The mechanism for electing and replacing directors on corporate boards — the shareholder vote — isn't working as it should at many companies.
The essential tool of corporate governance is blunted by companies that allow directors who have been opposed by a majority of shareholders in uncontested elections to continue to serve on boards.
One reason is most companies continue to have plurality voting standards. In uncontested elections, that means one vote in favor is enough for a director to be re-elected, even though all other shareholders are in opposition.
In fact, only 5% of directors who failed to receive a majority vote for election between July 1, 2009, and June 30, 2012, left the boards, according to a joint study by the Investor Responsibility Research Center Institute and GMI Ratings. The study examined 175 nominees for director that a majority of shareholders opposed at companies in the Russell 3000 index.
Even an activist shareholder drive urging corporations to adopt a majority-vote standard for election of directors has failed to achieve shareholder objectives at many companies.
In fact, at companies with majority-vote standards, only half of directors who fail to gain a majority of the vote leave the board.
For directors to remain in their positions after failing to win a majority of votes acts in defiance of a majority of shareholders. And boards that fail to request the resignations of such directors are placing loyalty to their board colleagues ahead of loyalty to shareholders, whom they are supposed to represent.
This must change.
If companies and boards continue to ignore shareholders' preferences, as shown by their votes, the Securities and Exchange Commission or Congress eventually will step in and force change the companies might not like.
Seeing shareholder votes being ignored, the Council of Institutional Investors in June called on NYSE Euronext and Nasdaq OMX to put teeth into shareholder voting.
The CII urged both stock markets to propose rules requiring companies that list equity securities on the New York Stock Exchange and the Nasdaq stock market to adopt majority voting standards to elect directors, with a requirement that incumbent directors who do not receive a majority of votes in uncontested elections promptly resign from the board and not be reappointed.
The move would force companies to end a practice of allowing so-called zombie directors, or those who fail to receive a majority of votes in uncontested elections, to remain on the board.
Even if NYSE Euronext and Nasdaq OMX act as soon as possible to propose such rules, it still might take some time before the rules would become effective. The SEC would have to put the rules out for public comment before it could act in deciding whether to approve them.
Electing directors is the most fundamental and direct way shareholders can influence corporate governance, corporate strategic direction and compensation policies to ensure they are aligned with investor interests, as well as hold board members accountable for their oversight of corporate management.
But it has been a daunting road for shareholders to assert their rights to elect their own representatives to corporate boards since the founding in 1985 of the CII, which marked a beginning of institutional shareholder activism. The challenge of electing uncontested directors approved by a majority of shareholders provides a window generally to the challenge of reforming corporate governance.
Even as more pension funds, other asset owners and investment advisory firms embraced shareholder activism, elections for directors were dictated more by corporate boards and management than by shareholders.
In the election of directors, an early battlefront was to stop brokers from voting uninstructed shares of shareholders. The tendency of brokers to vote with management in director elections diluted the votes of voting shareholders, often putting directors over the top in winning a majority of the votes.
“Counting uninstructed broker votes is akin to stuffing the ballot box for management as broker votes almost always are cast in favor of management's candidates for board seats,” Ann Yerger, CII executive director, said in a 2009 statement.
Only in 2010 did the New York Stock Exchange eliminate the uninstructed broker voting in election for directors, the rule taking effect after approval by the SEC following several years of pressure by activist institutional shareholders. The NYSE proposed the rule in 2006.
Even with that broker advantage eliminated, some companies still defy the votes of the majority of shareholders in election for directors.
That defiance has led to more shareholders embracing proposals for adoption of majority vote standards at companies. But only 33% of Russell 3000 companies have adopted some form of majority standard, according to data CII cited in its communication with the NYSE and Nasdaq.
Corporate directors are supposed to represent the interests of shareholders in recruiting and retaining management leadership, providing direction to set and meet strategic objectives, governing the organization and keeping the central focus on corporate performance.
But directors cannot be effective at protecting the interests of shareholders when shareholders don't want them on the board.
Directors who continue on boards in cases where shareholders vote in the majority against their election or re-election are defying the will of the shareholders who own the company. They continue to serve more in the interests of other board members and management than in the interests of shareholder oversight and accountability.
Elections for directors should not be meaningless exercises of shareholder voting rights. They should count.
A more representative board gives a company greater credibility with investors, a key to enhancing shareholder value.
