Senator Charles Schumer recently announced plans to introduce the “Shareholder Bill of Rights Act of 2009.”\u00a0 This bill is a compendium of corporate governance reforms that shareholder activists have been advocating for many years.\u00a0 Among other things, the bill would require companies to elect the entire board of directors each year, rather than putting only a portion of the board up for a vote.\u00a0 It would also require that directors receive a majority of the votes cast before being allowed to serve, and the bill would make it easier for shareholders to nominate their own director candidates to run in opposition to the candidates nominated by management.<\/p>\n
Senator Schumer’s bill is best understood as embodying the principle that, when it comes to corporate governance, more democracy is always better.\u00a0 The assumption is that corporate governance will improve in tandem with increased shareholder voting power.\u00a0 I question that assumption.<\/p>\n
First, more democracy might actually lead to worse directors.\u00a0 <\/p>\n
The transformation of director elections into real voting battles, with the attendant risk that a management-backed candidate might face serious opposition and possible defeat, could very well deter desirable candidates from subjecting themselves to the process.\u00a0 A director position already entails a risk of legal liability, and the days of “figure-head” directors who have modest demands placed on their time are long gone.\u00a0 The risk of an embarrassing election defeat only adds to the long list of reasons that well qualified candidates already have for declining a nomination to the board.<\/p>\n
Second, contested board elections assume that shareholders can cast an informed vote.\u00a0 In the past, the cost of gathering and disseminating information to the voters deterred all but the largest shareholder activists from mounting a challenge to board nominees put forth by management.\u00a0 This ensured that the voters heard only the pro-management side of the story prior to an election, unless activist shareholders succeeded in a time-consuming and expensive effort to include their views in the company’s proxy materials.\u00a0 The Internet has changed this equation by making information-gathering and communication on behalf of opposition candidates more cost-effective.\u00a0 But it is not clear that an explosion of information both in favor and against a particular board candidate will result in a better-informed shareholder electorate.\u00a0 Our experience under the political model suggests that multiple sources of contradictory information can lead to voter confusion or even apathy.<\/p>\n
Finally, and most significantly, the time when reforms to the shareholder voting process could make a meaningful difference to corporate governance has already passed.\u00a0 The direct ownership of stock by American households has declined from 91 percent\u00a0in 1950 to just 32 percent\u00a0in 2007.\u00a0 In contrast, in 1950, financial institutions such as mutual funds and retirement plans owned only\u00a0nine percent\u00a0of all stock, while in 2007 that figure was 68 percent.<\/p>\n
Today, the majority of votes in a corporate election are cast not by millions of individual shareholders, but rather by a small class of professional money mangers.\u00a0 These managers of large financial institutions do not behave like the prototypical private individual shareholders.\u00a0 In particular, the short investment horizon of these money managers makes them less motivated than private individuals to use their voting rights to demand improved corporate governance.\u00a0<\/p>\n