Corporate Governance

Wachtell, Lipton and the Opening Salvo Against the Shareholder Bill of Rights (Short Termism)

By J. Robert Brown

Senator Schumer is about to introduce a Shareholder Bill of Rights.  As an opening salvo, Wachtell Lipton has gotten out front criticizing the efforts.  We are taking a bit of time to examine these criticisms.

The legislation will apparently require public companies to implement say on pay, provide access (although in a way that ironically reduces rather than augments the Commission's authority in the area), separates the positions of chairman and CEO (and requires that it be filled with an independent director), eliminates staggered boards, require majority vote, and mandate some degree of risk assessment at the board level.  The Wachtell position is that the "Act proposes to enhance stockholder power and thereby . . . fuel the very stockholder-generated short-termist pressure that, in the view of many observers, contributed significantly to the financial and economic crises we face today."  In other words, the current crisis is the fault of shareholders and the bill will only make things worse by enhancing the authority of shareholders. 

The position is wrong for two reasons.  First, the legislation hardly enhances the authority of shareholders.  While the devil is in the detail, the collection of rights actually advances the goal of good corporate governance at best modestly.  It does not displace the anemic fiduciary duty standards imposed under Delaware law. It does not redefine the concept of independent director to make it meaningful. It does not alter the process of determining executive compensation. It is, therefore, at best a modest start in developing a regime of good corporate governance.  Ultimately, if this passes, there will have to yet be SOX III.

Second, the argument that the current set of problems is the fault of shareholders is both audacious and unfortunate.  As the memorandum notes:

• Increased stockholder power is directly responsible for the short-termist fixation that led to the current crises. . . .The undeniable fact is that the true 'investors' are now professional money managers who are inherently short-term (even quarterly) focused. That 'stockholder' pressure pushed companies to generate high financial returns at levels that were not sustainable, with management's compensation being tied to producing such returns (at stockholder urging). The increase in stockholder power and stockholder pressure to produce unrealistic profits fueled the pressure to take on increased risk. . . . That pressure became all the more irresistible as it combined with increased stockholder power to oust or discipline managers and directors — power available to enforce the stockholder and activist investor agenda of ever higher short-term returns.

We have heard this sort of thing before.  Remember then Chairman Cox railing against offshore hedge funds as a justification for voting against access?  The argument entirely exonerates management which in and of itself eliminates any credibility that it might have.   That management might have had a self serving role in the risk taking in order to enhance compensation is nowhere mentioned.  It is as if the excessive compensation problem never occurred.

But in the end, the main response is that you can't have it both ways.  Hostile takeovers have disappeared.  Shareholders rarely run competing slates against management nominees for the board, making proxy contests few and far between.  Even majority vote provisions are more light than substance.  They rarely succeed and when they do, management invariably has the discretion to refuse to accept their resignation, which so far it appears not to have much qualm about using. In other words, when it comes to ousting management, shareholders have little or no ability to do so. 

Yet apparently when it came to imposing on management a goal of excessive short term profits, shareholders suddenly had the ability to influence management.  Assuming that shareholders wanted these excessive short term profits (put aside that excessive short term profits ultimately damage the equity holders, perhaps reducing their value to zero, while CEOs who are well paid during the period of excessive compensation get to keep whatever non-stock wealth they've accumulated), exactly how were they going to force this on an otherwise prudent and reasonable management?  Take a look at the difficulty that even an 80% shareholder would have replacing the board. 

In other words, management could have said no.  The fact that management didn't is a form of abdication of their authority and a reason for reform by itself.  Of course, abdication is the charitable explanation.  Greed, as evidenced by excessive compensation, is the less charitable explanation.  Either way, this problem can't be put at the foot of shareholders, not in any systematic way.  

We will discuss some of the other Wachtell positions in the next post.

Full post as published by The Race to the Bottom on May 15, 2009 (boomark / email).