March 2004
Do the SEC's Shareholder Voting Rules Serve Any Useful Purpose?
On Monday, March 8, 2004, AEI hosted a conference on the SEC's shareholder voting rules. In a recent release, the SEC stated that the proposed rules "may serve to align the interests of the board and security holders, thereby giving investors greater confidence that the board is serving the interest of security holders." In a comment filed with the SEC, Randall S. Kroszner questions whether these proposed rules achieve the SEC's goal, increase shareholder value, or achieve any other useful purpose. To address this and other questions, the panel included Charles Elson, University of Delaware; Kevin Hassett, AEI; Eugene Scalia, Gibson, Dunn & Crutcher; Charles Calomiris, AEI; John J. Castellani, Business Roundtable; and Alan Hevesi, New York State Comptroller. A keynote address was delivered by Cynthia Glassman, Commissioner of the Securities and Exchange Commission.
Randall Kroszner
AEI and the University of Chicago
The SEC's shareholder voting rules do not serve any useful purpose. I believe the objectives of reform should include changing corporate governance to result in improved shareholder value via better monitoring and incentives, and to reduce the likelihood of manipulation or fraud on the part of management. Phase I action of Sarbanes-Oxley involves three principles to meet the objectives of reform: improve information availability and accuracy, improve managerial incentives and accountability, and improve auditor independence. Under current SEC rules, shareholders can discipline their boards by "voting with their feet," tendering their shares to a would-be acquirer or through a proxy contest.
Phase II creates conditions whereby "triggering events" allow "eligible" shareholders to include their nominees to the board on proxy materials. However, there are problems with phase II. First, ownership limits are arbitrary and may create a free-rider problem. Secondly, legal risks create lender liability and equitable subordination. In addition, barriers to effective market takeover exist. As a result of the SEC's proposal a firestorm of responses-over twelve thousand-were received in the form of comment letters. Why? I believe because of a mistaken view of objectives, new complex regulations, and the missed opportunity for reform. We must be careful not to allow capitalism to turn into Congress. Officers and directors of publicly traded firms have a fiduciary duty to improve shareholder value. We should not take that away. Instead, we need to find a compromise between a republic and a democracy. We cannot conclude that greater shareholder access would have beneficial effects in the corporate context. This proposal has a misplaced focus with potential costs that outweigh benefits. The costs of the proxy process could increase. Contested member elections could discourage qualified directors, and if elected, lead to fragmented boards. Companies may also have to offer increased compensation to attract qualified directors. Instead of offering new, complex procedures with potentially high costs relative to benefits, we should identify barriers in existing laws and regulations for active involvement by significant shareholders.
In conclusion, rather than promulgate a new set of regulations governing the inclusion of nominees of significant shareholders in company proxy materials, the focus should be on reducing inappropriate barriers for active beneficial involvement in the corporate governance of publicly traded firms.
Charles Elson
University of Delaware
I agree with the conclusion of the paper, but I do have some problems with how the conclusion was reached. The corporation does not model our political model. In a world of corporations, they need to move with near unanimity and purpose. If the goal is competition, fighting internally is unproductive and detrimental in the long run. Corporations must move to achieve consensus, and the key is consistency. Another point concerns potential costs and the problem of the dissident director being elected. I do not think it is as troublesome as others would believe. As a dissident director he/she also has fiduciary duties to the company, so I do not have a problem with a board member entering via a contested election. I do not think the individual being independent of the sponsored company will necessarily create this problem. The argument of creating an incentive for more active involvement is a good idea; however, I am not sure that reaching this through lessening ownership can get you there. The problem is the institution's focus is the bottom line, not corporate governance-at least not until recently. I do not think that percentage of ownership can make that much of a difference. The secret is creating an incentive for the owners to elect a board that represents good monitoring, and I am not sure ownership limits achieve this. Where you do get there, and where I agree with Randall, is increasing activism vis-à-vis more board competition. My problem with the SEC proposal is not with the goals, which I happen to agree with; but from a Federalism standpoint, I think it is better left to state law.
Eugene Scalia
Gibson, Dunn & Crutcher
I come at this issue from a regulatory perspective. I think we are talking about two different rules here. What we have is a narrow, mundane, and boring issue. What we are discussing is a larger issue of corporate governance. The costs here are enormous for the business community. The supporters also make broad claims far beyond what the commission claims. Some people believe the proxy process simply does not work and needs to be replaced, while others believe this will enable shareholders to protect their investments by taking meaningful action when the company is thought to do otherwise. Another view Randy identified is assuring shareholder value. The argument follows that if this is not the purpose of the rule, it should be. There is also the view that new leverage is being created among shareholders that never before existed. I think that the rule we should be considering, regardless of the various interpretations, is the one the commission issued. Section 14-A does not empower the commission to reorder the relationship between shareholders and the management of the corporation, and it is not a vehicle for corporate reform in general.
Kevin A. Hassett
AEI
This particular issue is one where shareholders participate in a democracy and can vote on how the company runs. This can be overrun by agenda-setters. Democracy cannot efficiently aggregate preferences. So, if you think that the idea of agenda-setting is too important, well too bad-agenda-setting is inherent in a democracy. In this problem, what can we hope to accomplish given that democracy is open to agenda-setting? What we have is a principal agent problem. There are some managers that can discreetly change the fundamentals of the business and in the process lose money for the shareholders. What we want is to protect them. One way is to create a better board, impose sanctions, or my preference, to ensure that management compensation is better tied to long equity positions. I am puzzled that we are about to impose all of these costs, and there are much better ways to address this problem. It does not seem to me that improving democracy can achieve a goal to protect shareholders.
Panel II
Charles W. Calomiris
AEI
I assume that when we are out to improve corporate governance, as the SEC is, our main goal is to enhance contestability of control in pursuit of shareholder value maximization. We want to allow anyone willing and able to increase shareholder value to be nominated. Would encouraging involvement by institutional investors help? The answer I will give you is that it depends on the level of involvement, incentives, and the sorts of policies we are considering. My point is that we do not just want to pursue activism of institutional investors. We know that extreme power vested in a small number of institutions does not necessarily produce good corporate governance. It depends on incentives and whether corporations care about shareholder maximization.
John J. Castellani
Business Roundtable
We believe that the SEC and this proposal are moving in the wrong direction. First, a period of historic reforms in corporate governance have brought many changes in the boardroom. Second, the proposal has a series of unintended consequences in terms of reach, the costs are greater than advertised, and most importantly we are going to vest more power in unregulated institutions in the proxy and governing process. Lastly, we feel that the SEC is overstepping its authority with this proposal and this issue should be left to the states. The simple statement is that the most compelling reason to not proceed with this rule is that we have dramatically changed and improved the system of corporate governance in the past twenty-four months. We should absorb these changes and see if these kinds of issues are still relevant in the future.
Alan Hevesi
New York State Comptroller
There have been unprecedented corporate reforms in recent months. I presume that shareholders should have the right to nominate directors to corporate boards, since they are able to do so now. The problem is that it is very difficult to do. What this proposal does is make it easier under limited circumstances. I accept the fact that 98 percent of corporations are honest, but you cannot underestimate the damage a few bad ones can do. The cases are not isolated, and the damage is enormous. This change proposed by the SEC is not that dramatic. It essentially makes it easier for shareholders to do what they are already allowed to do now. The bottom line is that this is not a crazy idea, and we are not the enemy. The union pension funds have to make a profit, and they want a say. The only special agenda is to improve the company and increase shareholder profits. What is so terrible if there is a debate on corporate boards? What is so terrible about allowing shareholders-those who own stake in the company-have a say in the boardroom?
This summary was prepared by AEI research assistant Jessica Browning.
