Managerial Response to Shareholder Empowerment: Evidence from Majority Voting Legislation Changes

Vicente Cuñat is Associate Professor of Finance at London School of Economics; Yiqing Lü is Assistant Professor of Finance at NYU Shanghai; and Hong Wu is Assistant Professor of Finance at Hong Kong Polytechnic University. This post is based on their recent paper. Related research from the Program on Corporate Governance includes Letting Shareholders Set the Rules by Lucian Bebchuk, and The Case for Increasing Shareholder Power, by Lucian Bebchuk.

Regulators often change the rules of shareholder democracy to improve the effectiveness of shareholder voting and to influence managerial authority. These rules may affect the election of firm directors but also more direct participation channels such as the voting of shareholder proposals. Given that these are two of the main ways through which shareholders can affect firm policies, it is therefore important to assess the effectiveness of reinforcing shareholder democracy and the reaction of managers to it.

In a recent paper we explore this research question by using a quasi-natural experiment the staggered passage of amendments to the Delaware General Corporation Law (DGCL) and Model Business Corporation Act (MBCA). These changes made it more costly for management to not implement the outcome of a subset of shareholder-initiated proposals. Specifically, under the new laws, the board cannot unilaterally amend or repeal the shareholder-adopted majority voting bylaw amendments related to director elections. Several states that use the MBCA as the basis of their own state laws subsequently changed their corporate law provisions to facilitate majority voting. This regulatory change provides a suitable setting for understanding managerial behavior and the underlying incentives when regulators tilt the balance of corporate governance away from managerial authority and toward shareholder empowerment.

To examine the managerial response to shareholder empowerment, we proceed in three steps. First, we exploit, implement a difference-in-differences (DiD) estimation using the staggered introduction of these legal amendments across different U.S. states as a quasi-natural experiment. Doing so enables us to obtain, from the filed proposals, causal estimates of managers’ reactions to the shareholder empowerment that derives from changes to the voting standards. More specifically, we find evidence that managers view shareholder proposals and management proposals on similar issues differently. After enactment of the new laws, the average number of management proposals per treated state grows by 11.3% to 39.2%. The direct adoption (without a vote) of majority voting standards in director elections also increases. We show that the increase in management-sponsored implementation of majority voting crowds out shareholder sponsored proposals on similar issues. That is, managers directly initiate and implement majority voting standards to pre-empt shareholder proposals.

Second, we investigate the details of these management proposals to see how they differ from shareholder proposals in order to understand the incentives of fronting. In particular, we examine the differences in the characteristics of similarly classified management and shareholder proposals related to the proposals’ reversibility and the resignation policies. We find that managers become less likely to implement majority voting via a bylaw and more likely to do so via charter. This implementation route favors managers because amending a charter requires the consent of both the board and shareholders while amending a bylaw only requires the latter’s consent. Managers are also more likely to install a favorable director resignation policy after the enactment of the new laws because such policies enable firms to retain directors who fail to win a majority of votes until a suitable replacement is found, rather than require an immediate resignation. These elements make the implementation of management proposals on majority voting more friendly to managers than that of the shareholder proposals on the same issue. Our results focus on those elements of majority voting adoption that are easy to measure and that unambiguously benefit managers, however, they are indicative of the possibility of managers using a broader set of specific adoption characteristics when fronting shareholder proposals. Such fronting behavior may dis-incentivize shareholder activists to implement deeper changes, given that activists would still face substantial costs to implement marginal changes.

Third and finally, we combine the DiD setting with a regression discontinuity design (RDD) of close shareholder votes to understand the value implications of implementing majority voting on the remaining firms that do not implement it, i.e., for which we observe related shareholder proposals. Firms where managers do not implement majority voting are in some way selected insofar as the managers decided that majority voting was undesirable either from the perspective of shareholder value or because of the impact on their own private benefits. By comparing the implementation of a majority voting standard and market reactions to the passage of shareholder proposals before and after the exogenous enactment of the legislation, we can understand the nature of this selection, giving us insight into managers’ motives for avoiding, amending, or replacing these voting rules. We find that after the enactment of the majority voting standard; however, the market reaction turns from neutral to negative. The results show that managers of firms for which the new legislation is likely to impose the greatest cost or the least benefit, tend to show the greatest resistance towards implementing the new standard. The findings indicate that managers do care about shareholder value and that majority voting can be detrimental for some firms in the sample. We cannot rule out, however, that the value of majority voting is positive for firms that have already implemented the standard, nor that in resisting implementation; managers have motives beyond improving shareholder value.

Overall, this paper presents evidence of managerial fronting when shareholders are empowered. Managers not only preempt shareholders in submitting more management proposals but also put forward provisions that are more management friendly than those in the shareholder proposals. We also provide insights into how managers choose to front shareholders and when they decide not to implement shareholder proposals. Our results suggest that when shareholder value is likely to suffer more or benefit less from the new legislation is precisely when managers show the greatest resistance to implementation of the majority voting standard.

The complete paper is available here.

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