Public companies have many ways to silence shareholders, entirely legally.
When IBM (NYSE: IBM ) and 3M (NYSE: MMM ) objected to a proposed regulation that would grant some investors the right to list their director nominees on company proxy statements, they expressed the concern that shareholder-backed directors would serve the narrow group that supported them rather than representing all shareholders.
The worry that directors' primary loyalty will be to those who backed them is a reasonable one. However, instead of providing us with good reasons to restrict proxy access for shareholders, this line of thought provides us with strong reasons to give shareholders more proxy access.
Whom will the directors represent?
3M worried that allowing shareholders to list their director nominees on the company's proxy will create conflicts of interest. In a letter to the SEC commenting on a proposed regulation requiring proxy access for some shareholders, 3M claims that while each director has a fiduciary duty to represent all shareholders, those shareholders have no such obligation and will nominate directors they think will support their favored direction for the business.
IBM expressed similar concerns and worried that giving shareholders more power in director elections would "shift power to differing factions of shareholders, many of which have their own contradictory goals and none of whom have any obligation to consider shareholder interests at large."
These objections appear to be driven by an unspoken premise -- that directors backed by shareholders will violate their fiduciary duty to represent shareholders equally and will instead act primarily on behalf of the shareholders that backed them.
As the SEC points out, the fiduciary duty to represent all shareholders exists regardless of how the director was elected. So it appears these companies are worried that fiduciary duties aren't enough to guard against a director's inclination to serve the interests of those who backed him or her.
But if these companies are right, then the current procedure for nominating and electing directors creates a set of worries at least as severe.
Putting management's interest before shareholders'
Many companies have the same person serving as CEO and chairman, which means the board of directors (including those on a company's nominating and governance committees) in many ways answer to the chief executive. This governance structure has arguably led to the formation of rubber-stamp boards that approve egregious executive-pay packages.
The problem of giving boards too much power over the selection of new directors is well illustrated by the scandals that occurred at Chesapeake Energy (NYSE: CHK ) under Aubrey McClendon's leadership. Until recently, only board-nominated directors were listed on Chesapeake's proxy. Some critics argued that McClendon hand-picked the board, which made them more likely to approve controversial decisions that put McClendon's interests before shareholders', including their approval of McClendon's decision to take out $1.1 billion in loans against his stake in company-owned wells.
IBM and 3M aren't the only tech companies that want to limit shareholder access to their company proxy. Last year, Dell (NASDAQ: DELL ) moved to exclude a shareholder proposal calling for Dell to list some shareholder-nominated directors on the proxy. The company argued that the shareholder proposal was "vague and indefinite" because, while it referred to the eligibility requirements in the SEC rule calling for greater proxy access, it failed to repeat those requirements explicitly.
In other words, if Dell were open to allowing shareholders to vote on this issue, this would have been an easy fix -- they just could have included a description of the SEC's eligibility requirements. Instead, the company chose to exploit a technicality that allowed it to avoid giving shareholders a say on the matter.
In contrast, Hewlett-Packard (NYSE: HPQ ) recently granted shareholders the right to list their director nominees on the proxy. HP's board even recommended that shareholders vote for the proposal calling for that change. Typically, boards recommend that shareholders vote against such shareholder proposals.
The Foolish bottom line
While the abandonment of fiduciary duties in favor of narrow special interests should worry investors, this worry does not go away by limiting shareholders' ability to nominate directors. Rather, it exacerbates the problem by filling corporate boards with directors who are loyal to the narrow group that selected them -- company insiders whose interests sometimes diverge from shareholders' at large.
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