August 26, 2010
Proxy Access Forum: Eric Talley (UC Berkeley)
Posted by Eric Talley

Viewed through the lens of editorial pages, Wednesday’s rule change was a watershed event. Shareholder activists have been calling for beefed up proxy access rules since at least the early 1990s. Critics have spent at least as much time (and probably more money) resisting the reform. It is therefore unremarkable that the SEC’s action was also highly politicized. Indeed, if it were itself a publicly traded company, the SEC’s stock price would not have changed much on the partisan, 3-2 party-line vote by the Commission. While such ideologically charged votes are historically rare, they have now become so commonplace at the SEC to border on the banal.

But beyond political remonstration, what does this actually mean for investors? That’s the exciting $60-trillion dollar question. My candid answer is a little less titillating: Given the stock of empirical knowledge we have today, I submit that the only responsible answer to this question is a cautious combination of “it depends,” or “we don’t fully know.” And that’s why I think – a bit ironically – that proxy access may have been the right move for the SEC to take.

The polar endpoints of the debate are well trodden terrain. One can very credibly argue (and many have) that proxy access portends a significant and unprecedented sea change in corporate governance -- for better or worse. After all, under the new rule dissident shareholders are no longer required to underwrite the administrative costs of proxy challenges personally, with only the speculative hope of being compensated should they win. Advocates contend that this enhanced credible threat of rival slates will effectuate greater accountability among board members, who have historically been able to use the governance process as a protective bunker, insulating them from any significant shareholder oversight and criticism. Critics contend that the new rule’s ownership thresholds are sufficiently low to invite commandeering opportunism by self-important shareholders whose interests diverge from the (putatively) most responsible goal of corporations: maximizing long term shareholder value. Moreover, some critics contend, the rule change may cause ordinary shareholders to be confused by a dizzying array of candidate choices, unable to discern sensible candidates from agenda-driven, tinfoil-hat-wearing zealots.

An equally plausible (though admittedly less scintillating) prediction is that the sound and fury attending Wednesday’s reform will ultimately prove to be mere fingerling potatoes in a stew combining the myriad forces at play in corporate governance. Shareholders tend, by and large, to defer to incumbent management unless they have good reason to jump ship (their confidence in management is what caused many of them to buy in the first place, after all). It is unlikely that such loyalists will become snowed or confused simply by having additional (but unproven) choices. In fact, public shareholders have long had to screen and evaluate qualifying proposals (including bylaw amendments) made by other shareholders, which under federal law must be included in proxy materials at company expense. Moreover, even prior to this rule change, dissident shareholders could wage a self-financed proxy contest, utilizing their inspection rights to locate other shareholders and disseminate to them a rival proxy solicitation for alternative candidates. While the new rule certainly makes some elements of a proxy challenge less expensive for such dissident shareholders (in the form of reduced postage and some administrative costs), it won’t save them many of the significant costs that attend a proxy challenge – they will still, for example, frequently want to influence other shareholders about their competing slate, and may still find it most effective to make their case(s) personally. In addition, many states (including Delaware, the incorporation home of most public corporations) had already authorized companies to implement a version of the rule in their own bylaws, and numerous companies were already on their way to a similar governance structure.

Finally, one must realize that the proxy access reform debate has not occurred in a complete statutory, regulatory and jurisprudential vacuum. Other concurrent developments in corporate and securities law may have effects that may tend to counteract (or at least inject considerable noise to) the proxy access debate. For example, Delaware’s Chancery Court has recently approved the maintenance of a dilutive shareholder rights plan triggered at an ownership threshold of 4.99% (see Selecteca v. Versata, a threshold far lower than conventional poison pills have historically prescribed (usually in the 15-20% range). If the Delaware Supreme Court affirms this holding – and many believe it will – the effect will be to remove a proverbial arrow from the quiver of dissident shareholders, just as Rule 14a-11 inserts another one. Similarly, Delaware courts have recently manifested a renewed willingness to whittle away at governance-related fiduciary duties (sometimes known as Blasius duties) that are a favorite and oft-utilized weapon of hedge funds and pension funds alike (see, e.g., the recent Barnes and Noble decision from Vice Chancellor Strine – Yucaipa v. Riggio). In short, proxy access is but a single eddy in a swirling endogenous sea of other corporate governance developments, many of which may tend to complicate or neutralize its effects.

Ultimately, of course, this debate will likely boil down to an empirical question. And even as I write this, I conjecture, hundreds of financial economists and legal scholars are designing empirical studies of this rule change, looking for good control and treatment groups, identifying “clean” events, and cooking up game-theoretic corporate governance models (all the while remaining monastically quiet at the faculty lunch table, convinced – optimistically – that they are the only ones hot on the empirical trail). The better of these studies will likely be read by SEC staff economists and discussed (hopefully in an adult fashion) by the Commission. Perhaps some of them will even induce the Commission to adjust the rule, create extensions and/or carve outs, or maybe even rescind it in years hence.

But no matter how the ongoing policy skirmish shakes down, the legions of social scientists who will soon sweep into the debate are likely to bestow a subtle benefit on our future selves – one that is worth our deliberative consideration now: the benefit of empirical knowledge. Republican SEC appointee Kathleen Casey strongly criticized the new rule change, arguing that "the policy objectives underlying the rule are unsupported by serious analytical rigor." Casey, along with many critics of proxy access, appears to believe that the burden of proof about proxy access must rest squarely on the shoulders of advocates before any regulatory change is implemented. This claim is in many ways right – but perhaps only half right, or only some of the time. In at least some regulatory areas, the stock of empirical data for or against a proposed intervention is so impoverished or underdeveloped that it would be difficult to reject virtually any empirical hypothesis about outcomes; and here the burden of proof becomes insurmountable. Proxy access may well be one of those areas. Yet in such arenas, regulators are still charged with the unenviable task of making policy in an environment of sparse data, underdeveloped models, immense public scrutiny, and a resulting miasma of perfervid (and even quasi-religious) advocacy. Some rule changes – and particularly non-voluntary rule changes such as the new Rule 14a-11 – have the potential merit of creating natural experiments that add to the stock of information for future researchers, policy makers, regulators and investors. That dynamic value may justify their adoption in close cases, even if one’s knee-jerk judgment – based exclusively on currently available static information – would tilt ambivalently towards preserving the status quo. At the very least, if we’re genuinely interested in maximizing “long term shareholder value” (a topic that may be ripe for another debate, another time), the benefit of modest regulatory experimentation deserves a seat at the prescriptive table.

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