The federal role in corporate governance

Ira Millstein and Harvey Goldschmid write in today’s WSJ that the 2d circuit opinion in AFSCME v. AIG (permitting a shareholder proposal for shareholder access to board nominations) should be an opportunity for the SEC to “strive for a solution that gives shareholders a voice in the director election process.” Echoing Gretchen Morgenson, they say that board elections are now like the “Soviet Union.”

Millstein and Goldschmid add:

a uniform approach to shareholder access is key to achieving a balanced result and avoiding the confusion and delay that can reign when ad hoc development by too many cooks is permitted to occur (as with majority voting reform, for example). We urge the SEC to balance the system and give shareholders the tools to hold boards accountable -- and, in the process, restore public confidence in the fairness and economic rationality of the governance system.

Millstein & Goldschmid are, alas, correct that the SEC has to do something, because the 2d circuit has introduced chaos as to whether corporations must allow these proposals. It is important to emphasize that this chaos is part of what happens when federal law gets involved in corporate governance – contrary to claims we often hear that federal law means “uniformity.”

A far more sensible system would be to let state law control. Unfortunately, the SEC’s role in corporate governance, in part through the shareholder proposal rule, is now so pervasive that Delaware's role is unclear. (Can Delaware adopt a shareholder access rule without stepping on federal law? Does it have any incentive to do so given the federal government’s dominant role in the area?)

It follows that whatever the SEC does in this area, it should make it clear that it is subject to state law. In other words, even if a shareholder nomination proposal is not barred under the director-election exclusion of Rule 14a-8, Delaware should still be able to clarify whether shareholders can initiate bylaw amendments. If they can’t, the proposal would be barred as “not a proper subject for action” by the shareholders under 14a–8(i)(1).

As for the Millstein/Goldschmid/Morgenson argument that director elections without shareholder nominations are Soviet-style – this is backwards. American corporate governance is fundamentally ruled by the capital markets, which discount information into stock prices and give firms and their managers incentives to respond to market demand. “Soviet-style” is when this process is circumvented by one-size-fits-all federal rules or, possibly even worse, by the chaotic system that exists in the absence of SEC clarification.

The basic policy question is what is the proper balance between making managers accountable and giving them the power to manage the firm. Gordon Smith and Steve Bainbridge ably debate this question. Steve asks, “[w]hat is the affirmative case for reforms to promote "increased shareholder participation? Or, for that matter, the negative case against the status quo?" Gordon responds:

In my view, increased shareholder initiation rights in the election of directors would go some distance toward addressing managerial incompetence and would also provide an additional incentive to avoid any residual managerial slack. Of course, the devil is in the details, and the design of such a reform is crucial.

Yes, "the devil is in the details." That's why these complex issues are best left to the dynamic process of contracts and state law, not the federal process of fiat, chaos and politics.

Comments

[Robert Schwartz]

A corporation is not a republic. the shareholders are not citizens, subject to its jurisdiction. The entire analogy between politics and corporations is flawed. A better way to think of the shareholder's voting rights are as a put option, a fire-alarm to be pulled when things get really bad.