Cumulative Voting

Discussion

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

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

Additionally, some companies use "contingent" cumulative voting charter and bylaw amendments in connection with classified board proposals. These proposals provide that standard voting will be used in director elections until an investor's ownership surpasses a certain threshold (for example, 20 percent), at which point all shareholders other than the controlling shareholder may cumulate their votes for directors.

The purpose of this type of proposal is to strengthen the antitakeover impact of a classified board. Classified boards alone make it difficult for a would-be acquirer to gain control of the board, but adding a cumulative voting requirement once the would-be acquirer holds a substantial block of stock further delays his or her ability to control the board. The reason cumulative voting is not permitted until there is a majority shareholder is to prevent holders of smaller blocks (ten percent, for example) from electing their own candidates.

Although cumulative voting was the standard practice in the early 1900s, it has become increasingly rare. Fewer than ten percent of S&P 500 companies currently provide for cumulative voting, although most companies have the option of using cumulative voting if provision is made in the charter permitting its use. Only six states still require that cumulative voting be available in the election of directors (Arizona, Kentucky, Nebraska, North Dakota, South Dakota, and West Virginia). California, one of the states that has historically protected shareholder rights, repealed its mandatory cumulative voting laws in 1989 and provided that companies may classify their boards if approved by shareholders.[1]

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

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

In recent years, many companies with cumulative voting policies have sought shareholder approval for charter amendments to eliminate this practice. At the same time, some shareholder rights advocates have sponsored shareholder proposals to permit cumulative voting at companies that do not use it. Shareholders sponsored 22 such proposals in 2002, compared to highs of 38 in 1998 and 33 in 1997. However, these proposals have failed to gain majority support, typically garnering about 25 to 27 percent of the votes cast-unlike proposals to submit poison pills to a shareholder vote or to declassify the board, which have experienced steady increases in shareholder popularity and now often command the support of the majority of the votes cast.

One of the reasons why such proposals fail to gain widespread support may have more to do with the companies targeted than the actual concept of cumulative voting. Companies that receive these proposals tend to be larger firms that already have a number of good governance provisions in place. And despite the failure of these proposals to achieve majority approval, shareholders tend to submit these same resolutions to the same companies year after year. Nevertheless, while the number of shareholder resolutions has declined, the support levels have crept up. In 2002, average support was 32 percent, and a proposal at Hartmarx Corp. won majority support.

While cumulative voting can be an important tool to promote management accountability, the need for such a policy should be evaluated in concert with the company's other governance provisions. If there are other safeguards to ensure that shareholders have reasonable access and input into the process of nominating and electing directors, cumulative voting is not essential. However, it would be necessary for a company's governing documents to contain the following provisions for ISS to recommend a vote against restoring or providing for cumulative voting:

• Annually elected board,

• Majority of board composed of independent directors,

• Nominating committee composed solely of independent directors,

• Confidential voting (however, there may be a provision for suspending confidential voting during proxy contests),

• Ability of shareholders to call special meetings or to act by written consent with 90 days' notice,

• Absence of superior voting rights for one or more classes of stock. For example, an unacceptable structure could consist of two classes of stock where Class A stock was entitled to one vote per share and Class B stock was entitled to ten votes per share,

• Board does not have the sole right to change the size of the board beyond a stated range that has been approved by shareholders,

• Absence of shareholder rights plan that can only be removed by the incumbent directors (dead-hand poison pill), and

• (optional) Published statement of board governance guidelines, including a description of the process for shareholders to submit director nominees that ensures valid nominees are considered.

In addition to these desired governance provisions, the company's performance must be comparable to that of its peers or the board must have demonstrated its focus on increasing shareholder value by taking action to improve performance. For example, the board may have recently replaced management or changed strategic direction.

After evaluating proposals to restore or provide for cumulative voting on a case-by-case basis, ISS recommends a vote in favor of these proposals in situations where the company's governing documents do not embody the positive governance provisions enumerated above and/or whose performance is not in line with its peers. ISS recommends a vote against these proposals only in situations where both criteria are met: the company's governing documents embody the positive governance provisions enumerated above, and performance is in line with its peers. However, ISS would recommend voting against proposals to eliminate cumulative voting.