Bringing balance back into the relationship with shareholders

While shareholders' views are important and should be taken into account in board decision-making, companies cannot be managed efficiently by shareholder referendum.

That is the view expressed by Ira Millstein and Holly Gregory, two partners of the US-based international law firm Weil, Gotshal & Manges, and their associate Rebecca Grapsas, in their annual reflection on corporate governance.

The authors convey their concerns about the tensions that have developed over the roles and responsibilities in the corporate governance framework for public companies.

They say the board's fundamental mandate under law – to "manage and direct" the operations of the company – is under pressure, facilitated by federal regulation that gives shareholders advisory votes on subjects where they do not have decision rights.

"Some tensions between boards and shareholders are inherent in our governance system and are healthy," Millstein, Gregory and Grapsas write. But they call on boards and shareholders to smooth away excesses on both sides to ensure a framework in which decisions can be made in the best interests of the company and its varied shareholders.

On the board side, the writers say directors need to be mindful that shareholders have legitimate interests in the governance of the company and this includes communicating their concerns to the board, whether via shareholder proposal or some other method of engagement. To be able to assess and parse shareholder concerns, boards also need to know who the company's shareholders are and appreciate that their interests are not monolithic.

"Shareholders who seek change are neither necessarily seeking changes that are harmful or undermine the board's responsibilities, nor are they necessarily seeking changes that are in the company's best interests. Boards must discern, in each particular situation, whether a shareholder is seeking to promote interests that are broadly in keeping with the company's long-term interests and the interests of other shareholders."

"On the shareholder side, shareholders need to appreciate that while their views are important and valuable – and should be taken into account in board decision-making – companies cannot be managed efficiently by shareholder referendum," write Millstein, Gregory and Grapsas.

They add: "Shareholders should be especially wary of proxy adviser policies that threaten to make precatory proposals that receive a majority of votes cast effectively compulsory, thereby shifting decision-making power from boards to shareholders. The rapid rise of powerful proxy advisers is the unforeseen – and yet to be addressed (by the Securities and Exchange Commission) – accelerant in the increasing tensions between boards and shareholders.

"All too often, shareholders are delegating their voting power to third parties whose business model depends on both attaining ever more influence through the growth of shareholder rights and making voting recommendations on a low cost basis. This leads to continual expansion of the governance practices that the proxy advisers advocate and an over-reliance on rigid corporate governance prescriptions on a 'one size fits all' basis."

While the authors support efforts by shareholders to have their voices heard on governance matters, they add: "We also believe that there is – and should be – a limit to shareholder power in the interests of efficient and effective corporate decision-making. The board of directors is and should be the locus of most corporate decisions; shareholding is, after all, designed to enable passive investment participation in the company. Shareholders should seek to replace directors when they do not perform well, but shareholders should also give directors a fair degree of deference (or rope)."