Harvard’s Shareholder Rights Project is Still Wrong

Martin Lipton is a founding partner of Wachtell, Lipton, Rosen & Katz, specializing in mergers and acquisitions and matters affecting corporate policy and strategy. Daniel A. Neff is co-chairman of the Executive Committee and partner at Wachtell Lipton. This post is based on a Wachtell Lipton memorandum by Mr. Lipton, Mr. Neff, Andrew R. Brownstein, Adam O. Emmerich, David A. Katz, and Trevor S. Norwitz. This post discusses the 2012/2013 activities of the Shareholder Rights Project, which are described in an earlier post here.

A small but influential alliance of activist investor groups, academics and trade unions continues — successfully it must be said — to seek to overhaul corporate governance in America to suit their particular agendas and predilections. We believe that this exercise in corporate deconstruction is detrimental to the economy and society at large. We continue to oppose it.

The Shareholder Rights Project, Harvard Law School’s misguided “clinical program” which we have previously criticized, today issued joint press releases with eight institutional investors, principally state and municipal pension funds, trumpeting their recent successes in eliminating staggered boards and advertising their “hit list” of 74 more companies to be targeted in the upcoming proxy season. Coupled with the new ISS standard for punishing directors who do not immediately accede to shareholder proposals garnering a majority of votes cast (even if they do not attract enough support to be passed) — which we also recently criticized — this is designed to accelerate the extinction of the staggered board.

While the activist bloc likes to tout annual elections as a “best practice” on their one-size-fits-all corporate governance scorecards, there is no persuasive evidence that declassifying boards enhances shareholder value over the long term. The argument that annual review is necessary for “accountability” is as specious in the corporate setting as it is in the political arena. In seeking to undermine board stewardship, the Shareholder Rights Project and its activist supporters are making an unsubstantiated value judgment: they prefer a governance system which allows for a greater incidence of intervention and control by fund managers, on the belief that alleged principal-agent conflicts between directors and investors are of greater concern than those between fund managers and investors. Whether these assumptions and biases are correct and whether they will help or hurt companies focus on long-term value creation for the benefit of their ultimate investors are, at best, unknown. The essential purpose of corporate governance is to create a system in which long-term output and societal benefit are maximized, creating prosperity for the ultimate beneficiaries of equity investment in publicly-traded corporations. Short-term measurement and compensation of investment managers is not necessarily consistent with these desired results. Indeed the ultimate principals of investment managers — real people saving for all of life’s purposes — depend not on opportunism, shareholder “activism” or hostile takeovers, but rather on the long-term compound growth of publicly-traded firms.

As we have said, it is surprising and disappointing that a leading law school would, rather than dispassionately studying such matters without prejudice or predisposition, choose to take up the cudgels of advocacy, advancing a narrow and controversial agenda that would exacerbate the short-term pressures under which U.S. companies are forced to operate. In response to our critiques, the activists resort to ad hominem attacks, suggesting that, “as counsel for incumbent directors and managers seeking to insulate themselves from removal” we “advocate for rules and practices that facilitate entrenchment.” The fact is that the board-centric model of corporate governance has served this country very well over a sustained period. A compelling argument should be required before those corporate stewards who actually have fiduciary duties, and in many cases large personal and reputational investments in the enterprises they serve, are marginalized in favor of short-term-oriented holders of widely diversified and ever-changing portfolios under the influence of self-appointed governance “experts.” Indeed a just published comprehensive study by a distinguished group of professors at the London School of Economics demonstrates that the statistical analyses relied on by these experts are seriously flawed and that the shareholder-centric governance they are trying to impose was a significant factor in the poor performance by a large number of banks in the financial crisis.

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  1. Professor Bruce W. Bean
    Posted Friday, November 30, 2012 at 10:51 am | Permalink

    “Prejudice and predisposition” are the heart of much shareholder activism by self appointed, self important academics. As many of the posts on this corporate governance forum demonstrate, there is much to criticize and correct in the corporate world. Charging ahead blindly is not the way to go.

  2. James McRitchie
    Posted Friday, November 30, 2012 at 12:19 pm | Permalink

    Lipton and Neff put forth some arguments that might actually be compelling around the idea that annual elections promote short-termism. However, given that directors are primarily self-selected (often with considerable CEO input), the likelihood of unwarranted entrenchment demands a system of annual accountability in the form of at least an up or down vote by shareowners.

    If we had a system that encouraged real input from shareowners in the nominations process, such as I propose in Proxy Access: A New Version for 2013 (http://corpgov.net/2012/10/proxy-access-a-new-version-for-2013/), I might find their arguments more compelling. We have much more to fear from self-appointed directors than we do from governance “experts.”

  3. Bernard S. Sharfman
    Posted Sunday, December 2, 2012 at 11:56 am | Permalink

    I am sure it must be fun and rewarding for a law student to feel like they are making a difference even before they officially enter the practice of law. However, thinking about the pros and cons (yes, the cons also need to be discussed) of shareholder activism in a corporate governance seminar or drafting a paper on the topic for publication with guidance from one of the many Harvard Law professors who are considered leaders in the field would be a much better use of a student’s precious time in school than leaping head first into world of shareholder activism where real harm may be done to the corporate governance of one or more of the public companies targeted.

  4. Sarah Wilson
    Posted Thursday, December 6, 2012 at 7:04 am | Permalink

    At the end of the day, this is what democracy is all about pushing the boundaries of debate to innovate and create better systems.

    The overwhelming majority of world capital markets have shareholder structures and rights which put the owners, not lawyers at the heart of the debate. The facts speak for themselves, the FTSE350 has outperformed the S&P500 over the past 10 years and shareholders have also had the additional protection of pro-shareholder company law which is distinct and separate from the securities markets. Other readers may find this historical analysis of the shareholder debate and how the US got to where it is today of interest:
    Stewart, Fenner L., Berle’s Conception of Shareholder Primacy: A Forgotten Perspective for Reconsideration During the Rise of Finance. Seattle University Law Review, Vol. 34, Summer 2011; Osgoode CLPE Research Paper No. 34/2010. Available at SSRN: http://ssrn.com/abstract=1651286

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