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Roberta Romano on the SEC's Proxy Access Initiative:

I thought the following informative and rather pointed email from Yale Law Professor Roberta Romano would be of interest to many readers (published with her permission):

I thought that I would pass along my reaction to a New York Times article by Gretchen Morgenson in Sunday's business section..... The article in question flunks Corporate Governance 101. Morgenson cites a study by the IRRC as supporting the SEC's proxy access initiative (a regulation proposed by the SEC by a 3:2 vote last week that has been promoted by union funds for quite some time). According to Morgenson, the study found a positive impact from dissidents elected in proxy fights. That is not news; it is well-established in the empirical literature that proxy fights increase value. Indeed, firms experience positive price effects from proxy fights even when dissidents lose.

But those data have no relevance to the proxy access proposal. Proxy fights require challengers to spend their own resources to get on the ballot and solicit votes; proxy access nominations require no such expenditures. In fact, the overwhelming empirical evidence on shareholder proposals, which are also for free and the model for proxy access, indicates that they do not add value. This should not be a surprise: the incentive for getting things right are very different when something is for free. Having to put your money where your mouth is, so to speak, means that you have to have a good grasp on how to resolve perceived problems of a firm, and select board nominees who will be effective. You also need to have a nontrivial stake in a company to engage in such activity, for the cost-benefit to work, and thus, also not surprisingly, the IRRC study Morgenson cites finds the performance impact was higher the greater the dissidents' stake. The proposed proxy access requires no expenditures, and trivial holdings (letting shareholders aggregate their holdings to reach specified levels, depending on firm size). Understanding the difference in incentives provided by the two processes is fundamental to understanding corporate governance; only someone woefully ignorant or intellectually dishonest would regard that data as relevant to the SEC's proposal.

There is nothing wrong with a journalist expressing a point of view, as Morgenson does, with respect to the efficacy of the SEC's proxy access proposal. But it is troubling when a prominent journalist does not consider a requisite part of her job to be seeking out opposing views (i.e., critics of proxy access), if not to provide balance to a piece, to ensure that she has not been misinformed by a like-minded source, and writes something, such as Sunday's column, which is an embarrassment.

byomtov (mail):
I don't actually understand why the effect on performance is relevant here. (Never mind the fact that shareholder proposals are not, IMO, any more relevant to proxy access than actual proxy fights).

This seems like a basic property rights issue to me. The point is that the shareholders actually own the company. If their decisions make things worse so be it. And why would they make things worse? It's not like most corporate boards are demanding overseers, carefully safeguarding shareholders' interests.
5.27.2009 6:54pm
Thales (mail) (www):
Romano writes:

"*You also need to have a nontrivial stake in a company to engage in such activity, for the cost-benefit to work, and thus, also not surprisingly, the IRRC study Morgenson cites finds the performance impact was higher the greater the dissidents' stake.* The proposed proxy access requires no expenditures, and trivial holdings (letting shareholders aggregate their holdings to reach specified levels, depending on firm size). Understanding the difference in incentives provided by the two processes is fundamental to understanding corporate governance; only someone woefully ignorant or intellectually dishonest would regard that data as relevant to the SEC's proposal."

Morgensen wrote:

"But the study, conducted by the Investor Responsibility Research Center Institute, a nonprofit organization, and Proxy Governance, a proxy advisory firm, certainly shows that directors put in place by dissident shareholders do not generally wreak havoc at these companies. In almost 90 percent of the cases, hedge funds were the driving force behind the hybrid boards.

The degree of outperformance registered at these companies varied in surprising ways. One element that seems to affect results was the size of the stake held by the dissident shareholder. The greater the stake, the bigger the gains.

At companies at which dissidents held 5 to 10 percent of shares, for instance, results over the following 15 months moderately exceeded those of their peer groups. But for companies in which the dissidents owned 10 percent to one-quarter of the stock, price appreciation significantly outshone peers, averaging almost 68 percentage points higher over the ensuing 15 months.

Performance at the companies where dissidents held less than 5 percent of shares was only in line with peers, on average."

and "In addition to allaying fears about the impact that dissident directors may have on a company's prospects, the study provides context on the issue of proxy access to shareholders and how broad it should be. That is the view of Jon Lukomnik, director of the I.R.R.C. Institute.

"I think what it says is there is some value to owners being able to challenge existing management and that there are also some limits to that value," Mr. Lukomnik said. "Dissidents can clearly get the market to focus on the hidden value in these companies, but delivering on it takes hard work.""

Sounds pretty intellectually honest to me and like Morgensen solicited balance and context . . . did Romano read the entire article?
5.27.2009 7:23pm
frankcross (mail):
Her theoretical points are good, but they do not completely demean the research. There is a certain threshold for proxy fights today, and they are associated with benefits. What would be the result for circumstances below today's threshold but above that after the change? We don't know, but I wouldn't say the data is irrelevant. It would be a fairly reasonable economic expectation to think that they would have smaller benefits. It might be that they would create negative effects to offset those. But it is relevant.
5.27.2009 7:33pm
devil's advocate (mail):

What would be the result for circumstances below today's threshold but above that after the change?


I believe Romano offers a proxy (sorry . . . not) measure for just that proposition in terms of the lack of value resulting from shareholder proposals, a lower threshold mechanism.

It does seem the primary source acknowledged the predictive quality of a larger dissident faction. It is unclear to me how the proposed changes would affect the likely size, and predictive ability of the dissidents so simply recognizing the graded effect while not speaking to precisely that point seems to gloss over the question.

But it does seem a rather obvious and glaring flaw to use this research as a predicate for results to be expected from essentially no cost opposition.

I don't have particularized faith in disicplined oversight of boards, and I'm not convinced that the current balance of proxy threshold is precisely correct in terms of economic results, but I tend to share the perception that improvements that result from a willingness to expend resources to protect one's share value cannot be equated with results likely to be garnered from free access to challenge the board.

While in theory one's own share value would be at risk, smaller shareholders or small groups of shareholders can have an agenda besides increasing value. This possibility tends to emphasize the relevance of a larger dissident fraction.

Brian

Brian
5.27.2009 10:04pm

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