When I testify before Congress about corporate governance, I like to watch the faces of the committee members when I explain the rules for electing corporate directors. “I know you, better than anyone else, understand what the word ‘election’ means,” I say. “Well, in the wacky world of public corporations, you win even if 99 percent of the shareholders vote against you.”
Except for the fraction of cases where someone nominates a competing slate of candidates and undertakes the multimillion-dollar expense of a proxy contest, management’s nominees are routinely elected to the board. Dozens of directors continue to serve, like boardroom zombies, even after a majority of the shareholders voted against them. In the past three years, about 200 directors failed to receive majority votes. Almost all of them continued as board members.
Some companies have responded to shareholders by voluntarily adopting a policy requiring directors who get less than a 50 percent vote to submit their resignations. Even that doesn’t necessarily mean directors must leave the board. In 2005, when Blockbuster’s chief executive officer was ousted by shareholders in a proxy contest, the directors created an extra board position and voted him back on to ensure “continuity.” It seems continuity was exactly what the shareholders were voting against. They were right; the stock continued to sink and, after the company declared bankruptcy in 2010, its assets were acquired by Dish Network Corp. for a song.
Checks and Balances
The genius of the corporate structure is the checks and balances that are supposed to make sure the interests of the providers of capital and the managers who spend it are aligned. The responsibility for that alignment is so important that the legal system imposes the highest level of care and loyalty, the fiduciary standard, on boards. That means directors must act for the benefit of shareholders, setting aside their personal interests. It doesn’t mean much if shareholders can’t replace directors who fail to meet the standard. Edward Jay Epstein, an investigative journalist, has said that director elections are “procedurally more akin to elections held by the Communist party of North Korea than those held in Western democracies.” Board candidates are selected by insiders (usually the CEO) and almost never have any opposition. Once picked, directors serve at the CEO’s pleasure -- a structure that at best discourages independent oversight and at worst thwarts it entirely.
No one is suggesting that director elections should resemble political elections, with open, contested seats. Still, there has to be some fallback mechanism short of a full-scale proxy contest with a dissident slate to oppose management’s choices. Here’s an idea: Most U.S. public-company stock is held by an assortment of institutional investors, including mutual funds and pension funds. If more than 50 percent of them agree that it is time for directors to go, they should go.
I once met with the chairman of a board nominating committee at a large, troubled company to talk about the procedures and criteria for selecting candidates for three openings. He explained that they didn’t have to look for anyone because all the current directors wanted to stay on. That isn’t how it’s supposed to work. Boards should continually evaluate their own performance to make sure all of the directors are fully engaged and capable, and that the board has the range of expertise and experience it needs.
We have come a long way since my first years in this field, when O.J. Simpson served on five public company boards (including one audit committee) and the CEOs of Inland Steel Co. and Cummins Inc. led each other’s compensation committees. But the reality is that there can be no meaningful independence on the board if a majority vote of the shareholders has no consequence.
It is risky and foolish for boards to retain directors rejected by the shareholders. Despite a spineless decision in November by the American Bar Association’s Corporate Laws Committee to decline to recommend that majority votes be required for directors, boards must recognize that they can’t retain zombie directors who serve without the support of shareholders.
I suspect the most powerful push won’t come from shareholders but from the providers of liability insurance for directors and officers. The law protecting them from personal or corporate liability for business failures gives deference to “business judgment.” That means if directors demonstrate care (doing their homework, participating in the meetings) and loyalty (making decisions on behalf of long-term shareholder value and not insider enrichment), the courts won’t second-guess their decisions by holding them liable, even in the case of “mistakes or errors in the exercise of honest business judgment.”
The business-judgment rule, however, is predicated on the assumption that shareholders delegated authority to directors by electing them, and could elect others if they chose. It is hard to imagine that the courts would grant business-judgment protection to directors who received a vote of no-confidence by shareholders. Like in the classic children’s book by Dr. Seuss, when shareholders tell Marvin K. Mooney that he should go now, boards should take heed.
(Nell Minow, the co-founder and director of GMI Ratings, which evaluates governance risk at public companies, is co-author of the textbook, “Corporate Governance,” now in its fifth edition. This is the second in a three-part series on corporate governance issues. Read Part 1. The opinions expressed are her own.)
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