Future proxy seasons will likely see a continuing tension between corporations and shareholders over the election of directors and board accountability.
This tension may have been intensified by a Washington-based Court of Appeals decision July 22 overturning Securities and Exchange Commission rules that were designed to enable shareholders to have access to corporate proxy materials to nominate directors.
Access — which Patrick McGurn, special counsel at Institutional Shareholder Services Inc., once called the holy grail of corporate governance — would have transformed elections to the board, adding an element of competition and potentially greater director accountability to shareholders.
But institutional shareholders, although disappointed in the decision, have many reasons for optimism about corporate governance.
The decision was the third time access proposals have been denied since 2003 when the SEC proposed a rule allowing access.
But over those same years, shareholders have been instrumental in developing an array of new tools to improve corporate governance and board accountability. In fact, the new ruling might prompt institutional shareholders to add even more tools.
Shareholders shouldn't give up on access. They should pressure the SEC to open the shareholder proposal process to permit resolutions on proposals calling for proxy access.
In 2006, Harvey L. Pitt, SEC chairman from 2001 to 2003, told a Council of Institutional Investors conference supporting shareholder access that access could help make corporate boards more accountable to shareholders. “The widespread abandonment of ethical, moral and legal obligation contributed to the loss of investor confidence,” he said. Some empirical evidence shows companies with better governance and transparency outperform other companies, he added.
Not everyone concerned about improving corporate governance and board accountability to shareholders supports regulatory-imposed access.
Instead, some shareholder advocates promote the use of proxy contests, in which shareholders nominate dissident candidates to the board who compete for seats against a company's candidates.
Charles M. Elson, professor of finance and legal studies at the University of Delaware, Newark, and director of its John L. Weinberg Center for Corporate Governance, suggests modifying the proxy contest to provide corporate reimbursement of the cost of nominating dissident directors, based on a sliding scale depending on how much of the shareholder vote the alternative nominees receive.
Shareholders ought to support that approach by introducing proxy proposals calling for its implementation, in addition to open access. Shareholders have sponsored only 17 such reimbursement proposals during the nine years ended last year. Nine achieved votes ranging from 32% to 48% in support; six, votes of 13.9% of less; and one was omitted from the ballot, according to ISS. None was introduced this year.
In fact, other corporate governance experts believe proxy contests have an advantage to shareholders over open-process access in terms of overall costs to shareholder groups nominating candidates.
An SEC-approved proxy access rule wouldn't reduce the cost compared to a traditional proxy contest, David Drake, president of Georgeson Inc., a proxy solicitation firm, said at a 2009 Council of Institutional Investors conference.
An access rule would in many cases limit shareholders to nominating only one director. Then, to prevail in an election, shareholders would have to campaign for their candidate, spending on advertising, road shows and the like as much as they would campaigning under a proxy contest, where they would have the opportunity to nominate more candidates.
Institutional shareholders, banding together as a group, should consider undertaking the proxy contest approach, which could be more cost-effective and advantageous in terms of eventual influence on boards than a proxy-access rule.
They couldn't afford many contests, but even under the open-access process, pension fund executives and other corporate governance experts believes shareholders would take advantage of the tool only infrequently.
Overall, the proxy proposal mechanism has proved a powerful tool for shareholders to demand more accountability of boards.
In fact, out of the ashes of earlier SEC inaction on proxy access, a movement calling for electing directors by a majority vote developed in 2004 and subsequently swept up shareholders generally in support.
Until the movement began, directors at virtually all U.S. companies were elected by a plurality-vote standard, meaning all they needed in an uncontested election was a single vote in support, no matter how many shareholders withheld their votes.
But shareholder proposals calling for a majority-vote standard gained traction. Among Standard & Poor's 500 companies, 75.3% now have a majority-vote standard for electing directors due largely to shareholder activists' efforts.
In addition, beginning in 2010, the SEC banned brokers from discretionary voting of shares in elections of directors, in effect strengthening the voting power of shareholders.
Institutional shareholder activists can draw on other achievements in corporate governance for ideas and inspiration to bring more accountability to boards.
For instance, under shareholder pressure, the SEC in 2007 enhanced executive compensation disclosure rules, improving transparency of pay packages and policies.
Starting this year, all companies have to hold shareholder advisory votes on executive compensation. As a result, some companies have been engaging shareholders in discussions about pay policies, and even revising them to improve support in say-on-pay voting.
In addition, companies this year will have to hold advisory shareholder votes on golden parachutes, or severance agreements, of top executives.
In recent years, largely because of the pressure of shareholder proposals, some 61% of S&P 500 companies declassified their boards as of 2010, providing for annual election of all directors and bringing greater accountability.
So even without proxy access, corporate governance has been transformed in the interests of greater corporate accountability. This should continue even in the absence of a proxy-access process.