Corporate Boards and Good Judgment: Does Rule 14a-8 Activism Help?

This post comes to us from Jeff Lipshaw of Suffolk University Law School.

My intuition, as a former senior vice president and general counsel of a publicly held corporation and as a theorist, is that Rule 14a-8 shareholder proposals on matters like poison pills, staggered boards, and executive compensation, bear at best a tenuous relationship to what shareholders should most want: the exercise by corporate management of exquisite judgment.

Keep in mind the complex milieu in which corporate management operates. My own experience is as a senior manager of a typical mature mid-cap company, not pathological like Enron, but not on the steep upslope of the “shareholder value creation” curve. The issues facing management in these companies are typically a mix of the following: product commoditization and obsolescence, loss of patents, pressure on R&D spending cuts, manufacturing inefficiencies, and so on. The shareholder base may be no less complex, consisting of long-term holders, short-term holders, arbitrageurs, social activists, and so on.

In our company, from 1998 to 2002, even as labor union pension funds filed shareholder proposals on the poison pill and the staggered board every year, two significant institutions, Berkshire Hathaway and Brandes Investment, increased their stake in the company from nothing to over 30% of the outstanding shares. The board redeemed the poison pill in early 2002 and sponsored a charter amendment to de-stagger the board in 2003.

Even though the proposals prompted the board’s actions, the question is whether they were meaningful to “good governance.” If y=f(x), with y being good governance and x being inputs having that functional output, I contend that the most we might hope for, given real-world complexity, are inputs that have some relationship to exquisite judgment. Are the elements of the corporate law in the proposals ones that drive good judgment? If our experience was typical (and I suspect it was), our two biggest shareholders demonstrated that they had questionable predictive power in the good judgment/good governance function.

Why this was so? I suggest judgment under complexity has defied all attempts at reduction to regression, model, or algorithm, at least to someone who is in, and not merely observing, the game. This kind of shareholder activism is one more example of what I describe in Law’s Illusion: Scientific Jurisprudence and the Struggle with Judgment as “scientific jurisprudence,” the way lawyers since Holmes (practicing and academic) have come to look at the law.

Shareholder activism under Rule 14a-8 is one area in which I have come to think that Holmes’ vision of the law does a disservice. In contrast to legal judgments, making judgments that involve the law goes beyond a prediction of what the adjudicator will do. It recognizes that adjudication, or even the legal system, is not the only game in which the next move must be assessed. As I discuss in the paper, even if we could reduce judgment to an algorithm, for the players in the game, there is a recursiveness problem with an infinite regress: whether applied to the judgment of others or to oneself, judgment piles on judgment piles on judgment, all the way down. This kind of shareholder activism merely privileges a particular model of corporate governance – a company characterized by particular choices under corporate law – without any showing that the model makes a difference in the judgment-making of the game players.

In Models and Games: The Difference Between Explanation and Understanding for Lawyers and Ethicists, I explore in more detail the problem of the objective and the subjective in dealing with rule-based systems. The article suggests that there is real danger in confusing models and games (which bear a “family resemblance” as philosophers of language might say) both for modelers and game-players. For the players, are accounting systems like GAAP models or games? Are they meant to convey a useful picture, less complex than a full description, of the financial condition of the business, or are they rules to be interpreted and manipulated to win the “earnings” game? For the observers, do the explanatory models have anything to do with what is meaningful to the players – that is, do the observers understand, from the players’ subjective point of view, what is going on?

Rule 14a-8 activism suffers from the latter problem. The models of governance may yield academic insights, but they are not meaningful to game players like directors, managers, and most shareholders. Instead, they appear to be the game pieces of players like labor unions and social activists with political or economic agendas of their own.

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