If the SEC Regulated California, Arnold Would Still Be in the Movies(A)

At a shareholder meeting last May, the CEO was asked how the company would respond to a shareholder proposal that had received 80% of the vote – one of the highest votes ever for a shareholder proposal. She answered that the board would, uh, look into it, prompting a flabbergasted shareholder to ask how on earth the board would not automatically implement a proposal supported by 80% of shareholder votes. The CEO replied that shareholder proposals are nonbinding. This is the open secret that enables board directors to sleep more quietly during annual meeting season, but it didn’t satisfy the shareholder, who looked as if she’d just learned that her pet chihuahua was actually a large rat.
Corporate “democracy” is its own thing, an enclosed political system in which shareholder votes are merely advisory and one share buys one vote. The reasoning behind such things is not entirely off base. For example, a reasonable case can be made that large shareholders have more at risk and therefore should have a proportionally larger vote than small ones. If one accepts this premise, then the nonbinding nature of the vote is a good thing, as it can provide a check against the tyranny of the majority.
Corporate board elections, on the other hand, are the furthest thing from democracy since the Soviet system, to which they are often compared. Shareholders have a non-choice of one management nominee for each open position. Candidate A or Candidate A? I think I’ll go with Candidate A. Candidate A then wins in a landslide, supported by institutional shareholders who hardly ever choose to make a statement against management’s selection of directors, compromised as many are by business relationships with their portfolio companies. Given the expense of financing an alternative slate, the old boy network has remained the de facto gene pool for all but a few board candidates.
In corporate theory, boards represent shareholder interests, but in reality, they are not accountable to them. “Directors appear to face a lower probability of facing such a contest.than of being injured in a motor vehicle accident,” observed Harvard Law School Professor Lucian Bebchuk recently.[1] Most investors didn’t care pre-Enron. Since then, however, disgruntled shareholders have prompted the Securities and Exchange Commission to look into changing all that – sort of. The Commission has proposed rules to allow shareholders greater access to the ballot to propose alternative board candidates. Fundamentally, this is about making boards accountable on more than just paper. Social investors also tend to believe that more diverse and independent boards are more attentive to their corporation’s social and environmental impacts. (This faith can’t be tested since boards are still overwhelming homogenous.[2])
The proposed rules are greatly flawed. The opportunity to nominate would occur only after one of two triggering events has occurred: (1) 35% or more of shareholders vote to withhold support for at least one director; or (2) a stockholder(s) holding at least 1% of the company’s stock puts a proposal on the proxy statement seeking the right to nominate, and that proposal is approved by a majority vote. After a trigger has been activated, the threshold is raised once again as only investors with 5% or more of a company’s stock can propose a nominee for the next election. If more than one stockholder or stockholder groups proposes a nominee, the candidate proposed by the largest number of shares will go forward.
In sum: Barriers to discourage all but the largest investors and a two-year lag between the surfacing of problems and the ability to take action.
There’s still time to demand better. The Shareholder Action Network’s web site offers more analysis of the proposal and a sample letter for investors to send to the SEC. You can find these materials at: www.shareholderaction.org.
[1] “The Case for Shareholder Access to the Ballot,” Lucian Arye Bebchuk, August 2003. www.law.harvard.edu/faculty/bebchuk.
[2] In November 2002, women represented less than 16% of corporate officers in America’s 500 largest companies, according the Catalyst Institute. www.catalystwomen.org/press_room/press_releases/2002_cote.htm.