Proxy Access: Shareholder Democracy Or Creeping Mercantilism? by R.J. Lehmann, R Street
Executive Summary
Following certain rule changes made by Congress and the U.S. Securities and Exchange Commission, the 2015 proxy season has seen a deluge of shareholder proposals at U.S. public companies calling for proxy access – the ability of minority shareholders to have their slate of directors included in the materials presented to shareholders ahead of a company’s annual meeting. Promoted as a means to enhance “shareholder democracy,” the legal and economic literature on proxy access does not support claims it maximizes shareholder wealth. Moreover, the process may allow unions and certain elected officials to use the corporate boardroom to effect politically motivated outcomes. This paper’s analysis of 65 proxy ballots completed through June 2015 suggests shareholders of firms that passed access initiatives lost $14.6 billion of wealth. The paper concludes with recommendations to grant more leeway to companies that omit or disqualify some kinds of proxy access proposals, as well as changes to rein in the power of elected officials who serve as administrators of public pension plans
Introduction
In his 1776 master work, “An Inquiry into the Nature and Causes of the Wealth of Nations,” Adam Smith expressed skepticism about the emerging business firm type that we know today as the public corporation. These new “joint stock companies,” chartered by the crown and granted certain monopoly privileges, were particularly active in Britain’s new overseas colonies. But what really concerned the godfather of all economists was their form of governance, ruled by directors who “seldom pretend to understand anything of the business of the company.”
The directors of such companies, however, being the managers rather of other people’s money than of their own, it cannot well be expected that they should watch over it with the same anxious vigilance with which the partners in a private copartnery frequently watch over their own. Like the stewards of a rich man, they are apt to consider attention to small matters as not for their master’s honor, and very easily give themselves a dispensation from having it. Negligence and profusion, therefore, must always prevail, more or less, in the management of the affairs of such a company.
Smith’s skepticism may indeed have been appropriate for the chartered joint stock companies of his time, which were more properly characterized as privatized instruments of the British state than they were examples of the free market. But since at least the mid-19th century, the public corporation – with its ability to tap deep and liquid markets, while limiting investors’ liability solely to the size of their investments – has worked out pretty well, on balance, playing a crucial role in the exponential economic growth the world has seen since Smith’s day.
To be sure, the evolution of accounting and reporting standards, not to mention a free and informed press, have been essential features of this success here in the United States. But so, too, has been the proxy statement. Issued by each U.S. public company in advance of its annual meeting, the proxy statement is the primary means by which companies
communicate important information about the firm’s performance and planned future direction to shareholders. It also must, by law, include various questions that shareholders are to settle through binding or advisory ballot elections. These typically include questions about board and executive compensation, as well as the selection of directors who will exercise appropriate oversight of a company’s management, bound by strict fiduciary duties.
When it comes to governance, to paraphrase Alexander Hamilton, corporations are more like republics than true democracies. Under both state laws that govern corporate bylaws and federal regulations promulgated by the Securities and Exchange Commission, companies historically have been allowed to determine which director nominees will appear in proxy materials sent to shareholders. Effectively, control of the proxy slate has remained the exclusive purview of the existing board and its nominating committee. Independent shareholders can and have mounted election campaigns, but doing so is a costly process that requires soliciting both shareholders’ attention and their votes. Because of their expense and the likelihood of failure, independent proxy solicitation initiatives typically have been limited to cases where a slate mounts a full-blown battle for control, such as those launched by hostile shareholders who in the 1980s were known as the “corporate raiders” – investors like Carl Icahn, Ron Perelman and Henry Kravis.
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