Giant Shadow of Corporate Gadflies

The Giant Shadow of Corporate Gadflies

The Giant Shadow of Corporate Gadflies, by Yaron Nili and Kobi Kastiel, (download at SSRN) is one of the more objective reviews of the recent influence of “gadflies” on corporate governance in America. It might have been even better if the authors had discussed their work with the subjects of their study – the gadflies. (Disclosure: I am a gadfly.) This is a slightly updated version of a July 2020 post, which is worthy of another read.

Regardless of which side of the debate one supports, it is clear that rather than determining whether gadflies or other individuals should be allowed to submit shareholder proposals, policymakers should instead recognize the role played by these individual shareholders in the ecosystem as governance facilitators and focus on whether and how to increase the input of all investors into the shareholder proposal mechanism.

In the following review, I point to some of the study’s more obvious flaws and my disagreements. My purpose is not to criticize the authors but to help future researchers avoid the same mistakes and to think more carefully about shifting more rights and responsibilities from regular people to “professionals.” The day before posting this, the authors now want to discuss and revise their paper before publishing. Dialogue can lead to real progress.

Giant Shadow of Corporate Gadflies: Introduction

Our data demonstrates that a large and growing proportion of all shareholder proposals among the S&P 1500 are submitted by a handful of gadflies. In 2018, five individuals accounted for close to 40% of all shareholder proposals submitted to S&P 1500 companies.

The study is based on 2005-2018 SharkRepellent data. However, that data did not include all proposals submitted. Many proposals are submitted but are subsequently withdrawn after negotiations, as the authors acknowledge. They may never appear on the proxy or in a list of  no-action requests or decisions.

My guess is that a higher proportion of proposals filed by institutional investors result in subsequent withdrawal than those submitted by gadflies. Two reasons spring to mind.

First, companies are more likely to negotiate with large shareholders. For example, if BlackRock ever stepped up and filed shareholder proposals, you can well imagine most companies would seek a quick negotiation. CalPERS and the New York City Comptroller hold far fewer shares than BlackRock, so get less attention, but more than a gadfly who may only meet the $2,000 threshold.

Representatives of institutional investors and corporations are more likely than gadflies to trust each other. That facilitates negotiations. They often attend the same conferences and get to know each other on a social basis.  Corporations rarely sue institutional proponents in court, rather than going through the SEC’s no-action process. However, they have more frequently sued gadflies than institutional investors. Getting sued is not a trust-building exercise.

Second, gadflies typically file governance proposals, which are more binary than many of the environmental and social (ES) proposals filed by SRI funds, As You Sow, and members of the Interfaith Center on Corporate Responsibility (ICCR). The annual election of all directors (declassifying the board), leaves little room for negotiations. The company either agrees or fights. Making a company greener, more diverse, or transparent can be accomplished in many ways, so is more subject to negotiation.

This differentiation may be changing somewhat since gadflies have begun to file environmental and social (ES) proposals and the SRI community is filing more governance (G) proposals. Additionally, negotiating proxy access (a complex governance proposal) led many more companies to negotiate with gadflies, at least until the boundaries of the SEC no-action decisions became more firmly outlined.

The authors acknowledge the success of governance proposals submitted by gadflies as winning, on average 47.8% shareholder support.

Gadflies thus operate in this system as “governance facilitators,” translating universal governance guidelines into company-specific governance changes.

Still, the authors assert the power of gadflies comes at a cost since some proposals submitted by individuals can be more idiosyncratic. However, these unusual filings represent a small proportion of total filings, a point the authors fail to make.

More substantively, Nili and Kastiel argue the market should not rely on a “handful of individuals to initiate market-wide governance changes… [since] they operate on a voluntary basis, have limited resources, and lack an institutional body of knowledge that would ensure the successful realization of their agendas. What will happen when this handful of players, most of whom are already in their 70s, gets tired or pass away?”

Additionally, the ability of gadflies to file is under attack by proposed SEC rules that would significantly raise submission and resubmission thresholds. If the SEC rules are enacted, the role of gadflies may fade.

The Growing Importance of Corporate Gadflies

Because of the work of gadflies and other filers, “boards are increasingly willing to remove important anti-takeover defenses, such as the classified board and poison pill, in response to shareholders’ requests, something rarely seen in the past.”

Gadflies have increased submissions over time in comparison with other filers.

Proposal Proponents Over Time
Critics of gadflies, such as the Business Roundtable, argue that gadflies’ “interests diverge from the ordinary diversified investor” and that “[t]hese investors are pursuing special interests, many of which have no rational relationship to the creation of shareholder value and conflict with what an investor may view as material to making an investment decision.”

However, that criticism is difficult to take seriously since gadflies submitted 53% of passed proposals in 2018. “Gadflies’ proposals do not focus on esoteric corporate policies, on pet peeves gadflies may have with specific companies, or even on larger societal issues.” Nili and Kastiel find that gadflies “have focused on key governance issues, such as shareholder rights and takeover defenses.”

The authors suggest gadflies fill a vacuum. Many companies do not follow what are widely considered good governance practices with respect to declassified boards, adopting majority vote standards for uncontested elections, or allowing shareholder rights such as proxy access, special meetings, or written consent. BlackRock, Vanguard, and State Street (The Big Three) could easily file such proposals favored in their proxy voting guidelines. They would almost certainly win at most companies but they have not filed any proposals.

“Scholars theorize that these investors often refrain from engaging in stewardship for three principal reasons: agency costs, concerns of regulatory backlash, and disclosures on Schedule 13D.” Their absence leaves a void filled by gadflies. [Note: Let me just interrupt here and announce that I would be more than happy to file proposals on behalf of any of the Big Three. Just send me an authorization to act as your agent.]

Several market developments have led to a rise in gadflies’ power: their ability to tailor their proposals to the voting guidelines of proxy advisors and large institutional investors; the credible threat of withholding or a negative vote against directors; gadflies’ ability to crowd out other shareholders; and gadflies’ limited concerns over management retaliation.

The authors provide a good analysis of each of these factors. A few caveats are worth noting. Yes, gadflies often submit proposals knowing large fundholders and/or proxy advisors have favorable policies. However, we do not passively sit by waiting for policies to change. We experiment with what appear to be idiosyncratic proposals, some of which lead to a shift in mainstream corporate governance practices, while many others fall by the wayside.

For example, proxy access came about, at least in part, because I filed a rulemaking petition with the SEC. Shareholder rights to hold special meetings didn’t become widespread among companies or governance policies until gadflies relentlessly filed. Eventually, voting policies changed to make that right a governance “standard,” at least within the S&P 500 where 67% allow it.

Nili and Kastiel suggest gadflies may be crowding out institutional investors by submitting so many proposals it is not worth the bother of larger shareholders.

Crowding out could lead to negative outcomes if the proposals that gadflies submit do not eventually pass because of factual errors, or gadflies’ unwillingness to negotiate with management or to comply with professional norms. In such cases, governance arrangements that shareholders favor will not be adopted.

The entire universe of people filing proxy proposals is small; the gadfly community can be counted on one hand. I generally try not to step in front of a larger investor. I usually check to see if someone else filed a similar proposal at a target company and ensure they do not intend to file again. If I file and a larger shareholder files a similar proposal after mine, I frequently withdraw my proposal. Larger shareholders typically get more attention from the press and spend more and can spend more on vote-getting efforts.  My purpose for filing it to prompt positive change. I am happy to defer and move on to the next possible target.

Proponents don’t have to be professionals to “comply” with professional norms, which are generally based on common courtesy.  We are no more likely to make many mistakes than are the employees of institutional investors who file proposals. We typically have filed many more proposals than most institutional investor employees.

Nili and Kastiel also suggest gadflies “can embrace the stereotype of pesky shareholders and freely submit proposals that might irritate management and the board.” They suppose we have “limited concerns about management retaliation.”

I am not sure why they would make such an assumption. In the next section, they raise the threat of lawsuits targeting gadflies. Companies threatened to put us out of our homes by suing us in court, instead of going through the SEC’s no-action process. Ours is not a risk-free avocation but we are not pushovers.

Limitations of the Existing Ecosystem

Structural Limitations

The authors identify “structural limitations” of depending on gadflies. Being a corporate gadfly can be costly and lacks financial rewards. True, but so does being an engaged citizen. Think of those involved in civil rights movements. Most public interest advocacy groups are created because of the perceived need to right a wrong or accomplish a positive goal. Being an informed and engaged citizen also costs money and lacks financial rewards.

Another structural limitation is the lack of succession. “Without any real economic rationale to motivate them, gadflies’ activity is “fragile” and subject to the risk of discontinuation.” Gadflies have been around since at least Aristotle. We are not going away.

Students at Harvard, Yale, and other universities are increasingly engaged, attempting to influence companies on issues ranging from LGBTQ rights to climate change. Rock climbing can be costly and lacks financial rewards, still many people do it. I find being a corporate gadfly more rewarding than rock climbing, golf, or sitting on the sofa.

Efficiency Costs

Nili and Kastiel then argue gadflies may be unfit for the task. It is like arguing some citizens are unfit to vote, mow their own lawns or cut their own fingernails. Let’s examine their arguments.

Personal Interests

Gadflies might be motivated by personal interests. Evelyn Davis sold an annual newsletter. James McRitchie runs ads on his website, John Chevedden filed his first proposal with his former employer, so it might have been an act of revenge.

Such explanations of motivation are baffling after arguing that being a gadfly is costly, with little hope of tangible reward. My ad revenue is negligible. Evelyn Davis may have charged an outrageous amount for her newsletter but her revenue was still small in comparison to the cost of attending all those meetings. Chevedden probably filed his first proposal with his former employer because he held stock in that company and knew something about it. Nili and Kastiel simply repeat the same arguments put forward by business groups trying to discredit our work.

The authors theorize that gadflies may over file at S&P 500 companies because it brings “the most publicity.” They are right, but not because gadflies are publicity hounds.

Getting a proposal passed at Apple does get a lot more publicity than a proposal at Reed’s Inc. Large companies generally set the standards of what is considered good practice. The next company is more likely to be swayed by the example of a large successful company than a small unknown. When trying to drive the herd, concentrate on the leaders, not the followers.

Another criticism; Gadflies are undisciplined since they have no clear chain of command or beneficial owners who can withdraw their funds if displeased.  Yes, there is no chain of command to misinterpret what beneficial owners want because we are the beneficial owners. Most beneficial owners of funds have no idea how their proxies are voted or their governance rights are used. Is that really preferable? To criticize gadflies on the basis of a lack of a chain of command from uninformed beneficial owners to unmotivated funds is absurd.

Disregarding Professional Norms

Anther criticism, “Gadflies’ passion and idealism can transform them into corporate crusaders, less willing to compromise, or even negotiate, with company insiders.” During the 2020 season, I was able to reach an agreement or boards substituted a slightly weaker version of my proposal about a third of the time. Would a student intern at Harvard have reached more agreements than this passionate gadfly? I doubt it.

Bernie Sanders may be more difficult to deal with than Joe Biden. A mother who lost a child to a dunk driver may be more difficult to deal with than a paid lobbyist. A young black male may be difficult for an old white male to deal with. Maybe it is time for corporations to work with diversity, tight and loose cultures.

Waste of Corporate Resources

Here again, the authors drink the kool-aid of the Business Roundtable, US Chamber of Commerce, and other industry groups.  They appear to accept the cost assumptions those groups provided for proposed SEC rules to raise the thresholds for filing and refiling shareholder proposals. At the same time,  make it make clear they do not support the proposals themselves. They should be questioning the assumptions

Yes, business groups don’t like shareholder proposals and say they must spend a large amount of money to keep them off the proxy.

When gadflies submit a shareholder proposal on an esoteric topic that barely interests other shareholders, or when their proposals receive low levels of support, the costs related to that proposal would, in our view, constitute a waste of corporate resources.

As an example, the authors cite a study by Emiliano Catan and Marcel Kahan on

the evolution of shareholders’ rights to call special meetings and act by written consents,” [which] does not find evidence that gadflies always target those firms where a grant of certain rights, such as the ability to act between annual meetings, would be most productive in light of their governance structure.

Yes, some gadfly proposals are not targeted optimally. As Catan and Kahan’s study pointed out, it does little good to win the right to call a special meeting at a company where shareholders cannot remove directors without cause. After reading that paper, I immediately began to correct the problem by filing proposals at companies to ensure shareholders have the right to remove directors without cause. In almost every case, the companies adopted the change without taking it to a shareholder vote.

All such proposals were either adopted without a fight or won a majority vote during the 2020 season. Many were embarrassed that shareholders could only remove directors for criminal behavior. I will continue to push this issue in 2021. I would love to see a large pension fund, with more extensive holdings, take up this issue. A simple letter from CalPERS might do the trick at most companies.

Yes, not every proposal from a gadfly is optimal. Like any new product or idea, proposals must be tested and refined. However, just like the three SEC Commissioners voting in favor of rules to disenfranchise gadflies, Nili and Kastiel appear to  accept the exaggerated cost estimates of corporations processing shareholder proposals. The SEC failed to critique those cost estimates. Nor did they take into account the benefits of proposals that are either adopted or that raise awareness of issues that help companies address costly or potentially costly issues.

The Giant Shadow of Corporate Gadflies: Backlash

Unlike the Chamber and other critics, Nili and Kastiel do think gadflies have played a constructive role. In their assessment, the backlash against gadflies “poses a major threat to the existing corporate governance ecosystem, which relies heavily on the ability of gadflies to submit governance-related shareholder proposals.”

Powerful corporate lobbying groups pressured Congress and the SEC for laws and regulations to severely restrict the activities of gadflies. The authors also worry that corporations have sued gadflies to keep our proposals off the proxy.

I suspect President Trump and the Republican Senate will be turned out in November. Trump became famous for generating fake news, beginning with the crowd estimate at his inauguration. Chairman Clayton is now famous for reading astroturff letters from supposed “Main Street” investors in support of his rules to clamp down on gadflies.

The overwhelming majority of comments from investors oppose the SEC’s proposed rules. Additionally, knowing the rules are unpopular, few corporations commented in support. Instead, they asked their lobbying associations to do their dirty work to avoid adverse publicity.

With regard to companies taking gadflies to court, although we initially lost some cases, we have been able to get all subsequent cases dismissed. Corporations involved in these misadventures hired dozens of attorneys at enormous cost (driving the inflated corporate estimates of proposal costs cited in the SEC rulemaking).

We represented ourselves in court, without the benefit of counsel. Yes, it took a few cases for us to find our footing. However, Nili and Kastiel need not worry. We will not be intimidated. No court awarded any costs to companies. After a few losses, we got all subsequent cases dismissed and were awarded costs. Since we represented ourselves, costs were minimal. Next time companies bringing litigation will not get off so cheaply. I will hire expensive attorneys and instruct them on how to win.

Policy Implications

Nili and Kastiel conclude the SEC’s focus on gadflies is misplaced. Gadflies have a role as “governance facilitators” because large institutional investors fail to utilize the shareholder proposal mechanism themselves. Instead of cutting gadflies out of the process, they ask what can be done to bring larger investors into the process? Here, Nili and Kastiel get to the heart of the problems. Unfortunately, their proposed solutions fall short.

The authors recommend the establishment of intermediate nonprofits that advise and assist large investors in the submission of proposals. These “professional” filers could achieve economies of scale, develop expertise, and would have a market-wide perspective. The Shareholder Rights Project at Harvard “provides proof of concept.”

The nonprofits could advise and support proponents, could submit proposals on behalf of any proponents, including gadflies, reducing “concerns about the quality of gadflies’ proposals.”

Furthermore, the SEC could promulgate a safe harbor provision, exempting gadflies from the restrictions on submission/re-submission if their proposal is made through a professional filer or receives its seal of approval.

First, I am not sure why the authors put so much weight on “professional” filers as if getting paid to do something automatically makes a person more capable. Harvard’s Shareholder Rights Project was staffed by student interns. I have filed hundreds of proposals over the last 20 years.  I defended my proposals through the no-action process at the SEC and in federal courts, including an appeals court just below the Supreme Court.

Why should I be considered less capable than a student intern at Harvard? Of course, if the SEC offered the suggested safe harbor provisions proffered by the authors, I would certainly consider filing through “governance facilitators.” However, that “safe harbor” is a fantasy of ivory tower academics.

Even with these objections, I embrace the idea of establishment nonprofits to advise and assist with proxy proposals. The Interfaith Center on Corporate Responsibility (ICCR) has been doing this work for almost 50 years, yet goes unmentioned by Nili and Kastiel. ICCR’s coalition of over 300 global institutional investors holds more than $500 billion in managed assets. Their members filed 280 proposals for 2020. I work with them frequently to support their efforts, to gain support for my own, and coordinate whenever possible.

As You Sow is another group of “professional filers,” which regularly introduces shareholder resolutions that “empower shareholders to drive companies toward a sustainable future.” Of course, I work with them as well. Last year, for example, we co-filed a proposal at JPMorgan Chase requesting a report on how the company intends to reduce GHG emissions associated with its lending activities.

I also co-filed at BlackRock, where we essentially asked BlackRock to expose their own hypocrisy. We asked them to write a report explaining how BlackRock’s systems should be altered to implement the BRT’s Statement of the Purpose of a Corporation, which BlackRock’s CEO had signed. The Statement of Purpose was a publicity stunt, not a real commitment to change. However, like the Declaration of Independence’s statement that “all men are created equal,” the BRT’s Statement is a welcome target. As You Sow listed 322 proposals for 2020 in its Proxy Preview.

Should ICCR and As You Sow be larger and should there be more such organizations? Yes, I would certainly welcome that. However, I would not expect the Big Three to flock to professional filers. The problem with large investors is not lack of resources; it is a lack of incentive.

Another resource unmentioned by the authors is the growing number of financial advisors filing on behalf of clients increasingly concerned with ESG issues. One such example is Newground Social Investments. They recently got Alec Baldwin, Jody Williams, and Roger Waters to address those attending the Chevron annual meeting concerning governance issues.

Maybe problems identified by the authors can be ameliorated by the involvement of wealthy/famous actors, Nobel Prize winners, and rock stars. I would be delighted to help any who wants to get involved, starting with my own proposals.

The problem is not a lack of professional filers. The real problem is a lack of concern or awareness of the issues among shareholders, potential shareholders, and beneficial owners. The public has been kept in the dark by industry propaganda convincing them they are incompetent to handle their own investments. Many people have separated making money from investing in what they value, the world they want to create. Financial illiteracy is a direct result of a lack of transparency and education.

A second significant proposal made by the authors is to require all companies to put certain key corporate governance provisions to a shareholder vote periodically, such as every five years. The proposals chosen would be those that typically receive more than 40% to 50% of the votes cast.

A representative sample of these proposals includes those to adopt annual election for all directors, majority voting, shareholder-initiated special meetings, separation of chairman and CEO roles (when applicable), proxy access, action by written consent, disclosure of gender diversity, and disclosure of political spending. Shareholders would not be permitted to submit individual proposals on those matters that are brought to an automatic vote …

To be clear, this solution does not, by any means, expand existing powers or rights afforded to public shareholders. All of the shareholder proposals that would be submitted to the company’s ballot are permitted to be submitted even under the existing legal regime. This solution simply adds a requirement that shareholders be required to vote on a set of pre-determined proposals every few years.

Many of these proposals are not as generic as the authors believe. Shareholder-initiated special meetings can have a wide variety of thresholds. For example, Woodward Inc. requires 67% of shareholders to agree to hold a special meeting, whereas Gilead Sciences requires only 10%. Which provision goes on the proxy every five years and who decides?

The real problem is, how can we incentivize the Big Three and other large funds to take on some of the work currently being done by gadflies? How can we make them better stewards or convince their customers to go elsewhere? (In the meantime, I would be happy to file proposals on behalf of the Big Three and I would do it for free … as a nonprofessional.)

A million and a half comments were submitted to the SEC to require political spending to be disclosed. Justice Kennedy believed this was already happening when he wrote the Citizens United decision. Yet, the Commission (under both Democratic and Republican administrations) has failed to take up that petition because Congress prohibits it in the SEC’s budget. Why would a proposal to require companies to put items on their proxy periodically have a better chance?

Four Big Ideas

Nili and Kastiel have done excellent work documenting the key role currently played by gadflies and they do point to real problems concerning our dependency on a few individuals. Here are some solutions that might actually work.

  1. Real-time proxy votes. One problem is that fund proxy votes don’t often reflect the full values of their investors. The SEC should require funds to announce their votes in real-time, in user-friendly sortable format, not just once a year in unreadable code. When investors see their ESG funds voting against ESG proposals and principles, there will be Mutual Fund Wars Over Fees AND Proxy Votes. Main Street investors will demand proxy votes reflect our full values as people. Promulgating such a change is not a huge stretch. Proposed amendments would simply fulfill the intent of the original rules by using technology that is now readily available.
  2. Encourage funds to be more democratic. Institutional Shareholder Services (ISS) is criticized by business organizations for dictating how customer funds vote their proxies. In reality, most subscribers to ISS vote according to their own policies. Those defaulting to ISS recommendations are buying into a sort of wisdom of the crowd. ISS employs an extensive feedback process from customers and other stakeholders before setting its benchmark proxy policy updates each year. If large funds did the same, they would take a much more active role in filing and voting proxy proposals. Greenwishing customers are demanding ESG focused options. Large funds are currently largely responding with greenwashing options. Better alignment is needed. Wider circulation of research by Jackie Cook and Jon Hale would also help in this regard.
  3. Capitalism Off-CourseHedge limited liability. A good portion of the problem of capitalism, as currently practiced, is that investors have limited liability. Investors are only liable for the dollar amount they have invested in a firm, so have little incentive to monitor possible corporate harm to the environment or society. In Redesigning Corporations: Incentives MatterNicholas Benes, outlines a system that could incentivize investors to take up their moral responsibilities to monitor company efforts to externalize costs. Capitalism is off-course. Benes offers a way to hedge limited liability through a small transaction fee rebated through an “ESG Dividend Fund.” The fund would incentivize investors into keeping companies well-behaved and out of bankruptcy.
  4. Promote employee stock ownership plans (ESOPs), with voting power, passed to employees. No one wants to work as a cog in the machine. With a greater voice, employees and their companies are more creative and productive. (link to studies) Employee owners have a greater incentive to participate in governance since they make firm-specific investments through their own human capital. Switching stocks is much easier than switching work. Plus, while employment is firm-specific, investments often involve such a large market-basket of stock it is not worth the time and effort to monitor them. Getting employees involved will improve corporate governance as well as environmental and social measures. ESOPS have traditionally received bipartisan support.

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