Grossmann represents the St. Paul Teachers' Retirement Fund Association, the Public Employees' Retirement System of Mississippi, the Jacksonville (Florida) Police & Fire Pension Fund, the Louisiana Sheriffs' Pension & Relief Fund, and the Louisiana Municipal Police Employees' Retirement System.

Other companies recently sued by investors include Juniper Networks, KLA-Tencor, American Tower, Nyfix, Computer Sciences, and Affiliated Computer Services. Last year, investors sued Tyson Foods, Cisco Systems, Brocade Communications, and Mercury Interactive over their option granting practices. More shareholder lawsuits are likely, as additional companies disclose probes into option grants. Sepracor and Quest Software are among the latest companies to announce option inquiries.

On June 5, Merrill Lynch released a research report concluding that 40 companies in the S&P 500 may have timed their option grants from 1999 through 2002. This list includes Dillard's, Sherwin Williams, Northrop Grumman, and other firms outside the technology and health-care industries, where much of the scrutiny by regulators and investors has been focused. The Merrill analysts compiled their list after finding that those firms had better-than-average stock performance in the 20 days after option grants.

Shareholder Response
In addition to filing lawsuits, investors have taken the issue directly to the SEC. In a June 7 letter, AFL-CIO Secretary Treasurer Richard Trumka urged the commission to amend its proposed rulemaking on executive compensation disclosure "to address stock option grant procedures and controls." As Trumka noted, "The most troubling aspect of stock option backdating is that boards apparently relinquished responsibility for setting option grant dates to executives" which Trumka said could open the door to self-dealing.

Several shareholder activists have indicated that they are following this issue closely and said they expect to file resolutions to address option grants.

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June 7, 2006

Interesting Column on Climate Change in Today's WSJ
Submitted by: Meg Voorhes, Director of Social Issues Services

A column in today's Wall Street Journal by Alan Murray titled "Frustrated 'Greens' Turn to Boardrooms," highlights the gravity of the climate change issue. Murray underscores for Journal readers that climate change is an urgent problem that requires action by the U.S. government. And, while Murray goes on to say that businesses "do best when they stick to business," and the issue of climate change belongs in Washington, the messages from both the Ceres report and ISS webcast emphasize that climate change is a business issue, one that poses varying risks and opportunities to individual companies.

Please send along your comments to let us know your views on the connection between climate change and corporate governance.

The Economy
BUSINESS: Frustrated 'Greens' Turn to Boardrooms
By Alan Murray
848 words
7 June 2006
The Wall Street Journal
A2
English

IF YOU ARE awake at the end of Al Gore's movie, "An Inconvenient Truth," you'll be called to action. Go to www.climatecrisis.org , the bold white words on a black screen tell you, and find out what you can do to combat global warming. The Web site allows you to "offset" the pollution of your house, your car and the rest of your carbon-besotted existence by investing in a wind farm or a project to "capture" methane from the hindquarters of farm animals.

This is the new face of the environmental movement in the U.S. Having failed at the ballot box (although Mr. Gore and many of his followers still believe he didn't fail), the greens have turned their attention to private action, exhorting individuals and corporations to do their part to solve the problem.

Among corporations, at least, this tack is yielding some results. While the powers in Washington still drag their feet on climate change, those in Fairfield and Wilmington and Bentonville -- following the lead of their colleagues in Europe -- are taking some surprising strides.

The latest example is Wal-Mart Stores, which said last week it is considering selling a heavy ethanol blend, known as E85, at the 385 service stations it owns and operates at Sam's Clubs and Wal-Marts around the U.S. This is big news, indeed -- although it comes with a hitch. Wal-Mart plans to take this step only if it concludes it can make money in the process. And right now, that's questionable.

For one thing, only about 4% of the cars on the road in the U.S. can run on E85. And those so'called flex-fuel cars tend to be concentrated in the Midwestern corn belt. Elsewhere, the percentage is lower.

For another, E85 is currently selling at about the same price as gasoline. Because ethanol is less efficient than gasoline -- drivers get about 25% fewer miles to the gallon -- that's not a very good deal for consumers.

"The approach we are taking," says Rich Ezell, Wal-Mart's senior strategy manager for fuel, "is how can we get E85 to the marketplace at a price that compensates for the loss in fuel economy and so that we as a company don't lose money on it."

Still, give them credit for trying.

Part of what's happening here is that a new generation of corporate leaders -- people like Chad Holliday at DuPont, Jeff Immelt at General Electric and Lee Scott at Wal-Mart -- are following the example of John Browne at BP and personally pushing this issue. They may agree with President Bush on tax and regulatory policies, but on global warming, they think he's missing the boat. They also believe the green movement could be a business opportunity.

Another prod to corporate action is coming from activist shareholder groups, who are a little too eager to turn the boardroom into a forum for controversial public-policy debates. In the wake of Hank Greenberg's departure as chief executive at insurance giant American International Group, for instance, activists representing labor unions and public-pension funds persuaded the company to create a new board committee to address public-policy issues like climate change. It is headed by Bill Clinton's former United Nations ambassador, Richard Holbrooke.

Last week, Institutional Shareholder Services, which advises pension funds and other institutions on how to vote their corporate proxies, held a Webcast entitled "Corporate Governance and Climate Change: Making the Connection." It highlighted a new report by Ceres, a subsidiary of ISS, which ranks 100 companies on how well they are addressing global warming.

The report gives BP its highest score of 90, DuPont a respectable 85 and GE a passable 58. But other companies, like ConAgra Foods, UAL's United Air Lines and Williams Cos., scored below 5. Representatives for all three companies declined my invitation to challenge whether global warming should be debated in the board room. Instead, they argued the Ceres report overlooked many of the fine things they were doing to address the problem.

The danger here is that boards of directors get turned into debating societies for the most fractious issues of our times. If they are going to take on global warming, why not health-care reform? Or the killings in Darfur? Or gay marriage? Corporations and their boards are lousy forums for settling such prickly partisan issues. They do best when they stick to business.

To be sure, global warming is an urgent issue. As one CEO recently put it: "We don't have a lot more time to deal with climate change." But the same man also emphasized that voluntary action alone can't solve the problem.

Who was that CEO? Hank Paulson of Goldman Sachs Group, recently tapped to be Treasury secretary. Now he's on his way to Washington, where the issue belongs.

---

Email me at business@wsj.com and read reader comments Saturday at WSJ.com/TalkingBusiness

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June 6, 2006

A Tale of Two Studies: China's Investors, Top Companies, and Corporate Governance
Submitted by: Stephen Deane, Vice President and Director, ISS' Center for Corporate Governance

What progress is China making in building modern capital markets? What are the prospects for success? What is the level of corporate governance among Chinese companies, and what role are institutional investors playing?

Two recent studies shed light on these questions, one focusing on investors and the other on companies:

* The ISS 2006 Global Institutional Investor Study, which features a Special Report on China.

* The Corporate Governance Assessment Report of the 100 Top Chinese Listed Companies in 2006, published by the Chinese Centre for Corporate Governance of the Chinese Academy of Social Sciences and the Faculty of Business of the City University of Hong Kong.

To see the ISS study, click here.

To see the Chinese Academy of Social Sciences Report, Download file

To see an analysis comparing the two reports, Download file

ISS will present the findings from its Global Investor Study the week of June 5 in a series of webcasts. To attend the online forums, please register here.

What are your views on investing in China? We welcome your comments.

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June 5, 2006

Fewer Firms Maintain Defenses
Submitted by: Carol Bowie, Vice President and Director, Governance Research Services

For the first time since the mid-1990s, the proliferation of takeover defense features at major U.S. corporations has begun to slow, and several defenses are now in decline, according to a new study by ISS' Governance Research Service (GRS).

For example, the study found that active "poison pills" are in place at barely more than half of the surveyed companies. Given this trend, maintaining a pill may soon no longer be considered "standard practice," along with classified board structures.

The 2006 edition of the Corporate Takeover Defenses (CTD) study surveyed corporate control features at 1,925 public firms as of the end of 2005. As in previous years, the biennial analysis finds that the most prevalent defenses remain blank-check preferred stock, advance notice requirements, golden parachutes, classified boards, and poison pills, each of which is found at a majority of the firms tracked.

Remarkably, though, the proportion of companies with an active poison pill or a classified board declined for the first time in many years, along with several other defenses once thought to be impregnable. The proportion of firms with pills (also known as "shareholder rights" plans) dropped from 55.1 percent two years ago to 51.2 percent.

Although shareholder proposals requesting companies to redeem poison pills or put them up for investor approval routinely receive support from a majority of voting shareholders, companies have traditionally been reluctant to comply with such requests. At least 119 of the companies profiled have taken action to eliminate their poison pills in the last five years, however, and others have amended their pills to institute "shareholder friendly" features such as Three-Year Independent Director Evaluation (TIDE) provisions or qualified offer provisions to assuage shareholder antipathy toward those defenses.

Another of the most effective takeover defenses, staggered election of directors, remains the fourth most popular defense, but the prevalence of classified boards also declined for the first time this decade, from 59.7 percent of the companies (as of the 2004 CTD edition) to 56.4 percent. Growing opposition to staggered board elec­tions by institutional investors has made it more difficult for corporations to justify them, and requests for the repeal of classified board structures continue to be one of the most numerous and most popular shareholder proposals. In 2005, such proposals received support from an average of 63.2 percent of votes cast.

The last few years have seen sizeable jumps in the number of management proposals seeking repeal of staggered board bylaw or charter provisions. Clearly, investor pressure to eliminate this takeover defense is finally driving real change. Nevertheless, many companies continue to enter the public market with staggered boards, which they assert enhances stability and continuity of the board, and these typically require significant effort to declassify. The supermajority vote requirements often needed to repeal or amend classified board provisions--usually 80 percent of outstanding shares--have hindered some companies from eliminating their staggered board structures. All but one of the 22 such proposals voted on in 2003 in the study universe received enough votes to "pass," however, as did all but four of the 46 proposals in 2004 and three of 45 proposals in 2005.

What's more, these changes are occurring in a fairly robust mergers and acquisitions market, which began to rise again after 2002. Despite some evidence that growth through mergers often fails to deliver higher returns, acquisitions--both friendly and hostile--remain a key component of many companies' growth strategies. Institutional activists and value investors continue to utilize shareholder proposals and proxy fights to inspire change at under-performing companies, and recently hedge funds have emerged as new players in instigating governance changes through often hostile advances. Proposed Securities and Exchange Commission rules that would permit companies to post proxy statements on the Internet, rather than requiring them to mail the statement to shareholders, are expected to boost the incidence of proxy fights, since costs to provide proxies would drop for dissidents as well as issuers.

Several other defenses that were popularized in the 1980s continue to lose ground, the study found. The ratio of companies with fair price provisions, for example, peaked at 33.2 percent in 1993, but has continued to fall since and now stands at just 19.2 percent (compared with 19.8 percent at the end of 2003). Similarly, the proportion of companies requiring supermajority vote requirements to approve mergers, which peaked at 18.1 percent in 1993, shrank to 14.9 percent as of 1997. Prevalence of this provision reached 15.5 percent at the end of 2001, but then dropped to 14.6 percent by the end of 2005.

Other Defenses Are Less Common
Meanwhile, the pace at which companies are erecting barriers against proxy contests and enacting rules to maintain tight rein over shareholder meetings has slowed to a crawl. The percentage of companies that have adopted provisions to limit shareholders' right to call special meetings, which doubled in little more than 10 years, from about 24 percent in 1990 to 49.5 percent as of the end of 2001, stands only slightly higher, at 49.7 percent, as of the end of 2005.

By the same token, the proportion of companies that restrict shareholders' right to act by written consent in lieu of a special meeting--which increased dramatically from about 35 to nearly 44 percent between 2000 and 2002 and rose another 3 percentage points by 2004--increased just 1.4 percentage points in the last two years to 48.2 percent. Typically, proposals to change these shareholder rights are put forth in bundled resolutions with a merger, reincorporation, or restructuring, which shareholders are more likely to approve than stand-alone restrictive resolutions, so it appears that fewer companies are now requesting these changes.

Another provison that remains on the rise, though its proliferation has slowed, requires shareholders to give advance notice of an intention to present director nominations or other motions from the floor. This feature, virtually unheard of in the early 1990s, has become the second most prevalent defense; nearly 81 percent of firms now have advance notice provisions, up from 77 percent two years ago. As of 1995 (the first year they were tracked), these notice requirements were present at only about 44 percent of the companies examined.

Executive Protections Continue to Spread
Golden parachutes--executive severance arrangements contingent on a change in corporate control--have been a popular management retention tool for many years, and their prevalence increased significantly in the past two years from 73.4 percent to 77.6 percent. The terms of these typically generous severance agreements vary considerably, but most of those packages provide for payments based on three years' salary and bonus, acceleration of stock options, and sometimes other incentive compensation and extra pension credit. Because most companies now consider golden parachutes to be critical components of compensation packages, and shareholder approval of them is not required, these arrangements have continued to spread. This trend has occurred despite the fact that investor activists concerned about excessive severance payments, sometime dubbed "pay for failure," have made anti-golden parachute proposals a cornerstone of their proxy season campaigns, with increasing success.

While most companies continue to maintain strong defenses against hostile shareholder action and to guard against perceived unfair and abusive actions by dissident groups, the findings in this year's study signal that the most potent defenses have peaked for the time being.

Meanwhile, shareholders and activists continue to monitor companies and their boards to ensure that takeover defenses are being utilized properly. In the last few years, shareholder proposals to eliminate classified boards and supermajority vote requirements and to eliminate or allow a shareholder vote on poison pills have garnered average support of more than 50 percent at U.S. companies each year, and the message appears to be finally getting through to corporate management and boards.

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June 1, 2006

The Growing Role of Institutions in Securities Litigation
Submitted by: Ted Allen, Director of Publications

In 1995, Congress enacted the Private Securities Litigation Reform Act (PSLRA), which sought to encourage institutional investors to serve as lead plaintiffs in securities class action lawsuits. More than ten years later, it appears that many labor and public pension funds have answered that call.

Of the 108 settlements announced last year, union and public pension funds served as lead plaintiffs in a record 35 settlements, according to the recently released "2005 Securities Litigation Study" by PricewaterhouseCoopers (PwC). To download the study, please click here.

This participation by labor and public pension funds significantly exceeds the 26 settlements in 2004, the 19 accords in 2003, and 13 settlements in 2002, where those institutions served as lead plaintiffs. In addition, the PwC study projects that union and pension funds will serve as lead plaintiffs in 68 of the 168 new lawsuits filed in 2005. That total would be less than the all-time high of 71 cases in 2004, but it would surpass the 49 cases in 2003 and 59 in 2002 where those institutions served as lead plaintiffs.

These findings are consistent with other research. A recent study by NERA Economic Consulting found that 38 percent of the settled cases in 2005 had an institution serving as a lead plaintiff, up from 14 percent in 2000.

According to the PwC study, the more prominent role of institutions was one of the factors that contributed to a significant increase in settlement dollars last year. Excluding the Enron and WorldCom multibillion-dollar accords, the average settlement in 2005 was $71.1 million, up from $27.8 million in 2004. The median settlement was $9.25 million in 2005, up from $6.75 million the year before. Other factors that fueled this increase include enormous investor losses, the "Fair Funds" provisions of the Sarbanes-Oxley Act, and the growing role of state and federal regulators in seeking fines and recoveries for investors, the authors concluded.

Like other researchers, the PwC study found that the total number of new cases declined in 2005. The study reported 168 new federal securities class action lawsuits, down from 203 in 2004. While the 2005 total is a nine-year low, the authors cautioned that this drop might not mean a long-term trend. They noted that the number of new suits has tended to fluctuate in a "seesaw pattern" (with increases in 2002 and 2004 and decreases in 2001 and 2003) in recent years.

As in 2004 and 2003, high technology companies continue to face the most investor lawsuits, accounting for 29 percent of the new cases in 2005, the study found. Next was the pharmaceutical/healthcare industry (19 percent of cases), followed by banking/financial services industry (13 percent).

Fewer Accounting Lawsuits
Another noteworthy finding from the PwC study is that the number of new lawsuits with accounting fraud claims fell to 46 percent, the lowest percentage in 10 years. By contrast, 61 percent of the initial complaints in 2004 including accounting allegations and 81 percent of the 2002 lawsuits had such claims.

The study theorizes that this decline in accounting cases may be due to "improved internal accounting and financial reporting and increased anti-fraud auditing" by outside auditors. However, the authors also note that these numbers may reflect the higher number of "product efficacy" cases against healthcare, pharmaceutical, and other companies, where investors allege that the firms made misleading statements about the effectiveness of a new drug or other product. Those cases accounted for 10 percent of all new cases in 2005.

Traditionally, a majority of the accounting-related lawsuits have included allegations that the defendant company failed to recognize revenue properly. In 2005, only 39 percent of the accounting cases had such recognition claims. This was the first time since 1996 since that this percentage fell below 50 percent, the PwC study noted. At the same time, 55 percent of new accounting lawsuits in 2005 included internal control allegations. This apparent shift in claims may stem from the increased focus on internal controls after large companies started complying with Section 404 of the Sarbanes-Oxley Act last year.

The study also reaffirmed the PwC authors' observation last year that restatements do not automatically trigger securities lawsuits. In 2004, 83 percent of the restatements did not lead to securities litigation. While there was a record number of restatements (almost 1,300) in 2005, only 37 of the 168 new cases filed last year involved a company that filed a restatement of earnings, the PwC study found. The authors explain this finding by noting that many restatements are issued for "benign" reasons (such as a change in accounting principles) and most do not lead to significant stock price drops.

Lawsuits Against Foreign Firms Decline
The number of securities class actions in U.S. courts against foreign issuers declined to 19 in 2005, down from an all-time high of 29 in 2004. However, the PwC authors note that this year's total is the third-highest in the past 10 years. Among the foreign issuers sued in 2005 were Tyco International, GlaxoSmithKline, Elan, Helen of Troy, and AstraZeneca. The lawsuits were directed against companies from 11 nations; Canada and Bermuda each were home to four of the companies sued.

Foreign issuers reached 12 class action settlements in 2005, up from 10 in 2004. Among the notable accords were Royal Ahold ($1.1 billion), Deutsche Telekom ($120 million), Asia Pulp & Paper ($46 million), Vodafone Group ($24.5 million), and Ashanti Goldfields ($15 million). Excluding the Ahold accord, the average foreign issuer settlement was $23 million, down from the 2004 average of $63.4 million, according to the PwC study.

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