Corporate Governance

Delaware Judges, Shareholder Rights, and the Appearance of Bias (Part 2)

By J. Robert Brown

We are discussing the article recently published by VC Strine from the Delaware Chancery Court in the Journal of Corporation Law, "Toward Common Sense and Common Ground? Reflections on the Shared Interests of Managers and Labor in a More Rational System of Corporate Governance," 33 J. Corpo. Law 1 (Fall 2007).

Let us look at a few of the positions taken in the article. It is clear that VC Strine does not like some of the post-Enron reforms of the corporate governance process, particularly the increased reliance on independent directors.

He labels them "professional" independent directors, a term used pejoratively. He notes first that these professional directors do not want to lose their sinecure because "[m]any . . . derive important elements of their net worth from board service." As a result, they have an overly solicitous attitude towards shareholders. These directors, he asserts, "are not anxious to incur the wrath of institutional nvestors and those who advise them." If they do, they "fear" that "they will face withhold campaigns." But its not just concern over shareholders. They also alter behavior out of fear of the New York Times.

• With power dynamics changing toward activist institutional investors, independent directors who wish to remain in the game will seek to avoid the ire of Institutional Shareholder Services (ISS), the business op-ed commentators at the New York Times, and so forth.

As a result of this, directors (read independent directors) are "anxious to compromise whenever the institutional investor community rattles toy sabers."

In other words, VC Strine views "independent" directors as a negative, that they harm the company through an overly solicitous relationship with shareholders. In the mind of VC Strine, shareholders (at least institutional shareholders) already have too much influence in the boardroom.

The views are particularly revealing given his misreading of the current dynamics in the corporate governance landscape. While it is remotely possible that a director would take into account the possibility of a possible campaign to withhold votes (or the anticipated criticism of the New York Times), the statistics suggest otherwise. Although companies have moved towards majority vote requirements (something in widespread use overseas, apparently without substantial harm to the governance process), it hasn't been used much in the United States. To date,only one director has failed to receive a majority of the votes cast and in that lone case, the boarddeclined to accept her resignation. In other words, withhold campaigns have not become common and have not given shareholders any real additional authority. They do not increase in any meaningful way the risk that a director will lose his or her seat.

With the number of election contestsanemically small and withhold campaigns rare, the only realistic way for a director to be removed is to have the board not renominate. VC Strine is right that fees may amount to "important elements" of net worth and may induce a director to want to stay on the board, but he is wrong to suggest that the dynamic results in a slavish adherence to the interests of shareholders. It is exactly the opposite. Directors have an incentive to slavishly follow the edicts of top management. It is this approach that ensures their sinecure on the board.

VC Strine can't admit this. While his article acknowledges that fees influence the decisions of directors, the Delaware courts have taken the position that in reviewing director independence, fees are largely ignored. VC Strine circumvents these otherwise antithethical positions by conceding that they result in a bias but contending that it is a pro-shareholder, rather than a pro-management bias.

For another, the attitude provides VC Strine with a basis for restricting the authority of independent directors. To the extent independent directors might actually step in and take charge and exercise limits over top management, VC Strine has articulated a basis for restricting their reach. It is clear that he will view actions taken by these directors warily. This attitude is already surfacing among other chancellors on the Chancery Court (as discussed here and here).

There would likely be few institutional investors who think independent directors are, as a group, overly solicitous towards their views. But this is the attitude of a judge who is sometimes asked to resolve conflicts between shareholders and management. It suggests that these investors will have a difficult time in this particular courtroom.

Full post as published by The Race to the Bottom on March 05, 2008 (boomark / email).