August 26, 2010
Proxy Access Forum: Nell Minow
Posted by Erik Gerding

To start off our forum on the new SEC Proxy Access rules, we have Nell Minow of the Corporate Library.  She writes the following:

The SEC's new proxy access rule is a modest and most welcome step forward. The post Enron reforms addressed many of the concerns that led to the avalanche of business failures almost ten years ago but did little to improve the ability of boards of directors to manage risk. And that led to the even bigger avalanche of business failures a few years later. One problem was the post-Enron reliance on board "independence," despite the fact that dozens of academic studies have failed to show any reduced risk or increased return correlating to the number of independent directors. That is not because independence is unimportant. It is because there is no such thing as independence as long as management controls who is -- and is not -- put on the ballot for election.

The very term "election" is absurd in this context. Edward J. Epstein has said that shareholder elections “are procedurally much more akin to the elections held by the Communist party of North Korea than those held in Western democracies.” Under the current system, management picks the slate of candidates, no one runs against them, and management counts the votes. Managers even know how shareholders vote. As soon as the votes come in, they can call and try to persuade (or pressure) those who vote against them. And, of course, management has access to the corporate treasury to finance its search for candidates and solicit support for their election, while anyone running against them must put up their own money. (Successful dissident slates often get reimbursed, however, once they are in office.) Management has access to the shareholder list; a dissident shareholder still faces significant obstacles, including millions of dollars for lawyers, ads, mailings, and more. As a result, CEO compensation has gone from being absurd to being offensive, to threatening the economy through perverse incentives. And shareholders have no way to respond. Panglossian free market acolytes will argue that objecting investors can sell the stock but that ignores the transaction costs and the fundamental contradiction that doing so is to sell at a low rather than a high. More important, it ignores the all-but universal adoption of shareholder-unfriendly management compensation due in large part to management control of the board.

Market forces will operate far more efficiently if board members are subjected to even the very small market test of a very limited ability for shareholders to put alternate candidates to a vote. The complaints of those who see specters of "special interests" are hypocritical and disingenuous.  No one will be elected to the board without the support of more than 50 percent of the shareholders.  That means they will need to persuade not just "activist" funds but also staid institutions like foundations and mutual finds that their candidates are better than managements'.  If the shareholders get more than 50 percent of the vote, it is their opponents who are "special interests."  It is appalling that the very people who rhapsodize about the purity of the markets when it comes to their products (unless they can persuade the government to impose barriers to entry or limits to liability) get weak in the knees when it comes to their board members.  Lehman Brothers had a board that included an actress, a theatrical producer, and a retired admiral -- and no one who understood the complex securities that lead to their implosion.  The Wall Street Journal found more than 80 directors currently serving even though a majority of the votes cast by shareholders were against them.  We have found some who serve despite only a third of the votes cast.  Proxy access is important but majority vote requirements for service on a board are crucial.

The providers of capital should play a role in deciding who has the all-important fiduciary duty to minimize the inevitable agency costs of a capitalist system. The proxy access rule will establish the credibility of our markets and economy and encourage investment. As Thomas Paine might have said, if this be capitalism, make the most of it. (Updated: Aug. 26, 4:18 PM EDT).

Administrative Law, Corporate Governance, Forum: Proxy Access, Securities | Bookmark

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