“Shut Up”: Not What Good Companies Tell Their Owners

04/24/2017 10:50 am ET

Corporations are about creating value. That is why they have investors. If you own stock in a corporation, you’re a part owner of that corporation. As an owner, you have some rights, and you have a group of people, the board, whose duty it is to represent your interests. Sounds something like democracy, doesn’t it?

Not so much, if some in Congress have their way with a new bill misnamed the Financial Choice Act. What that bill would do is give the vast majority of shareholders in America’s publicly traded corporations a lot less choice than they have now in communicating their concerns and ideas to the boards of those corporations. What that act would do is make a system that has worked very well—the ability of long-term shareholders to communicate their wishes through filing shareholder proposals—beyond the ability of all but a few very large shareholders like BlackRock, Vanguard and Fidelity. Whatever this is, it’s not democracy, nor is it populism.

The shareholder proposal process today allows shareholders who own at least $2,000 worth of shares, and have held them continuously for at least 1 year, to file a proposal that can be placed on the company’s proxy ballot for all shareholders with voting rights to vote on at the company’s annual meeting. That ability has been in place since 1942. Last year, there were nearly 1,000 shareholder proposals filed. To put that in context, there are nearly 20,000 publicly traded companies in the U.S., meaning that at most, about 5% of corporations received even one shareholder resolution. The vast majority of these proposals were aimed at making these companies better investments, and the overwhelming majority of them were non-binding.

What does it mean to make a company a better investment? Let’s look at a couple of examples. The majority of all shareholder proposals focus on corporate governance—and anyone who doesn’t think broken governance can be a financial problem needs to remember that the last two recessions resulted, in part, from poor governance practices arranged to enrich a few insiders very quickly, rather than serve shareholders over the long run. So a lot of shareholder proposals are filed in order to improve corporate governance, through, for example, (1) eliminating staggered boards, (2) allowing significant long-term shareholders to nominate board members (who are, remember, there to represent them), and (3) diversifying corporate boards.

All three of these things have been shown to help improve company value for investors. A recent paper on the effect of eliminating staggered boards (that is, boards whose members are not elected annually) noted that more innovative firms’ financial value increased when staggered boards were eliminated. Imagine for a moment how voters might feel about the House of Representatives if it were staggered: a change in voter sentiment could take years to effect, rather than one election cycle. “Throwing the bums out” couldn’t be done in one election. Is there a difference when we’re talking about corporations? Not much. Voters elect representatives; shareholders elect board members; both representatives and board members are there to serve the constituencies that elected them.

How about proxy access? Another paper examines the regulatory changes that permit proxy-access resolutions and demonstrated that the market tends to react positively to these proposals. The authors also note that “there is substantial evidence that the market believes that proxy access would be value-enhancing at many companies.” Not every company gets the same or even substantial value out of the process, but why would we not expect some variation? Not every Congress is equally productive either. But the process of allowing constituent input to elected representatives still remains a strong foundational principle of our government, as well as our society.

Finally, there is substantial and growing literature showing that diverse boards make better decisions, and that is value-enhancing for investors. Some of the representative studies are included in my recent white paper on this subject, and those papers come from places like Credit Suisse, McKinsey, RobecoSAM, MSCI, and a wide range of academic institutions. Credit Suisse found that companies with at least one woman on their boards outperformed those with none by nearly 40% between 2006 and 2016. But the urge to diversify boards was not generally self-initiated by companies: it took more than a decade of shareholders patiently filing shareholder proposals asking companies to include women and minorities in every director search to bring more management attention to the issue. And that’s a key point: management attention. Board members are generally not nominated by shareholders (unless they have proxy access, in which case they can sometimes nominate one), but by the board nominating committee, usually with significant guidance from management. How much would we like our Congress if every member (except in a few states that had ballot access) had to be nominated by one existing committee, with guidance from the President?

The Financial Choice Act raises the ownership thresholds for filing resolutions and obliges shareholders to maintain a three-year holding period in order to file at all. What would that mean? For any of the largest corporations in America, a shareholder would have to hold billions of dollars’ worth of shares for three years to file a proposal. Not many shareholders have individual holdings worth billions of dollars—even most billionaires have diversified portfolios, and with common risk controls limiting the size of each holding to no more than 5% of the portfolio, that has staggering implications.

You’ll hear from some companies that shareholder proposals come from a cottage industry of special-interest activists. Don’t believe them. The vast majority of shareholder proposals come from serious investment companies or asset owners who are simply looking to improve the quality of their investments.

“Shut up” is not something companies should ever say to their owners.

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