As seen in the New York Times
BARNEY FRANK, the Massachusetts Democrat who heads the House Financial Services Committee, recently said that the government should sue American International Group to recover the $165 million in bonuses it paid to executives in its financial products division. “We own this company, in effect,” Mr. Frank said, referring to the government’s 80 percent stake.”As the owners of the company, we do not think we should be paying bonuses or should have paid bonuses to people who made mistakes, who were incompetent.”
Sadly, though, under American corporate law share ownership does not count for much. Mr. Frank might be surprised to learn that a lawsuit would have almost no chance of success in court, even for a majority shareholder like the government. A.I.G. would most likely argue that the oft-cited “business judgment” rule gives management wide latitude to set compensation without shareholder interference. What the government should have gotten was board representation in return for its large investment in A.I.G.
Now, barring political resolution (including a confiscatory tax or a voluntary surrender of bonus money), the government’s choices are limited to exercising the rights of a shareholder. Perhaps one silver lining to this debacle is that it will finally alert Washington to the lamentable state of corporate governance in America. Our legislators will find — as I have as a shareholder who has waged many battles to get on corporate boards — that the rights of the shareholders are quite circumscribed.
One problem is that state laws allow companies to create complex “advance notice” requirements that let companies derail efforts to elect shareholder-nominated board members.
Although a majority shareholder like the government may be able to get its nominees onto the A.I.G. board without a fight, typically even a large shareholder must conduct an expensive proxy contest to elect its nominees — that is, he needs to solicit enough votes from other shareholders. This is accomplished by mailing a statement describing the shareholder’s positions, and a card on which to vote. At a large public company, mailing, printing and other costs can run into the millions of dollars.
Those costs could be reduced, and the election process could be made more open, if the Securities and Exchange Commission would allow “proxy access.”
Proxy access would permit shareholders to solicit votes for the election of their nominees by including the names and other relevant information about those nominees in their company’s annual proxy statement, and thus save the cost of sending additional documents. But so far the S.E.C. has said no to proxy access for the election of directors nominated by shareholders, though its new chairwoman, Mary Schapiro, said on Thursday that the commission will take up the issue in the coming months.
Alternatively, the government could propose a “say on pay” resolution to be voted on by shareholders. But under current law in various states — for example, in Delaware, where more than 50 percent of publicly traded American companies are incorporated — even if the company puts such a resolution to a shareholder vote the resolutions are merely advisory. This means that the board is legally entitled to ignore shareholder wishes regarding compensation of corporate executives.
With some exceptions, our public corporations are increasingly unable to compete globally, they pay excessive compensation to top brass and they are generally unaccountable to shareholders. The best hope to change this situation is to allow shareholders the power to move the state of incorporation of public companies from one state to another. For example, North Dakota passed a law in 2007 that, among other things, provides for proxy access and for the reimbursement of expenses to a shareholder who runs a successful proxy fight. A move to North Dakota would greatly advance shareholder rights for any company.
But under current state law shareholders can elect to move their company to another jurisdiction only if the existing board of directors approves such a move — and those incumbent boards will want to stay in the management-friendly states they already inhabit.
Federal legislation could correct this absurdity and permit shareholders to move the corporations they own to another state by a simple majority vote. Such legislation would override the restrictions of state laws that prevent such a change of jurisdiction unless approved by the board of directors. Most important, it would encourage the states, which profit from the tax revenues that flow from corporations, to compete with one another by reorienting their laws on corporate governance to benefit shareholders.
The legal landscape is filled with devices designed by state legislators and courts to prevent shareholders from influencing how companies are run and so allow management free rein. Legal mechanisms known as poison pills, permitted under the laws of most states, effectively prohibit shareholders from accumulating a large position in a company or working with other large shareholders to influence the company.
Furthermore, public corporations may legally adopt a staggered board, whereby board members are grouped into classes, with each one representing about a third of the total number of directors, so that only one class comes up for election in a year.
This means that seriously shaking up a board would require at least two very expensive proxy contests over two years. And current state laws permit incumbent board members access to the corporate treasury, allowing them to spend millions of dollars, to hire lawyers and public relations firms, run ads and mail materials to prevent shareholders from adding their designees to the board of directors.
The problem of disenfranchised shareholders can be found at the root of today’s financial crisis. A.I.G., for example, sowed the seeds of its own near-destruction by making a wholesale rush into risky derivative transactions without adequate collateral. Its board of directors was either unaware of it or did not stop it. If shareholders had enhanced legal rights to elect qualified and responsible board members, it would help our public corporations avoid the kinds of meltdowns we are now experiencing.
We can hope that the government’s experience with A.I.G. will demonstrate to Congress how little power shareholders actually have, and how important corporate governance reform is. It is time to remove the many devices that managements use to entrench their power, and give shareholders real power. The “ownership” rights that the government, as a shareholder, is now talking about are the same ones that activist shareholders have been demanding for years.