Governance by Business Decision: Dividends and Shareholder Voting

Abstract

For dual-class companies, stock dividends have become a potent weapon for corporate boards to reallocate control without shareholder intervention. For example, the CBS board proposed to distribute voting stock to all shareholders to drastically dilute the controlling shareholder’s voting power. By contrast, the Google board issued new non-voting stock to all shareholders to perpetuate the controlling shareholders’ lock on control. In both cases, the pro rata distribution of the identical stock seemingly treats all shareholders equally, but it has a starkly unequal impact on each class’s voting power. Are such governance changes by stock dividends within board discretion? The level of board discretion in making stock dividends is primarily governed by each company’s corporate charter, and this Article presents the original, hand-collected data of charter provisions on stock dividends from 222 dual-class companies. The analysis of the charter provisions shows diverse approaches to stock dividends across companies. Largely due to such heterogeneity, interpretation and limitation of charter provisions are often uncertain. At the same time, courts have long treated dividends as boards’ business judgment and declined to second-guess their substantive merits as long as dividends are pro rata. Given the potential impact on corporate governance, however, the need for a distinctive treatment of stock dividends is long overdue. The Article also offers normative suggestions to fill the legal vacuum over stock dividends. First, as an ex ante mechanism, state corporate statutes can provide a set of default provisions on stock dividends to guide companies. Second, as an ex post remedy, the business judgment rule protection should be limited to the narrowly defined pro rata stock distribution (i.e., proportional distribution within the same class of stock). Non-pro rata stock dividends without the approval by adversely affected class should be subject to heightened judicial scrutiny. This is because such stock dividends are not driven primarily by business purpose, are not pro-rata, and sometimes raise concern over the directors’ promotion of self-interest.