The myth of shareholder democracy holds a powerful sway over public opinion. The comments we’ve received on our two articles on the proxy access rules now up for comment at the Securities and Exchange Commission demonstrate that people continue to be bedeviled by the misguided analogy with democratic political regimes.
One of the mental levers the mythologists of shareholder democracy use to make their case is a kind of demonology of corporate managers. Although corporate insiders, especially chief executives, have demonstrably lost power in recent years to shareholders and independent directors while the risks of running a public company have increased, the continued climb of executive pay seems to have convinced many that executives are somehow fleecing shareholders. The evidence for this is underwhelming, however. While bad characters exist in executive suites and board rooms, they hardly justify enacting wide-ranging corporate governance reforms. Bad CEOs make bad law.
It’s important to remember that our system of corporate governance has generated enormous wealth for shareholders and workers over the years, bringing us unprecedented prosperity. We should exercise caution when seeking major reforms, especially when the costs of those reforms will be difficult to measure and the reforms will be next to impossible to reverse. By creating a uniform, national rule for proxy access, the proposed reforms would shut off jurisdictional competition and experimentation between the states. Worse, the proxy access reform is clearly viewed by many of its proponents as a first step in what they view as a revolution in corporate governance. There will be more to come. The proxy access reforms are precedent not a final resting place.
Some of the most thoughtful criticism of our first essay came from Beth Young, who I believe is the author of the Shareholder Proposal Handbook and a senior research associate at the Corporate Library.
We rough up Young’s objections to our articles after the jump.
Young helpfully focuses on exactly what the SEC is debating now, which is not as far reaching as the 2003 reforms proposed by William Donaldson, then head of the SEC. Young points out that what is being proposed is the creation of a two-step process for opening up proxy access for the election of directors. In the first step, shareholders—or groups of shareholders—who own just 5% of a company could initiate a vote on whether to amend a company’s bylaws to allow corporate outsiders to propose their own slates of candidates for election to the board of directors. Since outsiders may already make such proposals, what the change in bylaws really amounts to is forcing the company to pay for the election materials for these outside candidates.
But when Young moves beyond explaining the mechanics of the reform, she becomes more ideological and begins to lean heavily on the rhetorical crutches of shareholder democracy.
“Such a regime would not be adopted unless holders of a majority of outstanding shares (a significant hurdle since most corporate matters are decided out of shares voted) approve the proposal. Who is better situated to decide whether proxy access makes sense, from a cost/benefit standpoint, than a company's shareholders?” Young writes.
Baloney. Well-informed shareholders already decide whether a company’s proxy access makes sense when they decide to buy or hold shares in a company. Most shareholders are less well-informed, however, for the very rational reason that a diversified portfolio gives them an interest in the performance of broad corporate sectors and not in the mechanics of a particular corporation. Here the analogy with political democracy is misleading because citizens have an obvious interest in the performance of their country’s particular political leaders since they are not citizens of the world the way ordinary investors are investors in the markets. What’s more, the exit costs for citizens are much higher than for shareholders.
Young also objects to my emphasis on the dangers to ordinary shareholders posed by special interest shareholders. “It's interesting to me that management is not considered a ‘special interest,’ despite its usually low level of company stock ownership and its high enjoyment of private benefits of control,” she writes.
Of course corporate managers are a special interest. A whole body of economic literature focuses on agency costs associated with corporate managers. And this is part of the point. We have lots of experience in dealing with the cost of self-dealing managers. Empowering more special interests—which regulators, lawmakers, courts and shareholders have less experience dealing with—seems an ill-suited solution.
Right now, shareholders can purchase shares in widely held companies without worrying too much about who their fellow shareholders might be. The proxy access reforms—and other reforms made in the name of shareholder democracy—will mean that the identity of your fellow shareholders will matter much more, much the way citizens care about who is allowed to immigrate into their country or who their neighbors are when they move into a new neighborhood. The need for this information increases the cost of shareholding, and may eventually result in demand for more burdensome regulations about disclosing shareholder identities.
Perhaps the most disconcerting aspect of the debate over the proxy access rules has been the success the proponents have had at portraying themselves as the friend of the ordinary shareholder. As we’ve pointed out twice now, this friendship is illusory. Many of the proponents are ideologically committed or self-dealing representatives of special interests who hope to take advantage of public ignorance on matters of corporate governance. Their behavior in this debate is just a prelude to the manipulation of public opinion that will follow if the proxy access rule is enacted and they begin their campaigns to intimidate and unseat corporate directors.
Looking for more from DealBreaker on shareholder democracy? This morning we were interviewed over instant-messaging by Portfolio’s Market Mover Felix Salmon. Check it out.
Earlier on Dealbreaker: Against Shareholder Democracy and The Proxy Access Threat To Individual Investors.