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August 25, 2008

Shareholder Activism Shapes the New Corporate Governance

Frank Edwards
Arthur F. Burns Professor of Free and Competitive Enterprise; Director, Center for the Study of Futures Markets
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Professor Frank Edwards is the faculty chairman of the Corporate Governance Committee and created the new corporate governance module that is part of the revised CBS core curriculum.

There is no more basic question in corporate governance than “who gets to decide.” We are moving away from a world where shareholders are small, passive investors to a world where investors hold sizeable positions in companies and want to be heard on vital corporate decisions.

There is a growing movement to give shareholders — especially institutional investors and substantial block-holders such as private equity firms — a larger role in corporate governance. In recent years, we have seen large individual activist shareholders, such as Carl Icahn and Warren Buffett, influence companies’ policies and strategies; activist hedge funds, private equity funds and union and public pension funds have successfully persuaded or forced changes upon recalcitrant managers.

But moving away from the traditional director-primary model raises the fundamental issue of what powers should shareholders have. Will more shareholder involvement disrupt the very mechanism that makes the public corporation practical, which is the centralizing power in the board of directors?

One controversial area is the adoption of majority voting standards. In the United States, the traditional way of electing directors has been by plurality voting in which directors typically are elected if they receive one or more shareholder votes in favor. Shareholders are now demanding that the plurality system be replaced by a majority vote rule, a system used in many other countries, including the United Kingdom. Some American firms have already voluntarily instituted some form of majority voting, while many others are resisting this change.

Another area of controversy is whether or not advisory or even binding shareholder “say-on-pay” resolutions should be permitted. The law in the U.S. specifies that even shareholder resolutions receiving a majority vote are nonbinding on the board. In the past, even shareholder advisory votes on executive compensation plans have not been permitted under SEC regulations. This has changed and evolved into a new, more profound issue: should a wider range of shareholder resolutions be permitted and should those receiving a majority vote be binding on the board?

Lastly, some shareholders want the right to propose resolutions pertaining to corporate social-issue policies. Resolutions on the emission of greenhouse gases, effects of climate change on less developed countries, research on renewable energy sources and national healthcare programs have all been proposed by shareholders.

In the future, managers will have to balance shareholder involvement with the practical considerations of running a company efficiently. Understanding what good corporate governance practices are and how these can contribute to the success of a company will help mangers find the optimal balance between these competing considerations. The goal of introducing corporate governance into the CBS core is to lay a strong foundation to help future MBA managers decide these issues and to manage successfully.

Photo credit: Daniel Martini


by Thomas L. Doorley, III | September 03, 2008 at 5:25 PM

First of all, my compliments to CBS for introducing the issue of governance to incoming MBAs. They are the Directors of the future; the sooner they can dial into these issues the better! Professor Edwards addresses an important issue around "who gets to decide." The role of investors is receiving increasing and appropriate focus both here and globally. His work is on target; his insights most relevant. I'd add a further issue, which can be framed in comparable terms, namely, "who is capable of deciding; and on what issues." In my service on Boards, and as an advisor to other Boards, I see the need for the Board itself to engage in the strategic dialogue in a more fullsome and effective way. It begins with embracing the two fundamental roles of the Board--1) the compliance role (rebuilding/maintaining trust; and 2) the performance role (contributing is some fashion to making the enterprise better). The second role is often uncomfortable for the CEO and leadership team. The typical complaint: "How can they know enough to help? Even the best commit barely 5-10 hours per week to our company." The Director's issue is the inverse. "They don't tell us enough to be able to help." Both are selling the role and responsibility of the Board short. If a Director can not help he/she should step down. Similarly, the leadership team must figure out how to educate and engage the Board. Especially with new, global standards of accounting and governance gaining ground, the fact that it is a tough task is no defense. The best Boards with the best leadership teams get it done. And, their performance shows it. Hopefully the new governance segment for MBA orientation will incorporate this aspect as well. If MBA students aspire to be leaders they must understand early on importance of the twin roles the governance process comprehends.

by Rajansh | September 10, 2008 at 2:25 PM

Professor Edwards, First of all, the article beautifully explores fine aspects of shareholder activism. Thank you for sharing it with us. Also, Thank you CBS, for providing access to this knowledge pool. I have a view to share. Not sure how appropriate it is, but I feel that the point to consider is 'how qualified is the shareholder to suggest a particular measure? If he is backed by a majority of votes he must either be very influential or very rich or both. But the question is 'what is he influenced by?' Is it a common cause which represents shareholders' interests or is it vested interests or just popularity? I understand that the management is responsible to the board of directors, the board is responsible to the shareholders, but who is the shareholder responsible to? Does an ordinary shareholder need to bear the additional risk of an influential shareholder's activism when there is a mechanism already in place to protect shareholders' interests. If the mechanism, which constitutes functioning of the board isn't effective, let that problem be addressed. Recent events have shown increased interference by shareholders in strategic decisions made by the management. This calls for a new chapter in corporate governance "the need to protect a shareholder from fellow shareholders". Professor, I am not into finance by education, but I'll be glad to hear your view on this, even if it is to correct me. Rajansh

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