CA v. AFSCME: The Limits of Shareholder Power

Jay Brown laments that the Delaware supreme court's decision in CA v. AFSCME will limit shareholder power:

... the Court distinguished between procedural and substantive bylaws.

The process-creating function of bylaws provides a starting point to address the Bylaw at issue. It enables us to frame the issue in terms of whether the Bylaw is one that establishes or regulates a process for substantive director decision making, or one that mandates the decision itself.
Having framed the issue in that manner, the Court then agreed that the bylaw, although "infelicitously couched as a substantive-sounding mandate to expend corporate funds, has both the intent and the effect of regulating the process for electing directors of CA." It was, therefore, a proper subject for shareholders.

While AFSCME won the argument, shareholders lost the war. The need to have the bylaw involve process meant that any decision, no matter how small, that was not process oriented, would be invalid. Bylaws requiring boards to undertake steps to curb global warming, to disinvest from companies doing business with terrorists, or to withdraw poison pills would, under the Court's reasoning in this case, to be on their face invalid.

As well they should be, of course. Shareholders do not own the corporation. To the contrary, the corporation is a vehicle by which the board of directors hires capital by selling equity and debt securities to risk bearers with varying tastes for risk. The board of directors thus can be seen as a sort of Platonic guardian?a sui generis body serving as the nexus for the various contracts making up the corporation and whose powers flow not from shareholders alone but from the complete set of contracts constituting the firm. As a early New York decision put it, the board?s powers are ?original and undelegated.?

Shareholder involvement in corporate decisionmaking would disrupt the very mechanism that makes the modern public corporation practicable; namely, the centralization of essentially nonreviewable decisionmaking authority in the board of directors. The chief economic virtue of the public corporation is not that it permits the aggregation of large capital pools, as some have suggested, but rather that it provides a hierarchical decisionmaking structure well-suited to the problem of operating a large business enterprise with numerous employees, managers, shareholders, creditors, and other inputs. In such a firm, someone must be in charge, as Kenneth Arrow observed: ?Under conditions of widely dispersed information and the need for speed in decisions, authoritative control at the tactical level is essential for success.? Shareholder activism necessarily contemplates that institutions will review management decisions, step in when management performance falters, and exercise voting control to effect a change in policy or personnel. In a very real sense, giving shareholders this power of review differs little from giving them the power to make management decisions in the first place. As Arrow further observed, ?If every decision of A is to be reviewed by B, then all we have really is a shift in the locus of authority from A to B and hence no solution to the original problem? of allocating control under conditions of divergent interests and differing levels of information. Even though shareholders probably would not micromanage portfolio corporations, vesting them with the power to review major decisions inevitably shifts some portion of the board?s authority to them. Given the significant virtues of discretion, there needs to be a presumption in favor of preservation of board discretion. The separation of ownership and control mandated by U.S. corporate law has precisely that effect.

In contrast to both self and Brown, Larry Ribstein thinks the Delaware supreme court was careful to be neutral between directors and shareholders:

... the Delaware Supreme Court ?was careful to present itself as a pragmatic forum that would hear the shareholders out on a case by case basis.? This is important: the SEC gave Delaware an unprecedented chance to participate in the shareholder access debate, and the Court was determined not to blow it. It seized the opportunity by, in effect, emphasizing that it wasn't the defender of some general principle of director vs. shareholder power that the court will uphold whenever it?s asked. It?s about this particular contract, as set forth in the certificate, and how it applies to the particular issue of proxy expenses. Change the contract or the issue and you might get a different result. ...

This relates to Professor Bainbridge?s lament, ?We are not cited. We are depressed.? Indeed, if anybody deserves to be cited on the issues in this case it is Professor Bainbridge. But the court studiously avoided citing any academic except (in fn 8) to establish the unclarity in the law that the court had to unravel. This is part of the court?s avoiding taking a policy position that could be interpreted as inhospitable to insurgent rights, leaving it to the SEC to defend these rights.

It follows that the Professor is wrong ?to see a strong affirmation of the principle of director primacy.? The court is saying as clearly as it can, there is no principle, just the rule that happens to be expressed in the current version of DGCL Section 141(a). That is not necessarily to say that there is in fact no principle of director primacy that underlies Delaware decision-making, just that the court was doing what it could to keep it out of this case.

I'm not persuaded by Larry's last argument. In contrast, I agree with Broc that this decision is consistent with "Delaware?s historic model of director-centric governance." We see this in the way sec. 141(a) trumps sec. 109, for example. We also see it in the court's clear statement that ?it is well-established that stockholders of a corporation subject to the DGCL may not directly manage the business and affairs of the corporation, at least without specific authorization in either the statute or the certificate of incorporation.? This is a director primacy opinion.