Management groups, including the Business Roundtable, object to
this proposal, which has been defeated several times in the past.
But the proposed change is a worthwhile and moderate step and should
be supplemented with additional measures for making boards
accountable to shareholders.
Shareholder power to replace directors plays an important role in
the theory of the company. "If the shareholders are displeased with
the action of their elected representatives," says a seminal
corporate law case, "the powers of corporate democracy are at their
disposal to turn the board out." Shareholder power to replace
directors is supposed to supply a critical safety valve, preventing
directors from straying from shareholder interests.
But this safety valve is missing. In a recent study, I found that
electoral challenges to incumbent directors are rare. Aside
from attempts to have the company taken over or sold, contests over
directors occurred in fewer than 80 companies - among the thousands
that are publicly traded - during the seven-year period 1996-2002.
Furthermore, these businesses were usually small, with fewer than 15
having a market capitalisation exceeding $200m. Even directors whose
company performed poorly over a long period of time were highly
unlikely to face an electoral challenge.
How could one oppose an attempt to make the threat of replacement
in the event of dismal performance more meaningful? Opponents argue
that shareholder access would make distracting contests the norm.
But with nomination privileges permitted only to shareholders with a
significant stake, such nominations will be concentrated in
companies with significant shareholder dissatisfaction. By
discouraging directors from paying insufficient attention to
shareholder interests, making challenges possible could produce
significant benefits in a large number of cases, without costly
challenges being made.
There is also little basis for con- cerns that shareholder access
would produce "special interest" directors. Shareholder-nominated
candidates would not be elected without support from a majority of
the voted stock, most of which is held by institutional
shareholders. If anything, institutional shareholders are reluctant
to vote against managements. Should they wish to do so, their hands
should not be tied.
The insulation of boards from shareholders, some opponents argue,
is necessary for boards to be able to protect the interests of
stakeholders such as employees. But even though board insulation
reduces directors' accountability to shareholders, it does not make
directors accountable to stakeholders. Rather, it makes directors
accountable to no one, protecting them in the event of poor
performance that hurts both shareholders and stakeholders.
Opponents of shareholder access also claim that it will be made
unnecessary by pending reforms that would require nominating
committees to be composed of independent directors. To ensure that
directors act in shareholders' interest, however, it is not enough
that directors be independent of the company's executives. Directors
must also be at least partly dependent on the shareholders. And even
if most nominating committees will select well, shareholders should
have a safety valve.
Besides providing shareholders with access to the corporate
ballot as the SEC proposed, additional measures to invigorate
corporate elections should be adopted. Under existing corporate law,
incumbents' "campaign" costs are fully covered by the company, which
provides a great advantage over outside candidates, who must pay
their own way. To enable challengers to make their case to the
shareholders, companies should be required to re imburse reasonable
costs incurred by such nominees, at least when they draw sufficient
support in the ultimate vote.
Incumbent directors are now protected from removal not only by
impediments to running outside candidates but also by staggered
boards, on which only a third of the members come up for election
each year. Most public companies now have such an arrangement. As a
result, no matter how dissatisfied shareholders are they must
prevail in two annual elections to replace a majority of the
incumbents. Requiring or encouraging companies to have all directors
stand for election together could contribute significantly to
"The shareholder franchise," says a famous corporate law case,
"is the ideological underpinning upon which the legitimacy of
directorial power rests." The power to remove directors, now largely
a myth, is essential for a corporate system in which directors
cannot stray from shareholder interests. Investors should press for
all the changes necessary to making this power a real one.
The writer is professor of law, economics and
finance at Harvard Law School. His study on shareholder
access to the ballot was recently published by the school's
programme in corporate governance