End Corporate Demockary – Part One

The Shareholder Activist - End Corporate Demockary“Corporations determine far more than any other institution the air we breathe, the quality of the water we drink, even where we live. Yet they are not accountable to anyone.”

Those words were on the 1991 cover of Power and Accountability: Restoring the Balances of Power Between Corporations and Society by Robert A.G. Monks and Nell Minow, long before 2010 when the United States Supreme Court ruled that the First Amendment prohibits government from placing limits on independent spending for political purposes by corporations in Citizens United v. Federal Election Commission. It was a great awakening. Many more began to realize how much power over our government we had ceded to corporations.

In 1987 Time magazine estimated that “of the 170 countries that exist today, more than 160 have written charters modeled directly or indirectly on the U.S. version.” More recently, David Law and Mila Versteeg compared constitutions world wide and found ours losing influence. ”Nobody wants to copy Windows 3.1,” says Law. Our constitution fails to protect entitlements to food, education and health care and is considered by many to be “frozen in amber.” In contrast, the Canadian Charter is seen by those in developing countries as “more expansive and less absolute.”

Many are now engaged in a movements, such as “We the People,” to “end corporate rule” and “legalize democracy.” While I support those efforts, a multi-pronged approach aimed at “legalizing” democracy both within our governments and within our corporations is needed. While many have written a great deal about political democracy, fewer have drawn attention to the need for corporations to be more democratic. Since corporations have so much control over our governments, we can’t take control of our government without a higher degree of control over how our corporations are governed. It is a symbiotic relationship.

What would you do if the company in which you’ve invested your hard earned dollars frittered it away so that an investment of $20,000 is now worth $3,000? David Monier, a shareowner at Princeton National Bancorp, Inc (PNBC), decided he wasn’t going to sit by idly. He utilized model United State Proxy Exchange language and reports his proxy access proposal will be included on PNCB’s proxy. If adopted, it would allow:

  1. 1. Any party of one or more shareowners that has held continuously, for two years, one percent of the Company’s securities eligible to vote for the election of directors, and/or
  2. 2. Any party of shareowners of whom one hundred or more satisfy SEC Rule 14a-8(b) eligibility requirements ($2,000 worth of stock held for a year),

This is significant because shareowners don’t have access to place their nominees on corporate proxies. Their proxies are treated as management proxies. If shareowners want to nominate directors they must hire a soliciting firm and mail out their own proxies. Since costs can be in the millions, only hedge funds can generally afford to do it and they are often looking to break up the company and sell off the parts.  Monier will also be nominating Steve Bonucci from the floor of the annual meeting, so there is a real opportunity for change. Let’s hope CalPERS, PERA and other institutional investors at PNBC support this move initiated by a retail shareowner.

Some proposals, like Monier’s, are driven by shareowners who believe their companies retain substantial value but that value is jeopardized by poor corporate governance… often poor oversight by corporate boards.  Others, especially after Citizens United, are concerned their corporations are donating to bad political causes or should just get out of politics. Many have turned to the Center for Political Accountability for assistance in filing proposals seeking disclosure of corporate spending.  Still other investors are concerned with social or environmental issues like hydraulic fracturing. They are requesting greater disclosure of measures the company has taken to manage and mitigate the potential community and environmental impacts. Like political campaigns, those attempting to democratize corporations from the inside also face a Sisyphisian task.

The reality is that if you don’t like the way management handles your business, you have traditionally had two choices: hold your nose or sell out. The message is usually the same whether dispensed by Barron’s, Merrill Lynch or the manager of many “socially responsible” investment funds. Selling out is taking the “Wall Street Walk.”

Dumping stocks compounds the short term investment horizon plaguing Wall Street. The average stock is now held for 22 seconds, according to some. Although such high speed trading guarantees “liquidity” (buyers and sellers are always there), it has moved us from an ownership to a casino economy.  The Wall Street Walk is often wrong for the investor, the quality of our products and environment, the treatment of employees, our balance of payments, and society-at-large. The real issue is often not last quarter’s balance sheet but the company’s strategic direction and the integrity of its management.

Part One

Corporate Governance

Corporate governance, the nuts-and-bolts of how a public company fulfills its responsibilities to investors and other stakeholders, is frequently overlooked in debates over corporate social responsibility. Despite its still relatively low profile, it’s where much of the real action is going on when it comes to positively changing corporate behavior.

In 1932, Lewis Gilbert owned 10 shares in New York’s Consolidated Gas Company and found his questions were ignored at the annual meeting. Lewis and his brother pushed for reform. Finally, in 1942, the Securities and Exchange Commission adopted a requirement that companies put shareholder resolutions or proposals to a vote under specified circumstances. In 1967 organizer Saul Alinsky and several national churches turned to shareholder activism to target Kodak’s poor record of minority hiring.

Later, the social investment community focused on high profile, public campaigns aimed at divestment of corporations involved in perceived social injustices such as involvement in apartheid South Africa, Union Carbide’s Bhopal or GM’s Corvair.  Although such shareholder actions certainly had an impact, most won only a small fraction of votes. Progress resulted because targeted corporations wanted to minimize adverse publicity.

Corporate governance actions spearheaded by huge, multi-billion dollar pension funds such as CalPERS, the California Public Employees’ Retirement System, began to change the balance when such social concerns were also seen as affecting share value. Their entry provided the foundation for the beginnings of a much larger degree of meaningful self-regulation of businesses by owners.

Robber Baron Accountability

At the turn of the century, corporations were dominated by “captains of industry.” Carnegie, du Pont, Mellon, Morgan, Rockefeller, and others owned large blocks of stock and exercised direct control over their investments. “Agency costs” were minimal because ownership and control were embodied in the same individuals. Corporations were accountable to their owners.

By 1932, however, Adolph Berle and Gardiner Means documented a significant shift in their book The Modern Corporation and Private Property. Ownership had become so dispersed that control had shifted from owners to managers. Owners essentially traded their ability to monitor management for increased diversification and liquidity. Being an active shareholder no longer paid because, despite potential gains to shareholders as a group, it was no longer rational for any one shareholder to act. Why shoulder the entire expense of corporate activism for only a small portion of the gains while other shareholders get a “free ride?”

Mark Roe, a professor of law at Columbia University, reexamined the historical evidence and concludes that our corporate system based on strong managers and weak owners is not the inevitable result of large scale production as Berle and Means assumed. Instead, it is the unintended consequence of political decisions which reflect the public’s dislike of concentrated financial power. The framework of corporate democracy, much of which developed in reaction to the stock market crash of 1929, restored public confidence by subordinating finance to commerce and providing legitimacy for the otherwise uncontrollable growth of power in the hands of a few private individuals.

The New Deal’s Glass-Steagall Act separated investment and commercial banking. Similar laws limited control of stock by insurance companies and mutual funds. Together, they insured that financial institutions could not easily control industry, but they also restricted collective action. Although these reforms may have saved us from the real evils of concentrated wealth and power in the finance sector, they had the unintended result of ensuring that management of America’s corporations would soon be accountable to no one. The framework of corporate governance set up in the aftermath of the 1929 crash has the appearance of being democratic (one share, one vote) but lacks basic mechanisms to carry out more than an illusion.

Since the 1930s, “corporate governance” has consisted primarily of attorneys engaged in theoretical debates about reducing “agency costs” – essentially inefficiencies which arise when the “principles” (stockholders) hire an “agent” (chief executive officer, CEO) whose interests differ from their own. Shareowners want their shares to increase in value and pay higher dividends; the CEO wants status, a high salary, bonuses and perks. The Holy Grail for those in the field of corporate governance has been to develop a variety of rewards and punishments to better align the CEO’s interests with those of the shareowners. Instead of actively participating in corporate governance issues, shareowners became passive. With few options left to them, dissatisfied owners were told by the system to love it or leave. That strategy became known as the “Wall Street Walk” or the “Wall Street Rule.”

Read Part Two of this 3 part series next week.

To contact James McRitchie directly, please email jm@corpgov.net

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Posted in Corporate Governance, Featured, Shareholder Policies & Investor Regulations | 1 Comment

One Response to End Corporate Demockary – Part One

  1. Christopher Bayer, Ph.D. says:

    If we know anything, we know that corporations have an extraordinary amount of global power and control across world cultures. And money! I think it’s fair to say that this is a valid example of propositional knowledge espoused by early Greek epistemologists.

    Money is the backstory of history. It has been essential for the creation of civilization and democracy. Niall Ferguson’s astute treatise on this subject is extraordinary (“The Ascent of Money: A Financial History of the World”).

    Demockary is a blended word which comes from democracy and mockery. It occurs “when the actions of democratic governments, or their agents, make a mockery of the democratic process, as in denying citizens participation in decisions that will impact their lives.” Highbeam.com highlights a guest editorial on this process as related to a Public Service Commission problem.

    Corporations generally deny shareholders anything but minimal participation in their business. In order to be heard shareholders must be empowered to utilize the tools provided to them by TheShareholderActivist.com. Companies, more often than not, forget that it’s our business, and that we have a voice pitched to ensure sustainability.

    Psychologically, money seduces, lures, blinds, steamrolls and bankrolls, sustains, controls, helps innovate and invent, and so forth and so on. Money is a terrific tool. Keep in mind, however, people will do anything for money. View “Margin Call,” modeled after the Lehman debacle for some insight and flavor about money and survival. Whether or not the love of money is the root of all evil (the Biblical context), or the lack of money is the root of all evil (George Bernard Shaw’s poverty laden Ireland) is a matter for another day (post).

    Corporate rule is not inherently democratic. Corporations march to their own drummers (orchestras), and embrace and promote their own agendas which are not always in synch with the public good, the public trust, or shareholder needs and objectives. Costco is a sterling exception. They deeply respect shareholders and share value.

    Proper corporate governance enhances share value. McRitchie aptly notes: a company’s strategic direction and management’s integrity are essential for sustainability. And social concerns can affect share value as well. The world investment community’s divestment in South Africa was a prime example of righteous moral positioning. Apartheid’s oppression nearly destroyed a magnificent country.

    The issue of agency cost is an important feature of the problem. Divergent management and shareholder objectives and information asymmetry are key problem areas in corporate operations. Information asymmetry that exists between shareholders and the CEO is an example of a “principal-agent problem.” The agent (the manager) is working on behalf of the principal (the shareholder) who is not able to observe the actions of the agent. Information asymmetry can create moral hazards in a corporation. At those junctures, the actors (management, bondholders, board of directors, labor, and other stakeholders) can become embroiled in conflicts of interest, differential goals and objectives, and varying needs disputes. Chaos can ensue which jeopardizes profit and sustainability.

    Bottom-line: in well run companies, trust, brains, integrity, and judgment are essential. In fact, they are mandatory. The generic role of quality corporate governance is to develop creative, behavior modification platforms and systems which align the CEO’s interests with those of shareholders. Proper and expansive shareholder inclusion in the board room will counter corporate demockary. We are all partners in the enterprise. Costco CEO Jim Sinegal has added huge value for shareholders, customers, and employees (Jason Strip, 1/4/2012, morningstar.com).