Just read an interesting column of that title by the WSJ's Jason Zweig. The gist is that the internet makes it possible for small investors to become corporate governance activists. But is that a good idea?
I'm on record, of course, as doubting the desirability of activism by any shareholders--small or large--but I'm particular skeptical of the former. See The Case for Limited Shareholder Voting Rights. UCLA Law Review, Vol. 53, pp. 601-636, 2006. Available at SSRN: http://ssrn.com/abstract=887789
Some specific comments on Zweig's column follow:
... networks are springing up online to rally investors large and small. These websites could enable investors—anyone from a dogcatcher in Dubuque with 100 shares to giant pension funds holding tens of millions of shares—to mingle online and pool their dispersed power as never before.
Granted, corporate managers make mistakes (See, e.g., Kodak). But why on earth would we think "a dogcatcher in Dubuque" brings anything to the table as a governance activist that would add value to the firm?
Kenneth Steiner ..., 45 years old, is a private investor from New York's Long Island who filed petitions at five companies late last year under the new SEC rule. Over the past decade or so, Mr. Steiner estimates, he has formally made several hundred proposals to improve how companies are run—including simplifying the election of directors, giving more say over how top executives are paid and eliminating "poison pills" that can entrench management.
... Using a form he downloaded from proxyexchange.org, Mr. Steiner late last year requested that the boards at Bank of America, Textron, Ferro, Sprint Nextel and MEMC Electronic Materials amend their companies' bylaws to permit any group of 100 or more shareholders who have held at least $2,000 in stock for at least one year—or any holder of 1% or more for at least two years—to nominate directors.
First, private investors really ought to be in low fee passively managed index funds. Second, anybody who makes 100s of shareholders proposals over a 10 year period really needs to get a life. We're talking obsession here folks. Finally, this is a classic example of why shareholder activism doesn't improve corporate governance. The proxy access proposals Steiner is pushing are a really bad idea. As I've discussed before:
... there can be no doubt that giving shareholders access to the proxy statement to nominate directors is going to be expensive. Plus there are all the indirect costs. Companies are already having a hard time attracting independent directors. The shareholder access proposal likely will make that search even harder. Why would somebody be willing to serve on the board if he or she might be the one singled out to be ousted?
The election of a shareholder representative also will disrupt the delicate internal dynamics that make boards successful. ... The presence on the board of a single shareholder-approved director likely will have a highly disruptive effect on the board's decisionmaking processes. Granted, some firms might benefit from the presence of skeptical outsider viewpoints. The analogy to cumulative voting, however, suggests that such benefits will be rare. It is well-accepted that cumulative voting tends to promote adversarial relations between the majority and the minority representative. On such boards, the majority tends to resort to pre-meeting caucuses at which decisions are worked out. In addition, management tends to restrict the flow of information to such boards, out of concern that the minority will use confidential firm information for improper purposes. A chief indirect cost of the proposed compromise therefore will be less effective governance.
Back to Zweig:
Argus Cunningham ... is a former Navy pilot whose portfolio crash-landed in 2008. "Losing a lot of money will cause you to re-evaluate your role," he says. "You feel disempowered and disconnected even though you are the owner of your companies, and I started thinking about what I didn't like about the system."
Frustrated by how hard it is to find other investors willing to shake up moribund companies, Mr. Cunningham founded Sharegate. Likely to launch later this year, the website will join others that seek to rally shareholders, including United States Proxy Exchange, ProxyDemocracy.org and Moxy Vote.
Again, seriously, unless Navy pilots get paid a lot more than seems likely, low fee passively managed index funds are incredibly superior over the long run to direct stock ownership for the vast majority of private investors. As the Guardian summarized the economics of stock market investing:
Markets are, broadly speaking, efficient. You can't beat them, so fire your financial adviser and put your money into index funds. These are unburdened by investment management costs, so they will always outperform the average active fund. Build an asset allocation model that suits your age and risk profile, then diligently put money in every month until you retire. Annually rebalance your portfolio – selling what's gone up, and buying what's gone down. And that's about it, really. Oh, and don't forget China.
Next, Mr. Cunningham has a fundamental misunderstanding of the nature of stock ownership. He owns a share in the residual claim on the corporation's assets. He does not own the corporation. As I've explained before:
How do you own the a legal fiction? Ownership implies a thing capable of being owned. To be sure, we often talk about the corporation as though it were such a thing, but when we do so we engage in reification. While it may be necessary to reify the corporation for semantic convenience, it can mislead. Conceptually, the corporation is not a thing, but rather simply a set of contracts between various stakeholders pursuant to which services are provided and rights with respect to a set of assets are allocated.
Because shareholders are simply one of the inputs bound together by this web of voluntary agreements, ownership is not a meaningful concept in nexus of contracts theory. Someone owns each input, but no one owns the totality. Instead, the corporation is an aggregation of people bound together by a complex web of contractual relationships.
As I explain in detail in my article The Board of Directors as Nexus of Contracts, the shareholders' contract with the firm has some ownership-like features, including the right to vote and the fiduciary obligations of directors and officers.
Even so, however, shareholders lack most of the incidents of ownership, which we might define as the rights to possess, use, and manage corporate assets, and the rights to corporate income and assets.
As a shareholder, you're therefore supposed to be "disempowered and disconnected." As I've discussed before:
State corporate law provides clearly that the corporation’s business and affairs are “managed by or under the direction of a board of directors.” The vast majority of corporate decisions accordingly are made by the board of directors acting alone, or by persons to whom the board has properly delegated authority. Shareholders have virtually no right to initiate corporate action and, moreover, are entitled to approve or disapprove only a very few board actions. The statutory decision-making model thus is one in which the board acts and shareholders, at most, react. ...
... As Delaware’s Chancellor William Allen observed, our “corporation law does not operate on the theory that directors, in exercising their powers to manage the firm, are obligated to follow the wishes of a majority of shares. In fact, directors, not shareholders, are charged with the duty to manage the firm.” Paramount Communications Inc. v. Time Inc., 1989 WL 79880 at *30 (Del. Ch. 1989), aff’d, 571 A.2d 1140 (Del. 1990).
Allen further recognized that the fact that many, “presumably most, shareholders” would have preferred the board to make a different decision “done does not . . . afford a basis to interfere with the effectuation of the board’s business judgment.” In short, corporations are not New England town meetings.
I've dealt with these issues in greater length elsewhere, most notably The Case for Limited Shareholder Voting Rights, 53 UCLA Law Review 601-636 (2006), which explained that:
Recent years have seen a number of efforts to extend the shareholder franchise. These efforts implicate two fundamental issues for corporation law. First, why do shareholders - and only shareholders - have voting rights? Second, why are the voting rights of shareholders so limited? This essay proposes answers for those questions.
As for efforts to expand the limited shareholder voting rights currently provided by corporation law, the essay argues that the director primacy-based system of U.S. corporate governance has served investors and society well. This record of success occurred not in spite of the separation of ownership and control, but because of that separation. Before changing making further changes to the system of corporate law that has worked well for generations, it would be appropriate to give those changes already made time to work their way through the system. To the extent additional change or reform is thought desirable at this point, surely it should be in the nature of minor modifications to the newly adopted rules designed to enhance their performance, or rather than radical and unprecedented shifts in the system of corporate governance that has existed for decades.
And Director Primacy and Shareholder Disempowerment, 119 Harvard Law Review (2006), which was a response to Lucian Bebchuk's article The Case for Increasing Shareholder Power, 118 Harvard Law Review 833 (2005). In that article, Bebchuk put forward a set of proposals designed to allow shareholders to initiate and vote to adopt changes in the company's basic corporate governance arrangements.
In response, I made three principal claims:
First, if shareholder empowerment were as value-enhancing as Bebchuk claims, we should observe entrepreneurs taking a company public offering such rights either through appropriate provisions in the firm's organic documents or by lobbying state legislatures to provide such rights off the rack in the corporation code. Since we observe neither, we may reasonably conclude investors do not value these rights.
Second, invoking my director primacy model of corporate governance, I present a first principles alternative to Bebchuk's account of the place of shareholder voting in corporate governance. Specifically, I argue that the present regime of limited shareholder voting rights is the majoritarian default and therefore should be preserved as the statutory off-the-rack rule.
Finally, I suggest a number of reasons to be skeptical of Bebchuk's claim that shareholders would make effective use of his proposed regime. In particular, I argue that even institutional investors have strong incentives to remain passive.
In sum, corporate law was designed to make small investors like Steiner and Cunningham essentially powerless. Despite the agency costs inherent in that design, the benefits of director primacy have been so profound that the corporation has been the dominant form of economic organization for over a century and a half. There is no reason--nada, zilch, none--to think a regime of shareholder empowerment would be an improvement. To the contrary, there's lots of reasons to think it would make corporate governance far worse.
