Monday, November 27, 2006
If one were looking for a way to destroy the flexibility and dynamism of the American economy, among proposals that stand a chance of enactment it is hard to find a worse one than "shareholder democracy." The idea that a corporation's public shareholders should exercise genuine managerial control over the corporation is appealing because of the superficial analogy to civic democracy, but in fact shareholder democracy will lead to the diversion of the corporation's focus from its basic objective, which is to earn profits which, on average, will be reflected in the price of the shares. The reason for this is that "shareholder democracy" will become the means by which special political interests try to bend business corporations to their own ends.
This morning's Wall Street Journal contains the most succinct version($) of the many arguments against shareholder "democracy" that I have stumbled across recently:
Companies aren't mini-nations. A corporation has no governing powers over its shareholders. Management and boards do not exist as antagonistic "checks" on each other but are supposed to operate together to achieve business and financial success. Shareholders who feel a company is underperforming already have the ultimate "vote," which is to sell their stock.
The direct access rule, in contrast, would give a small group of activists unreasonable influence. The Donaldson-era access rule would have allowed "major" shareholders the right to nominate their own candidates on the company ballot if 35% of proxy votes are withheld from the company's nominees. So in this "democracy," only big shareholders get privileges.
Those large shareholders tend to be union-dominated pension funds, with ambitions for turning board rooms into new political battlegrounds. For an inkling of their agenda, consider the war the California public employees' pension fund (Calpers) waged in 2004 against Safeway, when it withheld its support for the CEO in retaliation for his tough bargaining with unions. More recently, some pension funds threatened to move investments out of financial firms that supported Social Security reform. This was an attempt to muzzle corporate speech masquerading as "shareholder rights."
Or consider the 350 shareholder proposals that members of the Business Roundtable fielded last year, most forwarded by the very groups that now want a seat at the board table. DuPont was asked to link executive pay to social criteria. General Electric was asked to report on the feasibility of ending its nuclear energy business. Merck was supposed to adopt a drug-price restraint policy, and Pepsi to report its political contributions in newspapers. Most of these proposals are rejected by shareholders who understand they have little to do with achieving higher returns on their investment. Yet companies are still required to spend shareholder money to address each proposal.
Imagine the costs if the SEC gives pension funds special rights to elect board members beholden to these agendas. One probable result would be the balkanization of boards, especially because the funds that exercise sway do not owe any fiduciary duties to other shareholders. Director dysfunction -- rival camps, leaks, obstruction -- was precisely what happened at Hewlett-Packard, distracting management and harming the company's public image.
The SEC might also look at Europe, where "codetermination" -- in which unions are guaranteed seats on corporate boards -- has allowed unions to redirect capital to labor (rather than business) priorities. Such a rule would also give managers one more reason to take their companies private (see the article on the opposite page), or to float their shares in Hong Kong or Shanghai, or somewhere other than in the United States.
The ugly truth is that the most outside shareholders are not genuinely owners of the company, but renters. Unlike genuine owners -- those whose entire livelihoods are bound up in the enterprise, or who own "restricted stock" or very large amounts that cannot be sold within a short period of time -- most shareholders do not bear the real risks of the enterprise. If they don't like a particular decision of the board or the management, they can quickly sell their shares and move on. Unlike citizens of a country -- who are exposed to the decisions of political leaders -- a corporation's public shareholders are not beholden to decisions of the management. They can "move to Canada" any time they want.
Because public shareholders can exit inexpensively, they can cast their vote frivolously in accordance with their political views or social conscience, whether or not that vote is in the best interests of the shareholders who are in for the long term. In effect, shareholder democracy is a means to bypass the actual legislative process to achieve certain social or political ends, and in the meantime create havoc within the business without having to bear the economic consequences.
There is a solution for this, and its unpopularity would prove that the advocates of shareholder democracy are not genuinely interested in shareholders. We could simply require that any shareholder who votes at an annual or special meeting hold their shares for a period of time -- six months or a year -- after casting the vote. We would quickly see that most shareholders of most public companies would much prefer to leave management in the hands of people with a long-term stake in the corporation's success, and retain the option of bailing out if they don't like what they see. America's stockholders would much prefer to rent than own.
It is also a challenge for large non-profit corporations to have their policy agendae set by member initiative and votes at an annual meeting. One such organization in the United States found itself on an anti-immigration kick a few years ago because of this kind of "shareholder" decision-making, resulting in a considerable degree of mission drift.
Excellent article and commentary.
I ordered and read "Who Really Cares" at your suggestion, and it lives up to expectations. I did have some quibbles, but my review at my own site is highly positive. Thanks for the tip.
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