SEC Lets Shareholders Act Like Owners – To A Point

A new rule that gives public company shareholders the power to nominate their own directors is not going to turn boardrooms into union halls, nor is it going to revolutionize corporate governance.

A best-case scenario is that making directors more accountable to shareholders will finally put a brake on senior-executive compensation, which has spiraled out of control for two decades. This is not to say that talented managers of large, complex enterprises are not worth a lot of money; clearly, they are. But too many corporate compensation schemes divert profits from shareholders, who bear all the financial risks of ownership, to managers, who are ultimately contributing their time and effort just like any factory worker.

Does $50 million buy a more-capable CEO than $10 million? If it doesn’t, then shareholders of a company that awards a $50 million compensation package to its chief executive are being overcharged. Those shareholders deserve a chance to put more-diligent directors on their board. This is doubly true if a company’s compensation package encourages managers to risk the enterprise’s long-term financial stability in pursuit of short-term gains and spikes in the stock price that can make gigantic paydays possible.

Though reining in runaway compensation is a best-case scenario, I suspect that the new rule will more often have no significant impact, either on the makeup of a corporate board or on the way companies are actually run – even in cases where some old stalwarts are removed and new faces are added.

Yet the new regulation, which the Securities and Exchange Commission recently adopted on a 3-2 vote, has generated controversy far more intense than the modest results it is likely to produce might suggest. The SEC merely allows investors or groups of investors, who own at least 3 percent of the company’s stock for at least three years, to nominate candidates for up to 25 percent of a board’s seats. It does not permit investors to replace a majority of directors in a single election, nor does it ensure that any new directors are actually going to be elected.

It’s hard to see what all the fuss is about. The SEC is merely taking a small step toward allowing the people who own a company to actually have a voice in how it is run. Walter Van Dorn, a corporate lawyer with Sonnenschein Nath & Rosenthal, pointed to the 3 percent for 3 years rule as the primary reason companies shouldn’t be alarmed. “That’s a lot of stock and a lot of money. You’d have to be a pretty serious shareholder to begin with,” he recently said to the Los Angeles Times.

Yet David Hirschmann, who heads the U.S. Chamber of Commerce’s Center for Capital Markets Competitiveness, complained that “Using the proxy process to give labor unions, pension funds and others greater leverage to try to ram through their agenda makes no sense.”

The executive director at the Millstein Center for Corporate Governance at Yale University’s School of Management, Stephen Davis, is one of several observers who has argued that the SEC’s new rule, in conjunction with its decision to give investors a vote on the level of their CEO’s pay, may push the U.S. toward a business model closer to that of the U.K. He says the vote on pay itself isn’t as important as the fact that the arrangement stimulates communication between boards and investors.

Davis also said that, at least in the U.K., the system seems to lead to salaries more closely aligned to performance. “There is less pay for failure there,” he observed.

A court challenge to the SEC’s decision is still possible. But the agency’s position was strengthened by the financial regulatory overhaul legislation that President Obama signed this summer. That law specifically authorized, though it did not require, the SEC to empower shareholders to nominate directors.

In the end, a system in which management is accountable to the board of directors and the board is accountable to shareholders will lead to companies that are, if not better managed, at least managed the way their owners want. That ought not to be a controversial proposition.

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