Recent debates have sometimes obscured the value of shareholder voting, which the Council of Institutional Investors (CII) regards as a key element in the legitimacy and functioning of the corporate governance system in the United States and elsewhere.
A factor in confusion on this may be overstatement of supposed claims made by institutional investors generally for “shareholder democracy.” In a current paper, for example, Bernard Sharfman writes that “Shareholder voting provides a means by which shareholders can participate in corporate decision making.”[1] However, he goes on to say, “very few public company decisions involve this decision-making mechanism.” Well, one could respond, of course that is the case.
Shareholders of both public and private companies generally expect management of the companies to manage the business and make operational decisions, with oversight and direction from boards of directors and accountability to the shareholders, who are the owners of the company. At least, this is the dominant view I hear from members of CII, including both asset owners and asset managers.
It is true that investors believe it is the legal and actual responsibility of the board to hire and, when necessary, change senior management, and to approve strategy and capital allocation. And shareholders have expectations for good and accurate disclosure (which at publicly held companies means good public disclosure) on strategy, capital allocation, and performance. Shareholders also commonly expect to have a part in approving uses of equity, including authorization of capital and highly dilutive actions, and when shares and options are used to compensate management. In recent years, many investors also have shown an increasing interest in engaging with management and boards to encourage not only good disclosure practices, but also greater focus on the long-term, including regard for long-term and systemic risks, and regard for various stakeholders that is critical to building long-term shareholder value.
But a claim that shareholders seek to routinely make operational decisions for a company seems to me to be misconceived. The error may derive in part from what appears to be a particular target for Sharfman: shareholder proposals. Such proposals do make recommendations to boards and management on a variety of topics. However, shareholder proposals account for less than 2 percent of voting items at U.S. companies, they almost always are framed as precatory non-binding recommendations, and in their usual form (shareholder proposals submitted under Rule 14a-8 of the Securities Exchange Act of 1934) they already are limited. Among other things, the shareholder proposal rule provides that shareholder resolutions on management functions (“ordinary business operations”) may be excluded from proxy statements.
The most common types of shareholder proposals are on corporate governance matters (for example, voting standards or independence of board leadership) and requesting disclosures to investors on various matters. Shareholder proposals, while nonbinding, provide a way for shareholders to express collective views on the issues raised in those proposals, which are a step or more removed from company business decisions. These expressions of the collective voice of shareholders provide useful information for boards and management teams, even if those teams do not always welcome news that a significant portion of shareholders are critical of governance or disclosure practices.
The number-one voting item in corporate elections is and always has been election of directors. Shareholder election of the board of directors undergirds the legitimacy of corporate governance and is a critical accountability structure. While the possibility of contested elections can be effective in disciplining boards, shareholders generally tend to be deferential to nominees selected by board nominating committees. The number of contested elections is small, and opposition to board members in the absence of an alternative slate is even lower. Only a tiny fraction of nominees of incumbent boards fail to gain majority support.
In his paper, Sharfman makes a number of useful observations, and he concedes that “shareholder voting is a necessary component of corporate governance.” Certainly he is correct that shareholders have less information than insiders. This is why managers and boards have wide discretion. He writes that “we should be extremely wary of any proposal to increase the use of shareholder voting as a decision-making tool.” Articulation of collective views of shareholders through voting on non-binding shareholder proposals, generally on corporate governance or disclosure, contributes to decision-making by boards and managers (as does engagement by shareholders), but these simply are not binding plebiscites on managerial decisions.
What may come closer to fitting Sharfman’s attacks are required votes on executive compensation, through say-on-pay requirements of Dodd-Frank and votes to ratify choice of auditor. However, say-on-pay votes are not binding; shareholders tend to defer heavily to boards (more than 97 percent of items subject to say-on-pay votes win majority approval); and the issue involves one of particularly clear agency risk – where the interests of the agents (in this case, corporate CEOs and other senior executives) can conflict with those of the principals (shareholders). Similarly, shareholders at most U.S. companies are asked to ratify the board’s choice of auditors. This generally is not binding, and shareholders overwhelmingly defer to boards, expressing concern through substantial dissent in only a very small number of cases.
It also is true that shareholders vote on certain fundamental matters, such as change in the articles of incorporation or sale of the company. The shareholder vote clearly is a “decision-making tool” for these purposes. But – again – shareholders in practice tend to defer to board recommendations. Shareholders at acquiring companies have more limited rights to weigh in, and these rights (which may be inadequate) have been driven in part by a history of M&A deals that significantly destroy value from the standpoint of shareholders of the acquiring companies.[2]
Given that the role of shareholders in corporate decision-making is limited, it is difficult to understand the perceived risk of “corporate governance run amuck,” to use corporate attorney Martin Lipton’s famous words in characterizing a meeting of Pfizer board members with company shareholders. As noted above, the concern seems to be shareholder proposals. The merits of further limiting 14a-8 shareholder resolutions, as the SEC has proposed, can be debated.[3] But it should be acknowledged that shareholder proposals already are limited, and based on historical evidence with the current set of rules, the average public company can expect to see one non-binding shareholder proposal every seven years. There is zero prospect that under the current regime shareholders will be voting on tens of thousands of shareholder proposals on the millions of management decisions made every year.
Shareholder proposals have played an important role as early bellwethers of significant corporate governance and disclosure matters, such as board independence and independent leadership, sensible executive-pay clawback policies, appropriate accounting for stock options, better disclosure on environmental risks including those linked to climate change, board diversity, and other matters. In some very abstract sense and on a limited range of key policy decisions, perhaps one could argue that board discretion is limited (no S&P company any longer has an all-male board, and perhaps some boards feel their discretion to keep women out of the boardroom was legitimate and has been harmed). But this type of argument survives only by being abstract. In truth, shareholder voting rules and practices as they now exist in the United States simply do not set up shareholders to compete with management in deciding business matters, and shareholders do not seek that role.
ENDNOTES
[1] Bernard Sharfman, The Risks and Rewards of Shareholder Voting, April 18, 2020 draft, available here.
[2] For interesting recent evidence on the value of shareholder voting in an M&A context, see Lingwei Li and Huai Zhang, “The Devil is in the Detail? Investors’ Mispricing of Proxy Voting Outcomes on M&A Deals,” available on SSRN (“post-merger abnormal stock returns are significantly higher for acquirers receiving higher approval rates: a one percentage point increase in the approval rate is associated with a 48 basis point increase in the market-adjusted stock return in the year after the merger is completed.”)
[3] A number of letters to the SEC on the 14a-8 amendments it proposed in November 2019 demonstrate historical benefits of shareholder proposals. A few of these include CII’s Jan. 30, 2020, letter; a Jan. 27, 2019 letter from the Interfaith Center on Corporate Responsibility; the Jan. 16, 2020, recommendation of the SEC Investor Advisory Committee; a Jan. 30, 2020, letter from John Coates and Barbara Roper; and a Dec. 17, 2019 letter from Tom Shaffner.
This post comes to us from Ken Bertsch, executive director of the Council of Institutional Investors.