How often do you see capitalists screaming and even going to court to defend the principle that legitimate owners cannot exercise any control over their property? It is not happening in Latin America or in socialist Sweden, but in the United States of America.
The capitalists in question are nothing short of the upper echelon of corporate America: the Business Roundtable, a powerful group composed of the CEOs of major US corporations, which promotes pro-business public policies. The object of their contention is the much-debated “shareholders’ access to proxy” rule, adopted by the Securities and Exchange Commission in August to address the fundamental lack of accountability of corporate boards.
In the current system, corporate boards are self-perpetuating entities. To be elected, a board member needs to be nominated by the current board, where executives have considerable influence. As a result, board members owe their loyalty to the managers who directly or indirectly appoint them – and thus have little incentive to dissent, lest they be punished with exclusion.
Even independent directors, often acclaimed as the solution to all problems, are subject to the same pressure.
To change this state of affairs, institutional investors must be allowed to propose their own slate of directors. The possibility of being rejected in a real election would naturally make board members accountable to shareholders, indirectly making the executives accountable as well.
The SEC rule was an attempt to grant institutional investors this right. It did it in a very mild format. Companies with a public share worth less than $75 million were exempted, and shareholders who want to propose a slate must hold at least three per cent of voting power of the company’s securities and have held it continuously for at least three years.
This is a very high hurdle. In June 2009, the largest US pension fund (Calpers) owned less than 0.3 per cent of large companies such as Coca Cola and Microsoft. Thus, one had to coordinate ten such funds to reach the quorum. And even that would not suffice. The average pension fund has an annual turnover of 70 per cent, which means that the probability that a stake is retained continuously for three years is less than three per cent. Thus, to achieve that three per cent of voting power and maintain it for three years continuously, one would have to assemble hundreds of institutions.
But even this cautious attempt to strengthen accountability generated an irate reaction from the Business Roundtable. “As our country works to emerge from this recession,” its executive director wrote, “American companies need to be focused on creating jobs and encouraging innovation to put us back on a path to sustained economic growth. This unprecedented intrusion into areas historically reserved for the states would handcuff directors and boards, shut out the vast majority of retail shareholders, and exacerbate the short-term focus that is now seen as one of the root causes of the financial crisis.”
Ironically, in 2007, in response to an earlier SEC proposal to grant shareholders’ access to proxy, Wachtell, Lipton, Rosen & Katz, a law firm famous for its anti-shareholders’-rights positions, used the opposite argument: “No real-world crisis has shown that the current system needs radical revision. Five years after Enron and WorldCom, the capital markets are well into a cycle of unprecedented vigour.”
In other words, if the stock market is doing well, we should not change the rules of the game that are credited for this success. But if the stock market is doing poorly, the rules of the games are not responsible and we cannot afford to change them. That is a peculiar notion of accountability.
To block the rule, the Business Roundtable filed a petition with the US Court of Appeals to invalidate it. The rule had been out for review for years, but the Business Roundtable accused the SEC of having “failed to engage in evidence-based rulemaking,” because it did not assess the rule’s effects on “efficiency, competition, and capital formation,” as required by law. This is just a pretense. A similar rule has been in place in Italy since 2005, and there is no sign that efficiency, competition, or capital formation has been affected.
There is some early sign, though, that board members nominated by institutional investors have the courage to stand up to management when it comes to excessive executive compensation. Is this the revolution that the Business Roundtable is afraid of?
Unfortunately, the scare tactics employed by the Business Roundtable worked. Following the suit, the SEC suspended not only the application of its rule mandating companies to grant access to qualified shareholders, but also a rule that was making it easier for shareholders to introduce a bylaw granting them access, even though the Business Roundtable had not challenged that rule. It is a great victory for business executives, but a huge defeat for the principles that should guide capitalism.
© Project Syndicate, 2010, www.project-syndicate.org.
The author is professor of entrepreneurship and finance at University of Chicago Graduate School of Business and co-author, with Raghuram G. Rajan, of Saving Capitalism from the Capitalists.