The Role of Shareowners

“I know of no safe repository for the ultimate powers of society but the people themselves; and if we think them not enlightened enough to exercise their control with a wholesome discretion, the remedy is not to take it from them, but to increase their discretion by education.”
Thomas Jefferson

An interesting, worthwhile, and even crucial discussion has begun. It entails a fundamental basis of the free market, capitalist economy. As the incursion of government (with its police power) has risen throughout the financial crisis, many news articles and opinion pieces have skirted around the issue without taking it on in a direct manner. It is the elephant in the room: the role of shareowners.

On April 25th, the Wall Street Journal reported that Senator Charles Schumer planned to introduce a bill that would alter corporate governance. Among its features is a provision requiring that investors in companies with publicly traded stock be given an advisory vote on executive pay.

My immediate reaction was: Finally! Maybe the elephant in the room would begin to be discussed.

Until then, the debate seemed myopically focused on what role the Federal Government or regulators should have in setting not just executive compensation, but essentially, compensation deep into the management and employee ranks. The “discussion” of compensation surrounding certain employees at AIG became a loud shriek. When emotions cooled somewhat, the application of the concept began to turn to companies, primarily banks, who had, at the insistence of the Secretary of the Treasury, accepted funds from the TARP. When TARP recipients began to announce plans to repay the government, President Obama weighed in with the idea that compensation matters for all financial firms should become the purview of the Federal government. More recently, the President has been credited with thinking that shareholders should receive more of a say in executive compensation.

Citizens, who do not follow the stock market or its seemingly mundane legal requirements too closely, may seem somewhat unsure about the discussions. After all, ask any business owner, from the corner laundry and dry cleaning proprietor to the executive of a multi-million dollar family business, what his or her role in setting executive compensation is, and you would expect to find that the owners have a fairly significant say.

However, only recently has Congress required an advisory vote on executive compensation by shareholders for recipients of government funds. Other companies have voluntarily adopted advisory votes by shareholders. An advisory vote, though, carries no requirement that a Board of Directors do anything. The Securities Exchange Commission has never seen fit to endow shareholders with any direct power over executive compensation. The SEC has likewise stymied efforts to allow shareholders’ groups to appoint an alternative slate of candidates for the Board or to force other issues to a shareholder vote. In short, shareholders have historically been disenfranchised.

News stories which have appeared in the wake of Senator Schumer’s governance proposal express some of the rationale for this history. In a Wall Street Journal opinion piece, two lawyers and a business professor allege that his proposal “misses the mark” and will in fact have the effect completely opposite of its intention to prioritize the long-term health of a firm. Their argument proceeds along the following line: “excessive shareholder power” with its focus on short-term results created excessive risk taking by executives; these executives were incentivized to engage in risk taking to boost the share price in the short term; the risk taking was not balanced by “prudent regulation;” and the result is the current crisis. Since shareholders do not know what is good for them or for the firm, the authors’ solution is that shareholders should, in fact, have their power further diminished.

At this point, the words of Thomas Jefferson should be recalled. Even if one accepts the “excessive risk taking” premise (lack of wholesome discretion) as the cause of the financial crisis, it does not seem that the remedy should be to remove power from them. A broader understanding of the causes of the crisis would seem to be in order before a rush to disenfranchise shareholders further is embraced.

Bob Decker, CFA

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