Are the calls for shareholder democracy merely ceremonial?

by Cydney Posner

According to this paper, despite all the sturm und drang associated with corporate governance issues, these issues amount to little more than corporate governance kabuki—highly stylized, symbolic rituals with little substantive effect. (Although, for fun, check out this article from Slate, which tells us that we’re all misusing “kabuki,” and it doesn’t really mean what we think it does.)  The authors of the study analyzed the impact of issues such as majority voting, staggered boards, say on pay, independent directors, even proxy access, and conclude that the stakes involved in each of these controversies are, in the end, not material.   In effect, the authors argue, these are all simply moral campaigns with little practical impact. Rather, they contend, “corporate governance politics, like politics more generally, may have a significant ‘symbolic’ element in which the stakes, and the intensity, are largely divorced from the specific issue being debated but instead serve a variety of different functions, including a ‘mythological’ or ‘ritual’ function.”

For example, proposals to require redemption of poison pills were the most common type of proposal filed between 1987 and 2004, according to Georgeson. These proposals tend to receive shareholder support, and boards tend to take these votes seriously.  However, the authors argue, since pills can be adopted unilaterally by the board without shareholder approval, boards can simply adopt a new pill if faced with a hostile threat: “To bind a future board, it would take a charter provision limiting a board’s power to adopt a pill. But shareholder proposals on pills do not ask for such a provision. So why do shareholder activists push so hard for companies to remove the current pill and ignore the real issue that pills can be reinstated at any time?”

Similarly, as you may know, the SEC took three stabs at “proxy access,” none of which survived. (See my News Brief of  9/7/11 and the other News Briefs and Cooley Alerts cited in it.) After the demise of the last version of the SEC rule (which, the authors maintain, would have had little impact as few shareholders would have qualified to use it), the SEC settled for only a modification to Rule 14a-8, which allowed shareholder proposals for proxy access to go forward – through so-called “private ordering.”  Proxy access was highly controversial, and the rhetoric surrounding it was heated, with institutional activists viewing it as a “top priority” and “groundbreaking.” Beginning in 2012, investors could have submitted mandatory proxy access shareholder proposals.  But what happened? Proxy access turned out to be only the 10th most common shareholder proposal, according to Georgeson. Institutional investors submitted only three of those proposals (all of which resembled the SEC rule), and all three were successful (either through the vote or through negotiation with the issuer). But not many more proposals were submitted the next year.

“What explains, then, why shareholder activists made such a strong push to get proxy access adopted by the SEC, but then failed to lift a finger to get it adopted through shareholder resolutions? In an earlier article, [the authors] argued that proxy access would have had a trivial impact on corporate governance. Most importantly, proxy access would result in only small cost savings for challengers, but entail substantial strategic disadvantages. Any challenger serious about obtaining board representation would thus be unlikely to use proxy access rather than wage a traditional contest… Why, then, were [the activists] fighting?”

Likewise, majority voting is a “dream issue” for shareholder activists. Under plurality voting, in uncontested elections, a director may be elected with just a single vote, offending “basic notions of ‘shareholder democracy.’”  Many activists have, therefore, pushed companies to adopt majority voting, with the promise that it would empower shareholders. And a number of large companies have made the move. Although the authors do not claim that the shift is “meaningless,” the “net effect of a move from one standard to another is, in [their] assessment, small.”All but a relatively small number of directors, the authors maintain, receive a strong majority of the votes; those receiving significant withhold votes are often regarded as an “embarrassment,” requiring some type of “corporate response,” even under plurality voting. The authors have previously found that, where directors receive majority “withhold” votes, for about 70%, “the company’s response, usually within one year of the vote, was deemed satisfactory by shareholders,” whether the result was to repeal a pill, terminate an insider relationship or other action. Although the director cannot be forced to resign, he or she can be pressured to resign or the board can decide not to renominate the director.  With majority voting, the result is actually almost the same:  if the company has majority voting with an “offer to resign” policy, it is up to the board to accept or reject the resignation.  If the nominee is simply not elected by a majority vote, the director can hold over until the board, if it chooses, appoints another director – or perhaps the same director — to fill the vacancy. As a practical matter then, the board has significant influence in all of these circumstances, and the differences among them may not be that great.  Of course, the board may believe that it acts at its peril if it somehow retains a director that has lost a majority vote. The authors contend, however, that the different results really reflect the depth of the message sent by shareholders under the two different standards: the plurality standard simply allows shareholders to send a message that a problem should be fixed, without necessarily signaling a need to change board composition.  But, the authors ask, does that difference really warrant the highly charged rhetoric about the need for shareholder democracy?

The authors suggest several possible, but ultimately unsatisfying, rationales for this behavior – that proponents are operating under false perceptions, that effecting change is difficult, that the battles are really matters of principle or proxies for other underlying issues, that governance professionals benefit by pursuing activism for its own sake – before settling on a different concept.  This theory, propounded in concept originally by judge and legal theorist, Thurman Arnold, holds that these corporate governance battles “are ‘semi-sacred’ ceremonies through which we make peace with the inherent but necessary contradictions between our ideals and reality.”

What is the contradiction here?  The authors posit that a component of the basic American individualistic mythology is the “need to  believe that in even — and especially — the largest corporations, there are shareholders who collectively own the corporation and control it.” (Perhaps the myth of shareholder control makes it more “acceptable that a small group of managers control huge concentrations of capital and get paid princely sums for doing so.”) But, certainly, in modern publicly held corporations, there is a wide gulf between that myth and the reality.  Rather, shares are held by various intermediaries and managed by agents.  Ownership by institutional investors has increased significantly (not to mention the development of high-frequency trading, where share purchases are determined by an algorithm and often held momentarily).  While intermediaries may have some influence over managers of large firms, that level of influence does not come close to validating the myth of shareholders electing directors to be managers of the shareholders’ property.  However, “because the myth of American corporate governance conflicts with the reality of large publicly owned corporations, and because large concentrations of capital are necessary for many business entities operating in world product and capital markets, ‘it was inevitable that a ceremony should be evolved which reconciled current mental pictures of what men thought society ought to be with reality.’” In essence, these efforts to achieve shareholder democracy through various corporate governance initiatives provide the symbolic rituals that allow us to mediate the tension between myth and reality, to believe that we are addressing the problem without substantially interfering with the practical reality (or necessity, depending on your point of view) of how business is conducted.

What does this mean for us?  The authors’ most immediate message is that perhaps we should not fall so easily for activist rhetoric regarding corporate governance reforms.  In their view, most of these issues will not have the kind of profound effect that the rhetoric would suggest. Second, activists may be distracted by their own hype away from ideas that, while they may lack crowd appeal, could actually make a difference or trigger even more opposition. Third, arguments over shareholder democracy are not black and white; shareholder activists “all have more complex motivations than maximizing firm value or protecting privileges.” They “frequently have economic incentives that are not aligned with those of shareholders at large, or pursue a political or ideological agenda.” Ultimately, though, the authors give their blessing to the ritual dance: perhaps the U.S. owes the stability of its corporate governance system to the illusion created by, and legitimating function of, the  these “symbolic, and largely harmless, disputes.”

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Sidebar: Recently, there has been a lot of discussion, in light of SCOTUS’ decision in Citizens United, affirming that corporations are “persons” with First Amendment rights.  As discussed in the paper, Thurman Arnold also theorized about the underlying rationale for the personification of corporations:

“[T]he ‘personification of the corporation’ was all about identifying large concentrations of economic power with the autonomous entrepreneur who figures prominently in 19th century rugged individualism. Our pioneer civilization, which formed the bedrock of American conceptions of legitimacy, was one ‘in which the prevailing ideal was that of the freedom and dignity of the individual engaged in the accumulation of wealth….’ But this ideal of rugged individualism clashed with the reality of large industrial organizations…. On the other hand, technological change and the emergence of specialized techniques made large scale operations essential to realizing economies of scale and scope, ‘to producing goods in large enough quantities and at a price low enough so that they could be made part of the American standard of living.’ How have we dealt with this tension? For Arnold, the key to understanding the doctrine of ‘corporate personality’ is that it mediated this gap: ‘[I]n order to tolerate [large corporations], men had to pretend that corporations were individuals.’ “

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