Disney and Comcast: A Contrast in Governance Industry Focus: Household & Personal Products Top CGQ Scores-S&P 600 Bottom CGQ Scores-S&P 600 Changes in Governance Practices

Disney and Comcast

Contrasting Profiles in Governance

This articles sets out to examine the key corporate governance characteristics of The Walt Disney Company and Comcast Corp. and the governance implications of a Comcast takeover of Disney. Generally, we found that Disney significantly outperforms Comcast on board, accounting and takeover defense governance issues. Comcast outscores Disney on compensation-related matters. Two noteworthy conclusions were reached, the first being that the “independence” of Disney’s board on paper did not mean that the board was an effective counter balance (on governance issues) to the influence of the CEO. The second conclusion is that a Comcast takeover of Disney would result in the dilution of the voting power of Disney shareholders, which, from a purely corporate governance perspective, would harm shareholder rights more than if Disney remained independent.

Disclaimer: This article does not represent the views of the ISS Research Department and should not be construed as an ISS vote recommendation.

Board and Committee Issues

Both Disney’s and Comcast’s boards are controlled by a majority of between 50 percent and 66.7 percent independent outsiders. ISS defines an “independent director” as one having absolutely no material relationship with the company outside of the board seat. Disney earns a higher CGQ score on board issues because its nominating, compensation and audit committees are composed entirely of independent outsiders who have the authority to hire their own outside advisors. Comcast’s nominating audit and compensation committees, on the other hand, include insiders and/or affiliated outsiders. Both companies have governance committees, but only Disney disclosed that the committee met in the past year. Disney also disclosed its governance guidelines. Were Disney to merge with Comcast, Disney shareholders would be governed by board committees with less independence than those of Disney’s existing board committees (assuming there were no changes in the board made in connection with the merger).

On March 3, 2004, the Dow Jones Corporate Governance newsletter reported that the AFL-CIO has raised concerns about the corporate governance structure of Comcast. Dow Jones paraphrased a letter sent by the AFL-CIO to Comcast's board, stating that “Comcast's restrictive charter, dual-class voting arrangement, chief-executive-dominated nominating committee and lack of independent directors will be perceived by Disney shareholders as a significant reason not to support the merger.”

The chart below lists the directors for both Comcast and Disney, as well as the composition of their nominating committees. Note that “I” stands for insider, “IO” represents independent outsider and “AO” is an affiliated outsider.

1. Gary Wilson is a former Executive Vice President and CFO of the company. Source: Company's proxy filing, page 31.

2. Robert Iger is employed as president and COO of the company. Source: Company's proxy filing, page 30.

3. John Bryson's wife serves as Executive Vice President for Lifetime Entertainment Television, in which the company has an indirect 50% equity interest. Source: Company's proxy filing, page 8.

4. Duane Morris LLP provides legal services to the company. Sheldon M. Bonovitz is Chairman and CEO of that firm. Source: Comcast Corp. 2003 Proxy Statement, p. 13

5. Landmark Communications, Inc. maintains various transactional relationships with the company. S. Decker Anstrom is the Chief Operating Officer of that firm. Source: Comcast Corp. 2003 Proxy Statement, p. 13.

<p class="body"><span class="body"><strong>Composition of Disney and Comcast Board Committees</strong> </span> </p>

Compensation and Ownership Issues

ISS believes compensation should be aligned with company performance and that executive and director ownership (up to a certain threshold) directly correlates with improved financial performance (Bohren & Odegaard, 2001; and Bhagat, Carey & Elson, 1999). At Disney, all directors with more than one year of service own stock. At Comcast, there are directors with more than one year of service who do not own stock. Both companies do subject their directors to stock ownership guidelines, but only Comcast has stock ownership guidelines for its executives as well.

Regarding the cost of option plans, the last time shareholders at both companies voted on option plans, ISS deemed the cost of the option plan excessive for Disney and reasonable for Comcast.

Divergence in Subscores

CGQ Subscores provide a measure of a company's governance in a particular governance area by ranking companies into quintiles relative to a relevant index and industry group.

Subscores are calculated for four categories:

Board of Directors; Takeover Defenses; Executive and Director Compensation and Ownership; Audit Review. Subscores are expressed from one to five, with five indicating a company is in the top quintile in a governance area and a one indicating a company is in the bottom quintile in a governance area.

ISS ranked Disney with a Board subscore of five and a compensation subscore of one. Only twelve other companies (including Halliburton) in the S&P 500 earned Board subscores of five and compensation subscores of one. This discrepancy between board “independence” and compensation practices, suggests that Disney's board is not a strong counterweight to the CEO on compensation issues. At Disney's Annual Meeting on March 3, 43 percent of shareholders withheld their support from Michael Eisner. Though the Disney board elected George Mitchell chairman, Eisner remains as CEO to the chagrin of the 43 percent of shareholders who withheld their votes from him.

Coincidentally, Comcast has the reverse situation with its CGQ subscores. Comcast's compensation subscore is a five, but its board subscore is only a one. In Comcast's case, the lower degree of board committee independence actually resulted in superior compensation practices.

Takeover Defenses

The anti-takeover governance practices of both companies are really a mixed bag with one glaring exception: Comcast's dual-class stock structure. In its 2003 annual meeting proxy, Comcast disclosed that it had outstanding 1,355,552,596 shares of Class A common stock (with .209 votes per share), 9,444,375 shares of Class B common stock (with 15 votes per share!), and 883,806,939 shares of Class A special common stock (with no voting rights). Brian L. Roberts, President and CEO of Comcast, controls all of the 9,444,375 shares of Class B common. Pursuant to the Comcast charter, the shares of Class B Common Stock, as beneficially owned by Roberts, represent 33.33 percent of the voting power of the two classes of the Company's voting common stock combined. This percentage is non-dilutable. As of March 10, 2004, there was no indication that Comcast would change this charter provision in a potential acquisition of Disney. ISS opposes dual-class stock capitalizations on the grounds that they contribute to the entrenchment of management and allow for the possibility of management acquiring superior voting shares in the future.

On other antitakeover issues, Comcast has a non-shareholder approved poison pill, while Disney does not have a poison pill. The Comcast pill does also lacks the following mitigating provisions: TIDE (three-year independent director evaluation), sunset (where the pill expires after a set number of years) or qualified offer.

Audit Issues

On audit-related issues, CGQ rates companies on whether: they ratify auditors at their annual meetings; they disclose a policy on auditor rotation; the composition of the audit committee; and audit fees.

As mentioned previously, Disney's audit committee is composed solely of independent outsiders. Comcast's audit committee includes affiliated outsiders. Both companies ratified their auditors at their last annual meeting and both companies paid more in audit fees than in non-audit (consulting) fees to their auditors. Disney disclosed a policy on auditor rotation, Comcast did not.

Based on these CGQ variables, one must conclude that Disney shareholders benefit more governance-wise from the current Disney audit-related practices than they would under Comcast's audit-related practices.

Conclusions

Understanding the nuances of CGQ is key to appreciating the governance implications of a Comcast takeover of Disney. Although Comcast scores higher than Disney on compensation issues, the existence of a dual class stock capitalization with unequal voting rights has negative consequences for Disney shareholders and their ability to fully exercise shareholder rights.

Industry Focus: Household & Personal Products
Room for Improvement in the Household Sector

Audit Issues

This issue of CGQ View spotlights the corporate governance practices of the Household & Personal Products (Household) industry. We find that this industry sector averages the second lowest CGQ scores (after media companies) out of the 24 GICS industry groups in the CGQ database. The lower rankings in the Household sector are caused by the industry’s lower degree of board and committee independence, higher rate of companies with dual class stock capitalizations, lower incidence of CEO/Chairman separation and fewer Household companies ratifying their auditors at their annual meetings.

The Household sector is interesting because of the strong correlation between large market capitalization and high CGQ scores. With only 45 companies, it is one of the smaller industry groups in the CGQ database. Twenty-three of these companies are too small to be included in the Russell 3000. Of the 12 Household companies in the S&P 500, S&P 400 and S&P 600, 11 are among the top 13 CGQ scorers. The charts below list the highest-scoring and lowest-scoring Household companies.

Top Five CGQ Scores in Household & Personal Products Industry

*CGQ Universe is the ISS designation for companies outside the Russell 3000

Opponents, on the other hand, believe poison pills lead to management entrenchment and discourage legitimate tender offers. Even if the premium paid to companies with poison pills is higher than that offered to unprotected firms, a company's chances of receiving a takeover offer in the first place might be reduced by the presence of a pill.

Early research on pills tends to support the management entrenchment hypothesis, attributing significant negative stock price effects to a company's adoption of a pill. A 1988 study by university professors Paul Malatesta and Ralph Walking showed that, on average, a firm's stock price fell 1.13 percent upon the announcement that it intended to institute a poison pill.

Pills are designed to aid target companies in negotiating higher takeover prices, and current studies demonstrate that poison pills do work in this regard. Georgeson & Co. examined 319 transactions between 1992 and 1996 and concluded that companies with pills receive higher takeover offers-typically eight percent higher-than companies without pills.

The key element to pill effectiveness may lie in the independence of the board. A Cotter, Shivdasani and Zenner study in 1997 found that shareholder returns were 24 percentage points higher when a target company's pill was coupled with an independent board versus a nonindependent board.

Large- and mid-cap companies more likely to adopt pills

To study the profile of companies adopting poison pill defenses, Institutional Shareholders Services' (ISS) extrapolated poison pill data for each Index Group in the CGQ database. The market Index groups in the CGQ database are S&P 500 (large cap), S&P 400 (mid-cap), S&P 600 (small cap), Russell 3000 (excluding the S&P 500, S&P 400 and S&P 600) and the CGQ Universe (companies covered by ISS that are outside the Russell 3000). In general, companies with higher market capitalization are more likely than lower cap companies to have poison pills, more likely to authorize blank check preferred stock, as well as more likely to have features such as “TIDE” provisions and qualified offer clauses. The chart points out that 59 percent of S&P 500 and S&P 600 companies have poison pills, while 64 percent of mid-cap S&P 400 companies have poison pill defenses. Only 37 percent of the Russell 3000 companies have adopted poison pills, while a meager 23 percent of “CGQ Universe” companies have done so.

Companies with poison pills

*CGQ Universe includes companies ranked by ISS that fall outside the Russell 3000 **Russell 3000 Index excluding S&P 500, S&P 400, S&P 600.

Minimal results regarding shareholder-friendly pill provisions

We find that while many institutional shareholders may be pressing for more “shareholder friendly” features to be included in poison pills and shareholder support of shareholder proposals requesting that any poison pill device be put up for a shareholder vote is also increasing, nearly all poison pills in place were adopted without shareholder approval and features such as “TIDE” provisions and qualified offer clauses are the exception rather than the rule.

“TIDE” stands for Three Year Independent Director Evaluation and is a policy adopted by some of the more progressive companies in corporate governance that requires the independent directors of the board to re-evaluate the ongoing need for a poison pill every three years and to make recommendations to the full board as to whether the pill should be redeemed. A “qualified offer” clause is a provision whereby certain takeover offers that meeting conditions relating to price, form of consideration, and financing, can be presented to shareholders without triggering the poison pill, even if the offer is not supported by the board of directors.

Pills with TIDE provisions

Pills with qualified offer clauses

Most pill triggers under 20%

We find that the vast majority of companies have triggers in their poison pills of less than 20 percent. The trigger is the level of ownership interest in a company that could potentially trigger the dilutive or harmful effects of a poison pill. The most common trigger used in the U.S. is 15%. ISS believes that if a company is going to have a poison pill it should have a relatively high trigger so as not to limit the ability of large investors to accumulate shares when the investor is not seeking to acquire a majority stake in the company.

Industry Analysis

This tables below show the industry groups (based on GICS industry classifications) where companies are most and least likely to have a poison pill device in place. Curiously, companies in the utilities industry are most likely to have a poison pill device in place even though this industry has the highest average overall CGQ scores of any of the industries covered. Conversely, the media industry, which has the lowest average CGQ score, is the least likely to have poison pill defenses. This is partially explained by the fact that utilities are more likely to be larger cap companies, and thus more prone to adopting poison pills. Media companies are more inclined to adopt a more effective takeover defense, dual-class capitalizations with unequal voting rights between classes of stock, thus lessening the need for a poison pill defense. The charts below illustrate some of the industry differences regarding poison pill adoption.

Industries most likely to have a poison pill

Industries least likely to have a poison pill

Conclusions

When analyzing poison pill adoption rates among stock index groups, the 1,500 largest companies (by market capitalization) are twice as likely to have adopted poison pills than smaller cap companies. Although activists have spent years pushing for more shareholder-friendly provisions (such as TIDEs and qualified offer clauses), less than five percent of companies have adopted such measures. The average trigger that causes pill provisions to activate is 15 percent --ISS' position is that triggers should be 20 percent or higher so as not to discourage potential bidders from accumulating a meaningful stake in the company or cause a large shareholder to inadvertently trigger the rights. Finally, there is considerable diversity in poison pill adoption rates among industry groups.

Top 10 and Bottom 10 CGQ Scores by Stock Index

To view the top 10 scores all of the indexes that CGQ covers, please visit www.issproxy.com.

Top CGQ Scores- S&P 600

Company Name Industry Group Jan. 1 CGQ Score MacDermid, Inc. Materials 100.0 Capital Automotive REIT Real Estate 99.8 Jack In the Box Inc. Hotels, Restaurants & Leisure 99.7 The Cooper Companies, Inc. Health Care Equipment & Services 99.5 Ryerson Tull, Inc. Materials 99.3 Stillwater Mining Co. Materials 99.2 Tetra Tech, Inc. Commercial Services & Supplies 99 Southwest Gas Corp. Utilities 98.8 URS Corp. Capital Goods 98.7 Zale Corp. Retailing 98.5

Bottom CGQ Scores- S&P 600

Company Name Industry Group Jan. 1 CGQ Score Goody's Family Clothing, Inc. Retailing 0.2 Coca-Cola Bottling Co. Consol. Food, Beverage & Tobacco 0.3 Invacare Corp. Health Care Equipment & Services 0.5 Triarc Companies, Inc. Hotels, Restaurants & Leisure 0.7 The Cato Corporation Retailing 0.8 Vicor Corporation Capital Goods 1.0 The Dress Barn, Inc. Retailing 1.2 Papa John's International, Inc. Hotels, Restaurants & Leisure 1.3 Hughes Supply, Inc. Retailing 1.7 Medicis Pharmaceutical Corp. Pharmaceueticals & Biotechnology 1.7

Changes in Key Governance Practices from February to March 2004