August 27, 2010
Proxy Access Forum: The Weirdo Shareholder Problem
Posted by Usha Rodrigues

I have a paper cooking about post-crisis corporate governance reform that makes a pretty simple point. 

1. The corporate governance reformist view of the crisis is: managers ran amok, enriching themselves by sacrificing their companies' long-term health--and with it, the well-being of the economy--in order to cash in on flawed compensation models.

2. Solution: reform compensation schemes and give shareholders more say...on pay, on golden parachutes, on director nominations.

3. Result: accountability and less of that pernicious short-termism that got us into this mess in the first place.   

4. The fly in step 2's shareholder-empowerment ointment is that the actual shareholders of public companies are overwhelmingly short-term players.  As I blogged last year, Vice-Chancellor Strine has aptly observed:

Most Americans invest with a rational time horizon consistent with sound corporate planning. They invest  with the hope of putting a child through college or providing for themselves in retirement. But individual Americans don’t wield control over who sits on the boards of public companies. The financial intermediaries who invest their capital do.

5. Those financial intermediaries--hedge funds and mutual funds--turn over their portfolios at a dizzying clip, buying and selling stakes in companies willy-nilly.  Even pension fund managers feel the pressure to have their portfolios perform well each year.  And forget about the flash traders, which according to the popular press accounts for about 60% of exchange trading volume these days.  Holding shares for over a year is so 20th century. 

The new proxy access rule neatly addresses the short-termist shareholder problem by imposing a 3-year holding period and a 3% ownership hurdle before you get to nominate a director.  Does that solve the short-termist problem?  Yeah, but...   

My intuition is that the 3%/3 year holders will mostly be 1) company founders or their descendants, and 2) funds like Calpers.  Now, empowering these shareholders might be a good thing.  The financial intermediaries certainly lack the motivation to invest any resources about director nominations, and the 3%/3 yearers have demonstrated a vanishingly rare commitment to a particular public company.  The SEC's own data, cited by Lisa in her helpful post, show that only a minority of firms have even 1 of these shareholders.  But if we have reason to think that the interests of the 3%/3 yearers are too idiosyncratic--they want to push a pro-labor agenda or preserve the status quo for the sake of the family name--(i.e. are, in Eric Talley's memorable words, "agenda-driven tinfoil-hat-wearing zealots") then shareholder empowerment is distinctly not a good thing. 

Like Eric, in the end I think the sensible response is: "Let's see how this thing plays out."  Fun stuff.

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