Corporate Governance, Shareholder Proposals, and Engagement between Managers and Owners

Abstract

In the corporate governance area, few regulations have greater importance than Rule 14a-8. Put in place in 1942, the provision requires companies to include in their proxy statements proposals properly submitted by shareholders. Phrased in precatory language, proposals typically advise rather than command. Rule 14a-8, therefore, provides a cost effective mechanism for obtaining the collective views of shareholders on the designated matters. The rule did not always play such a central role in the governance process. For the first four decades following adoption, proposals did not receive significant support. Through 1981, only two were approved by a majority of the votes cast. Unsurprisingly, therefore, management often viewed the provision as a soapbox used by “special interest” investors to air issues of little importance to most shareholders. As institutional investors became more active and various regulatory restrictions were lifted, however, Rule 14a-8 assumed a more central role in the governance debate. The rule emerged as an important component of the engagement process between owners and managers. Proposals uniquely provide companies with insight into the collective views of shareholders. Moreover, support for proposals can be assessed over time, allowing managers to better understand the evolution in shareholder attitudes. Proposals also result in increased communications between long-term shareholders and directors, an important development in an era of activist investors. Despite the role of the rule in the engagement process, calls have arisen for additional restrictions that would effectively eliminate use for most shareholders. Characterizing the provision as “dominated by a limited number of individuals” who have pursued “special interests” that “have no rational relationship to the creation of shareholder value”, critics have argued for, among other things, a dramatic increase in the ownership thresholds and holding periods. Similarly, asserting that proposals contain “general social issues” that “rarely garner meaningful shareholder support”, they have sought changes designed to limit these types of submissions. These descriptions do not accurately characterize the state of the shareholder proposal process. Moreover, the calls for additional restrictions cannot be explained as a consequence of an increase in the use of the rule. The number of proposals submitted in recent years are commensurate with earlier periods. Nor is the opposition explainable by the costs associated with proposals. The actual cost of distribution has likely gone down, particularly with the advent of electronic distribution of proxy statements and other technology enabled changes. The expenses associated with the no action process are readily controllable and, in any event, the number of requests have declined from earlier periods. What has changed, however, has been an increase in shareholder support for proposals. While proposals are advisory, they can and do affect the decision making process inside the boardroom. Those favoring significant restrictions on the use of the rule would, presumably, prefer to avoid this type of influence by denying shareholders the right to collectively speak on relevant issues. In addition to conflicting with a board’s fiduciary obligations, the approach will also generate significant unintended consequences. Denying access to Rule 14a-8 will not lessen interest in the relevant issues. It will, however, interfere with the engagement process between owners and managers and force shareholders to pursue other avenues of influence, whether litigation, public campaigns, or broad based regulatory reform. Rule 14a-8 could use some updating, as the student articles published in this edition of the law review forcefully demonstrate. Most of the needed revisions can be implemented through interpretive changes issued by the staff of the Division of Corporation Finance. The interpretations would allow the rule to function more effectively and better reflect the provision’s current position in the corporate governance debate. Current proposals designed to significantly reduce the number of proposals, however, would have the opposite effect. This paper is an introduction to an issue of the online edition of the University of Denver Sturm College. The issue includes articles written by students on all important aspects of Rule 14a-8. This issue is the second of three and includes seven student articles. The articles in this issue address the exclusions for personal grievances (Rule 14a-8(i)(4)) and for the absence of power/authority (Rule 14a-8(i)(6)). In addition, the issue includes articles on disclosure of the identity of the proponent (Rule 14a-8(l)), the evidence needed to establish shareholder eligibility (Rule 14a-8(b)), the number of proposals that can be submitted to a single company (Rule 14a-8(c)), and the time period for submitting proposals to the company (Rule 14a-8(e). For the first issue, see “The Shareholder Proposals Rule and the SEC”. A third issue is anticipated in 2018.