Strategic Choices in Shareholder Advocacy, A Corporate Governance Perspective

California Coalition for Investor Responsibility

Democratic Values
In a democracy, there should be a positive correlation between the values of society and the value of our investments. If the society values a clean environment, investments in corporations that pollute should be losers. Polluting corporations should get fined, receive bad publicity, get sued, and lose market share. Voters need to change the government to clamp down on polluters, consumers need to organize boycotts, and shareholders need to introduce proxy resolutions seeking change. But if the system isn’t working to our satisfaction, shareholders may have to look at more fundamental changes in the area of corporate governance.

Corporations as Dominant Mediating Structures
Building accountability into the governance of corporations themselves may be the most urgent reform we can make. True, government and public interest groups play an important role in keeping corporations in check but its no secret that corporations control much of the dialogue in both government and the nonprofit sector. Corporations have become the dominant mediating structures between the individual and society. Unless corporate governance itself becomes more democratic, we may be fighting a losing battle.

Governing by Resolution has Limited Potential
Religious groups, environmentalists and others have been introducing resolutions on specific concerns for years and we have been effective to some extent, mostly because of accompanying publicity. However, trying to change the direction of a company by resolution is like trying to govern California through propositions…even worse, proxy resolutions are only advisory, whereas propositions carry the weight of law.

During the 1st half of this year, 42 proxy resolutions got majority votes. All were concerned with corporate governance.

Corporate Governance Defined
So, what is corporate governance? The simplest definitions use corporate governance as a synonym for sound management or transparency and disclosure. More detailed definitions go into the roles and tasks of the most important parties: shareholders, directors and management. Those concerned with corporate governance can concentrate on the micro level of the individual firm and be concerned with issues such as succession planning or how board meeting materials are distributed.

On the macro level corporate governance compares systems such as the two tiered board structures of Germany, the interlocking Kiretsu and Chaebols of Japan and Korea and the unitary Anglo-American boards or the split CEO/Board chair typical in the UK vs combined role in the US.

Fundamentally, corporate governance is about power, accountability and the rules of the game. Corporate governance is the relationship among various participants in determining the direction and performance of the corporation. Concern for “corporate governance” as a field of study began to rise dramatically in the 1970s with the rise of “corporate raiders.”

Focus of Corporate Governance
By the 1970s much of the developed world was in the grip of “managerial capitalism.” CEOs weren’t pursuing shareholders’ interests so much as treating companies as their own fiefdoms. This “principal-agent” problem is a central focus of most in the field. The principals, shareholders, have entrusted our affairs to an agent, the board of directors and CEO, who often pursue their interests instead of the shareholders.

Another fundamental problem in corporate governance is that many shareholders have concluded it is rational to take a “free ride” on the monitoring efforts of others. The risk is that if everybody takes that attitude, nobody does the work of holding management or the board accountable.

Governance by Market Forces
The simplest way for shareholders to hold managers to account is to vote with their feet. By selling the shares of a poorly run company we depress the share price. That makes the company a more attractive target for a rich person or consortium to take a controlling interest and make whatever changes are necessary to attract investors back.

Incumbent managers often attempt to frustrate takeovers in order to keep their jobs. This is why takeover rules are important and why much of corporate governance is devoted to poison pills, staggered board elections and other mechanisms concerned with management entrenchment.

Relying on a plunging share price to force change is hardly ideal. In the process, shareholders can see considerable wealth destroyed. External corporate takeovers are expensive. Even after much of the wealth has been destroyed, the takeover and transition back to profitability is also expensive…generally ranging between 2-4% of the value of the firm. Of course, there are often also very heavy transaction costs for employees in the form of layoffs, lost wages, increase divorce and suicide rates, as well as to communities in the form of lost taxes and charitable contributions.

However, there are two other major schools of thought in corporate governance. Once is “stakeholder” theory; the other is democratic corporate governance.

Stakeholder Theory
Stakeholder theory is based on the notion that corporations ought to be accountable to more than just shareholders. Everyone who has a stake in the corporation’s success should have some say in how it is governed. Those subscribing to stakeholder theory often favor government intervention to require representatives from the community, employees or others on the board, federal chartering and other mechanisms designed to spread accountability.

The problem, with this approach is that if companies are accountable to multiple stakeholders, they can all too easily end up being accountable to none because the CEO can play one group against another.

Democratic Corporate Governance
My own interests lie primarily in democratic corporate governance, which attempts to build systems of accountability into corporations themselves as well as into the institutional investors, such as pension and mutual funds which own 58% of the market. As I mentioned before, the corporate raider approach is often and expensive proposition but proxy driven changeovers have run “considerably below” 1%.

A few of the reforms that I am working on:

  • Educating individual shareowners is critical. Many simply throw their ballots away. I fully support Mark Latham’s initiative to allow shareholders to hire proxy advisors to analyze ballot issues.
  • Broker voting should be eliminated. Currently, if shareholders don’t vote their proxies within 10 days of the annual meeting, their broker will vote for them…always in favor of management’s recommendations.
  • Workers need better access to their own pension fund boards. Even CalPERS, which is structured so that employees elect about 1/2 the board members, has many problems:
    • members excepting gifts from contractors
    • serving on up to nine other investment boards
    • no runoff elections (so one member was elected with less than 6% of the vote)
    • rules which favor board incumbents and allow blatant election violations
    • no term limits; one member has remained on the board for almost 30 years
  • Since 1988 DOL has held that voting rights must be voted in the interests of members and beneficiaries, not plan sponsors. That rule should be enforced and extended to mutual funds and other institutional investors. The rule should also require disclosure. How can we hold our pension and mutual fund fiduciaries accountable unless we know how they vote?
  • The SEC prohibition against using the resolution process to nominate directors must go. The only way shareholders can run candidates is to pay for a solicitation, while the current management uses our funds to tout their candidates on the company proxy.
  • In addition, we need a third-party provider to consolidate the voting advice of Domini, CalPERS and others who will surely follow, such as Calvert and Citizens.

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