The SEC: Gatekeeper of Shareholder Rights?

Professor Lynn Stout recently published an op-ed in the Wall Street Journal entitled Corporations Shouldn’t Be Democracies. The piece opposes shareholder access to the proxy for the adoption of election-related bylaws and urges the Commission to adopt a proposed rule that would eliminate such access. (One of us has explained our opposition to the no-access proposal in a comment letter submitted by the Race to the Bottom Blog.) The absence of concrete data in the piece exemplifies the difficulty opponents have had in developing credible positions against shareholder access.

The piece contends, for example, that the discouragement of active shareholder involvement under U.S. law has “proven [to be] a tremendous recipe for success,” and argues that the “proxy access rule is driven by the emotional claim, unsupported by evidence, that American corporations benefit from ‘shareholder democracy.’” The editorial thus describes shareholder democracy as “a shallow idea.”

The article contains little evidence, however, in support of that claim. The piece notes that “13 of the world’s largest corporations are American,” and that “long-term investment becomes impossible if shareholders have the power to drain cash out of the firm at any time.” If true, the latter contention suggests that the costs associated with shareholder access will negatively impact the worldwide rankings of large American companies. But that claim is supported neither empirically–there is no quantification of the costs related to access, or an explanation as to why the costs of access in this area would be greater than the costs in other context–nor by common sense.

The first claim, however, is the most startling. Professor Stout suggests that 13 of the world’s largest corporations are American because our system of corporate governance discourages shareholder involvement. In other words, she credits the financial success of U.S. companies to our ostensibly hostile approach to shareholder rights.

That argument, however, ignores the history of the growth of U.S. businesses. The infrastructure projects that the piece mentions–the construction of railroads, canals and factories–were financed largely by bonds, not stocks, purchased by European investors chasing returns in our rapidly expanding economy. The enormous growth of American industry over the last century is explained not by any unique feature in the corporate law but by the simple expedient of growth cycles.

Historical analysis of the growth of the largest corporations worldwide makes this readily apparent. For example, in 1995, there were just as many Japanese companies among the world’s top 200 firms as American (58 and 59, respectively). Had a similar list been compiled a century before, British companies would have featured prominently. If Fortune or Forbes were to publish such a list 25 years from now, a significant number of the largest companies are likely to be from India and China. In addition to the growth cycle, favorable immigration policies, greater natural resources, and geopolitical power help to explain the fact that many of the world’s largest corporations come from the United States. 

Professor Stout’s analysis of British firms is even less persuasive. She claims that “the United Kingdom seems a paradise for shareholders,” and that this explains why very few of the 30 largest companies are headquartered there. Several of the reforms ushered in by the reports of the Cadbury (1992), Greenbury (1995), and Hampel (1998) committees are less than a decade old. The Director’s Remuneration Regulations were just issued in 2002. The decline in British corporate performance can be traced back several decades to the period immediately following World War II–long before the pro-shareholder reforms that made Britain a “paradise.” Moreover, most experts attribute the decline in British corporations to poor management–not shareholder activism.

Professor Stout contends, correctly, that “[c]ompanies seem to succeed best when they are controlled by boards of directors, not by shareholders.” On this point, opponents of the no-access proposal agree. The principal reason we favor the access proposal is the reality that boards have failed effectively to watch out for the interests of shareholders. Without any serious risk of losing an election, directors know that the key to job retention is nomination by the board. Because the CEO is invariable on the board–and, in the U.S., often serving as Chairman–directors who want to be reelected have strong incentives to favor the interests of management over shareholders. Shareholder access, we think, would improve board members’ incentives to act in the interests of shareholders.

In any event, as one of us has explained elsewhere, the problem of access is one created by state law. Professor Stout would have the SEC become the gatekeeper that prevents the implementation of state-law rights she does not like. This is an inappropriate role for the Commission.