Commentary: Proactive Corporate Governance

In the fall of 2008, RiskMetrics (RMG) updated its corporate governance guidelines for 2009. These guidelines are critical for public real estate companies to understand as they suggest best practices on a variety issues that companies should address going forward.

Perhaps the most notable change is the revised methodology employed by RMG in the performance evaluation of company directors. Historically, the performance metric was the company's five-year total return to shareholders (TRS) on a relative basis to each GICS group. RMG's new policy states that a withhold/against vote will be recommended on all director nominees if the board lacks accountability and oversight, coupled with sustained poor relative performance, which will now be measured by one- and three-year TRS. REITs and public real estate companies derived a significant benefit from the five-year TRS measurement since dividend payments aided in "smoothing" the results.

The current market volatility and wave of dividend cuts could have a meaningful effect on one- and three-year TRS comparisons. Since directors do not have control over a company's stock price, it is important to address issues of accountability and oversight that can be controlled by the board.

Companies should take a proactive approach by reviewing their in-place policies, including board structure, voting requirements, pay practices, the ability of shareholders to call special meetings and act by written consent and poison pill provisions, among others. A third-party perspective may provide the board with an objective point of view in interpreting the guidelines.

Compensation practices continue to be a focus of investors, regulators and the media. Accordingly, REITs and real estate companies should consider a review of their pay practices to be critical as RMG is also focused on this topic. RMG's expectations are high; companies are expected to eliminate excise tax gross-up provisions in executives' contracts and implement "double-trigger" change-in-control provisions in equity plans. Real estate companies should also note that RMG's policies call for the elimination of all tax gross-ups on executive perquisites, and consider the payment of dividends or dividend equivalents on unearned performance awards a poor pay practice.

In instances where companies are in violation of RMG policy, RMG will not issue a "Withhold" or "Against" vote recommendation for board members as long as such companies disclose in the Compensation Discussion & Analysis section of their proxy that the practice will be discontinued on a prospective basis. A violation of any individual RMG policy will not automatically lead to a "Withhold" or "Against" vote recommendation, but rather, RMG will evaluate a company's overall corporate governance practices prior to issuing voting recommendations. Ultimately, the analyst team reviewing a company's proxy will have significant discretion in the determination of RMG's final recommendation.

RMG's guidelines have been written in a liberal fashion, allowing RMG to have wide ranging discretion to consider other non-specifically identified company policies as poor governance practices. As a result, companies could be subject to a "Withhold" or "Against" vote recommendation on the election of board members for a policy not specifically mentioned in RMG's guidelines. Companies and board members should review the updates and the existing RMG policies to ensure compliance.

Editor's Note: To view RMG's Corporate Governance Rankings of REITs be sure to check out the July/August issue of Real Estate Portfolio.

Anthony Saitta is managing director and Sydney Hilzenrath is senior manager of The Schonbraun McCann Group, an FTI Company.