Volume 3, Issue 1 (2013) – Shareholder Activism

Foreword

Marc Weingarten

ARTICLES

Improving Director Elections

Bo Becker and Guhan Subramanian

It is well known that U.S. director elections are largely a formality: incumbents typically nominate themselves, for elections that are almost always uncontested, and are re-elected with virtual certainty. The result, as illustrated by the recent debacle at J.P. Morgan Chase, is what one might expect: directors who are elected not for their qualifications but rather because shareholders simply have no other choice. In the aftermath of the 2008/2009 financial crisis, efforts were made to improve corporate democracy. The introduction of majority voting, the introduction of eProxy rules, and elimination of broker voting of uninstructed shares were predicted to dramatically improve the vibrancy of the director election process. Our analysis, based primarily on data from the 2007–2011 proxy seasons, indicates that these reforms have been ineffective in achieving their stated goals. Specifically, we find that: (1) only two incumbent directors who did not receive a majority of the votes cast have actually left their boards; (2) not a single insurgent candidate has made use of eProxy; and (3) only one director election outcome has changed due to the elimination of broker voting of uninstructed shares. We also find no evidence that these reforms have influenced the “shadow” negotiation between the board and major shareholders in favor of shareholders. In contrast to these reforms, our research suggests that a properly designed proxy access regime has the potential to meaningfully improve the director election process at U.S. corporations.

 

Who Calls the Shots? How Mutual Funds Vote on Director Elections

Stephen Choi, Jill Fisch, and Marcel Kahan

Shareholder voting has become an increasingly important focus of corporate governance, and mutual funds control a substantial percentage of shareholder voting power. The manner in which mutual funds exercise that power, however, is poorly understood. Because of the economic structure of mutual funds, there are particular reasons to be concerned about the extent to which mutual funds may seek to economize on the cost of their voting decisions by employing short cuts or delegating voting decisions to proxy advisors. These concerns, if true, hamper the potential effectiveness of regulatory reforms such as proxy access and say on pay.
This Article analyzes mutual fund voting decisions in uncontested director elections—an area in which the likelihood that funds will employ voting short cuts is high because the information costs of informed voting are high, and the stakes are low. We find evidence that mutual funds use various cost-saving measures but that the incidence of implicitly delegating voting authority ISS is less than commonly believed, especially for larger funds. Only a small proportion of mutual funds as measured by asset size appear to vote in “blind reliance” on ISS recommendations. Although ISS recommendations are extremely important, their importance seems to take the form of identifying problematic directors, forming a focal point around which funds may consider withholding their votes. Most funds do not appear, however, to follow these recommendations automatically. To the contrary, as measured by asset size, more funds seem to blindly follow management recommendations than blindly follow ISS.
We examine, in more detail, the voting behavior of the three largest mutual fund families:Vanguard, Fidelity, and American Funds. Together these three families account for more than one third of total mutual fund assets. We find that with respect to uncontested director elections the funds in these families vote largely in lockstep. Voting decisions of the three fund families differ substantially both from each other and from ISS recommendations. This is strong evidence of heterogeneity in the voting behavior of mutual funds in director elections.
Finally, we examine the factors associated with high “withhold” votes in director elections. Although an ISS “withhold” recommendation is a key factor in triggering a high “withhold” vote, the effectiveness of the recommendation is limited unless it is combined with an additional factor. We identify four significant additional factors: a “withhold” vote by Fidelity, the director missing 25% of board meetings, the company having ignored a shareholder resolution that received majority support, and a Vanguard “withhold” vote on outside directors with business ties to the company. Our findings suggest steps that companies and directors should take to reduce the likelihood of receiving a high “withhold” vote.

The Commercial Real Estate Bubble

Adam J. Levitin and Susan M. Wachter

Two parallel real estate bubbles emerged in the United States between 2004 and 2008, one in residential real estate, the other in commercial real estate. The residential real estate bubble has received a great deal of popular, scholarly, and policy attention. The commercial real estate bubble, in contrast, has largely been ignored.
This Article shows that the commercial real estate price bubble was accompanied by a change in the source of commercial real estate financing. Starting around 1998, securitization became an increasingly significant part of commercial real estate financing. The commercial mortgage securitization market underwent a major shift in 2004, however, as the traditional buyers of subordinated commercial real estate debt were outbid by collateralized debt obligations (CDOs). Savvy, sophisticated, experienced commercial mortgage securitization investors were replaced by investors who merely wanted “product” to securitize. The result was a decline in underwriting standards in commercial mortgage backed securities (CMBS).
The commercial real estate bubble holds important lessons for understanding the residential real estate bubble. Unlike the residential market, there is almost no government involvement in commercial real estate. The existence of the parallel commercial real estate bubble presents a strong challenge to explanations of the residential bubble that focus on government affordable housing policy, the Community Reinvestment Act, and the role of Fannie Mae and Freddie Mac.

America’s Changing Corporate Boardrooms: The Last Twenty-Five Years

Jay W. Lorsch

Since 1987 there have been many significant, positive changes in the manner in which boards of American public companies conduct themselves. In our first book published in 1989, Pawns or Potentates: The Reality of America’s Corporate Boards, Elizabeth McIver and I found that boards were acting more like pawns and not so much as the potentates they were legally intended to be. By 2001, Colin Carter and I concluded in Back to the Drawing Board: Designing Boards for a Complex World that many, if not most boards of public corporations had adopted new “best practices” and were trying to live up to their legal obligation to be potentates. Many boards, however, in the United States and other countries, were still struggling to meet these legal expectations. Despite all of the progress that has been made, boards still face many difficulties, especially oversight of complex multinational corporations and companies that operate several lines of business.
In this Article, I outline several significant changes in corporate boardrooms over the past twenty-five years and use those lessons to propose a thought experiment about how boards can be shaped in the future. I argue that the major problems in the last twenty-five years have been the negative, unintended consequences of reforms and the inability to balance the interests of the various stakeholders. Future policymakers should turn their attention to resolving these issues, because they have the potential to thwart other attempts at progress.

Fair Markets and Fair Disclosure: Some Thoughts on the Law and Economics of Blockholder Disclosure, and the Use and Abuse of Shareholder Power

Adam O. Emmerich, Theodore N. Mirvis, Eric S. Robinson, and William Savitt

In March 2011, our law firm (Wachtell, Lipton, Rosen & Katz) formally petitioned the Securities and Exchange Commission to modernize the rules promulgated under Section 13(d) of the Securities Exchange Act of 1934. The petition sought to ensure that the reporting rules would continue to operate in a way broadly consistent with the statute’s clear purposes, and that loopholes that have arisen by changing market conditions and practices since the statute’s adoption over forty years ago could not continue to be exploited by acquirers, to the detriment of the public markets and security holders. Among other things, the petition proposed that the time to publicly disclose acquisitions of over 5% of a company’s stock be reduced from ten days to one business day, given investors’ current ability to take advantage of the ten-day reporting window to accumulate positions well above 5% prior to any public disclosure, in contravention of the clear purposes of the statute.
In their article
The Law and Economics of Blockholder Disclosure, Professors Lucian A. Bebchuk and Robert J. Jackson Jr. challenge the need for any modifications to the ten-day reporting window. Bebchuk and Jackson argue that, given the purported benefits of blockholder accumulations, extensive cost-benefit analysis should be done before Section 13(d)’s reporting rules are modified.
We argue that Bebchuk and Jackson offer no sound basis for the cost-benefit analysis they suggest nor any reason to question the need for the modernization of Section 13(d)’s reporting rules proposed in the petition. Specifically, we explain that Bebchuk and Jackson’s position follows largely from an erroneous interpretation of the statute’s legislative history and that the blockholder interests for which they advocate run directly contrary to Section 13(d)’s underlying purpose—“to alert the marketplace to every large, rapid aggregation or accumulation of securities.” We also discuss how developments in market liquidity and trading—which allow massive volumes of public company shares to be traded in fractions of a second—have made the Section 13(d) reporting regime’s ten-day reporting window obsolete, allowing blockholders to contravene the purposes of the statute by accumulating vast, control-implicating positions prior to any disclosure to the market. Finally, we explain how corporate governance developments since the passage of the Williams Act offer no reason to fail to update Section 13(d)’s reporting rules. To the contrary, we note that the blockholder reporting rules in other major capital markets jurisdictions only confirm the need to modernize the Section 13(d) reporting regime to ensure that it once again fully achieves the statute’s express purposes.

Towards the Declassification of S&P 500 Boards

Lucian Bebchuk, Scott Hirst, and June Rhee

This Article provides an overview and analysis of the work that the Shareholder Rights Project (SRP) undertook on behalf of a number of institutional investors during 2012, the SRP’s first full year of operations. During 2012, the SRP worked on behalf of SRP-represented investors on board declassification proposals submitted for a vote at the 2012 annual meetings of 89 S&P 500 companies, and this work has produced substantial results.
First, negotiated outcomes involving a commitment to board declassification were reached with 48 S&P 500 companies––slightly over half of the companies receiving proposals. Following the agreements into which these 48 companies entered, 37 of the companies brought management proposals to declassify for a vote at 2012 annual meetings, and 11 companies will do so in their future annual meetings.
Second, declassification proposals brought by SRP-represented investors received majority support at the 2012 annual meetings of 38 S&P 500 companies (all but 2 of the annual meetings in which such proposals went to a vote), with average support of 82% of votes cast.
Third, a total of 42 S&P 500 companies declassified their boards during 2012 as a result of the work of the SRP and SRP-represented investors (including declassifications following 2012 agreements, 2011 agreements with SRP-represented investors, and successful 2012 precatory proposals). The 42 companies whose boards were declassified during 2012 represent one-third of the 126 S&P 500 companies that had classified boards as of the beginning of 2012.
The work of the SRP and SRP-represented investors is expected to produce a significant number of additional board declassifications during 2013 as a result of (i) management declassification proposals that will go to a vote pursuant to 2012 agreements, (ii) companies agreeing to follow the preferences of shareholders expressed in 38 successful precatory declassification proposals, and (iii) ongoing engagement by the SRP and SRP-represented investors. We estimate that, by the end of 2013, this work will have contributed to movements towards board declassification by a majority of the 126 S&P 500 companies that had classified boards at the beginning of 2012.
Finally, beyond board declassification, the SRP’s 2012 work also facilitated a substantial increase in successful engagement by public pension funds and in their ability to obtain governance changes favored by shareholders. The proposals that the SRP worked on represented over 60% of the shareholder proposals by public pension funds that received majority support in 2012, and over 30% of all precatory shareholder proposals (by all proponents) that received majority support in 2012.

 

NOTE

Chapter 13 Debtors’ Home Loss in the Foreclosure Crisis

Joshua L. Boehm

The foreclosure crisis that began in 2007 and continues as of 2012 has heightened interest in whether chapter 13 bankruptcy helps families in financial distress save their homes and prevent foreclosure. This Note studies whether homeowners who filed chapter 13 bankruptcy were able to keep their homes during the foreclosure crisis. Using a sample of homeowners who filed chapter 13 bankruptcy in 2007 in Broward County, Florida, a hard-hit area in the foreclosure crisis, I find that half of chapter 13 debtors lose their homes within three years of seeking bankruptcy relief. An additional 22% of the sample continued to own their homes but were in foreclosure. I estimate linear regression models on home loss and find that being in foreclosure at the time of filing bankruptcy, the months in arrears at filing, and debtors’ mortgage-to-income ratios and loan-tovalue ratios predict home loss. In the foreclosure crisis, chapter 13 was only modestly effective in saving homes. Drawing on these findings, I offer implications for financial regulatory reform, including Consumer Financial Protection Bureau rulemaking and legislative proposals on mortgage modification. For chapter 13 to become a useful instrument in combating foreclosures, I conclude, policymakers must focus on the need for troubled homeowners to file bankruptcy sooner in the home default process.