Corporate Governance

Delaware Judges, Shareholder Rights, and the Appearance of Bias (Part 3)

By J. Robert Brown

We are discussing the article recently published by VC Strine in the Journal of Corporation Law, "Toward Common Sense and Common Ground? Reflections on the Shared Interests of Managers and Labor in a More Rational System of Corporate Governance," 33 J. Corpo. Law 1 (Fall 2007).    

We have already noted that he does not care for "professional" independent directors, contending that they are too solicitous towards shareholders.  What else doesn't VC Strine like?  Institutional investors, at least those who challenge management.  

His analysis largely starts with a section on "forced capitalism."  These "ordinary Americans" (he may as well have called them "regular folks") invest not into the market directly but through intermediaries.  "It is these intermediaries, and not the forced capitalists, who determine . .. how the mountain of shares owned for their benefit is used to influence the management of public companies."  And those institutions?  What are they like?  Incessant, grasping, short term. 

• At some point, the mantra of "more, more, more" has to stop.  If executive pay, takeovers, and elections have all been addressed in a way that creates greater accountability, will institutional investors back off on precatory proposals?  On the withhold vote?

Moreover, they are motivated by self interest and short term returns.  They "can use the threat of a withhold campaign to bargain for concessions and the seating of some of their favorites by action of the incumbent slate."  It is, as VC Strine believes, something that "smacks of green mail and a hidden form of cumulative voting, the benefits of which arguably flow largely to short-term activist investors." 

Likening shareholder efforts to influence management to greenmail?  The term is entirely pejorative and entirely inapposite.  Greenmail essentially involved the threat of a hostile tender offer to induce management to repurchase shares.  Back in the greenmail days, the threat was meaningful, with the board confronting a disruptive transaction and disruptive changes in management.  The "threat" presented by a withhold campaign has nothing close to the same punch.  They occur rarely and generally don't succeed.  Even if they do, they entail a resignation by the losing director that may or may not be accepted.  Indeed, the only director so far to lose in a withhold campaign did not have her resignation accepted by the board.  But what is clear is that VC Strine believes that even the weak authority to engage in a withhold campaign is excessive.   

As for the actual exercise of leverage, his contention that institutional investors use the threat of a withhold campaign to place their "favorites" on the board is unsupported by any example or authority.  Indeed, while the SEC requires public companies to disclose the process for shareholders to submit nominees to the nominating committee of the board, there is no evidence that this process has in fact resulted in any appreciable increase in the number of shareholder nominees actually getting elected.  The comment, therefore, is not a reflection of what is happening in the market but is a reflection of what VC Strine believes.  And one thing he believes is that shareholders have too much authority. 

Finally, he criticizes institutional investors, noting that they may not have the same interest as "individual index fund investors."  With respect to pension plans in particular, he sweepingly observes that they demand "outsized returns," a product of their own blunders, including "actuarial risks because of underfunding and past investment mistakes."  This need for "outsized returns" has created a "fertile environment" for hedge funds.

In other words, it is a central theme of the piece that institutional investors are a bad thing for corporate America.  They either don't operate under a profit maximizing approach (they may have "non-financial objectives") or if they do seek profits, it is only of the short term kind, a necessity arising from their own investment mistakes.  They have excessive amounts of authority that they use to browbeat management and insert on the board their favorites.  

The role of institutional investors is worthy of debate but are these views appropriate for someone on the bench?  Would an institutional investor like to have its issues litigated in front of VC Strine?  Would it come as a surprise that, even where VC Strine finds improper behavior by management, he would nonetheless discourage such suits by exacting a heavy financial penalty on the intuitional investor with the temerity to bring the suit?  The answer can be found in Portnoy v. Cryo-Cell.  

Full post as published by The Race to the Bottom on March 06, 2008 (boomark / email).