January 23, 2006
Winning A One-Person Race
Posted by MichaelDorff

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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