Corporate directors inevitably must make real-time decisions on complex and nuanced matters that impact not only the company, but also the company’s various stakeholders—e.g., shareholders, creditors, and employees. The pressure cooker that often is the corporate boardroom is not for the faint of heart. The directors’ job becomes even more challenging when the company experiences a financial or operational setback. The divergence in interests among the company’ stakeholders intensifies, and there rarely is one clear path forward.
In theory, state law fiduciary duties should guide directors’ decisions in these difficult situations and protect the company’s and its shareholders’ interests. In practice, however, fiduciary duties are limited in scope and effect, as well as by the reality that directors are human. Conflicts of interest, lenders or investors with differing agendas, or cognitive biases may influence directors’ decisions, including those of directors trying to do the right thing.
Consider a company that has experienced consecutive quarters of losses, is facing a liquidity crisis, and is operating in an increasingly competitive market. Its board frequently must evaluate the company’s operational and financing options in the face of strong pressure from lenders, bondholders, and suppliers and the looming threat of a downgrade of the company’s stock by analysts and debt securities by credit rating agencies; the board may suffer from commitment bias or overconfidence, which may color the potential success of any given option; and certain members of the board and management team may be, at least subconsciously, concerned about their own job security or reputations. Even a cursory review of the downward spiral of distressed companies suggests that boards in these kinds of situations tend to favor short-term fixes that fail to address fundamental underlying problems and wait too long to even acknowledge that a problem exists. Companies need better tools to balance leverage and perspective in the boardroom, which in turn will help boards reach optimal results for their companies and shareholders.
My recent article, Disciplining Corporate Boards and Debtholders Through Targeted Proxy Access, forthcoming in the Indiana Law Journal (“Targeted Proxy Access”), directly addresses this potential lapse in corporate governance. It documents the various challenges facing boards and companies—particularly when companies experience financial or economic distress—through the literature and detailed case studies of Darden Restaurants, Inc. and RadioShack Corp. The case studies highlight the role of shareholder engagement in two different settings, with two different outcomes. The article focuses on aspects of shareholder engagement in each case study that either enhanced or restricted the company’s opportunities to preserve or create value. It then draws on these lessons to evaluate the potential utility of a more structured approach to shareholder engagement in corporate governance generally.
Commentators debate the role and potential value of shareholder engagement, with supporters emphasizing the need for enhanced oversight and monitoring of boards, and opponents underscoring the need for boards to remain nimble and autonomous in decision-making given the complexity and time sensitivity of corporate decisions and the diversity of interests in the shareholder base. Each side in this debate raises valid concerns, but corporate governance reform proposals often fail to allocate sufficient import to the full spectrum of concerns. For example, take the concept of proxy access, which generally allows qualifying shareholders to nominate a certain percentage of the board through the company’s proxy materials. In the proxy access debate, most proposals either give shareholders access in all situations, provided that the shareholder seeking access meets certain threshold requirements (e.g., owning at least three percent of the stock for at least three years), or they advocate no access at all. Neither position adequately accounts for the needs of both management and shareholders, or considers when access might best serve the company and all of its shareholders.
Targeted Proxy Access examines this deficiency in current approaches, reviewing how shareholders might use proxy access and when that kind of intervention might prove most effective. It then proposes a private ordering solution that would strike a better balance between board autonomy and accountability. The proposal suggests the adoption of a bylaw that would give shareholders (meeting certain threshold requirements) the ability to nominate directors upon the occurrence of predefined trigger events. The trigger events could be tailored to the company’s particular industry, capital structure, and the like, but the article posits triggers such as a material default under a credit facility or bond issuance; a restructuring, refinancing, or forbearance to avoid a material default under a credit facility or bond issuance; a downgrade by one of the major credit rating agencies; or a certain number of consecutive quarters of significant losses (or misses on other significant financial metrics). The article includes draft bylaw provisions that could guide boards and shareholders in crafting targeted proxy access in their particular circumstances.
The primary objective of the proposed targeted proxy access is not only to allow boards to run companies consistent with their fiduciary duties, but also to provide a mechanism for shareholder intervention when boards fail or falter in their efforts to do so. Notably, the Securities and Exchange Commission suggested a form of targeted proxy access in 2003, but that proposal was withdrawn because of, among other things, federalism concerns. The private ordering solution set forth in Targeted Proxy Access avoids any potential conflicts between federal and state law rights; it also is a more defined and tailored solution that mitigates over- and under-inclusiveness concerns associated with one-size-fits-all regulations. And although both shareholder proponents and boards may critique the proposal as not going far enough (or going too far), any such opposition suggests that the proposal strikes an appropriate compromise that works to the benefit of the company as a whole.
As boards, shareholders, practitioners, policymakers, and academics work to improve the efficacy of corporate governance, they should consider private ordering solutions, such as the targeted proxy access proposal, as a means to give boards opportunities to run profitable and stable companies and to strengthen shareholders’ rights and collective voice when those objectives are not met. Subjecting boards to proxy access on an annual basis could, among other things, stifle innovation and appropriate risk-taking by boards. Targeted proxy access, however, could encourage more responsible and proactive management, with boards recognizing the consequences of decisions that jeopardize the longer-term success of their companies. A solution that promotes better management, while maintaining an appropriate balance between board autonomy and accountability, has the potential to enhance value for all.
The preceding post comes to us from Michelle M. Harner, Professor of Law at the University of Maryland Francis King Carey School of Law. The post is based on her paper, which is entitled “Disciplining Corporate Boards and Debtholders Through Targeted Proxy Access” forthcoming in the Indiana Law Journal and available here.