shareholder activism in the united states: managing shareholder interventions
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This is a presentation I gave at the University of Auckland Faculty of Law on May 19, 2014. It is based on my paper Preserving Director Primacy by Managing Shareholder Interventions (August 27, 2013), which is available at SSRN: http://ssrn.com/abstract=2298415. Even though the primacy of the board of director primacy is deeply embedded in state corporate law, shareholder activism nevertheless has become an increasingly important feature of corporate governance in the United States. The financial crisis of 2008 and the ascendancy of the Democratic Party in Washington created an environment in which activists were able to considerably advance their agenda via the political process. At the same time, changes in managerial compensation, shareholder concentration, and board composition, outlook, and ideology, have also empowered activist shareholders. There are strong normative arguments for disempowering shareholders and, accordingly, for rolling back the gains shareholder activists have made. Whether that will prove possible in the long run or not, however, in the near term attention must be paid to the problem of managing shareholder interventions. This problem arises because not all shareholder interventions are created equally. Some are legitimately designed to improve corporate efficiency and performance, especially by holding poorly performing boards of directors and top management teams to account. But others are motivated by an activist’s belief that he or she has better ideas about how to run the company than the incumbents, which may be true sometimes but often seems dubious. Worse yet, some interventions are intended to advance an activist’s agenda that is not shared by other investors. This paper proposes managing shareholder interventions through changes to the federal proxy rules designed to make it more difficult for activists to effect operational changes, while encouraging shareholder efforts to hold directors and managers accountable.TRANSCRIPT
Shareholder Activism in the United States:Managing Shareholder Interventions
Stephen M. Bainbridge
William D. Warren Distinguished Professor of Law, UCLA
2014 Cameron Visiting Fellow, University of Auckland Faculty
of Law
Introduction
Part I
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Kamin v. American Express (N.Y. Sup. Ct. 1976)Bayer v. Beran (N.Y. Sup. Ct. 1944)
Smith v. Van Gorkom (Del. 1985). Manson v. Curtis (N.Y. 1918).
Marx v. Axers (N.Y. 1996). DGCL § 141(a)
Director Primacy:USA Corporate Governance is Board Centric
“The business and affairs of every corporation organized under this chapter shall be managed by or under the direction of a board of directors….”
“the business judgment rule is the offspring of the fundamental principle, codified in [Delaware General Corporation Law] § 141(a),that the business and affairs of a Delaware corporation are managed by or under its board of directors. ... The business judgment rule exists to protect and promote the full and free exercise of the managerial power granted to Delaware directors.”
“To encourage freedom of action on the part of directors, or to put it another way, to discourage interference with the exercise of their free and independent judgment, there has grown up what is known as the “business judgment rule.” “
“By their very nature, shareholder derivative actions infringe upon the managerial discretion of corporate boards. . . . Consequently, we have historically been reluctant to permit shareholder derivative suits, noting that the power of courts to direct the management of a corporation’s affairs should be “exercised with restraint”
The board’s powers are “original and undelegated.”
“The directors’ room rather than the courtroom is the appropriate forum for thrashing out purely business questions which will have an impact on profits, market prices, competitive situations, or tax advantages.”
Acquiring >5% of target company stock, File Schedule 13D disclosure statement. Include critique of management and proposals.
Meet with target management to outline critique and proposals.• If management resists, make stance public
SEC Rule 14a-8 allows shareholders to put proposals on company proxy statement.• Most must be non-binding
Certain proposals under Rule 14a-8 may be mandatory.• Key: Certain mendments to bylaws
Seek board representation, but not control
Taking a Position
Negotiations
Precatory Proposals
Binding Proposals
Short Slate Proxy Contest
But Shareholders are Not Powerless:Mechanisms of Influencing Management
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Corporate Social Responsibility Corporate Governance
Concerned primarily with ensuring that their investments are consistent with their values/
Tend to be individuals, charitable and religious organizations, government pension funds.
Typically use non-binding shareholder proposals• Request reports on topic• Change corporate policy• Review corporate policy
Issue set has evolved over time• Environmental (e.g., climate change)• Human rights (e.g., divestment and boycott)• Divest certain product lines (e.g., defense, tobacco,
nuclear power)• Affirmative action (e.g., gay rights)• Animal rights (e.g., no lab experiments)• Tie executive pay to social benchmarks• Labor rights
Primarily concerned with increasing investment value
Union/government pension funds and hedge funds dominate
Activism form varies by type• Union/government pension funds focus on non-
binding proposals• Hedge funds use full arsenal
Issue set:• Takeover defenses• Board diversity and independence• CEO compensation• Political contribution disclosure• Separate CEO and Chair
Activist Types
Goals and Methods
The Emergence of Hedge Fund Activism
THE PLAYERS | Activist Hedge Funds
7© Stephen M. Bainbridge 2014
Less likely to PubliclyPress for Change
More likely to PubliclyPress for Change
Constructive Activist
Operational Activist Reluctant Activist
Pure Activist
IdentifyUndervalued
Stock
ExamineCorporateStructure &Governance
ReviewShareholder Base
DetermineChange Threshold
Buy MoreStock
Buy Stock
Contact Mgt. andRequest Change
Publicly
Discuss withOthers
Tagalong Investors Accumulate Positions
Buy More StockThreaten Proxy
ContestBuild Proxy
PlatformLaunch Proxy
Contest
NegotiateSettlement
Agreeable?
Settle
Shareholder Vote
Timeframe: 1 – 1.5 years
The Activist Process Model
Director versus Shareholder Primacy
Activism in a Theoretical Framework
“A corporation is just a nexus of contracts, subject to rearrangement in many ways.”
--Central States, Southeast and Southwest Areas Pension Fund v. Sherwin-Williams Co., 71 F.3d 1338, 1341 (7th Cir. 1995)
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The Central Office: “All corporate powers shall be exercised by or under the authority of, and the business and affairs of the corporation managed under the direction of, its board of directors . . . .” (DGCL § 141(a))
12© Stephen M. Bainbridge 2008
On the necessity for a central office
Kenneth J. Arrow
Where constituents have asymmetric information, divergent interests, and face collective action problems,it is “cheaper and more efficient to transmit all the pieces of information to a central place”that makes “the collective choice and transmit it rather than retransmit all the information on which the decision is based”
13© Stephen M. Bainbridge 2008
On the necessity for a central office
Kenneth J. Arrow
Where constituents have asymmetric information, divergent interests, and face collective action problems,it is “cheaper and more efficient to transmit all the pieces of information to a central place”that makes “the collective choice and transmit it rather than retransmit all the information on which the decision is based”
14© Stephen M. Bainbridge 2008
On the necessity for a central office
Kenneth J. Arrow
Where constituents have asymmetric information, divergent interests, and face collective action problems,it is “cheaper and more efficient to transmit all the pieces of information to a central place”that makes “the collective choice and transmit it rather than retransmit all the information on which the decision is based”
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Directors are not agents of the shareholders. Directors’ powers are
“original and undelegated”
Shareholder wealth maximization
Contribute equity capital
16© Stephen M. Bainbridge 2008
On the necessity for authority
Kenneth J. Arrow
“If every decision of A is to be reviewed by B, then all we have really is a shift in the locus of authority from A to B”
Managing Shareholder Interventions
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Goals of Governance Activism
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Beneficial
Most Controversial
Undesirable
Ranking Desirability of Shareholder Interventions
Directed at increasing director and manager accountability
Do we really think a hedge fund manager is systematically going to make better decisions on issues such as the size of widgets a company should make than are the company’s incumbent managers and directors?
Private rent-seeking
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Allowed Disallowed
Sorting
Process-focused interventions:• Shareholder interventions directed at
issues on which they are statutorily entitled to a vote—election of directors, removal of directors, approving mergers or other changes of control, amending the bylaws, and so on
• Interventions making use of existing shareholder rights to communicate with the board, to bring direct and derivative litigation, or to acquire additional shares and/or control of the company.
• Interventions designed to provide procedures for effecting such interventions—such as bylaw amendments relating to nomination of directors—likewise would be permissible.
Substantive interventions:• If shareholders are not entitled to a
vote (or other form of governance action) with respect to a given issue under state corporate law, however, that issue presumptively would be deemed substantive and thus impermissible.
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Disclosure of Holdings
Rule 14a-8 Eligibility
Rule 14a-8 Substantive
Specific Rule Changes
Amend Schedule 13D to require filing within 2 days after crossing 5% threshold
More rigorous definition of group activity
Current eligibility—lesser of $2000 or 1% of float—should be raisedMuch higher limits on shareholder support necessary for proposals to be
repeated in future years
Expand and revitalize exemption allowing exclusion of proposals relating to ordinary business matters
Proposals that are not a proper subject of shareholder action should be disallowed, even if phrased as a recommendation
Allow companies to opt out