Shareholder democracy isn’t what it’s cracked up to be
But some at the time expressed a different kind of concern, one whose consideration was cut short by the plan’s ultimate failure: that making the federal government a significant stakeholder in private enterprise almost certainly was an invitation to all kinds of mischief.
Bush didn’t get his private accounts, but we’re nonetheless currently in the midst of a major experiment in what happens when markets are politicized. Led by New York City Comptroller Scott M. Stringer, and emboldened by recent rules changes enacted by Congress and the Securities and Exchange Commission, major public employee pension funds are flexing their muscles in a serious way in the 2015 proxy season. Thus far, they seem to be winning.
At issue is whether and under what terms to grant “proxy access” to activist shareholders to nominate their own slates of directors and have those directors’ names included in the proxy materials sent ahead of companies’ annual meetings. The Dodd-Frank Act, currently celebrating is fifth anniversary this week, empowered the SEC, for the first time, to set minimum proxy access standards. But the agency’s initial attempt to do so, just weeks after the law’s passage, was later struck down by the D.C. Circuit for violating federal procedures and failing to account for costs.
Instead, more subtle tweaks made to the so-called “private ordering” process has sparked a move by pension funds and other activist shareholders to target companies with non-binding proxy access questions on their annual ballots. There were six such votes in 2012, 11 in 2013 and 13 in 2014. This year, the floodgates truly opened, with 108 initiatives for proxy access, 75 of them registered by Stringer’s so-called “Boardroom Accountability Project.”
Stringer’s initiative is emblematic of where this new wave of proposals is headed. While asserting that proxy access would maximize shareholder wealth, Stringer notably did not target those companies he believed were underperforming their fundamentals. Instead, he targeted companies for having insufficiently diverse boards, highly compensated CEOs and, primarily, for operating in the fossil-fuels sector.
Through the end of June, there have been 65 shareholder-sponsored proxy access votes at public companies this year, including 22 in the energy sector and eight in the utilities sector. There were 39 successful votes, 31 of which were sponsored by Stringer. Based on the relative performance of companies where the votes were close, we estimate as much as $14.6 billion of potential shareholder wealth was foregone by companies that adopted the proposals.
That result shouldn’t be terribly surprising. The literature is thick with studies finding events that increase the probability of proxy access result in abnormally negative returns, while those that decrease the probability of proxy access result in abnormally positive returns. The effect is seen most demonstrably at firms where large stakes are held by activist investors. Indeed, evidence from the older kinds of proxy battles that lit up Wall Street in the 1980s show that the long-term record is no better. Even two years after such battles are waged, firms where dissident directors won seats performed 20 to 40 percent worse than their peers.
Though often pitched as a victory for “shareholder democracy,” it is unavoidable that proxy access transfers power to nominate directors from boards’ nominating committees – each comprised of independent directors with fiduciary duties to all shareholders – to a mass of unaccountable shareholders, many of whom may have vested interests. Even where such contests are unsuccessful, the result frequently is to give a minority of shareholders a megaphone for politicized concerns, which then can be used as a point of leverage with management and traded for other concessions.
In his 1776 masterwork “The Wealth of Nations,” Adam Smith was famously skeptical of the corporations of his day: royally chartered “joint-stock companies” who were granted certain monopoly privileges by the crown. Smith particularly decried their form of governance, ruled by directors who “seldom pretend to understand anything of the business of the company.”
History has mostly proven Smith wrong on this front, as corporations have played a major role in the world’s exponential growth of wealth over the past two and a half centuries. But given recent developments, we would be wise to remember his counsel.