A Framework for Analyzing Legal Policy Towards Proxy Contests

Abstract

In this paper, we develop a framework for analyzing the desirable legal policy towards proxy contests and apply this framework to assess the rules governing the allocation of costs in proxy contests. Proxy rules affect efficiency in three ways: they influence who will engage in proxy contests, they have an impact on who wins proxy contests, and they affect ex ante managerial behavior. Taking these effects into account, we examine how the three main dimensions of choice in the design of proxy rules - success contingency, neutrality, and the level of reimbursement - can be varied to make allocation rules more efficient. We conclude that the present rules, which provide full reimbursement to incumbents but reimburse challengers only if they gain control of the company, should be modified in three ways: to give incumbents less than full compensation and make it contingent on success, to make challenger compensation contingent on the fraction of votes received rather than on whether they gain board control, and to provide for more generous compensation to challengers in contests over matters other than the election of directors. We further argue that companies should be free to adopt rules more favorable to challengers, and less favorable to incumbents, than the standard proxy rules; however, companies should be restrained from opting for rules favoring incumbents over challengers.