After taking a break last proxy season, “golden leash” arrangements are back in the spotlight. A few days ago, Institutional Shareholder Services Inc. (“ISS”) gave “cautious support” to so-called “golden leash” arrangements between Third Point LLC and its two nominees to the board of Dow Chemical Co.
As background, “golden leash” arrangements arise when a shareholder activist privately offers to compensate its nominee directors in connection with such nominees’ service as a director of the target corporation. Arrangements vary but include compensating activist directors who are elected based on achieving benchmarks, such as an increase in share price over a fixed term. Shareholder activists only provide such incentives to elected activist directors, not re-elected incumbent directors. See our prior articles for more background, ISS’s position, and the Council of Institutional Investors’ position.
When we last wrote about Third Point’s arrangements with its nominees, Third Point was considering launching a proxy contest at Dow’s annual general meeting. Since then, Third Point and Dow reached a settlement with Dow agreeing to add two nominees proposed by Third Point to its board. Third Point’s SEC filing from before the settlement disclosed that its two nominees:
- had received a cash payment from Third Point equal to $250,000 in consideration for their agreement to serve as nominees;
- would receive a second cash payment from Third Point equal to $250,000 in the event that the nominee is appointed as a director, regardless of whether this occurs by election or settlement;
- agreed to invest their second payment of $250,000 in Dow shares if the nominee did not own at least $250,000 of Dow shares at the time of such payment; and
- may be entitled to two additional cash payments from Third Point subject to Dow’s share price appreciating three years and five years after they joined the board – regardless of whether Third Point remained a shareholder.
Shareholders will vote on directors at Dow’s annual meeting on May 14, 2015.
ISS applies a “case-by-case analytical framework” to assess whether a third-party compensation arrangement poses any risk to “governance, stewardship, risk oversight, or fiduciary responsibilities.” Its “cautious support” of Third Point’s arrangement is a meaningful step forward for shareholder activists who argue that “golden leash” arrangements are an important tool to link director pay to target company performance, which they say can benefit all investors.
It is important to recognize that ISS’s endorsement of Third Point’s “golden leash” arrangement occurred in the context of a settlement between the company and the activist. Nevertheless, Third Point’s strategic design of the compensation arrangement provides activists with a blueprint for arrangements that may appeal to proxy advisory firms and shareholders in future contested campaigns. When designing “golden leash” arrangements, consider the following:
- Details of the arrangement should be disclosed. Third Point released details of its contracts with the nominees.
- The payouts to nominee directors should be moderate.
- The arrangement should not incentivize nominees to pursue riskier strategies.
- The arrangement should benchmark payouts to the company’s medium to long-term performance. Third Point’s arrangements are linked to Dow’s stock performance over the next 3 and 5 years.
- The arrangement should be firm. Third Point’s arrangement with its nominees cannot be altered.
- The arrangement should continue to apply even if the activist divests its interest in the company.
Directors cannot contract out of their fiduciary duties. Therefore, any “golden leash” arrangement requiring directors to do or not do something that is clearly against the best interests of the company — regardless of whether it benefits their nominating shareholder — would raise governance issues, and if acted upon, would expose those directors to litigation.
We also note that prior to its settlement with Dow, Third Point, well known for its CEO, Daniel Loeb’s, public letters criticizing executives of companies that are the target of his activist campaigns, amped up the pressure on the Dow Board with the release of its first video taking on a target. The video, called “Broken Promises” (which has since been taken down, surely in conjunction with the settlement reached with Dow), was posted to Vimeo and a website simultaneously launched by Third Point (value-dow.com, also since removed) and outlined Third Point’s issues with Dow. This is an example of the use of social media in the context of a threatened proxy contest. See our previous posts here and here on the use of social media in proxy contests.