The Shifting Landscape of Corporate Governance

This post comes to us from John J. Madden, a member of the Mergers & Acquisitions Group at Shearman & Sterling LLP, and is based on an article that first appeared in the BNA Corporate Governance Report and appears with permission; the complete article is available here.

The widespread public criticism of boards of directors arising from the financial crisis, and the ensuing governance reform initiatives, should not have come as a surprise to those following trends in corporate governance. Instead, they should be seen as part of a series of developments in the evolving relationship between shareholders and their boards in the United States that has been underway for the past two decades. As the shareholder base has largely consolidated into the institutional investor community and those investors have become more organized and focused on exerting the influence inherent in their substantial ownership stakes, we have seen in recent years an accelerating shift in the “balance of authority” exercised by boards and shareholders in the corporate decision-making process.

There is no indication that this trend will reverse or even slow down significantly. Accordingly, directors should understand the origins and key drivers involved, and determine how they can most effectively adapt to this changing environment and secure the confidence and support of their companies’ shareholders.

The Longstanding Corporate Decision-making Model

For almost a century the U.S. model for corporate decision-making has been based on the principle of separation of ownership and control. This model recognizes the impracticalities of collective ownership decision-making in corporations with widely-dispersed stock ownership and with divergence of interests among, and varying levels of information available to, the many owners. The costly and cumbersome shareholder consensus-based approach to decision-making therefore gave way to vesting most decision-making in a more centralized authority – the board of directors. This director primacy model was seen to be more effective, particularly where decision-making had to reflect the interests of multiple constituencies, including shareholders, employees, customers, suppliers, creditors and communities in which the corporation operates.

The director primacy model has long been reflected in the corporate law. In Delaware, where most U.S. public companies are incorporated, the corporate statute specifically calls for a corporation’s business and affairs to be managed by or under the direction of the board of directors. [1] Shareholders are given limited authority to initiate corporate action, while their voting rights are generally restricted to such fundamentally important matters as the election of directors, approval of extraordinary transactions such as mergers and the sale of substantially all the corporation’s assets, and approval of charter amendments.

This construct of board authority, coupled with directors’ overriding fiduciary responsibilities to serve the shareholders’ best interests, has been broadly successful over the years in the development of the public corporation model and in facilitating business growth and access to the capital markets. The board’s authority and discretion – which, in my experience, the overwhelming majority handle responsibly and with the interests of shareholders in central focus – has allowed for the generally effective decision-making that has contributed to this success.

The Rise of the Institutional Investor

The relatively passive role of shareholders in corporate America began to change more than two decades ago as the equity holdings of institutional investors gradually increased. While there are diverse categories of institutional investors – with varying investment strategies and policies – the increasing institutional equity ownership was widespread. Pension funds (both governmental and private) increased their equity holdings both through their growth in absolute size and through their portfolio shifts from debt to equity. In addition, mutual funds experienced substantial growth, while we saw the emergence of sizeable hedge funds and other investment managers. Institutional investors’ percentage ownership of the stock of the largest 1,000 U.S. public companies increased from 46% in 1987 to more than 76% in 2007 (while slipping to 73% in 2009). [2] By 2009, total assets controlled by institutional investors was over $25 trillion. [3]

This consolidation of the public company shareholder base, and corresponding decline of the historically substantial and less influential retail shareholder universe, began a rethinking the nature of the relationship between shareholders and the companies in which they invest. While investment strategies and policies vary widely among institutions, depending on their nature, some of the factors contributing to the relationship shifts can be identified. For some pension funds and other institutions holding large indexed portfolios, or large long-term positions that could be costly to liquidate due to their size, the traditional “Wall Street Rule” approach of selling positions when dissatisfied with corporate performance or management was not always a practical or economically attractive alternative. Instead, trying to engage with boards to address governance or underlying performance issues became an increasingly explored alternative. In addition, activist hedge funds (in some cases managing more traditional institutions’ money) began to pursue strategies to build a significant stock position and press the board directly for change – whether strategic, operational or otherwise – to increase the stock price in the near term. Finally, there also developed other categories of investors, some of which, like large program traders, showed no interest in management or operations as they traded on technical market data on a moment to moment basis; and they contributed significantly to the large trading volume increases as average annual stock turnover exceed 250% by 2009, compared to 78% ten years earlier. [4]

As their equity portfolios grew and their individual corporate holdings became more substantial, several of the large institutions – particularly leading pension funds such as TIAA CREF, CalPERS and some of the large union funds – pursued efforts to improve corporate governance and, through that, they thought, performance. Some did so directly by promulgating their own governance guidelines and others participated indirectly through their reliance on governance advisory firms such as ISS and Glass Lewis as well as industry organizations like the Council of Institutional Investors.

The early governance efforts focused on encouraging boards to dismantle the takeover defenses that had largely been put in place during the 1980s in response to the surge of junk bond financed “two tiered, “bust up” takeover bids and other coercive takeover tactics employed in that period. These initial efforts in the 1990s were generally met with varying degrees of resistance by boards, but the efforts persisted and, over time, gained increasing attention and support among shareholders.

Developments Accelerating the Pace of Change

In the past decade, two significant developments accelerated the pace of this change. First was the enactment of the Sarbanes-Oxley Act in 2002 and the adoption by the national stock exchanges of new regulations in 2003 establishing requirements for director independence, board committees, governance guidelines, codes of business conduct and ethics, and other matters – both initiatives undertaken in the wake of the bursting of the technology/telecom bubble and the discoveries of major frauds at Enron, WorldCom and other well-known public companies. Those initiatives led to greater activity from institutional investors, who became increasingly successful in focusing wider attention on governance reforms, as well as the broader emergence of activist hedge funds seeking to force strategic and operational change, or financial restructuring, at companies in which they invested.

The second significant development accelerating the pace of change was the global financial crisis. The extraordinary level of criticism of boards coming out of this crisis was noteworthy for its aggressiveness and breadth – the media, politicians, regulators and the public at large all chimed in to criticize boards for their alleged failures to adequately oversee the companies they served. The resulting reform initiatives included, most prominently, the enactment of Dodd-Frank with its “say-on-pay” requirements and authorization of proxy access.

A Decade of Significant Change

The growth of institutional investors, their improved organization and focus, and the regulatory and legislative initiatives at the beginning of this century and more recently, together have generated significant change to the corporate governance landscape. Some of the more noteworthy developments include the following:

Takeover Defenses. We have seen meaningful change in the status of corporate takeover defenses as, for example, only 29% of companies in the S&P 500 now have classified boards (compared with 60% in 2000) and only 13% of such companies have poison pills in place (compared with 60% in 2000). [5] And activists continue to press shareholder proposals, in many cases garnering considerable support, to permit shareholders to act by written consent and to call special shareholder meetings, and to eliminate supermajority voting requirements in corporate charters. [6]

Majority Voting. More than 70% of the S&P 500 companies now have some form of majority voting in uncontested director elections, while a decade ago hardly any varied from the prevailing plurality voting standard. [7] Although there have been relatively few instances to date of directors failing to attract the majority of votes needed for re-election, this may change, particularly as the ability to wage “withhold vote” or “vote no” campaigns – from regulatory, communications and cost perspectives – continues to improve; and the elimination of broker discretionary voting in director elections can further aid challengers here.

Proxy Contests. 2009 saw a record number of proxy contests (beating the record previously set in 2008) and, for the first time since the proxy solicitor Georgeson started tracking contests in 1981, the dissidents had more successes than management. [8] In 2010 the number of actual contests decreased as the markets improved and companies became more engaged with their shareholders and more willing to make concessions. The exceptional success rate for dissidents in 2009 was likely an influential factor in spurring the 2010 negotiations and concessions, and can be expected to remain influential going forward.

Proxy Access. In August 2010, the SEC adopted its final rules on proxy access pursuant to the authority granted under Dodd-Frank – allowing owners of at least 3% of a company’s stock for three years access to the company’s proxy statement to nominate directors for up to 25% of the board, so long as the action does not have the purpose or effect of changing control. In October 2010, the SEC stayed implementation of the rules pending the resolution of the legal challenge brought by the Business Roundtable and the U.S. Chamber of Commerce. As a result, the rules will not be effective for the 2011 proxy season. It remains uncertain how widely utilized proxy access will actually become, given the investment size and holding period requirements, as well as the control limitations. Nevertheless, assuming it is cleared by the courts, the mere fact of its availability will likely influence board decisions on matters of particular interest to shareholders.

Governance Activism (Executive Compensation, etc.). The “say on pay” provisions of the Dodd-Frank Act mandating nonbinding shareholder votes on executive compensation and imposing other requirements related to the management of executive compensation represent an extraordinary foray by the federal government into the corporate governance arena, legislatively imposing a requirement pursued particularly aggressively by activists in shareholder proposals in recent years. We also continue to see shareholder proposals and other initiatives on a broad range of governance topics, including several other aspects of executive compensation, CEO succession planning, risk management, and separating the chair and CEO roles. [9]

Strategic and Operational Activism. Activist hedge funds and other institutional investors have also pursued campaigns pressing companies for change in strategic direction and even in operational matters. Current examples include Pershing Square Capital Management’s pressing for strategic change at Fortune Brands where, two months after the announcement of Pershing Square’s acquisition of its 11% stake in the company, it was reported in December 2010 that Fortune Brands would split itself in three, leaving the company as only a liquor company. Although not reportedly under a similar activist threat, in January 2011 ITT announced that, after looking at several options for increasing shareholder value, it would split into three separate listed companies – prompting an increase of more than 16% in its share price that day. And in January 2011 J.C. Penney Co. announced that three representatives of Pershing Square and Vornado Realty Trust would be added to the company’s board, three months after those investors had surfaced with a combined 27% holding in the company. Concurrently, Penney announced several operational changes it was making to improve profitability. The company’s share price increased 20% in the four month period of October through January.

In the current environment, activist and other institutional investors are more inclined to scrutinize and challenge both corporate strategy and management performance and to push aggressively for change where they identify directional or other operational change that they believe likely to create greater shareholder value. The principle of more proactive engagement generally by institutional shareholders has been endorsed by some prominent figures in the industry, [10] and has been reinforced by reports such as the study by Wilshire Associates finding that the activist involvement by CalPERS in a sampling of 142 “focus list” companies on average increased companies’ returns materially. [11] At the same time, however, institutional investors and others (regulators, governance organizations) are also beginning to look at the ownership responsibilities of the institutions themselves, as has been done in the UK in the development of the Stewardship Code issued last year by the Financial Reporting Council.

Increasing Transparency. In December 2009, the SEC adopted additional rules for greater corporate transparency, requiring proxy statement disclosures on subjects such as director qualifications and skills, board leadership structure and responsibilities, the board’s role in risk management, and diversity in the director nomination process. [12]

These various developments over the past decade are reflective of the substantially increased organizational skills, influence and focus of institutional investors and their representative organizations, and indicative of the changing relationship between shareholders and their boards. This active engagement by shareholders in corporate decision-making – both procedurally and substantively – is blurring the historic distinction between ownership and control, and is shifting the shareholder/board “balance of authority” toward greater shareholder influence in the corporate enterprise.

Whether this trend will evolve to a more fundamental change in the longstanding corporate model will depend, in important part, on the ability of boards to secure the confidence of this more actively engaged shareholder community.

Four Steps for Boards to Take to Improve Performance and Gain Shareholder Support

Even in this changing environment, the essential nature of the board’s job remains management oversight – specifically, overseeing the performance of the CEO and the senior management team to enhance the corporation’s long-term prosperity. While a board’s oversight role naturally encompasses a broad range of particular responsibilities – the priorities of which can vary among industries and among particular companies within industries – I set forth below four fundamental steps directors should consider to improve their performance and to proactively respond to the shifting governance landscape.

(1) Review Board Composition and Size. Two important starting points for establishing a sound foundation for a high performance board are the qualities of the individual directors and the size of the board.

The board should be comprised of individuals with relevant experience and expertise to fully understand the company’s businesses and the markets in which it operates, and to add value through their individual and collective contributions toward defining, and overseeing the achievement of, the company’s strategic goals. The important categories of relevant experience and expertise will, of course, vary depending on the particular company involved – expertise in financial, industry, risk, technology, marketing or international matters may be more or less important depending on the company. In addition to the essential experience and expertise, directors must have the integrity, judgment and courage to make tough decisions in the best interests of the shareholders and to do so independently of their senior management relationships. Admittedly, it is not always easy to confidently assess these character traits in director candidates; however, their importance is clear. The quality and “value added” capability of directors as a critical element of board performance cannot be overstated. Although making director changes on the board’s own initiative can be challenging, including because of the personal relationships that are generally established among fellow directors, the subject of board performance and individual director qualifications is gaining increasing attention and, with majority voting now broadly in place for director elections and the prospect of proxy access potentially available as early as next year, individual director contribution will be subject to increasing scrutiny. Accordingly, the subject deserves current attention by boards.

The commitment of time and effort called for by directors to successfully fulfill their responsibilities is significant (see paragraph (2) below) and requires that boards organize themselves and function as productively as practicable. Among other things, it means deciding on the right size of the board and, in most cases, smaller is more effective than larger. [13] While a smaller board places a greater burden on individual directors, with each taking on more tasks that could otherwise be spread out over a larger board population, a smaller board can result in better informed individual directors, encourage a grater sense of individual responsibility, enhance the board’s cohesion and potentially its overall quality, and improve the efficiency and effectiveness of meetings. According to one recent study, it appears that this is the direction in which public companies have been gradually moving. [14] The focus here should be on determining the optimal structure to facilitate timely and effective decision-making.

(2) Clarify Requisite Director Commitment and Align Compensation. The board’s oversight role spans a range of responsibilities, including the hiring and, when necessary, firing of the CEO, deciding on the CEO’s and other senior management’s compensation, planning for senior management succession, reviewing and approving the company’s strategic plan and evaluating its execution by management – all of which require a solid understanding of the company’s businesses, including the opportunities, challenges and risks. Ensuring constructive communications lines with management and with shareholders, as well as serving as stewards of the corporation’s reputation, only add to the list of responsibilities. The time commitment necessary for directors to do their job well has been generally thought to be approximately 200 hours annually. However, with the increasing demands on boards in the current environment, that may well underestimate the personal commitment now required. Of course, the necessary investment of time will vary depending on the complexity of the company’s operations and other factors, and will increase significantly during periods of particular challenges facing the company. Otherwise well-qualified directors who are unable to devote the requisite time to the job cannot be effective and should not take on the responsibility.

As the demands on directors’ time and expectations for their performance have increased, it is important to ensure that their compensation reflects those elements of the job. This would include a review not only of the appropriate amount of compensation called for but also of the form of payment. Structuring director compensation to ensure directors have, and maintain at least through their board tenure, some “skin in the game” through a meaningful personal investment in the company’s stock will help to align, and be perceived to align, directors and shareholders’ interests.

(3) Focus on Key Issues; Operate Efficiently. Boards should insist on addressing the company’s most important issues and on having effective reporting systems in place to bring relevant information to their attention on a timely basis, whether in internal controls, key compliance functions, risk management, or other strategic areas. And boards should call for presentations by management to not only focus clearly and cogently on the subjects brought before the board, but also to reflect management’s thought process and analysis in arriving at its recommendations and, where relevant, the rationale for rejecting alternative courses of action considered in the process.

The mindset should be to proactively approach the task as owners – to be satisfied that the board is right-focused and has a robust internal support and reporting system to deliver timely and relevant information for review, analysis and decision making. It may be worthwhile to recall Warren Buffett’s admonition to “beware of geeks bearing formulas” and to underscore the importance of boards being satisfied that they understand adequately the information brought before them and that, where they have questions, senior management has fully vetted the information in advance and is prepared to respond to board probing.

(4) Know, and Constructively Engage With, the Shareholders. In the current environment, boards must ensure that management maintains a well-developed knowledge of the company’s shareholder base. That includes not only monitoring trading activity and assessing shifts in the ownership profile, but also understanding the market perceptions of the company – how the principal shareholders and the relevant analysts and industry experts view the company, its strategy and the senior management team.

Boards are not only now required to be more transparent, as discussed above, but the market also now expects boards to be more communicative with shareholders than in the past. Certainly, care must be taken in developing the appropriate communications strategy – including determining the right forum for communication, the right spokesperson for the board and, importantly, the right subjects to address (board oversight topics, rather than operational matters) and messages to be conveyed. And coordination with the CEO, the company’s principal spokesperson, to avoid conflicting messages and to reinforce support of the leadership team is essential. The key is to demonstrate to shareholders the board’s proactive engagement in its oversight role and its commitment to the shareholders’ interests, through both listening to the concerns of shareholders and responding to issues raised for the board to address.

For some companies, a shareholder communications forum could present an opportune time to address the current public discussion of the tension between the board’s fundamental responsibility to advance the long-term prosperity of the enterprise and the objective of some shareholders to achieve shorter-term investment returns. Of course, managing for long-term and short-term results are not inherently inconsistent and many successful CEOs will argue that one must manage for both objectives. In some cases, current strong market performance in the stock can be a reflection of confidence in the long-term plan and, on the other hand, poor current stock performance may reflect a distinct lack of confidence in the longer-term strategy. To the extent a company may be facing this kind of tension, the board’s role is to ensure that the company has the right long-term strategy and, having done so, to build support among the shareholder constituency for that strategy.


It is important for boards to understand the nature and scope of the shifting governance landscape, and to evaluate whether they should make any changes to adjust to the new environment, where their own performance is the subject of increasing shareholder attention. Focusing on fundamentals such as their composition, priorities, operational efficiencies, compensation structure, and shareholder communications strategy would be a constructive starting point.


[1] Del. Code Ann. tit. 8, §141(a) (2010).
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[2] The Conference Board, The 2010 Institutional Investment Report: Trends in Asset Allocation and Portfolio Composition 27 tbl.13 (2010), available at
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[3] Id. at 7 tbl.1.
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[4] John C. Bogle, Restoring Faith in Financial Markets, Wall St. J., Jan. 18, 2010 at A25.
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[5] Poison Pills in Force Year Over Year,, (last visited Jan. 27, 2011); Classified Boards Year Over Year,, (last visited Jan. 27, 2011).
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[6] Institutional Shareholder Services, An Early Look at 2011 Governance Proposals, ISS Governance Weekly, Jan. 14, 2011, at 3, available at
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[7] Id. at 2.
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[8] Georgeson, 2009 Annual Corporate Governance Report 8 (2009), available at In 2009, dissidents succeeded in gaining at least one board seat in 49% of the contests fought to the shareholders meetings. If one factors in the number of contests that settled after filing a definitive proxy statement and before the meeting, the figure climbs to nearly 63%. Id.
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[9] In October 2009, the SEC opened the door for shareholder proposals on the board’s role in risk management and CEO succession planning. See SEC Division of Corporation Finance, Staff Legal Bulletin No. 14E (CF), (2009), available at (last visited Jan. 28, 2011). According to a Spencer Stuart survey, 40% of the S&P 500 companies had a separate Chair and CEO as of 2010, up from 23% in 2000. Spencer Stewart, 2010 Spencer Stuart Board Index 20 (25th ed. 2010), available at (last visited Jan. 28, 2011).
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[10] See, e.g., Bogle, supra note 4; Roger W. Ferguson Jr., Riding Herd on Company Management: Institutional Investors Have the Power—and They Should Use It, Wall St. J., Apr. 27, 2010 at A1.
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[11] Andrew Junkin & Thomas Toth, Wilshire Associates, The “CalPERS Effect” on Targeted Company Share Prices 3 (July 31, 2010), available at
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[12] Proxy Disclosure Enhancements, Exchange Act Release No. 34-61175A (Dec. 16, 2009) (to be codified at 17 C.F.R. pts. 229, 239, 240, 249 & 274), available at
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[13] I have previously written in support of smaller boards. John Madden, Restoration Project: Respect for the Board, Directors & Boards, Third Quarter 2009, available at
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[14] According to a Spencer Stuart survey, the average size of S&P 500 boards currently is 10.7 directors, down from 11.5 in 2000. 2010 Spencer Stuart Board Index, supra note 11, at 13.
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One Comment

  1. Anthony Previte
    Posted Tuesday, October 4, 2011 at 3:36 pm | Permalink

    I was searching for an explanation of how shareholders became the alpha and omega when it comes to corporate priorities, this article is exactly it. The timeline of this change corresponds perfectly with the increase in income-disparity in our economy and perfectly explains the cold-shoulder that employees and customers now get from corporations. It has developed from the tunnel-vision-like focus on increasing shareholder value at any cost. This is required reading for anyone who wants to understand what is truly driving the ‘war’ on the middle class.