The email brought the following question from a reader who works for a government agency:
I am looking into the rationale for the option to "withhold" one's vote (instead of an "against" option) in the election of directors. There does not seem to be much literature on this aspect of director elections. Any insight would be much appreciated.
I replied as follows:
I have always assumed that the withhold authority option was created by the SEC to deal with the prevailing rule of electing directors by plurality.
Until quite recently, under plurality voting rules in most states, a vote "against" a director candidate had no legal effect.
My reply continued:
SEC Release No. 16356, which was the adopting release for the relevant language, states:
Rule 14a-4(b)(2), as proposed, would have required that a form of proxy relating to the election of directors list the nominees individually. It also would have permitted shareholders to vote for or against each nominee, individually, by marking a box or by other similar means. A mechanism for shareholders to vote in favor of the entire slate of nominees by marking a single box, rather than by marking boxes for each of the nominees, also would have been permitted provided that there was a similar means for the security holder to vote against the entire slate. …
Virtually all of the commentators addressed themselves to questions concerning the feasibility of structuring a proxy card to allow individual voting and the costs necessary for implementation. The corporate commentators generally expressed opposition to the proposal based on cost estimates included in their comments. Most of these commentators, including corporate transfer agents, asserted that this proposal would make the current vote tabulation system obsolete, thereby requiring new data handling systems in order to tabulate the expanded number of proposals. It was further argued that the proposal would not only reduce the accuracy and efficiency of the tabulation process, but also would overly complicate the process of voting on a proxy card, thereby fostering shareholder disinterest and confusion.
A number of legal commentators questioned the treatment of an “against” vote under state law, most arguing that it normally would have no effect in an election. They also expressed the concern that shareholders might be misled into thinking that their against votes would have an effect when, as a matter of substantive law, such is not the case since such votes are treated simply as abstentions. …
The Commission has carefully considered the comments and recognizes that, given the present state of proxy tabulation procedures, the rule, as proposed, could be burdensome to some companies and that there may be other ways to achieve similar benefits without the economic and practical difficulties presented by the proposed rule. Therefore, as adopted, rule 14a-4(b)(2) has been revised to delete the specific requirement of a for and against vote for individual nominees. Instead, the rule provides that the form of proxy shall clearly provide one of several designated methods for security holders to withhold authority to vote for each nominee. It is contemplated that the rule will allow issuers to provide shareholders the opportunity to express themselves in the most economic and practical manner. The Commission intends to monitor the workings of the rule and will consider appropriate revisions as deemed necessary to facilitate shareholder participation in the corporate electoral process.
Rule 14a-4(b)(2), as revised, requires that the names of the persons nominated to the board shall be set forth on the form of proxy. This requirement will provide shareholders with the readily accessible information upon which to withhold authority from individual nominees if such is their desire. It is contemplated that a horizontal listing of the nominees could be set forth in the space available on the form of proxy.
Robert Todd Lang explains in 1486 PLI/Corp 1115:
The SEC Adopting Release clearly indicates that the SEC knew that the effect, under state corporate law, of executing a proxy in this manner, whatever it was called, would be equivalent to an abstention, and would not count toward the vote required under the prevailing plurality requirement, concluding that the term “withhold authority” more accurately conveyed the concept to shareholders. Consequently, it seems that the SEC's creation of the “withhold authority” proxy option represented the creation of a unique form of abstention for the election of directors which could be affirmatively selected on the proxy card by shareholders. Underlying this affirmative ability to abstain was the idea that withholding authority represented an expression of dissatisfaction with the particular candidate, a different means of implementing the proposed rule's “against” voting mechanism. Indeed, the rule provides in an instruction that a means to “vote against” should instead be provided on the proxy card where legally effective under state law. Accordingly, both the “vote against” proposed by the SEC and the “vote withheld” it adopted provided a means for shareholders to express dissatisfaction with nominees, but without having a direct effect on the election. In serving primarily as a shareholder communication mechanism, the withheld vote was largely the same in purpose as a precatory proposal required to be included in company proxy material under Rule 14a-8. Based on the federal regulatory history, the withheld vote in the case of plurality voting may be considered a form of abstention for reasons of dissatisfaction with respect to the election of one or more nominees, but the legal effect is primarily dependent on state law and each corporation's charter and bylaws. Accordingly, the meaning to shareholders may not be entirely clear, particularly since shareholders are likely to have different reasons for withholding their votes. …
Under the plurality voting system used for the election of directors, a vote is cast for each nominee or it is not cast at all, since there is no vote against. This inability to dissent means that a nominee can be elected to the board if at least one share is voted in his or her favor, as long as no nominee receives a greater number of affirmative votes and a quorum is present. The number of shares actually voted in the election are irrelevant once a quorum is established.
Might I ask why you’re interested?
No answer to that last query so far.
Interestingly, I today came across a new paper on SSRN entitled Are Uncontested Director Elections Meaningful?
Abstract: Almost all company directors are routinely approved in uncontested elections; that is, no outside group contests director nominees via a vote-no campaign or a proxy fight. Because of plurality voting rules, such elections are meaningless, in the sense that the director nominees are almost surely elected. We hand collect over 10,000 individual director vote tallies from these meaningless elections and assess whether they serve as an aggregator of investor perceptions regarding firm management. We document that vote approval is extremely high for almost all nominees in uncontested elections, with the lowest quintile of vote approval still having a mean of 90%.
Nonetheless, we provide evidence that uncontested elections serve as meaningful aggregators of investor perceptions by documenting that (1) vote approval is associated with prior-year stock return and prior-year return on assets, and (2) vote approval predicts stock price reactions to subsequent announcements of management turnovers. In addition, we provide evidence that boards are responsive to the sentiment captured in the uncontested vote by documenting that vote approval predicts forced CEO turnover in the twelve months after the annual meeting. Furthermore, we show that other statistics that determine or reflect investor perceptions (i.e., prior stock returns, prior return on assets, and change in institutional ownership) do not subsume the information content in vote approval, which suggests that it captures some unique aspects of investor perceptions. Finally, we document that both the change in institutional ownership, which captures institutions voting with their feet, and the vote approval measure both have predictive value in identifying forced turnovers, which suggests that each type of voting captures different investor perceptions. We conclude that while director do not directly determine who sits on boards, they do reflect investor perceptions regarding board performance and the board appears to be responsive to those perceptions.
There's a glitch in that last sentence, but I take the finding "that uncontested elections serve as meaningful aggregators of investor perceptions" as suggesting that the SEC's imposition of a requirement that the form of proxy provide a "withhold authority" option actually has had informational value for firms. The finding that the vote is associated with "forced CEO turnover," moreover, suggests that the requirement may also have positive governance effects.
