First, my thanks to Gordon, Christine, and Vic for letting me sit in. I'm really looking forward to joining this conversation. Here it goes:
The SEC’s new executive compensation disclosure proposal has already spawned a heated debate. Lucian Bebchuk and Jesse Fried argue that greater disclosure will help rein in the economic rents captive boards award to CEOs (Pay Without Performance). Larry Ribstein and Steven Bainbridge counter that rational shareholders will not care about greater disclosure, and that the new rules will impose substantial, unjustified costs on public corporations. Gordon Smith has decided the proposal is a lot of fuss about very little.
I agree with Bebchuk’s op-ed piece in Fortune (from this past Friday) that the new rules can matter, but only if we also reform the director selection mechanism. Even assuming that shareholders pause on their way to the recycle bin to read the new, more effective, disclosure tables, why should directors care if shareholders believe executives are overpaid (or worse, paid without regard to their performance)? (More under the fold.)
Under the current election system, the individuals chosen to fill seats on the board are almost always –- barring a takeover attempt –- those nominated by the current board. Even when shareholders are particularly energized, such as in 2004’s fight over Eisner’s continuing role as Chairman of Disney’s board, the best they can do is to withhold their approval. Delaware law states that the candidate with the most votes wins election to the board. Since Eisner ran unopposed, even if only a single share had voted for him, his reelection was assured under Delaware law, no matter how many thousands of protest votes there were. We need a cost-effective mechanism irate (but responsible) shareholders can use to propose their own nominees. Otherwise, the only real power shareholders yield over the board is public embarrassment. (Not that a good public shaming isn’t very effective sometimes, but shareholders shouldn’t have to resort to the pillory to get responsible governance.)
I am not proposing that any person with 100 shares of Microsoft be able to nominate herself for the board. But I do think large shareholders, whether acting alone or in combination, ought to be able to place their nominees on the corporation’s proxy form, without jumping through the narrow (and delay-ridden) hoops provided by the SEC’s current proposal for competitive elections (proposed Exchange Act Rule 14a-11). Reasonable limits are perfectly in order. Perhaps only one alternative slate ought to be permitted, with the nod going to the shareholder group with the largest block of shares. But directors who are not responsible to the shareholders whose interests they represent are unlikely to be, well, responsible.
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1. Posted by Michael Guttentag on January 23, 2006 @ 15:32 | Permalink
Michael. Your post assumes that the only way that the disclosure of agency information (information about transactions between the firm and its agents) reduces agency costs is by encouraging competition/change in the boardroom. It is an interesting theory, but it is certainly not the only plausible theory as to how requiring the disclosure of agency information can reduce agency costs. We do know that requiring the disclosure of agency information has a long history going back many centuries, thanks to Paul Mahoney’s work. My sense is that this reliance on agency information disclosures as a way to reduce agency costs is also based on a different theory of prevention: shaming, if I may borrow Dan Kahan’s term. I think the hope is that if agents are forced to disclose information about transactions between themselves and the firm, this disclosure requirement alone would have a prophylactic effect, even if you couldn’t “fire the bastards.” In any case, the most interesting question remains: where’s the evidence of effects based on one theory or another of how disclosure works?
2. Posted by Michael Dorff on January 24, 2006 @ 17:36 | Permalink
Hi Michael. Thanks very much for your comments. I certainly agree that shame can be a powerful motivator. But as I said in my post, I don't believe that shareholders should be limited to the pillory as a remedy. I also agree that more empirical evidence is always welcome. We're not likely to get any, though, unless the law is changed to permit shareholders of at least some corporations to put an alternative slate on the corporate proxy form. Otherwise, where will the data set come from? If the SEC does pass the proposed rule, it's conceivable we may get a few examples to study, but I'm not terribly optimistic.
3. Posted by Michael Guttentag on January 24, 2006 @ 21:28 | Permalink
Well said. I just want to remain clear that we are talking about two distinct, albeit related issues: requiring the disclosure of more agency information, and granting shareholders greater power over board of director selection. You and Bebchuck understandably want to get to the issue of changing the way boards are selected. One can certainly understand why. But I think there are also many interesting questions that remain open as to what are the effects of requiring the disclosure of more agency information, even without other changes. And it is precisely the required disclosure of more agency information that these the new requirements implement. As to where and how we might get more empirical evidence about this, I’ll let you when I figure something out.
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