April 04, 2006
Requiring Contested Elections
Posted by Elizabeth Brown

Thanks Gordon, Christine and Vic for inviting me to be a guest blogger!  I am really looking forward to this opportunity.

In my Business Associations class, we have just finished discussing the problems inherent in the current process by which shareholders in publicly-traded companies elect directors.  While many proposals have been offered in the last few years regarding ways to address some of these problems, one possible solution, which I have not seen raised to date, would be for the SEC to require publicly-traded corporations to hold contested elections for directors.  In other words, the corporation must nominate at least two persons for every vacancy on the board of directors that shareholders will be asked fill in an election.  So if there are five directors on a board of directors, then the corporation would have to nominate at least ten people as candidates to fill those slots.  The five candidates who received the most votes would become the directors.  Some non-profit corporations routinely hold contested elections. 

This proposal is similar in some respects to the State-Authorized Ballot Access Statute that Vice Chancellor Leo Strine proposed, although he advocated opening the ballot for directors up to include nominations by shareholders only every three years for corporations without staggered boards of directors and he wanted his proposal to be enacted at the state level, not the federal level.

A requirement by the SEC that publicly-traded corporations hold contested elections would not conflict with state law.  Certainly, Delaware’s General Corporation Law would allow corporations to adopt such a structure for electing directors in their bylaws.  Requiring contested elections only for publicly-held corporations would make sense because individual shareholders in publicly-held corporations lack the access to control the corporation’s management and directors that shareholders in closely-held corporations have.  Since the requirement would be aimed at publicly-held corporations, it makes more sense for the SEC to adopt it rather than the individual states as it would keep all public-traded companies on a level playing field with regard to the costs to comply with the regulations governing their corporate governance processes. 

This requirement would avoid some of the problems that have been leveled at the SEC’s proposed Rule 14a-11.  For example, opponents of Rule 14a-11 have argued that shareholders would nominate unqualified candidates to serve as directors and that directors nominated by shareholders would create factions within the board that would undermine the board’s effectiveness.  If the corporation is required to nominate enough candidates to hold a contested election for its directors, it would probably be choosing only individuals that it considers qualified to sit on its board.  All of the candidates nominated by the corporation also are likely to be people who would be willing to work as a team.  Nevertheless, all of the directors who are elected would know that if they do not manage the business in a manner that the shareholders deem appropriate then the shareholders can replace some or all of them at the next election.  As a result, requiring contested elections would increase director accountability.

Obviously, one problem with this approach is the ability of corporations to find enough qualified people who are willing to undergo a contested election in order to sit on the corporations’ boards.  Probably some of those who are currently willing to serve as directors might not want to do so if they might suffer the indignity of not being elected as a director in a contested election.  I have read many articles asserting that the Sarbanes-Oxley Act’s requirements have made it more difficult to find people willing to serve as directors of publicly-held corporations.   I have not, however, seen any empirical studies that back up the anecdotal evidence provided in these articles.  I would appreciate it if someone could point me to any empirical studies that back up (or refute) the claims that corporations having difficulty finding qualified directors in the wake of Sarbanes-Oxley.

One way to address the problem of a lack of identifiable, qualified candidates to serve as directors would be to allow shareholders to nominate individuals, who meet certain minimum qualifications, to the corporation as possible candidates.  The corporation would then screen those nominations to select the most qualified candidates.  REI uses a similar process when seeking candidates to possibly serve on its board of directors.

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