The Giant Shadow of Corporate Gadflies

Kobi Kastiel is Assistant Professor of Law at Tel Aviv University, and a Research Fellow at the Harvard Law School Program on Corporate Governance; and Yaron Nili is assistant professor at the University of Wisconsin Law School. This post is based on their recent paper, forthcoming in the Southern California Law Review. Related research from the Program on Corporate Governance includes The Agency Problems of Institutional Investors by Lucian Bebchuk, Alma Cohen, and Scott Hirst (discussed on the Forum here); Index Funds and the Future of Corporate Governance: Theory, Evidence, and Policy by Lucian Bebchuk and Scott Hirst (discussed on the forum here); and Towards the Declassification of S&P 500 Boards, by Lucian Bebchuk, Scott Hirst, and June Rhee.

Modern-day shareholders influence corporate America more than ever before. From demanding greater accountability of executives to lobbying for a variety of social and environmental policies, shareholders today have the power to alter how American companies are run. Indeed, much attention has been directed towards the rise of large institutional investors and their influence on corporate governance and competition. But that attention has also largely left out of public and academic debate one of the most unique corporate governance actors: “corporate gadflies.” As we document in our recent study, forthcoming in the Southern California Law Review, much of the corporate governance agenda setting in the U.S. has been, and still is, dominated by a handful of individuals with limited resources, who own tiny slivers of most large companies, rather than by the “Titans of Wall Street.”

Our study is the first to address the giant shadow that corporate gadflies cast on the corporate governance landscape in the United States. How does an economy with corporate equity in the trillions of dollars cede so much governance power to corporate gadflies? More importantly, should it? In answering these questions, we make three contributions to the literature. First, using a comprehensive dataset of all shareholder proposals submitted to the S&P 1500 companies from 2005 to 2018, our study offers a detailed empirical account of both the growing power and influence that corporate gadflies wield over major corporate issues and of their power to set governance agendas. Second, we use the context of corporate gadflies to elucidate a key governance debate over the role of large institutional investors in corporate governance. Specifically, we underscore the potential concerns raised by the activity of corporate gadflies and question the current deference of institutional investors to these gadflies regarding the submission of shareholder proposals. Finally, the study proposes policy reforms aimed at reframing the current discourse on shareholder proposals and potentially sparks a new line of inquiry regarding the role of investors in corporate governance.

The crucial role of corporate gadflies in initiating governance changes: In the past, gadflies were perceived as an esoteric phenomenon. This is no longer the case. Using a comprehensive dataset of all shareholder proposals submitted to the S&P 1500 companies from 2005 to 2018, we deep dive into the remarkable and curious story of corporate gadflies, offering a first-of-its-kind, detailed empirical account of the growing influence that corporate gadflies wield over major corporate governance issues and of their power to set companies’ agendas. For example, in 2018, a small group of five individuals accounted for close to 40% of all shareholder proposals submitted to S&P 1500 companies. As a whole, gadflies as well as other individual shareholders submitted 2,628 proposals during our sample period (38.5% of all proposals), exceeding more established investors, such large institutional investors, hedge funds, and the uber-rich investors. Clearly, gadflies’ scope of activity is no longer marginal.

Our data also show that the narrative promoted by companies and their advisors—that gadflies’ interests diverge from the ordinary diversified investor and that they tend to pursue their own narrow interests—is simply not true. Rather than pursuing esoteric personal agendas, as companies would have the public believe, gadflies initiate shareholder proposals focused primarily on governance terms that institutional investors publicly endorse in their guidelines. Indeed, gadflies’ governance-related proposals attracted, on average, 47.8% shareholder support between 2005 and 2018 and accounted for a large portion of all passed proposals. For example, in 2018, gadflies submitted over 53% of the passed proposals, which means that these individuals are receiving widespread support from the larger investors who fail to submit proposals of their own.

And when gadflies’ non-binding proposals receive majority support, we also find that it is likely to lead to an actual change in company policy. This is because absent such a response by management, leading proxy advisory firms such as ISS and Glass Lewis are likely to recommend voting against individual directors or even the entire board. Gadflies thus operate in this system as “governance facilitators,” translating universal governance guidelines into company-specific governance changes.

The absence of large institutional investors: Gadflies’ dominance, however, is also puzzling. Why do large investors refrain from submitting any proposals, even if they support the underlying question at stake, and why is this key governance tool largely controlled by “Main Street” retail investors? Ostensibly, the natural candidates for submitting shareholder proposals are the largest institutional investors, in particular the so-called “Big Three” indexing giants of Wall Street: Vanguard, BlackRock, and State Street. However, a recent article by Lucian Bebchuk and Scott Hirst revealed that the Big Three did not submit a single proposal between 2008 and 2017. Instead, while these large investors have left this particular power to individual investors, they oftentimes support the proposals submitted by small investors who barely meet the low minimum ownership thresholds required by the SEC for proposal submissions. Several factors, including fear regarding regulatory compliance, political, and corporate backlash have left these institutions on the sidelines. It is therefore gadflies and other small, non-for-profit organizations that have been left to carry the burden of bringing forth valuable proposals for other shareholders to consider.

However, a closer examination of gadflies and their current role also reveals the fragility of the existing ecosystem, which relies heavily on a handful of individuals to initiate market-wide governance changes through the submission of shareholder proposals. We demonstrate why gadflies cannot, and should not, provide a systemic solution to institutional investors’ lack of involvement in the submission of shareholder proposals. Gadflies face several structural limitations that restrict their ability to exploit the shareholder proposal mechanism to its fullest: they operate on a voluntary basis and have limited resources. What will happen when this handful of players, most of whom are already in their 70s, gets tired or pass away? The answer is unclear.

Finally, and most significantly, gadflies’ activity is under attack. As gadflies have gained traction, public corporations and their lobbyists have begun to push back against them by strongly advocating for revised rules regulating the submission of shareholder proposals. These lobbying efforts showed their first signs of success in September 2020. Recent rule changes passed by the SEC now risk driving gadflies out by making the barriers to submission higher and more costly, which may lead to significant reduction in the adoption of governance practices that large investors overwhelmingly support.

Understanding gadflies’ role is, therefore, particularly important in light of these regulatory developments. The recent SEC reform, we argue, overlook the larger, more important issue of how and why companies implement widely-supported governance policies. This reform looked at shareholder proposals in a vacuum and failed to examine shareholder proposals against a broader understanding of the systemic legal, financial, and structural constraints that prevent large institutional investors from utilizing the shareholder proposal tool to advance governance terms they publicly support.

The SEC also failed to consider the role that small retail investors currently play as “governance facilitators” by initiating important governance changes that large institutional investors overwhelmingly support at annual meetings. Considering this symbiotic relationship between gadflies and large institutional investors, any effort to silence retail investors that does not address the systemic constraints that large institutional investors face, or that does not empower a replacement mechanism, effectively “kills the messenger”—hindering the adoption of governance policies that investors as a whole strongly support. News of potential repeal of the SEC rules are a positive development and should spur the agency to consider a more holistic response to the issues we identify.

Finally, our study also presents fresh solutions to further foster the shareholder proposal mechanism in a manner that would disarm the concerns associated with gadflies’ activity. In particular, we suggest a reconceptualization of the way shareholder proposals are brought to the ballot, either by enabling the use of “professional filers” or by requiring that the most important and popular governance-related shareholder proposals be brought to a shareholder vote on a periodic basis. Such reforms could eliminate the dependence on a handful of individual proponents, and, as a result, proposals that large investors support, many of which are not currently being submitted in a timely manner, would be included in the company’s ballot.

The complete paper is available for download here.

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One Comment

  1. James McRitchie
    Posted Wednesday, April 21, 2021 at 10:59 am | Permalink

    I review and point out a few relatively minor flaws in the authors’ original paper at