The merits of increasing shareholder power are less obvious than reforms that increase companies’ exposure to pressure from activist shareholders, since increasing shareholder power tends to increase the influence of special interests. Part 2 of a two-part series.
My previous blog post on corporate governance focused on reforms that increase the company’s exposure to competitive pressures, with generally positive conclusions. This post focuses on reforms that increase the company’s exposure to pressure from activist shareholders. I argue that the merits of increasing shareholder power are less obvious, because it tends to increase the influence of special interests.
This post focuses specifically on shareholder proposals. A shareholder proposal, as the name implies, allows a shareholder to propose a change in corporate policy that is voted on by the other shareholders. Although state law requires most votes to be binding, managers tend to abide by the majority opinion.
While available under state law for more than a century, shareholder proposals were only embraced by modern reformers in the late 1980s and 1990s. Since 1997 there have been more than 16,000 proposals at large corporations, and votes have been held recently on breaking up the largest commercial banks, cutting executive pay, removing staggered boards, enhancing proxy access, disclosing contributions, and a variety of other issues. Recent regulatory changes have enhanced voting rights, such as the SEC’s 2010 rule allowing binding votes on proxy access and Dodd-Frank’s provision for shareholder votes on executive compensation.
Shareholder proposals, unlike the corporate governance reforms discussed in my previous post, do not increase the company’s exposure to competition in the form of control contests, but rather tilt power toward activist shareholders. This is a good thing if activist shareholders are motivated to increase firm value, but there is reason to suspect they may have other goals as well.
Figure 1 shows the number of proposals made by different types of groups at large corporations since 1997 (proposals by individuals, the single largest category, are omitted):
The most active groups may not be concerned only with profit: unions may be concerned with wages and benefits of existing members; public pension funds may care about local employment and political issues; and SRI funds and religious groups are concerned with issues such the environment, energy, and human rights. The group most likely to be focused on profit, hedge funds, is a bit player in the proposal process. When we expand shareholder rights, in practice we are empowering labor unions, public pensions, and social activist organizations.
The concern with such shareholders was expressed by the D.C. Circuit Court in its 2011 Business Roundtable decision vacating new SEC rules on proxy access: “union and state pension funds might use [proxy access] as leverage to gain concessions, such as additional benefits for unionized employees, unrelated to shareholder value.” Activist shareholders might use proposals as bargaining chips: the group proposes a policy that managers dislike, such as a cap on executive compensation, but offers to withdraw the proposal in response to a “side payment” from managers. Over 40 percent of proposals are withdrawn before going to a vote, so plainly a lot of negotiation and accommodation is taking place.
I provide some evidence on proposals from labor unions in a recent paper with two colleagues. We observe that unions have a strong incentive to make “opportunistic proposals” in years when they are engaged in collective bargaining with the company, and find that the probability of a proposal from a union roughly doubles in years with contentious contract negotiations, compared to other years. Other groups do not increase their proposal rates in years with union contract bargaining. We also find some evidence that wages are higher following negotiations in which a proposal is withdrawn. This evidence indicates that unions use proposals opportunistically to influence negotiations.
A working paper by Min and You provides evidence of opportunistic proposals by public pension funds. The most active public pension funds are managed by elected officials (e.g. CalPERS, the New York City funds) who all happen to be Democrats. Min and You show that their proposals requiring disclosure of political contributions are disproportionately targeted at companies whose executives are Republicans. In addition to showing that their proposals might have a political motivation, this evidence suggests that empowering public pension funds might inject political considerations into corporate decisions where they are otherwise absent.
Managers actively resist shareholder proposals, both through organizations that seek to influence regulations such as the Business Roundtable, and by seeking to exclude individual proposals from appearing in their firms’ proxy statement. They argue that shareholder proposals are misguided or are designed to advance private goals of activist shareholders. Is this a self-serving justification by managers, or are there reasons to be concerned about some shareholder proposals?
I investigate this question in a recent study with two colleagues using stock price reactions to SEC no-action letter decisions. SEC rules allow companies to exclude a proposal from the proxy statement under certain conditions. If a company wishes to omit a proposal, it submits a letter to the SEC asking the staff to confirm that the agency will not take action against the company if it omits the proposal, called a “no-action letter.” We study the stock price reaction in the days surrounding the SEC’s decision: when the SEC shuts down a proposal, if managers opposed it for responsible (value-maximizing) reasons, the market reaction should be positive; while if managers opposed it for self-interested (value-reducing) reasons, then the market reaction should be negative.
Based on examination of all 2,826 proposals for which a no-action letter was requested during 2007-2016, we find a positive market reaction when a no-action letter is granted. The mean return ranges from 0.20 percent to 0.55 percent depending on the event window, and is statistically distinguishable from zero, meaning the market approved of shutting down these proposals. The evidence suggests that managers fight these proposals for responsible rather than self-interested reasons. By extension, the market appears to agree with managers that many of these proposals would be harmful to firm value.
In the end, the consequences of corporate governance reform seem mixed. Reforms that expose managers to competitive pressure by making it easier for control markets to work, seem well-advised, although the evidence is not yet overwhelming. Reforms that expose managers to pressure from activist shareholders seem to raise more questions. Because many activist shareholders in effect behave like special interests, empowering them may push companies down paths other than profit maximization.
Disclaimer: The ProMarket blog is dedicated to discussing how competition tends to be subverted by special interests. The posts represent the opinions of their writers, not those of the University of Chicago, the Booth School of Business, or its faculty. For more information, please visit ProMarket Blog Policy.