In corporate boardrooms across America, they're warning that the sky is falling — again. Shareholders have heard this before, and it has usually been about money: companies resisted new rules to change how they account for stock options, for example, or how they value certain complex investments in corporate financial reports. And when the Securities and Exchange Commission wanted to restrict the types of consulting work an accounting firm could perform for an audit client, the cry was familiar.
Now, we are told, the sky is truly going to fall — and this time it's about control. If the S.E.C. adopts a rule to give qualified shareholders the limited ability to place a director's name on a ballot for a company's board, many executives say, they will have less control of their companies. The Business Roundtable, an association of chief executives of some of America's largest corporations, argues that a small number of shareholders would pursue narrow agendas at the expense of most other investors.
They needn't worry. The proposal, which is expected to be voted on by the full commission soon, is not exactly a revolutionary idea. Why shouldn't the true owners of a corporation — the shareholders — have the right to nominate a board member?
While concerns about unnecessary disruption and special interests are reasonable, the business community and investors, particularly pension and mutual funds, should work with the commission in fashioning a final rule that fulfills a basic principle: investors deserve the right to place a potential board member up for a vote in the face of widespread disaffection with the board's governance or performance. This is a modest and well overdue step that will increase transparency and accountability in the boardroom.
Shareholders now have no realistic options if they want to replace directors: they can really vote only on those candidates nominated by the company, and even if they withhold their votes from these nominees, the directors are always elected. Of course, if shareholders are dissatisfied with how a corporation is being run, they can always undertake a proxy contest. But they bear all the costs to put a nominee up for a vote. Management, in contrast, can spend as much of the corporation's money as it wants to get a director re-elected.
It's not surprising, then, that contests over board nominees are rare. According to one study, absent special circumstances, there have been 10 such instances since 1996. I think we can safely rule out universal shareholder satisfaction as the primary reason for the lack of contested elections.
Still, the commission's proposal hardly conjures up images of thousands of shareholders running unrestrained through the boardroom. To succeed in getting a nominee on the board, shareholders who meet a certain ownership threshold would still face significant hurdles.
First they would have to attract a substantial amount of support from other shareholders, either through a shareholder resolution or by asking them to withhold votes for a current director. Then they would have to wait a year to get their nominee on the ballot. Then they would have to assume the costs of a campaign to convince other shareholders to vote for their nominee. Finally, they would have to win majority support for their candidate.
Some investors feel the S.E.C.'s plan does not go far enough in putting pressure on management. It would allow only large shareholders to nominate and elect a limited number of board members — and only then if at least 35 percent of shareholders withhold votes against a director. While almost everyone agrees that greater shareholder democracy is a good thing, there is widespread disagreement on how to achieve it. This is precisely why the commission's initial proposal is so worthwhile: above all else, it is pragmatic. It is written in such a way that it would be hard for shareholders to abuse the voting process, but it would still allow large groups of shareholders to not only reject management's candidate, but also to nominate their own.
It may well be true that some corporate boards would find themselves subject to the narrow agendas of certain shareholders. But this pressure is mitigated by the fundamental principle of incentive. Investors bear the ultimate cost. They put up the capital and, after everyone else is paid, they get what's left. Their economic incentive is profitability and efficiency. How many times has management asked shareholders to trust them? Isn't it time we trusted shareholders to do what's in their interest?
The post-Enron period has seen the empowerment of America's institutional shareholders. Mutual funds, as well as state and local pension plans, have aggressively pursued pro-investor initiatives. It is essential that such activism take aim at the kinds of excess and self-dealing that erode public trust. Institutions must steer clear of ill-considered political attacks on highly regarded managements of successful, well-performing enterprises. Trying to "send a message" or seeking to advance a specific political or policy agenda will not garner the support of other shareholders. Indeed, this new rule will not only impose greater oversight on management, but also put appropriate restraint on the institutional shareholders who will have a greater responsibility in the governance of their companies.
No matter how active investors are, however, there will always be companies that are insulated, stuck or unresponsive. There will always be companies whose management ignores a dissatisfied majority of shareholders. There will always be companies whose chief executives' compensation bears no resemblance to any objective view of performance, year after year. And there will always be companies whose boards are obsequious rather than assertive, undemanding rather than challenging.
If shareholders don't have the leverage to put a voice in those boardrooms that will confront such situations, the likelihood of any near-term change is remote — and that has its own economic consequences. Shareholders deserve this right. The sky won't fall.
Arthur Levitt was chairman of the Securities and Exchange Commission from 1993 to 2001.