Corporate Governance Activists Headed in Wrong Direction

Joseph Hinsey

Activist corporate governance reformers are spending too much time-and capturing too much of the media's attention-on fringe issues. One current initiative, for example, focuses on promoting "majority voting" for directors, a process that requires a nominee to receive a majority of the votes cast in order to be elected. Contrast that, these activists warn, with the prevailing procedure that puts a candidate on a board with just a plurality of votes. They claim that under these conditions, directors can be elected with just one "for" vote.

Although they are having a good time tweaking corporate America with this campaign, the scenario they describe is, in reality, impossible.

First, let's understand why the plurality standard dominates director voting. Corporations' internal affairs, including the election of directors, are governed by state law; accordingly, all corporations incorporated in a given state-public or private, big or small-are subject to the same statutory framework. State statutes typically specify plurality selection as the default rule for director elections.

                              

Joseph Hinsey is the H. Douglas Weaver Professor of Business Law, Emeritus, at Harvard Business School.

Most private-enterprise shareholders attend their annual "town meetings," and director nominations from the floor often exceed the board "slots" to be filled. Nominees receiving the highest number of votes (albeit perhaps not a majority) are elected under the plurality rule. Shareholder democracy prevails.

The proxy problem

As for public corporations, with advance proxy solicitations enabling them to reach their widely scattered ownership, the slate of candidates proposed in the proxy materials, absent any kind of contentiousness, is routinely elected (without regard to withheld votes). Sparsely attended annual meetings typically produce preordained outcomes for the election of directors. Under these circumstances, shareholder democracy in the traditional sense has limited relevance.

A majority-voting regime could lead to failed elections and other knotty legal complications.

Beyond touting the abstract theme of shareholder democracy, activists assert that voting for directors should be more meaningful; corporate owners should be able to vote their board representatives in or out. Accountability is another common theme in their repertoire.

But here's the rub. In light of public corporations' widespread shareholder diversity (and without taking into account the legitimate interests of employees, creditors, communities, and other non-shareholder constituencies), which shareholder components are directors supposed to be representing and to which components are they supposed to be accountable: Institutional investors? Individual investors? Long-term investors? Short-term investors? Transient investors?

In addition, how are dispersed shareholders to sort out which nominees deserve their "for" votes? In the case of re-nominations, how is an incumbent's past performance to be gauged? It would be easy, of course, for shareholders to show their dissatisfaction by voting against every nominee. With a majority-voting regime, that reaction (namely, "throw the bloody buggers out") could lead to failed elections and other knotty legal complications. As far as public corporations are concerned, majority voting is a flawed concept that doesn't enhance shareholder democracy and, more important, doesn't improve corporate governance.

Who oversees oversight?

That said, there are corporate governance issues that do warrant activists' attention. Virtually all of them center on directors' oversight responsibilities. Enron-era reforms such as the Sarbanes-Oxley Act emphasize oversight enhancement, especially the independence of non-management directors. In U.S. boardrooms today, however, the CEO typically also serves as board chair. Consequently, the boardroom leadership responsible for independent directors' oversight of management is the responsibility of none other than the corporation's number-one manager, a conflict of interest that is awkward at best.

The obvious solution is separating the two positions-a move many Ford Motor Company shareholders supported recently at the corporation's annual meeting. Aside from the perennial objection that having two leaders is confusing, those opposed to this idea undoubtedly cite situations where a separate board chair hasn't worked. But the fact of the matter is, it has worked well in Great Britain. Rather than making the recently-retired CEO the chairman of the board, however, the outside directors should show their independence by filling the separate chair position with non-executive boardroom leadership of their own choosing.

This is an effective solution to a pressing problem that continues to escape the attention of activists who have riveted their attention on less important matters. If they actually want to help, it's time for them to turn their efforts in a different direction.