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E-MailThe Securities and Exchange Commission yesterday held its first roundtable on proxy access, and Chairman Cox told the press that the Commission will propose a rule in the early summer on shareholder rights in the proxy process. We’re very pleased to host the following commentary on these events from J.W. Verret, a recent Harvard Law graduate and Olin Fellow in Law and Economics who has written extensively on corporate governance matters. Jay (who can be reached at jayverret [at] gmail.com) and I welcome your comments on his analysis below.
The shareholder empowerment battle originated as a brief sortie to develop a withhold vote capability in the early 1990s, but has since become more of an unending campaign. The academic community has debated shareholder empowerment for several years, and the fight has recently been given new life. The SEC is convening a series of roundtable discussions on proxy access and the Commission’s role in protecting the state-law voting rights of shareholders. And yes, that is deja vu you’re feeling: Lucian Bebchuk has studied, in depth, the justification for proxy access, and indeed can be credited for much of the momentum behind the movement.
But another movement is already afoot to empower shareholders: majority voting for uncontested elections, which will seriously affect the calculus of the proxy access debate. In August of 2006, the Delaware Legislature passed an amendment to the General Corporation Law that renders shareholder-approved bylaws that set the minimum number of votes necessary for an election victory unalterable by the Board absent shareholder ratification. This post summarizes my findings on that issue in my article Pandora’s Ballot Box, or a Proxy With Moxie? Majority Voting in Delaware Corporate Elections, forthcoming in the May edition of The Business Lawyer.
The Delaware amendment requires shareholder approval to alter a shareholder-adopted bylaw specifying the vote required to win a board election. This has resulted in adoption of board-adopted majority-voting bylaws, but only for uncontested elections, by nearly half the boards comprising the S&P 500. This is likely intended to forestall more onerous shareholder-adopted majority bylaws, and ensure that such bylaws are not protected by the Delaware amendment. Could a Board keep a shareholder majority-voting bylaw off the ballot under Rule 14a-8 if it had already adopted a less onerous bylaw? This seems to be an open question.
Some would claim that the growing popularity of majority voting bylaws limits the need for proxy access. However, that oversimplifies the analysis. Though board-adopted bylaws were ostensibly adopted to facilitate shareholder withhold-vote campaigns and thus enhance director accountability, the reach and effect of these bylaws is rather limited. For instance, most of the bylaws, as adopted, give the board discretion in determining whether to accept a board member’s required resignation where the member has failed to receive the requisite number of votes for reelection.
The state-law consequences of a board’s decision to reject such a resignation are unclear. Would it be protected by the business-judgment rule? Or would it be found an inequitable means of entrenching incumbent board members and managers? Your guess is as good as mine. In addition, the holdover rule would mean that a director targeted by a withhold vote could stay until the Board decided to replace him. Is the holdover rule merely a Delaware Code-based default rule from which shareholders could opt out through a bylaw? Again, this is uncertain.
However, bylaws mandating the minimum vote needed to elect a director, if adopted by shareholders and if worded to give maximum effect to withhold-vote campaigns, may significantly alter the balance of power. The amendment to Exchange Rule 452 disallowing broker non-votes in uncontested elections, when combined with the vote-tallying method embraced by the Delaware Supreme Court in Emerald v. Berlin, could seriously reduce management’s edge in withhold-vote campaigns. (Management does have one clever strategy for halting operation of majority voting in uncontested elections, though. They could simply recruit a stalking-horse candidate to make the election artificially contested, exempting the election from an uncontested-majority-voting bylaw.)
Those in favor of proxy access want a method for a majority of dispersed shareholders to legitimately express their preferences for board membership. Those opposed, of course, express a fear of the divisive presence of special-interest directors–who may be electable by a mere plurality under the default plurality-voting standard of the Delaware Code. The conflict between advocates and detractors of proxy access thus stems, in part, from the structural limitations of plurality voting, a method used to address elections in which no candidate receives a majority of votes.
However, a voting method proposed in my article could be an effective compromise. I propose majority voting for contested elections combined with instantaneous runoff voting using an ordinal ballot to rank candidates. The candidate ranked highest would receive a vote in the first round, and if a runoff were necessary, giving votes to the remaining candidate in the order of the shareholder’s preference. This would allow a majority of shareholders to express their preferences for and against candidates; it would limit special interest directors because candidates would need majority support based on shareholder rankings; the runoff would eliminate the possibility that an election would fail to produce a victor due to a lack of majority support; and there would be no need for the expense or delay of a second round of solicitations to obtain runoff results.
The SEC could encourage this method by, for instance, limiting the application of a proxy access rule to companies that have an instantaneous-runoff bylaw in place. Though of course I recognize that such a voting system may present its own unique challenges (including, for example, voting behavior that exhibits Condorcet’s Paradox), I think that my approach should be explored as a means of resolving the existing deadlock on this issue.
Majority voting bylaws will play an important role in the SEC’s consideration of proxy access, and the two policies interact in a number of counterintuitive ways. For example, if insurgents use proxy access to elect a director by a plurality of votes, a majority-vote bylaw would enable incumbents to institute a withhold vote campaign against that director in a subsequent election. Thus, to the extent that one believes that facilitating shareholder nominations is a good thing, majority-vote bylaws may, in some circumstances, limit its effects. The SEC should therefore carefully consider the effects of majority-vote bylaws while considering a new rule on shareholder access to the ballot.
Feel free to contact me at jayverret [at] gmail.com with any comments or suggestions on my post or my forthcoming paper on this subject.
