Common mythology holds that shareholders of public corporations choose who sits on the board of directors. Nothing could be further from the truth.
Under the laws of most states, directors are automatically elected if they run unopposed. Most do. In the vast majority of public corporations, directors have no competition, making the end result a foregone conclusion. Typically, directors who do not receive majority support submit a perfunctory letter of resignation that is rarely accepted. These “zombie directors” live on despite their metaphorical deaths at the hands of shareholders.
The absence of real shareholder participation in the director selection process can be seen from the results. Directors selected by the board often lack meaningful diversity. Women and minorities at most boards of large public companies are either absent or subject to an unofficial limit of one or two. Likewise, these boards tend to approve compensation packages for executives that are disproportionate to the pay of other employees and often insufficiently linked to actual performance.
The solution: more shareholder input
A solution to the problem of zombie directors and lack of accountability is to increase the role of shareholders in the director selection process, which is exactly what Scott Stringer, the comptroller of New York City and investment adviser for its $160 billion in pension funds, has proposed.
Under the aptly named Boardroom Accountability Project, he has asked 75 companies to allow large, stable shareholders (those owning 3% of a company’s shares for at least three years) to include a modest number of director nominees (no more than 25% of the total board size) in the company’s proxy statement, a document containing information the SEC requires firms to provide to shareholders. The Project selected firms that lacked adequate diversity on the board, had experienced strong shareholder opposition to executive pay packages, or were involved in “carbon-intensive” industries.
The mere possibility that shareholders could run a competing slate would likely have a profound effect on the way corporations are governed. Incumbents aware that they could actually lose their job would have a much greater incentive to focus on the interests of long-term shareholders. And providing the right to shareholders would impose little or no additional cost on the company.
Evidence in fact indicates that providing shareholders with these rights will actually increase a company’s value. The CFA Institute, the largest association of investment professionals in the world, estimates that simply having this right could boost the market value of the outstanding shares of all publicly held companies in the United States by as much as $140 billion.
With so much on the line, the efforts of the NYC comptroller are bold and necessary and promise to accentuate the voice of shareholders at the 75 companies he has named. But the need for increased shareholder influence in the director-selection process cannot be fully addressed on a company-by-company basis. Longstanding shareholders should have access to the proxy statement of all public companies.
Enter the SEC
It is the Securities and Exchange Commission that imposes the costs that make the nominating process prohibitive and it is the SEC that possesses the ultimate solution. Congress in the Dodd-Frank Act made explicitly clear that the SEC has the authority to adopt a rule that would give access to the proxy statement to shareholders at all public companies.
Indeed, the SEC at one time had such a rule in place but saw it struck down by the courts on procedural grounds. One of the five commissioners at the agency, Kara Stein, recently suggested that communications between companies and shareholders might be improved by the Commission “try[ing] again on shareholder access.”
Issues over inadequate diversity and excessive compensation have long existed. It is clear that the existing system for selecting directors has not proved up to the task of addressing these concerns. It is time for shareholders to have a more direct say on these matters through heightened involvement in the director-selection process. The Boardroom Accountability Project is an important first step but any permanent solution must come from the SEC.