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E-MailThis post is from Marcel Kahan of the NYU School of Law.
In Embattled CEOs, Edward Rock and I argue that chief executive officers of publicly-held corporations in the United States are losing power to their boards of directors and to their shareholders. This loss of power is recent (say, since 2000) and gradual, but nevertheless represents a significant move away from the imperial CEO who was surrounded by a hand-picked board and lethargic shareholders.
The decline in CEO power has multiple, and interacting, causes and symptoms. On the dimension of shareholder composition and activism, reduced CEO power is related to the their continuing increase in the stock ownerships by institutional investors, especially mutual funds, and the concomitant decline in stock ownership by individuals; the recent rise of hedge funds, the most activists type of institutional investors; the increased level of activism by mutual funds; and the role of proxy advisory firms in targeting portfolio companies for and coordinating activism. On the dimension of governance rules, several developments may represent both symptoms of reduced CEO power and contribute to further declines in CEO power. These include the virtual demise of staggered boards among the largest US companies (and the less significant, but still pronounced decline, in staggered boards among smaller ones); the meteoric rise of majority voting for directors; and the increased number of shareholder proposals that receive majority support and, more importantly, that are implemented by the board. On the regulatory front, important recent developments include the NYSE proposal to end discretionary broker voting in director elections; the new rules governing the electronic delivery of proxy materials which reduce solicitation costs for both companies and dissidents; and the governance reforms adopted n the wake of Sarbanes-Oxley which, among others, require that companies create select committees exclusively composed of independent directors. On the board level, the loss of CEO power is related to the fact that directors who have long been nominally independent (i.e. have no business ties to the company) now act more substantively independent (i.e., defer less to the inside directors). This is reflected in the increased board time devoted to monitoring the CEO (and the increased overall time demands placed on outside directors); regular meetings of outside directors only in executive session and occasional ones with shareholders and independent consultants; the increased number of companies that have formal processes for evaluation CEOs, lead outside directors, or that split the CEO and Chairman position; and the increased level of CEO turnover, both overall and especially performance-related.
All of these changes have contributed to a decline in CEO power in several way. CEOs have less control over important strategic decisions, such a whether to sell the company. They have less control over setting the agenda presented to the board and to shareholders. They have less control over audit, compensation, director selection, and other governance matters. And even on the operational level, where CEOs retain significant over initial decisions, the CEO is more likely to be held accountable, and likely to be held accountable sooner, over operational decisions than in the past.
We believe that the shift in CEO power to outside directors and institutional shareholders represent in fundamental trend that will continue at least over the medium term. While we do not exclude the possibility of a regulatory backlash – analogous to the passage in anti-takeover laws and the sanctioning of the poison pill is response to the hostile takeover movement in the 1980s – we believe that such backlash is unlikely. As a result of this shift, outside directors will be increasingly composed of retired high-level executives or professionals, such as former CEOs or former partners in accounting firms; that “flavor of the year” shareholder resolutions will become harder to ignore; and that the locus of resistance to having the company be acquired will shift from inside managers to outside directors and shareholders. At the same time, we believe the change in this change in the governance regime represent a convergence of the U.S. to other Anglo-American countries (in which CEOs have long held a weaker role) and that it calls into question the case for legal change that further increases shareholders’ voting right.
The article is available here.
One Comment
The paper excellent concludes with agnosticism but subtly leans toward the status quo and going no further with shareowner empowerment, for example by granting proxy access.
“The intuition that drives this paper is nicely captured in Milo Winter’s famous 1912 illustration of Gulliver tied down by the Lilliputians.” Gulliver is clearly the CEO. I’m not sure if the Lilliputians are directors, shareowners or something more abstract. I see the CEO more as first among equals, not larger than life. The recent reduction in power makes CEOs less like dictators and more like prime ministers.
One factor left out of the influences resulting in the shift of power were the SEC’s rulemakings that require mutual funds and investment advisers to disclose their proxy voting policies and votes. Having to disclose how their votes meet their fiduciary obligation to investors may actually be more important than the more widely discussed development of eliminating broker votes, especially given the rise of funds and decline of retail investors, which the authors document so well.
I have a couple of other minor quibbles. Kahan and Rock note that “even though the formal powers of the board have not changed, boards have become much more receptive to shareholders… This obviously reduces the need for removing board veto power over governance changes…” While it may reduce the need to shift more power to shareowners, it doesn’t demonstrate the need has been fully met, as the authors seem to hint.
Another train of thought that seems to stretch in its conclusion is their argument that “CEOs who have lost power may find the possibility of great wealth offered by private equity relatively more attractive.” Yet, not more than a paragraph before they state that the CEO who goes to work for a private equity firm “now has a boss – the management of the private equity firm – which has the ability and the incentives to monitor him and to fire him if they are dissatisfied. Whatever financial rewards the CEO may obtain in his new position, one thing is clear: the power of a CEO of a company owned by a private equity fund is much less than the power of a CEO of a comparable company that is publicly traded.”
Obviously, CEOs lose more power by switching. Additionally, it is not clear that in the long-run they make more money under a private equity structure. How much does Warren Buffet pay his managers? Contrary to the hints, they provide no support for the notion that CEO pay and power has been reduced to the point that recruitment will be much more difficult.
They appear give one last plug for maintaining the status quo balance of power, “One of the great virtues of the corporate form is centralized management.” Yet, this shift in power, even if it increases, does not decentralized management — although I’m not sure that would be bad. The real questions to be argued are those concerned around the pluses and minuses of more democratic forms of organizing our investments and our work. Which forms are more likely to lead to increased productivity and a more salubrious environment? The answers will be found in more democratic forms.