Tug of War Between Board and Shareholders

The war between boards of directors and shareholders has been raging for many years, heating up and cooling down based on success or failure, evolving goals and opportunities, and opponents’ actions. Some might not see it as a tug of war, instead viewing the respective roles of boards and shareholders as continuing to evolve and mature with the common purpose of enhancing share value. Probably both viewpoints are accurate, depending on one’s perspective and where we are at a particular point in time.

As I begin to write this month’s column, two things are clear. One is that I’m stepping into a field of land mines. Knowledgeable people have extremely strong feelings on these issues, and discussing it is like talking politics in what’s supposed to be a relaxed social setting; the risk of igniting some fireworks is great. Another is that it’s difficult to provide a truly balanced view on this topic, especially in the space available. Nonetheless, here it goes.

Without getting into the long history of how power has been shared over time between shareholders, boards, and managements, suffice it to say that shareholders are the owners of a corporation, the board hires and oversees management, and management manages. Pretty simple, right?

It is simple as long as everything goes well. But when shareholders see what they believe to be bad things happening, they want to see action taken. That brings up the issue of how much a company’s owners can and should be able to influence what happens—beginning with the ability to grab directors by the lapels and throw the bums out.

Shareholder Activism

We’ve seen shareholders taking action to make things better for decades, even long before institutional investors took up the battle. Years ago I had the opportunity to spend time regularly with the Gilbert brothers—Lewis and John—who worked diligently to help gain even the most basic shareholder rights. They told stories of their attendance at the first Exxon (then Esso) shareholder meeting, which took place in a garage in New Jersey with about 30 in attendance, and how they were treated. Incidentally, they weren’t “gadflies,” but rather were—especially Lewis—statesmen of shareholder rights who worked the system from both the inside and out to gain badly needed reforms.

Further advances have occurred over time through the legislative process, government regulation, stock exchange rulemaking, and the judicial system. Matters such as independence of board and key committee membership, private meetings of independent members with presiding directors, expanded disclosure of management’s compensation, financial experts on the audit committee, board assessments, and enhanced financial reporting and other disclosures, to name just a few, have been established. And there’s been movement for either separating the board chair and CEO roles or having an independent lead director (as I’ve discussed in past columns, I support the latter in most cases). These have positioned boards to provide enhanced oversight of management and help shareholders gain better insight into board processes and decision making, and make boards more accountable.

But more and more is demanded. Shareholders want greater power over such matters as access to the proxy statement, majority election of directors, say-on-pay votes (or even decision making on CEO pay), elimination of broker “non votes,” annual elections of all directors, dismantling takeover defenses—the list sometimes seems endless.

Where to Draw the Line

Where to draw the line is in the eye of the beholder. In terms of perhaps the major issue—who elects the board— our democratic nature might lead us to think intuitively that sure, shareholders should be able to choose the company’s directors, beginning with the ability to nominate a slate of directors, and going on from there.

What’s relevant here is the oft-heard notion, “Be careful what you wish for,” which has great merit in this context. Shareholder activists should be extremely careful in what they wish for and are working to achieve. When we look at why Corporate America has been and continues to be successful, we see that the kinds of changes some seek would be counterproductive.

Years of experience shows that companies grow and prosper under outstanding management leadership with a similarly outstanding board of directors providing excellent advice, counsel, and direction, while also carrying out its monitoring role. Yes, some boards haven’t given the necessary attention to CEO compensation and aligning pay with performance. And in recent years, with Sarbanes-Oxley and related regulations to deal with, many boards have focused largely on their compliance and monitoring role. Now, however, the pendulum is swinging back, with more effective action on doing what needs to be done.

In my view, we must be extremely cautious before allowing shareholders to run roughshod over the board nominating process. Experience shows that companies and shareholders prosper when boards do the jobs they are charged with doing, and retain the power and ability to do them well. This occurs when a board is comprised of the right people, with the right backgrounds and chemistry to work collegially together, and with management to drive growth and return. They use their knowledge base, leadership skills, experience, and business judgment to ensure the company has the right strategy, the right leadership, and the right processes to grow share value.

Listen to Those Who Really Know

Certainly I’m not the first to speak out on this topic. Many knowledgeable people are doing so, and one of the most experienced and eloquent voices out there is the well-known corporate lawyer Martin Lipton. With respect to the nominating process, he says, “The foremost criterion is competence: Boards should consist of well-qualified men and women with appropriate business and industry experience. The second important consideration is collegiality. A balkanized board is a dysfunctional board; a company’s board works best when it works as a unified whole, without camps or factions and without internal divisions.” For more of Marty Lipton’s views on the subject, refer to his excellent editorial in Compliance Week’s Jan. 3, 2006, online edition.

We’ve seen instances where a dissident director, or one with a one-topic agenda, is thrust onto a company’s board. The result often is counterproductive, if not disastrous. Those boards were sidetracked, failing for long periods to provide management with the guidance and direction needed, instead peppering management with different and sometimes even contradictory voices. Yes, there are instances where shareholders justifiably achieve change in control via the proxy process, and few would argue with that. But we need to avoid circumstances where the process for choosing directors is high-jacked by minority investors with limited and often personal agendas.

And what about shareholders looking to gain power on issues that rest within the board’s province? Perhaps no greater lightening rod for shareholder activists exists than CEO compensation, where influence (if not decision-making authority) is at risk. Are these decisions best made by a company’s board and its compensation committee—held to duties of care and loyalty, including acting in good faith? The board and compensation committee look in-depth at performance and motivational factors, linked to the company’s strategy; they recognize the realities of a competitive marketplace and are supported by qualified independent compensation experts that we want dealing with these issues. Are they best suited to decide issues of pay, or is a group of shareholders looking in from the outside?

Yes, there have been bad decisions and lack of meaningful negotiations on compensation on the part of some boards, and one could argue that the system was broken. My experience, however, shows otherwise, and frankly with the spotlight on compensation and newly required enhanced disclosures, we’re seeing greater diligence in the compensation-setting process. All in all, I cringe at the thought of shareholders without the requisite knowledge making these kinds of decisions, with the potential of failing to recruit or retain the best possible leader for a company.

Where We Need to Evolve

Certainly most systems can be improved, which is likely the case with regard to the sharing of power between shareholders, the board, and management. I know and respect some of the shareholder activists, having discussed these matters with them at length. And just where the line should be drawn is subject to honest debate.

But I am convinced that the current system of board collegiality, with the right people providing the best advice, counsel, and direction to the CEO and his or her management team, provides Corporate America with the greatest likelihood of continued success. We can argue exactly how those directors are chosen. But until we find a better system than the current one, we shouldn’t have change for the sake of change, or to empower shareholders who aren’t positioned to make the right choices.