NO DEMOCRACY PLEASE, WE'RE SHAREHOLDERS
Apr 29th 2004
From The Economist

ANOTHER PROXY SEASON, ANOTHER GAZILLION WASTED VOTES

AMERICA is the world's most prominent democracy, and its most successful exponent of shareholder capitalism. But when it comes to shareholder democracy America has barely moved beyond the corporate equivalent of the rotten borough. American firms look democratic. During these past few weeks of the annual “proxy season”, shareholders have been electing board members and voting on resolutions listed on a firm's proxy statement. But given how little difference such votes can make, they might as well not have bothered—which is why shareholders typically vote unthinkingly for what the incumbent board wants, much as citizens of the Soviet Union used to vote for their leaders.

For instance, if a shareholder resolution actually makes it on to the proxy statement—and a board can refuse to put to the vote any resolution it deems to be about “ordinary business” activity—it is typically not binding but “precatory”: advice that the board can take or, more likely, ignore. No wonder most of the resolutions tabled are exercises in political grandstanding on social issues by trade-union shareholders—although, to be fair, a chunk of this year's record crop of resolutions have addressed corporate governance and executive pay.

As for electing directors, there is rarely a genuine contest for a boardroom seat. According to a recent study by Lucian Bebchuk of Harvard Law School, in 1996-2002 there were fewer than two attempts each year to vote out directors of American firms worth over $200m. This is abysmal, but understandable. Under current rules, voting out a director is almost impossible.

In theory, shareholders should be able to elect to the board whomsoever they want. America's reality falls far short of this. Unlike in Britain, shareholders of American firms typically cannot call an extraordinary general meeting to vote in a new board. Indeed, 60% of American firms have staggered boards, which means that only one-third of board seats are up for election each year. Nor is voting for a new director, and against an old one, simply a matter of putting a cross against one name and not the other. The only votes which count are those cast in favour of those names on the corporate proxy—and the firm's board decides which names go on the proxy, and typically only nominates one candidate per seat.

FAIR VOTES FOR ALL

So, for all the recent excitement at the Walt Disney Company, where 45% of votes were withheld from its chief executive, Michael Eisner (see article), even if 99.9% of shareholders had withheld their votes, Mr Eisner would still have been re-elected. To oust him, shareholders would have had to organise and pay for the distribution of a separate proxy carrying a rival slate of candidates, a complex task costing several million dollars. Whichever slate got most votes would win, but the system is so weighted in favour of the official proxy, which the board is free to spend as much as it likes promoting, that contests rarely happen.

All that is why two cheers should be offered to the Securities and Exchange Commission (SEC), which has summoned up enough spirit to propose a small step in the direction of genuine shareholder democracy. It will soon decide whether to implement this proposal—in the face of hysterical opposition from corporate bosses, who can think of nothing worse than being humiliated in a genuine election. Yet the SEC's proposal would not, as bosses fear, turn American firms into models of corporate democracy. The proposal is, if anything, too timid. It would allow shareholders controlling more than 5% of a firm's shares, which they must have held for at least two years, to nominate just two rival candidates—not enough to control the board—on the official proxy. Moreover, they would get this right only in the year after either a majority of shareholders had voted for a resolution demanding it or if at least 35% of votes were withheld from any director on the official proxy.

The SEC should implement this modest rule-change forthwith. It might then consider adopting another quite modest proposal, recently advanced by Ira Millstein, a leading lawyer and corporate-governance reformer, and a rule long observed in more shareholder-friendly places such as Britain: if, by withholding support, shareholders cast more votes against a candidate than in favour, he should not be elected to the board. How daringly democratic.

Last updated: may 2003
Copyright © The President and Fellows of Harvard College.
Comments and questions should be directed to Sigal Bar-Gill at: sbargill@law.harvard.edu