Gut Proxy Access

Lucian Bebchuk worries that the Senate-House conferees will gut the provisions on proxy access in the Wall Street "reform" legislation:

The Senate’s representatives on the conference committee finalizing financial regulatory overhaul have proposed weakening the proxy-access provisions included in both the House and Senate bills. The senators’ amendment would prevent shareholders owning less than 5 percent of a company’s shares from ever placing director candidates on a corporate ballot.

Hard-wiring such an ownership threshold in the financial regulatory bill would be a significant setback for shareholders and corporate governance reform.

While shareholder power to elect new directors is supposed to serve as a foundation for our system of corporate governance, American shareholders seeking to replace incumbent directors face considerable legal impediments. Lowering these impediments would make directors more focused on shareholder interests. The case for doing so is supported by empirical evidence indicating that arrangements increasing directors’ insulation from removal are associated with lower company value and worse performance.

Bebchuk is wrong, of course. Those impediments are what make the modern corporation possible, as I documented in my article The Case for Limited Shareholder Voting Rights.

Bebchuk continues:

Any reform of corporate elections should include ending incumbents’ monopoly over the corporate ballot — the proxy card sent by the company at its expense to all shareholders. Only board-nominated candidates get to appear on this ballot; challengers must bear the costs of sending (and getting back) their own proxy card to shareholders. Providing shareholders with proxy access — the right to place candidates on the ballot — would contribute to leveling the playing field.

Wrong again.

Carter Wood explains:

Labor unions, environmental groups and other activists have long sought more access and authority to force corporate boards into making decisions that serve the activists' agenda over those of the shareholder. (See the AFL-CIO's commentary.) The bill's Subtitle G--"Strengthening Corporate Governance," would effect that fundamental shift.

In the Heritage Foundation's new webmemo, "Senator Dodd's Regulation Plan: 14 Fatal Flaws," the corporate governance language is Flaw 13:

Allows activist groups to use the corporate governance process for issues unrelated to the corporation or its shareholders. Section 972 of the bill authorizes the SEC to require firms to allow shareholders to nominate directors in proxy statement. Such proxy access turns corporate board elections from a process designed to ensure that each board has a good mix of skills and experience into a popularity contest where the long-term interests of the stockholders become secondary to political agendas or corporate raiders. The process can also be used by labor unions, politicians who manage public pension funds, and others to force corporations to respond to pet social or political causes.

Major business associations -- including my employers at the National Association of Manufacturers -- joined with free-market advocates to also register sharp objections to the proxy access language in an April 12 letter, warning it could unleash "an onslaught of activists trying to manipulate the proxy process to force corporate decisions that adversely impact shareholders as a whole in order to further their parochial social or political agenda." ...

The approach, the letter argued, will create:

a "one-size-fits all" approach to the resolution of these issues that will deprive the American economy of diversity and innovation, impose an unwarranted burden on mid-sized and smaller companies, marginalize the state corporate law expertise that has been developed over decades and is better suited to address these issues, and undermine ongoing reforms undertaken by the State of Delaware and the "Model Business Corporation Act," which impacts 30 states.

Right.

Back to Bebchuk:

The primary purpose of a proxy-access reform is to facilitate increased involvement by long-term institutional investors that have “skin in the game” but not a big block of shares. Consider, for example, the asset manager TIAA-CREF, a long-term investor holding on the order of half a percent of the shares of many large public companies. Because such an investor would be able to capture only a very small fraction of the benefits of improved governance, it cannot be expected to undertake a costly proxy solicitation even when it believes that replacing directors would significantly enhance firm value. But if this investor could place a director on the ballot, it might do so when it views governance as especially poor. And the ability of such institutional investors to do so might make boards more attentive to shareholder interests in the first place.

But which institutional investors?

Here's let's go to the archives for my post Who Would be Empowered by Obama's Corporate Governance Ideas?

At his recent Cooper Union speech on financial reform, President Obama claimed that "these Wall Street reforms will give shareholders new power in the financial system. They'll get a say on pay: a voice with respect to the salaries and bonuses awarded to top executives. And the SEC will have the authority to give shareholders more say in corporate elections, so that investors and pension holders have a stronger role in determining who manages the companies in which they've placed their savings."

Wrong.

As a recent corporate governance commentary by lawyers at Latham & Watkins explains:

Institutional voting of portfolio stocks,for the most part,is no longer in the hands of institutional money managers, except for votes with clear economic significance (such as mergers or election contests).

In their place,the vast majority of institutional investors has delegated voting decisions to a separate internal voting function or have outsourced voting decisions to third-party proxy advisory firms.

As a result,institutional investor votes are largely determined by one-size-fits-all voting policies based on perceived corporate governance best practices, without reference to the particulars of each company’s situation. While rare exceptions are made, the default position is determined by voting policies developed either internally by a specialized corporate governance function, or, in a large number of situations, externally by outside proxy advisory firms.

As documented elsewhere in this series of posts, the beneficiaries of Obama-Dodd-Frank financial reform will not be retail investors. Nor will it be institutional investors (such as pension or mutual funds). Instead, the prime beneficiary will the firms that provide proxy voting advice. Since RiskMetrics Group dominates that select group, it will be the main beneficiary of reform. But, as we've asked before, who holds RiskMetrics accountable?

Back to Bebchuk one last time:

The proxy rules have been intended by Congress, a famous court opinion stated, “to give true vitality to the concept of corporate democracy.” If the conference committee adopts the senators’ proposed amendment, the legislation’s provisions on proxy access would undermine the S.E.C.’s ability to advance this important goal.

An even more famous Supreme Court decision, however, opined that “state regulation of corporate governance is regulation of entities whose very existence and attributes are a product of state law.” CTS Corp. v. Dynamics Corp., 481 U.S. 69, 89 (1987). The court continued: “It ... is an accepted part of the business landscape in this country for states to create corporations, to prescribe their powers, and to define the rights that are acquired by purchasing their shares.” Indeed, the Supreme Court opines that “[n]o principle of corporation law and practice is more firmly established than a State’s authority to regulate domestic corporations.”

Federalism is the genius not only of the American system of corporate governance, but of the American system of government itself, of course. Yet, Bebchuk seems wholly incapable of appreciating the virtues of federalism as both an economic and a political system, as I discussed in my essay The Creeping Federalization of Corporate Governance.

Those of us determined to resist Bebchuk's efforts to transform the United States' system of competitive federalism in corporate law and governance into that of a European-style system run by a unitary national sovereign need to draw a line in the sand. Proxy access is as good a place as any.

Update: Larry Ribstein is also critical of Bebchuk:

... leaving the issue with the SEC is only marginally better than leaving it with Congress. Even if state competition is imperfect, there is no a priori reason to believe the SEC generally will reach better results. A political process necessarily gores somebody’s ox. Although Bebchuk thinks shareholders lose in Delaware, shareholders are a rather diverse lot. Some do better in Delaware than on F Street, some do better on Capital Hill.

Unless all policy arrows point to a particular locus of power, a competitive rulemaking process like the market for state corporate law would seem to trump alternatives.