CEOs Running Scared in Washington

Businesses have intensified their efforts to kill the “proxy access” provision of the Senate’s financial regulation bill. Forty CEOs lobbied in Washington, DC last week alone.  “This is our highest priority,” said John Castellani, president of the Business Roundtable, which represents 170 chief executives. Last week alone, Castellani said, 40 chief executives were in town visiting Capitol Hill about proxy access, since they see it eroding their power.

“This hinges on senators recognizing the fact that boards in too many companies like Citigroup or AIG really failed in their responsibilities here,” said Daniel Pedrotty, director of the AFL-CIO Office of Investment. With proxy access, shareholders would be able to send a strong message to management if they weren’t happy with a company’s strategy, for instance, in managing risk or charting growth.

Currently, shareowners must pay thousands, sometimes millions, of dollars to run candidates that aren’t selected by current CEOs and boards. Proxy access would force companies to add shareowner nominees to the corporate proxy, at minimal cost, allowing them to comprise up to 25% of boards… if a majority of other shareowners agree with their picks. That still leaves current boards in control but the mere idea that some directors could be replaced has CEOs worried.

Senators Thomas R. Carper (D-Del.) and Bob Corker (R-Tenn.) have introduced amendments that would cut proxy access from the bill, but there are more than 250 other proposed amendments as well. It is hard to know which will get heard. Castellani said the BRT has gotten a sympathetic hearing from several Senators.

Jeff Mahoney, general counsel at the Council of Institutional Investors, said fears are overblown. “Just because you put someone on the proxy card doesn’t mean they’ll be elected,” he said. “At the end of the day, no one is going to get on the board unless most of the owners of that company want that.” (CEOs from far and wide band against financial bill provision, The Washington Post, 5/14/10.

Robert Sprague and Aaron J. Lyttle analyze the development of current corporate governance standards and examine whether the current financial crisis can provide an avenue for change. They find that a “significant shortcoming of the shareholder primacy norm, as supported by the business judgment rule, is that corporate directors and officers have a plain incentive to maximize short-term profits, possibly, as in the case with Citigroup, at the expense of the overall viability of the firm.”

There is one critical assumption underlying the discretion provided to corporate directors and officers under the business judgment rule—if shareholders are displeased with directors, and the officers they hire and supervise, the shareholders can elect new directors. This replacement power is especially important when director decisions are insulated from judicial review due to the business judgment rule.

Unfortunately, that ability is largely an illusion. Shareowners have very little input into electing directors, since in most cases all they can do is vote for or withhold their vote from management’s candidates. Sprague and Lyttle conclude, “The most viable possible revision to corporate governance in the United States is to allow shareholders access to proxies to nominate alternative directors.” (Sprague, Robert and Lyttle, Aaron J., Financial Crisis: Impetus for Restoring Corporate Democracy (January 26, 2010). Midwest Academy of Legal Studies in Business Conference Proceedings, 2010. Available at SSRN:

Martin B. Robins would take a complimentary but different approach, reversing the present burden of proof placed on plaintiffs in actions alleging breach of a directors’ duty of care under certain circumstances. (Require Affirmative Proof in Specified Circumstances of “Too Big to Fail Companies” in Order to Meet the Business Judgment Rule)

We need a legal regimen which forces directors at systemically important firms to familiarize themselves with what management is doing, and ask the tough questions of management before policies are implemented, to see if the downside risk of those policies is understood (or has been considered at all) and to change course when even an originally well conceived strategy is no longer suitable. Ultimately, we need to force directors to consider on an ongoing basis whether their firms’ managements should be in their positions at all, in order to screen out dishonest, reckless or incompetent persons.

Elsewhere, Robins argues, “pending bills only divert the focus from holding responsible those making the decisions requiring resolution and encourage more bad decisions.” (ROBINS: Financial regulations miss the target, The Washington Times, 5/13/10)

Although far from the recommendation of Robins, reports on two amendments to the Dodd bill that “would significantly expand the disclosure obligations of ’34 Act companies – principally because they contain no meaningful disclosure thresholds (i.e. materiality), and in the case of the Byrd Amendment, would significantly expand the bases upon which directors and officers may be found personally liable for failures to disclose.” (Drilling Down Into the Dodd Bill Amendments: Personal Liability for Directors and Officers!, 5/14/10)

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