Proxy Access and Optimal Standardization in Corporate Governance

According to conventional wisdom, “one size does not fit all” in corporate governance. Firms’ governance needs vary, implying that the optimal corporate governance structure for one company may not work for another. This one-size-does-not-fit-all axiom has featured prominently in arguments against numerous corporate law regulatory initiatives, including the SEC’s failed Rule 14a-11—an attempt to impose mandatory, uniform “proxy access” on all public companies—which the D.C. Circuit struck down for inadequate cost–benefit analysis.

In a recent paper, I present an alternative theory on the role of standardization in corporate governance—in which investors prefer standardized terms—and empirical evidence that is consistent with this theory.

Under my theory, shareholders prefer standardization because they must incur considerable transaction costs to exercise control rights with idiosyncratic terms. To use a control right, an investor must determine its scope, mechanics, and application to her circumstances for each firm in her portfolio. Accordingly, a diversified investor may rationally prefer that the terms of a control right are uniform across portfolio companies. With standardized terms, the investor faces reduced costs of acquiring and processing the information necessary to exercise the right. To the extent that use of the control right efficiently reduces agency costs, these savings increase shareholder value. In short, standardization reduces transaction costs, facilitating the efficient use of control rights.

To test this theory, I use a hand-collected data set to study the private ordering of proxy access occurring between 2012 and 2016. Consistent with my theory, I find that standardization has pervaded the private ordering of proxy access. The main terms are remarkably homogeneous among shareholder proposals that request proxy access and the bylaws that boards actually implement. Additionally, regression analysis suggests that this standardization reflects shareholder preferences: Standardization in the terms of a shareholder proposal is associated with significantly higher shareholder support (in my preferred specification, approximately 39 percentage points of votes cast in favor). Moreover, employing a regression-discontinuity design, I find evidence indicating that markets have generally reacted favorably to the passage of these standardized proposals. In my baseline model, approval by a narrow margin leads to mean cumulative abnormal returns of 335 basis points, implying a 3.35 percent increase in shareholder value. However, robustness checks cast some doubt on the internal validity of this regression-discontinuity design, and thus these results should be taken with a grain of salt.

My theory and empirical findings have important implications for longstanding debates in corporate law. With a proper understanding of the role of standardization in corporate governance, the one-size-fits-all critique—though not baseless—takes on a different meaning. Although lawmakers would still do well to retain a presumption in favor of default rules instead of mandatory rules, the need for heterogeneity does not appear to be as great as some have supposed, and lawmakers may benefit from a greater focus on encouraging optimal standardization instead of optimal heterogeneity. As explained in my paper, these insights are useful in evaluating the design of regulations in the abstract and the wisdom of pending federal legislation.

This post comes to us from Reilly S. Steel, the Millstein Fellow with the U.S. Senate Committee on Banking, Housing, and Urban Affairs. It is based on his recent article, “Proxy Access and Optimal Standardization in Corporate Governance: An Empirical Analysis,” available here. The views expressed in this post are solely his own and do not necessarily reflect those of the committee, its staff, or any member of Congress.

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