For years, investors in American companies have had little say in corporate affairs. Don't like the way the company you own is being run? Too bad: Pound sand or sell your shares.
Why there's so little accountability at the top
Theoretically, publicly traded corporations are little capitalist democracies, in which shareholders elect a board of directors to represent their high-level interests and hire a management team to run the company. But everyone knows that companies are not always run for the benefit of their owners; they're sometimes run for the benefit of the people running them. That's the upshot of golden parachutes, no-strings-attached "bonuses," and escalating CEO pay that bears little correlation to performance.
So why can't shareholders simply elect boards that better represent them? Here's Nell Minow, founder of The Corporate Library:
The very term "election" is absurd in this context. Edward J. Epstein has said that shareholder elections "are procedurally much more akin to the elections held by the Communist party of North Korea than those held in Western democracies." Under the current system, management picks the slate of candidates, no one runs against them, and management counts the votes. Managers even know how shareholders vote. As soon as the votes come in, they can call and try to persuade (or pressure) those who vote against them. And, of course, management has access to the corporate treasury to finance its search for candidates and solicit support for their election, while anyone running against them must put up their own money. (Successful dissident slates often get reimbursed, however, once they are in office.) Management has access to the shareholder list; a dissident shareholder still faces significant obstacles, including millions of dollars for lawyers, ads, mailings, and more.
The result of this phony "election" process is unmistakable: Out of the thousands of publicly traded American companies, only 39 board members even had to run against anyone at all last year.
On the heels of an epic financial crisis that laid bare so much greed (Citigroup (NYSE: C ) ), stupidity (Lehman Brothers), and material omissions (Bank of America (NYSE: BAC ) -- just to name a few -- on the parts of managements and directors, how much do you want to bet the approval rating of corporate directors was truly higher than 99.9%?
Why you should care
When we asked Warren Buffett at the height of the financial panic what he thought was the single most important thing that needs to be fixed in our companies, he named incentives:
If an executive gets the upside but suffers none of the downside, when he can cash out now and what happens tomorrow doesn't hurt him, we have a problem.
Unfortunately, intelligent incentives for the people managing our companies are the exception:
CEOs pick the compensation committees. I've seen in 40 years that boards have done very little in the way of thinking of the way to do the right thing and not to do the wrong thing with regards to executive compensation. Who wants rationality when irrationality pays more?
What's Buffett's solution?
We should have directors who think like owners. They should be intelligent, independent-minded, and have business sense. A lot of directors love the job for the money and sociability, so they aren't going to do anything that gets them kicked off that board or not invited to another board.
We need a shareholder revolution
For some time, Fools have championed a "Shareholder Bill of Rights" that would give shareholders a say on executive pay, majority voting rights, and the ability to nominate candidates to the company ballot. We've gotten answers to your questions from the White House and testified before Congress on behalf of individual investors.
The financial reform bill was set to give the Securities and Exchange Commission the ability to enforce those rights. But at the eleventh hour, lobbyists tried to cram language into the bill that would have effectively killed the proposed shareholder rights.
Fools struck back. Shareholders, including 1,500 Fools, wrote to tell Congress not to kill shareholder rights. Congress listened, and in under a week, lobbyists were largely beaten back, and shareholders' right to nominate their own representatives was saved.
The new era for investors
While majority voting rules for uncontested director elections did not make it into the final legislation that passed in July, several critical measures did.
- Management will have to clearly disclose executive compensation and provide a graph showing five-year compensation versus stock performance.
- Shareholders will receive a non-binding say on executive pay.
- Most importantly, the SEC now has the ability to set up rules granting shareholders the right to nominate board members to the company ballot.
Of course, we don't want to have every fringe group running its own candidate, nor should short-term traders or takeover firms be allowed to use the new rules to the detriment of long-term investors.
So the SEC struck a fair compromise that could help shift the balance of power more in favor of the interests of long-term owners, which has been all-too-often eluded by managements and short-term market pressures. Shareholders (or a group of shareholders) who want to nominate their candidates to the official company ballot must:
- Own at least 3% of the company,
- For at least three years, and
- Not use it to gain control of the company.
These are high hurdles for large companies. Here's an example.
Verizon's (NYSE: VZ ) CEO and chairman, Ivan Seidenberg, collected about $100 million in total compensation from 2005 through 2009, according to data from Capital IQ, during which time earnings per share declined substantially while the stock returned a mere 2% annually, including dividends.
Mr. Seidenberg, whose 2012 bonus will include a portion measuring at least $11 million if Verizon merely performs in-line with the average Dow component over the next three years, unfortunately, isn't alone. Many others, including Goodyear Tire (NYSE: GT ) , Abercrombie & Fitch (NYSE: ANF ) , and BorgWarner (NYSE: BWA ) , have been noted for their unhinged CEO pay. As Buffett noted, the problem is pervasive.
The point is that these rules for shareholder representation are quite modest: If Verizon's owners felt the board wasn't representing their interests, many would have to band together to meet the 3% ownership threshold for this $90 billion company -- only two shareholders (barely) have held 3% of Verizon stock for at least three years.
While a sliding ownership threshold based on company size -- say, 5% for small companies, 3% for medium-sized companies, and 1% for large companies -- would have been better, granting long-term shareholders the right to nominate better representatives to company ballots could ensure that in many cases, management and boards will be more responsive to the interests of long-term investors, and, in the worst instances, we could vote to replace them.
An ominous footnote
Unable to completely kill the Shareholder Bill of Rights in Congress, The Business Roundtable, a lobbyist group primarily representing Fortune 500 CEOs, and the Chamber of Commerce, a lobbyist group apparently representing Fortune 500 CEOs, have teamed up to block shareholder rights by suing the SEC.
"The Chamber and Roundtable are following the same playbook that they used in earlier cases that challenged SEC regulations, claiming that the SEC didn't give adequate consideration to this or that factor or piece of evidence," Cornish Hitchcock, principal of Hitchcock Law Firm, which specializes in administrative law, told me. "I think that the SEC has learned from those earlier cases and has done a thorough job of addressing the various objections that the Chamber, Roundtable and others presented to this regulation."
Lobbyists' primary objection had been that giving shareholders the right to nominate their own representatives would empower "activist shareholders [to] use the rule as leverage to further their special interest agendas."
This is, of course, ridiculous. Anyone who holds hundreds of millions of dollars' worth of stock for more than three years is a long-term shareholder, whose interests in selecting directors have as much legitimacy as elite employees of the company. Moreover, shareholders would still have to elect the candidate before he or she could serve on the board. The SEC rule merely gives elections teeth.
"Their goal is to drive a stake through the heart of the rule, or, at a minimum, to delay its implementation," according to Hitchcock.
Far from protecting shareholders from "special interests," the Roundtable and Chamber of Commerce seem to be fighting tooth-and-nail to perpetuate the disenfranchisement of American shareholders for the benefit of the special interest group that cuts their checks -- CEOs.
This is a blatant attack on shareholder and property rights. Management and boards must be accountable to us, the owners of the companies employing them. That's called capitalism.
If you want me to keep you up to date on issues related to investor rights or financial reform, just shoot a blank email to imoscovitz@fool.com.
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