Accountable Strategies blog

A blog about accountability issues in the public, private, and nonprofit sectors

More on shareholder power

Posted by David Kassel on May 31, 2007

Does the center of power in a corporation reside in its executives, its board of directors,  its shareholders? As previously noted here, at least one researcher is changing some long-held views that the shareholders’ interests are paramount. 

The work on the dynamics of corporate shareholder and board power by Lucian Bebchuk at Harvard is proving to be groundbreaking in that it is challenging some long-held assumptions–in particular about the power of a company’s investors, the true owners of its wealth.  Bebchuk’s seemingly counter-intuitive but well-researched findings point to the conclusion that the corporate deck is stacked in favor of the company’s executives and the board of directors, and that the shareholders are relatively powerless outsiders.

As Jonathan Chait notes in The New Republic, Democrats in Congress are currently proposing a bill that would simply give a company’s shareholders an advisory say on how much the company’s CEO can be paid.  But even that would apparently represent too much of a shift in power.  President Bush has promised to veto the measure.

Chait cites the work of Bebchuk and Jesse Fried at Berkeley, who have found evidence supporting the theory that disporporationate increases in CEO pay during the past decade have been at least partly due to the fact that boards of directors, which set CEO compensation, are more accountable to the CEOs than to the companies’ shareholders.

In “Insider Luck,” an article in Harvard Magazine,  Bebchuk discusses his research on the less-than-arm’s-length arrangements that often exist between executives and boards of directors and some of the implications of that close relationship, particularly regarding executive compensation. 

Much of the executive pay issue has revolved around controversial provisions granted by boards to corporate executives of stock option grants and the opportunistic timing processes of granting them, such as backdating.   Stock-option grants have largely consisted of  rights to purchase shares at a price equal to the company’s stock price on the grant date.  Bebchuk and colleagues, examining more than 19,000 stock option grants during the decade from 1996-2005, found that a day was most likely to be chosen as the grant date for awarding options if the stock price was at the lowest level of the month. 

The so-called “lucky grants” were more likely to occur when a company’s board lacked a majority of independent directors, as well as when the CEO had been in place for a long time.  Opportunistic timing of outside directors’ grants was also more likely to occur when the firm had more “entrenching provisions” (weaker shareholder rights) that protect insiders from the risk of removal.

The passage of the Sarbanes-Oxley Act in August 2002 required firms to report grants within two days of any award.   Bebchuk noted that the legislation reduced but did not eliminate the backdating.

Bebchuk has done much of his research on the power of “entrenched” boards whose members are particularly insulated from removal.  For instance, in “The Costs of Entrenched Boards”, Bebchuk and Alma Cohen found that “staggered” boards of directors, in which not all directors are up for re-election in one year, are associated with a reduction in the market value of companies that have them.  Staggered boards are more insulated from removal than boards in which all members are up for re-election at the same time.

Bebchuk calls on investors to press boards to make executive pay arrangements fully transparent, sensitive to performance, and not subject to gaming.  He warns that bonus payments are as susceptible—probably more susceptible—to gaming than stock-option plans.  In fact, he notes, bonus payments have historically been only weakly linked to performance.  And the ability to game bonus compensation is helped by companies’ common use of “constantly shifting short-term performance metrics whose specifics are generally not disclosed to shareholders.”

Bebchuk maintains that the rules governing corporate elections should be reformed to provide shareholders with a viable power to replace directors.  And barriers to shareholders’ ability to place changes in governance arrangements on the ballot and adopt them should be dismantled.  It’s a prescription, however, that doesn’t appear to be going down easily either on Wall Street or in Washington.


One Response to “More on shareholder power”

  1. Herschel said

    A friend of mine and I had a discussion on this subject some time ago.(

    It is a fact that the investors are the owners and ultimate power in publically traded company.

    Most of the abuse and issues in today’s world occur in the Fortune 1000. The problem with the mega companies is that the majority of the investors are large mutual and hedge funds and they don’t have the same investment goals/time-lines as the small investor.

    Any business structure that man comes up with can be gamed by the insiders. The only real solution for small investors is to “value invest.” Only invest in companies that have great management and great products. Read the proxy statements that you get in the mail and research the company’s compensation report. If the executive team is overpaid, DON’T put your hard earned money into that company. Yes, it is a little simplistic, but it is the only real course of action you have unless of course, you have a few billion like Warren and can buy controlling interest.

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