ProfessorBainbridge.com

Q&A on Corporate Governance After the Financial Crisis Part 5: "What is the link between shareholder involvement and corporate performance?"

The latest issue of the UCLA Lawyer magazine has a series of Q&As with yours truly about my book Corporate Governance after the Financial Crisis. I'm reprinting the Q&As in this series of blog posts. As the article intro explains, the book argues "that federalizing corporate governance impinges on state sovereignty, hobbles corporate efficiency and shortchanges both investors and the American taxpayer .... Professor Bainbridge offers an incisive analysis of the landscape-altering Sarbanes-Oxley and Dodd-Frank acts, responses to the near-cataclysmic economic downturns of the last decade," which "advances a critical dialogue about the limits of crisis-driven public policy."

Q: What is the link between shareholder involvement and corporate performance? Does an increase in the former always trigger an improvement in the latter?

A: Actually, the bulk of the evidence is that shareholder involvement does not—outside a few special cases—improve firm performance. I review the evidence at length in Chapter 7 of Corporate Governance after the Financial Crisis. While there is little evidence that activism has benefits for investors as a class, there is considerable evidence for the proposition that activist shareholders can profit through private rent seeking.

This result is not surprising, of course. First, the high costs and low success rate of activism suggest that its net gains are substantially lower than many proponents of shareholder activism claim. Second, if activism increases the target firm’s stock price, all of its shareholders can free ride on the activist’s efforts. It makes no sense for an activist to expend substantial resources when the bulk of the gains from doing so will be captured by others. Instead, we would expect activists to pursue an agenda of private rent seeking rather than altruistic public service. And that’s exactly what we tend to see. 

PROXY MONITOR REPORT Fall 2012 A Report on Corporate Governance and Shareholder Activism

From the Manhattan Institute's Proxy Monitor project comes this assessment of the 2012 proxy season:

This report draws upon information in the Proxy Monitor database to assess the 2012 proxy season in historical context. Among its key findings:

• A small group of shareholders continue to sponsor the overwhelming majority of shareholder proposals. In 2012, 36 percent of all such proposals were sponsored by labor-union pension funds; 31 percent were sponsored by three individual investors and their relatives and family trusts; and 22 percent were sponsored by investors with a “socially responsible” investing purpose or express religious or public policy purpose. Only 10 percent of shareholder proposals were sponsored by individuals other than the three “corporate gadflies,” and only 1 percent by institutional investors unaffiliated with organized labor or a social, religious, or public policy purpose.
  
  
  • Public-employee pension funds played a heightened role in the 2012 proxy season, sponsoring 38 percent of all labor-backed proposals, as compared with 26 percent in the entire 2006–12 period.
  
  
  • Religious-affiliated investors were far less active in the 2012 proxy season: proposals backed by religious investors constituted only 15 percent of all proposals backed by social, religious, or policy groups, as compared with 42 percent in the full 2006–12 period. Notably, Catholic orders of nuns sponsored only two proposals at Fortune 200 companies in 2012, as compared with 11 in 2011 and 16 to 19 annually between 2006 and 2012.


• Shareholder proposals related to corporations’ political spending grew in number in 2012 but gained little traction. Proposals seeking to increase the disclosure of or to limit companies’ lobbying or spending on political purposes constituted a plurality of all proposals in 2012 and 45 percent of proposals with a social or policy-related purpose. The number of such proposals submitted per company in the Fortune 200 was 20 percent higher than in 2011, double that in 2010, and more than three times that in 2008. However, only 17 percent of shareholders, on average, supported these proposals in 2012, down from 22 percent in 2011 and lower than any other year in the 2006–12 period.


• Labor-union pension funds’ sponsorship of shareholder proposals appears to be unrelated to shareholder return and connected to union-organizing activities and other labor objectives. As is the case across the full 2006–12 period, labor pension funds’ shareholder proposals are concentrated in companies and industrial sectors targeted by union-organizing campaigns. Each of the companies facing more than two labor-sponsored shareholder proposals in 2012 had share returns that outperformed its peer group in 2011; each company, however, had been engaged in public disputes with labor unions or had played an active role in the political process against organized labor’s interests.


• The number of shareholder proposals receiving majority support fell in 2012, but this shift appears to be attributable to the types of proposals being introduced rather than a broader trend. Only 6 percent of shareholder proposals received majority backing at Fortune 200 companies in 2012, down from 7 percent in 2011, and below every other year in the full 2006–12 period. The average shareholder vote in 2012, however, was 25 percent, in line with the 2006–12 average. Econometric analysis of Proxy Monitor data shows that there is no statistically significant difference between 2012 shareholder voting and other years; the decrease in voting this year instead appears to be attributable mostly to shifts in the composition of shareholder proposals.


• The recommendations of the proxy advisory firm ISS significantly influence shareholder voting, though the firm’s recommendations are systematically more inclined to favor such proposals than are the majority of shareholders. The proxy advisory firm Institutional Shareholder Services (ISS) makes recommendations to institutional investors on shareholder voting and has a dominant market share position (61 percent). Econometric analysis of Proxy Monitor data shows that a positive recommendation from ISS increases voting support for a shareholder proposal by 15 percent, controlling for other factors. However, ISS consistently supports a much higher share of shareholder proposals (63 percent) than do shareholders overall (less than 8 percent).

Overall, empirical analysis of Proxy Monitor data, in 2012 and across the 2006–12 time span, challenges the efficacy of the shareholder-proposal process, at least from the perspective of the ordinary investor. The prominent role being played by a small number of investors, most prominently labor-union pension funds whose actions in this area appear to deviate from concern over share value, suggests that this process may be oriented toward influencing corporate behavior in a manner that generates private returns to a subset of investors while harming the average diversified investor. The significant influence of the proxy advisory firm ISS, along with its substantial deviation from shareholders’ observed preferences, amplifies concerns about whether shareholder voting on proxy ballot items is effectively working to improve share value.

 

Trends in Proxy Access: 2012 Proxy Season Overview

A very useful overview.

More evidence that proxy advisory services can have invidious effects

An important new paper shows that ISS and other proxy advisory services are wielding increasing amount of power, which does not always redound to the benefit of shareholders:

This paper examines changes in executive compensation programs made by firms in response to proxy advisory firm say-on-pay voting policies. Using proprietary models, proxy advisory firms, primarily Institutional Shareholder Services and Glass, Lewis & Co., provide institutional shareholders with a “for” (positive) or “against” (negative) recommendation on the required management say-on-pay proposal in the annual proxy statement. 

Analyzing a large sample of firms from the Russell 3000 that are subject to the initial say-on-pay vote mandated by the Dodd-Frank Act, we find three important results. 

First, proxy advisory firm recommendations have a substantive impact on say-on-pay voting outcomes. Second, a significant number of firms change their compensation programs in the time period before the formal shareholder vote in a manner consistent with the features known to be favored by proxy advisory firms apparently in an effort to avoid a negative recommendation. Third, the stock market reaction to these compensation program changes is statistically negative. 

Thus, the proprietary models used by proxy advisory firms for say-on-pay recommendations appear to induce boards of directors to make choices that decrease shareholder value.

Larcker, David F., McCall, Allan L. and Ormazabal, Gaizka, The Economic Consequences of Proxy Advisor Say-on-Pay Voting Policies (July 5, 2012). Stanford Graduate School of Business Research Paper No. 2105. Available at SSRN: http://ssrn.com/abstract=2101453

Say on Pay Myths

I just read a very important paper, challenging the mythology that has grown up around say on pay. Larcker, David F., McCall, Allan L., Ormazabal, Gaizka and Tayan, Brian, Ten Myths of 'Say on Pay' (June 28, 2012). Available at SSRN: http://ssrn.com/abstract=2094704

Abstract: Say on pay is the practice of granting shareholders the right to vote on a company’s executive compensation program at the annual shareholder meeting. Under the Dodd-Frank Act of 2010, publicly traded companies in the U.S. are required to adopt say on pay. Advocates of this approach believe that say on pay will increase the accountability of corporate directors and lead to improved compensation practices.

In recent years, several myths have come to be accepted by the media and governance experts. These myths include the beliefs that:

1. There is only one approach to “say on pay."
2. All shareholders want the right to vote on executive compensation.
3. Say on pay reduces executive compensation levels.
4. Pay plans are a failure if they do not receive high shareholder support. 
5. Say on pay improves “pay for performance."
6. Plain-vanilla equity awards are not performance-based.
7. Discretionary bonuses should not be allowed.
8. Shareholders should reject nonstandard benefits.
9. Boards should adjust pay plans to satisfy dissatisfied shareholders.
10. Proxy advisory firm recommendations for say on pay are correct.

We examine each of these myths in the context of the research evidence and explain why they are incorrect. We ask:

* Should the U.S. rescind the requirement for mandatory say on pay and return to a voluntary regime?

Readers familiar with my work on say on pay will not be surprised to learn that my answer to that question is "no." See, e.g., Remarks on Say on Pay: An Unjustified Incursion on Director Authority. Available at SSRN: http://ssrn.com/abstract=1101688:

Proponents of H.R.1257 or similar federal legislation entitling shareholders to vote on executive compensation must carry their burden of proving three distinct claims: First, that there is an executive compensation problem justifying legislative intervention. Second, say on pay is an effective solution to the problem. Third, that any such legislative intervention should be imposed at the federal level. 

If any of these claims fail, the case for a federal say on pay law collapses. In these remarks, I hope to demonstrate that none of the three holds up to close examination.

Congratulations to Lucian Bebchuk

Bebchuk was named to the list of 100 most influential people in finance and risk management:

LUCIAN BEBCHUK
PROFESSOR
HARVARD LAW SCHOOL
Co-author of the book “Pay Without Performance,” Bebchuk has criticized huge compensation packages for corporate executives in years when their companies lose money or even go bust.

Of course, IMHO, Bebchuk's criticisms are mostly misplaced. See Stephen M. Bainbridge, Executive Compensation: Who Decides?. Texas Law Review, 2005. http://ssrn.com/abstract=653383:

Abstract: Pay Without Performance: The Unfulfilled Promise of Executive Compensation by Harvard law professor Lucian Bebchuk and UC Berkeley law professor Jesse Fried is an important contribution to the literature on executive compensation. Bebchuk and Fried's positive account of executive compensation is entirely managerialist; i.e., they argue that top management of public corporations so thoroughly control the board of directors that the former are able to extract compensation packages from the latter far in excess of that which would obtain under arms'-length bargaining. In this review essay, I argue that Bebchuk and Fried overstate the extent to which management controls the compensation process. I also argue that they have not made a convincing case for the reforms to corporate governance they propose.

See also Stephen M. Bainbridge, Director Primacy and Shareholder Disempowerment. Harvard Law Review, Vol. 119, 2006. http://ssrn.com/abstract=808584:

Abstract: This essay is a response to Lucian Bebchuk's recent 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 make 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.

Corporate political spending is good for shareholders

The WSJ opined this morning that:

Liberals have been trying to persuade CEOs and corporate boards to stop spending money on politics by claiming that it doesn't pay. But according to a new study by the cofounder of the Democratic-leaning Progressive Policy Institute, corporate participation in politics works for the companies and their shareholders.

In a report to be released Tuesday by the Manhattan Institute, economist (and former senior Clinton Administration official) Rob Shapiro and co-author Douglas Dowson sort through the academic literature and find that "corporate political efforts generally have positive effects on a firm's market value and its shareholder returns."

The relationship between business and government is complex, but Messrs. Shapiro and Dowson find that "most firms, like most individuals, behave rationally and strategically in their spending decisions on campaigns and lobbying, devoting resources in ways that, they have reason to expect, will benefit the corporations themselves and their shareholders."

The Manhattan Institute report is available here. The executive summary states:

Since the Supreme Court’s 2010 Citizens United decision held that corporate political expenditures are free speech under the First Amendment, various groups and individuals have advocated imposing new limits on corporate political activity. These efforts include calls on shareholders to demand that corporations refrain from involvement in the political process. Such demands have been buttressed by an emergent academic literature which, in contrast to what had been an established perspective, has questioned whether corporate financial contributions and even lobbying are actually in the interest of corporate shareholders. This paper reviews this new literature, contrasts it with previous work on this subject, and determines that the new studies ultimately fail to establish that corporate political activity adversely affects shareholder returns. ...

The dominant academic view for the last 20 years is that companies undertake political activity to secure advantages for themselves, based on a combination of opportunity and necessity. Their incentives to do so are clear, given that modern governments influence national economies in ways that affect the sales and returns of particular industries and companies.

There is a robust academic literature, both theoretical and empirical, on campaign contributions to candidates, especially those provided through corporate political action committees (PACs). The most common explanation for these PAC contributions is that they help corporations and other interests secure greater access to legislators and other public officials. Empirical studies also have shown that corporate PAC activities are positively related to a corporation’s size, concentration, level of regulation, and sales to the government. This research clearly suggests that cost-benefit considerations influence corporate decisions to form and use PACs.

The academic research on lobbying has stressed the role that corporate lobbying plays in providing information to legislators and other public officials, or, in one variation, providing political intelligence and connections. Further, various recent studies have shown that lobbying generates positive economic returns. A 2009 study published in the American Journal of Political Science, for example, found that for the average firm lobbying Congress, across industries and various measures of financial performance, each additional $1 spent on lobbying was associated with $6-to-$20 in new tax benefits. Similarly, a 2010 working paper by Hui Chen and two co-authors found that $1 spent on lobbying was associated with an additional $24–to-$44 in corporate income. The same study further found that those firms which lobbied most intensively—defined as lobbying expenditures as a share of assets, sales, and market capitalization—outperformed their benchmarks by 5.5 percent to 6.7 percent per year, for the three years following their intense lobbying.

Other studies have demonstrated the value of corporate political connections, measured through PAC contributions, and found additional, positive contributions from corporate political activity. These studies include, for example, event studies examining the effects on the value of politically-active firms of the sudden death of Senator Henry “Scoop” Jackson (D-WA) in 1983 and the surprise defection of Senator James Jeffords (R-VT) from the Republican Party in 2001. Further, a 2010 study published in The Journal of Finance suggests that the economic benefits of a corporation’s political connections are also evident over the long term. The authors reported that a one-standard-deviation increase in the number of candidates supported by a firm over the previous five years was associated with excess abnormal returns of 2.6 percent.

Extensive analysis and evidence, then, support the view that corporate participation in the political process yields generally positive returns for firms and their shareholders.

Quoted re shareholder activism

Fortune.com:

As we recently saw with Scott Thompson at Yahoo and at many annual meetings this proxy season, shareholders are raising their voices and many of them mean business. What's next?...

The Thompson episode "encourages investors that it may be worth doing better background checks, and boards need to do a better job vetting candidates," says Stephen Bainbridge, a law professor at UCLA. ...

"I think we will see continued attention to and parsing of political campaign donations," predicts Bainbridge.

Not, of course, that I think that's a good idea.

Saul Alinsky comes to the annual shareholder meeting: Politicized shareholder activists carrying Democratic water

In my book Corporate Governance after the Financial Crisis, I argue that proposals to empower shareholders to be more actively engaged in corporate decision making are problematic because, among other ills, the shareholders most likely to make use of such powers will use them to engage in private rent seeking.

With many categories of institutional investors thus eliminated as potential activists, we are left mainly with union and state and local pension funds, which in fact generally have been the most active institutions with respect to corporate governance issues.  Unfortunately for the proponents of institutional investor activism, however, these are precisely the institutions most likely to use their position to self-deal or to otherwise reap private benefits not shared with other investors. With respect to union and public pension fund sponsorship of Rule 14a-8 proposals, for example, Roberta Romano observes that:

It is quite probable that private benefits accrue to some investors from sponsoring at least some shareholder proposals. The disparity in identity of sponsors—the predominance of public and union funds, which, in contrast to private sector funds, are not in competition for investor dollars—is strongly suggestive of their presence. Examples of potential benefits which would be disproportionately of interest to proposal sponsors are progress on labor rights desired by union fund managers and enhanced political reputations for public pension fund managers, as well as advancements in personal employment. … Because such career concerns—enhancement of political reputations or subsequent employment opportunities—do not provide a commensurate benefit to private fund managers, we do not find them engaging in investor activism.

There have been several troubling incidents of the sort to which Romano refers. In 2004, for example, CalPERS organized a proxy campaign to remove Safeway’s CEO and chairman of the Board Steven Burd. At that time, Safeway was in the middle of acrimonious collective bargaining negotiations with the United Food & Commercial Workers Union. It turned out that CalPERS had acted at the behest of Sean Harrigan, Executive Director of the United Food and Commercial Workers Union, who was then also serving as president of CalPERS board.  Nor is this an isolated example. Union pension funds tried to remove directors or top managers, or otherwise affect corporate policy, at over 200 corporations in 2004 alone.  Union pension funds reportedly have also tried shareholder proposals to obtain employee benefits they could not get through bargaining.  

There's a new wrinkle to the problem, however, which is that union pension funds are now using the corporate governance process to effect a specific political agenda.

Unions, of course, are one of the key special interests of which the Democratic Party is comprised. The vast majority of union campaign contributions go to Democrats. The vast majority of union endorsements go to Democrats. The vast majority of union volunteer efforts go to help Democrats. Whether you think the Democrats are in the unions' pocket or vice-versa, their political alliance is undeniable.

In this highly-charged political year, union-controlled pension funds are using their corporate governance powers as shareholders to carry water for a left-liberal agenda intended to help Democrats and other liberal causes.

Consider, for example, the current campaign to get disclosures or/restrictions on corporate political contributions. If you believe Lucian Bebchuk and his law professor allies, this is just a matter of good corporate governance:

... public investors have become increasingly interested in receiving information about corporate political spending.

... disclosure of information on corporate political spending is important for the operation of corporate accountability mechanisms, including those that the Supreme Court has relied upon in its analysis of corporate political speech.

Unfortunately, of course, this is all bullshit.

If you want a close-up look at why certain shareholder activists have seized on this issue, take a look at what happened at Wellpoint's shareholder meeting:

Union representatives and other protesters repeatedly interrupted Chairwoman and CEO Angela Braly after she opened the meeting and introduced proposals for shareholder voting. ...

"Full disclosure of corporate spending on political activities is in the best interest of shareholders," audience member Dave Wallace shouted as Braly told him in a monotone he was speaking out of order, before the meeting's question-and-answer session. Wallace is the president of the American Federation of State, County and Municipal Employees, or AFSCME, Local 1117 in Torrance, Calif. ... (Source)

Union activists didn't just try to disrupt the shareholder meeting. They also presented a proposal calling on Wellpoint to provide greater disclosure of political and campaign contributions. Their fellow non-activist shareholders overwhelming rejected the proposal:

WellPoint later said a total of 83 percent of shareholders voting rejected the proposal calling for greater disclosure. Company officials also said a similar measure was rejected a couple of years ago. (Source)

The Wellpoint shareholders' rejection of the union proposal is part of a growing trend of non-activist investors wising up to the anti-corporate/anti-business agenda motivating these union-backed proposals:

Support for political proxy proposals has fallen significantly at other big companies as well. Overall, according to the Manhattan Institute's Proxy Monitor, in 2012 political spending or lobbying proposals have received an average shareholder vote of 18.3%, compared with 22.6% last year. Could shareholders be getting wise to the political charade? (Source)

In addition, the union pension fund activists "asked shareholders to vote against board members Julie Hill and Susan Bayh (wife of former Indiana Senator Evan Bayh) because of the board's refusal to disclose political spending. The result was a rout: Two non-targeted board nominees received between 93% and 94% of the votes, but Ms. Bayh and Ms. Hill got nearly as many votes with between 92% and 93%." (Source)

As they have done at many corporations recently, the union pension fund activists also tried to bully Wellpoint into "cutting ties with the American Legislative Exchange Council, or ALEC, a conservative nonprofit group that brings together lawmakers and private sector organizations to develop legislation and policy." (Source)

All in all, what we see here are massive union-controlled pension funds flexing their corporate governance muscles to advance their private political agenda of electing Democrats and promoting liberal causes by defunding conservatives.

It's easy to understand why unions support on-going efforts to empower shareholder activism. It's less clear why law professors like Bebchuk want to promote an agenda that empowers private rent seeking by politically motivated activists. But whatever their motivation may be, it's impossible to deny that they are carrying water for the unions carrying Democrats' water.

Saul Alinsky would be proud.

‘Say on Pay’ vote destroys $500M+ in shareholder value

Marc Hodak:

It had to happen.  At some point, the CEO pay critics second-guessing the board of directors would lead a CEO to say “Screw it,” and leave the shareholders to deal with the aftermath.

Yesterday, Aviva’s shareholders, saw the departure of Andrew Moss, their CEO, after his pay package was voted down.  While it’s difficult to interpret any given Say on Pay vote, it’s a fair assumption that these votes respond to headline news about a company.  In the case of Aviva, the headline appeared to be “Insurer performing badly; CEO pay goes up.”  So, here is what the shareholders have wrought:

1.  While the stock price jumped on news of Moss’s departure, it quickly came back down to earth, then continued sinking as the realization set in of who they might get to succeed him.  The stock price is now six percent below where it started just before Moss’s announcement. ...

By the way, the stock drop has cost Aviva’s shareholders over $500 million, even accounting for the general slump in the market over the last couple of days. The shareholder’s putative complaint was that the board had agreed to pay Mr. Moss a $1.86 million bonus, on top of his $1.55 million salary. So, it appears that the shareholders, in their trading capacity, have penalized the company with a half billion dollar CEO changeover cost because they believed, in their proxy voting capacity, that two million dollars was too much to pay their CEO in a bonus.

via hodakvalue.com

Go read the whole thing. It is devastating critique of say on pay, which remains one of the dumbest ideas to come along in corporate governance in years. 

On say on pay, see Bainbridge, Stephen M., Remarks on Say on Pay: An Unjustified Incursion on Director Authority. UCLA School of Law, Law-Econ Research Paper No. 08-06. Available at SSRN: http://ssrn.com/abstract=1101688

Intimidation by Proxy

The campaign to intimidate companies from exercising their free-speech rights is in high gear as shareholder proxy season arrives, and the most prominent early target is health-insurer WellPoint. The arc of this attack will be one of the election year's political leitmotifs, and it should be on the radar of every corporate boardroom.

In the favored new tactic of the left, unions and activists are using politicized shareholder resolutions to send a message to corporations: Drop support for free-market and conservative causes, or you'll take a political beating. ...

The larger political goal is also to stigmatize and shut down funding sources for any business group that seeks to influence policy debates, such as the U.S. Chamber of Commerce. ...

... The proxy campaign is part of the larger campaign by unions and liberal lobbies to demonize corporate donors so they leave the political field to unions and liberal lobbies. Expect more of this in the months to come.

via online.wsj.com

This is basically the case I've been making about shareholder activism for years, including my last two books:

Is trust in large shareholders warranted?

From the Vancouver Securities Law Blog:

Corporate directors are the stewards of a company. The directors are supposed to make decisions in the best interests of the corporation. In instances where a company is not performing as expected, there are certain shareholders who are taking the reins and trying to force the change they feel will best turn around a company’s share price.

[Citing a couple of examples]

... Investors have usually supported the directors placed before them during proxy time; if a company is not performing well or has been subject to a series of significant missteps along the way, then be prepared for a proxy fight. And rightfully so, because if the directors do not seem to be delivering in the best interests of the company, then a large shareholder will bring in directors who will.

But why would an economically rational large investor do so? In my book, Corporate Governance after the Financial Crisis, I explain that:

… the returns to [investor] activism likely are low. Because many companies must be monitored, and because careful monitoring of an individual firm is expensive, institutional activism is likely to focus on crisis management. In many crises, however, institutional activism is unlikely to be availing. In some cases, intervention will come too late. In others, the problem may prove intractable, as where technological changes undercut the firm’s competitive position.

Even where gains might arise from activism, only a portion of the gains would accrue to the activist institutions. Suppose that the troubled company has 110 outstanding shares, currently trading at $10 per share, of which the potential activist institution owns ten. The institution correctly believes that the firm’s shares would rise in value to $20 if the firm’s problems were solved. If the institution is able to effect a change in corporate policy, its ten shares will produce a $100 paper gain when the stock price rises to reflect the company’s new value. All the other shareholders, however, will also automatically receive a pro rata share of the gains.  As a result, the activist institution confers a gratuitous $1,000 benefit on the other shareholders.

Put another way, the gains resulting from institutional activism are a species of public goods. They are costly to produce, but because other shareholders cannot be excluded from taking a pro rata share, they are subject to non-rivalrous consumption. As with any other public good, the temptation arises for shareholders to free ride on the efforts of those who produce the good.

So why do we occasionally see large investors nevertheless engage in proxy activism? One possible explanation would draw on behavioral economics, seeking to explain seemingly irrational behavior as arising out of ego, hubris, and so on.

The other possible explanation is that large investors are behaving in an economically rational way because they expect to reap non-pro rata gains that will not be shared with their fellow stockholders. As I also explain in Corporate Governance after the Financial Crisis, much institutional investor activism seems to be driven by rent seeking:

In several high profile cases, …  activist hedge funds have used financial innovations to pursue private gains at the expense of other shareholders. In 2005, for example, a hedge fund launched a proxy campaign to elect three candidates to the board of Exar Corporation. The hedge fund had boxed 96% of the shares it owned—i.e., had taken offsetting short positions on those shares—and “was thus almost completely indifferent to how the company performed since a ‘boxed’ position is capable of generating no further profit or loss.”  Another well-known case involved Perry Capital’s innovative investments in King Pharmaceuticals and Mylan Laboratories. The hedge fund was a large shareholder in both Mylan and King. Mylan proposed an acquisition of King at a price many industry observers thought excessively high. Perry nevertheless supported the acquisition. As it turned out, Perry had used derivatives to hedge away its economic interest in Mylan. As a result, the only way Perry could make money on the deal was through its investment in King stock. Accordingly, Perry would prefer that Mylan overpay for King, even though that obviously would be detrimental to Mylan’s other shareholders.  Scholars have identified several other examples of such private rent seeking by hedge funds and other activist investors.

In either case, the assumption that the interests of activist large shareholders and those of a firm's other shareholders are one and the same is clearly unwarranted. Activists thus deserve at least as skeptical an assessment as do entrenched managerial incumbents.

ISS Influence on 2012 Shareholder Voting

In 2011, the Manhattan Institute launched its ProxyMonitor.org database, which catalogs shareholder proposals at America’s largest companies. Drawing upon information from the database, we have been examining a growing trend in shareholder activism wherein investors attempt to influence management and corporate practices through the shareholder voting process, sometimes in ways not directly related to maintaining or increasing shareholder value. [1]

This finding summarizes early trends in 2012 shareholder proposal findings and examines 2012 results to date in shareholder advisory votes on executive compensation—including the significant role played by the shareholder advisory firm Institutional Shareholder Services (ISS). This report also looks ahead to significant classes of shareholder proposals on the horizon that I have previously identified as items to watch for this year [2] — proposals relating to corporate campaign finance and political spending, proposals to separate the positions of corporate chairman and CEO, and proposals to grant shareholders proxy access for their director nominees. While votes on these issues have not occurred to date, several such proposals are on proxy ballots in the coming weeks, and we expect these to be major issues during this proxy season.

via blogs.law.harvard.edu

Very helpful analysis

SEC Commissioner Troy Paredes cool to new proxy access rule

As i documented in the chapter on shareholder activism in my book Corporate Governance after the Financial Crisis, SEC Commissioner Troy paredes has become a leading voice of reason and caution in the ongoing battles over shareholder activism. BNA reports (sub reqd) that:

Securities and Exchange Commissioner Troy Paredes told a gathering of institutional investors April 2 that until the commission has reviewed the experience of proxy access through private ordering, he would be “hesitant” for the agency to tackle another federal access regulation.

Exactly right.

Quoted re shareholder proposals requiring corporations to disclose lobbying expenditures

Adam Piore:

Activist shareholders are aggressively pushing to get broad new lobbying disclosure initiatives on proxy ballots this year, in an effort to convince a number of corporations to voluntarily disclose campaign contributions to investors. ...

Stephen Bainbridge, a UCLA law professor and expert on corporate governance ... offers the example of a mining company: if that company were forced to report that it was lobbying state legislators for mineral rights on a particular property, it might allow competitors to infer that ‘you found gold there’. ...

Bainbridge adds that there is ‘an incentive for corporations to be spineless on this issue.

‘There are multiple areas where they are engaged with activist shareholders on a wide variety of issues that strike more closely to home – particularly for management – and here I am talking specifically about say on pay,’ Bainbridge continues. ‘If management’s thinking is that it’s best to pick your battles, this may be a battle they think is less worth fighting.’