Executive Compensation and Mosquito Abatement: A Public Goods Economic Argument to Revisit Mandated Proxy Access

Abstract

In 2010, the US Court of Appeals for the DC Circuit struck down the mandated “proxy access” rule adopted by the Securities and Exchange Commission (“SEC”) on the grounds that the SEC had conducted a fatally inadequate economic analysis in promulgating the rule. This paper argues that the SEC can, and should, revisit the rule and consider one particularly compelling economic factor in favor of proxy access: The long-acknowledged economic condition called the “public goods” problem. “Public goods” analysis describes why market forces alone, in the absence of government intervention, historically under-provide socially beneficial “goods” such as national defense, fire protection, unpolluted air and water, or mosquito abatement. Similarly, the public goods dynamic prevents the dispersed mass of public company investors from having a meaningful mechanism to control agency costs generally, and runaway executive compensation costs in particular. The paper discusses three premises underlying this argument: (1) that a public goods problem must be addressed by government intervention, because market forces have already failed in a predictable way; (2) that corporate and financial managers and their apologists reflexively, and vehemently, defend even bad status quo business practices that benefit them, reviewing the experience of 80 years ago when government intervention, in the form of the securities laws, addressed the public goods problem of the under-supply to investors of corporate business information; and (3) that even though agency costs are inevitably incurred by companies, excessive executive compensation represents a specific type of agency cost that most boards currently do not constrain. The paper concludes that mandated proxy access represents an appropriate — and economically necessary — intervention by government to address the failure of the market to provide investors in all publicly traded companies with a mechanism to improve the accountability of board members to shareholders rather than to management, and thereby to improve the chances of addressing excessive executive compensation.