CAMPAIGN OUTSIDER Money issue needs a champion
By Muhammad Cohen
WASHINGTON - We interrupt this non-stop coverage of the election for something
completely different: an issue. Not just any issue, but an issue that any of
the candidates could embrace and win the support of 100 million Americans,
nearly all of them voters.
It's an economic issue that transcends party and class lines and speaks to a
basic American value: fair play. It's an issue that's extraordinarily simple,
and yet it scares mighty moguls to the marrow. It's the single most important
corporate reform within reach, and it doesn't rely on taxes or tax breaks or
new
government spending. It's about one of the most fundamental American rights:
democracy.
Simply put, it's time to introduce democracy to corporate elections. As John
McCain says, 100 million Americans are invested in equities, either through the
stock market, mutual funds or their 401(k) plan. The presumptive Republican
nominee warns that Democrats want to raise taxes on investments that would cost
most investors pennies. Lack of corporate democracy costs investors tens of
billions every year.
Most investors understand that shareholders own companies. A share of stock
grants partial ownership of that company. While anyone with enough money can
buy stock in a publicly traded company, it takes special skills to run a modern
corporation. So shareholders hire corporate executives, and investors rely on
them to run the business for them. (In this article, the terms stockholder,
shareholder and investor are used interchangeably.)
Agency dilemma
Still, shareholders and executives conflict at a basic level. Executives
control assets that don't belong to them (yes, some executives are also
shareholders but they own a tiny percentage of the company) and shareholders
expect them to manage those assets in their best interests. But executives may
manage the company simply to feather their own nests. In management theory,
this situation is known as the agency problem or agency dilemma. Representative
government also creates agency problems.
To combat the agency problem, shareholders elect boards of directors to oversee
management. Directors are supposed to supervise management as representatives
of investors. Their duties include hiring and firing the chief executive
officer (CEO) and setting executive compensation, including giving them
incentives such as stock and stock options to align management interests with
those of the stockholders.
To ensure that director act in the shareholders' best interests, elections are
held for boards of directors of public companies. Every year shareholders
receive a ballot to elect directors at the annual shareholder meeting, usually
held during the second quarter. The ballot is known as a proxy card, since
shareholders don't typically attend the annual meeting where the votes are
counted. Shareholders fill in their proxy ballot (or in most cases, don't), the
votes are counted and directors are elected to oversee the company as the
guardians of investors.
That's how they teach it in business class. But in modern corporate practice,
board of director electors are a sham, reminiscent of Soviet Union-style voting
without a whiff of real democracy.
Inmates empowered
Take a look at a corporate ballot. There's only one choice for each seat on the
board of the directors, so nomination is tantamount to election. But that's
hardly the worst part of the process. The real problem is that corporate
executives, not investors, control the nomination process, thanks to outdated
regulations. So the lunatics run the asylum.
The sitting board of directors nominates candidates for the next board of
directors; typically, they renominate themselves. Being a board member pays
tens of thousands of dollars for a few days work a year, and directors travel
meetings on the company's dime, which means shareholders' money since
shareholders own the company. It's a nice chunk of change and resume builder.
Those company nominees are the only ones you see on the proxy ballot that you
receive from the company. Keep in mind that company funds, again shareholder
assets, pay for sending these ballots, usually done by a specialized proxy
service that charges tens of thousands of dollars, plus postage. Today
shareholders can opt to receive these proxy materials by e-mail from the
company or its agent.
Let's say shareholders want to nominate their own candidate for the board of
directors. They have to go through a vast legal maze full of trap doors. While
the company can use company funds to send ballots to stockholders, the
stockholders - who own the company - cannot; they have to send separate ballots
at their own expense. They also have to send their separate ballot to every
shareholder - not some, not most, but all - by first class mail, or else none
of the votes will count. The company controls the shareholder list and, while
required by law to provide it, typically will delay and make the process as
difficult as possible. Since shareholders usually ignore company elections
(since they're normally uncontested), shareholders running their own candidates
often spend tens of thousands more dollars to inform shareholders that there is
a contested election, also known as a proxy battle.
Beyond fairness Putting aside the fairness issue, there seems to be a
case for making director nominations difficult. After all, shareholders do want
experts to run their company, and board members, in turn, should be experts
qualified to judge the performance of the company and set its direction on
behalf of the shareholders. But because the company, not the shareholders,
controls the nominating process, directors become loyal to the company and
often lose sight of shareholder interests. Even the best intentioned directors
find it difficult to buck the system.
To ensure that directors toe the line, boards typically nominate like-minded
individuals. Boards of directors are studded with top executive of other
companies, present and retired. While those corporate leaders can provide value
insights and connections, they also reliably take management's point of view,
since they are management in their real job, and as CEOs, they're too busy to
pay much attention to other companies anyway. They're particularly compliant
when it comes to voting obscene pay packages for one another. Companies say
they're just paying the industry standard, but through board memberships,
sitting executives set those standards for one another.
Academics are another popular choice as directors. They will generally differ
to management since they don't have hands-on experience with running a
business. More importantly, they need the money a directorship provides so
won't rock the boat. Many board members are also accountants, due to the
Sabanes-Oxley reform act put in place after the Enron wave of scandals that
requires a percentage of board members with specific expertise to oversee
auditors. Again, most of them can use the money and status that comes with
board membership. Generally, management nominates people it knows and likes as
directors, so board meetings are chummy, clubby affairs.
Most ridiculous of all, in most companies the CEO sits on the board of
directors and often chairs it, even though one of the board's primary acts is
to oversee the CEO. You can bet he's an understanding audience when it comes to
any corner office shortcomings.
School for scandal
If companies were run well, then corporate electoral minutiae would be good for
laughs. But investors have lost billions of dollars due to corporate abuses,
from Enron, WorldCom, Tyco, et al, to the current subprime mortgage debacle.
All of these events are, at least to some extent, examples of system failure.
Directors chosen under the present system don't ask management tough questions
or challenge basic assumptions, two key tasks for directors. Directors are
loyal to management, they rely on management to keep their positions and their
perks, and there's no reason for them to take shareholders' interests too
seriously.
Today, shareholders have no real recourse. Shares in Citigroup lost more than
two-thirds of their value from last summer to March, just ahead of the
company's annual meeting. That's a loss of US$197 billion in shareholder
equity. You can bet few shareholders are happy about the direction of the
company, yet last month they reelected Citigroup management's full director
slate that presided over the stock's plummet. Shareholder weren't endorsing the
team that lost 67% of their investment, the system just gave them no choice.
There's a simple solution to fix the system: fair director elections. Let the
shareholders, the owners of the company, offer their own nominations for
directors, put them all on the company ballot, and then let shareholders chose
the directors they deem best.
Even in the depths of the George W Bush administration four years ago,
corporate democracy nearly became reality. In 2003, the Securities and Exchange
Commission (SEC), which regulates publicly traded shares and markets, proposed
a limited form of investor ballot access. Its initiative would have allowed
shareholders holding 5% or more of a company's shares to make one or two
director nominations that would be placed on the company ballot right alongside
the company's nominees, giving shareholders a real choice.
That proposal generated the greatest outpouring of public comments ever for a
SEC proposal, nearly all of it favorable. Despite the severe limits of the
proposal, corporate America brought out all of its big guns to oppose it. The
most laughable argument was fairer elections would allow "special interests" to
interfere with company business. First, the "special interest" making the
nominations would be a shareholder, and the full body of shareholders would
have a chance to decide whether the nominee was better for their interests than
a company nominee. Second, boards of directors already are dominated by a
special interest, company management. Management didn't want anything
threatening its stranglehold on the nomination process and its domination of
the board.
The proposal was shelved without ever coming to a scheduled vote in 2004. But
the idea has as much merit for shareholders, and as much danger for
underwhelming corporate managers and uninspiring directors, as it did four
years ago.
Any presidential candidate can take up the banner. Promising to appoint
(subject to Senate confirmation) an SEC chair that wants to bring fair
corporate elections to a vote or bringing a Fair Corporate Voting bill before
Congress (perhaps as part of an Investors Bill of Rights) would get the
attention of those 100 million Americans that invest in publicly traded
companies and expect a fair shake. It's a simple, appealing, and fair idea
whose time is past due. But it could be hell on contributions from corporate
fat cats and their pals. With all this talk of standing up for working people
and against special interests, let's see if any candidate really means it.
Former broadcast news producer Muhammad Cohen told America's story to the
world as a US diplomat and is author of Hong Kong On Air (www.hongkongonair.com),
a novel set during the 1997 handover about television news, love, betrayal,
high finance and cheap lingerie.
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