The President of the Business Roundtable once infamously said that "[c]orporations were never designed to be democracies ..." (1) American courts respectfully disagree and have repeatedly held that the democratic rights of shareholders are sacrosanct. (2) The context for the Business Roundtable President's comment was the battle over say on pay--a battle the Business Roundtable lost in the United States with the passage of the financial reform legislation known as Dodd-Frank. (3)
As I will explain in this piece, courts' robust conception of corporate democracy rights for shareholders should protect both shareholders' ability to have a say on pay and a say on politics. Say on pay is the practice in United States, among other nations, of mandating a non-binding shareholder vote on executive compensation at publicly traded firms. (4) A shareholders' say on politics does not yet exist in America. But theoretically, just as say on pay mandates shareholder democracy in the case of executive remuneration, say on politics would require shareholders to vote on corporate political spending. (5) Binding say on politics votes already exist in the U.K. (6)
Critiques of say on pay and say on politics have been couched as constitutional objections based on either the Tenth or First Amendments of the U.S. Constitution. But at their heart, these objections seem less rooted in the text of the Constitution and more inspired by a cribbed conception of shareholders' corporate voting rights. To untangle who has the stronger legal argument requires a review of how American courts have conceptualized "corporate democracy." I conclude that as framed by key courts such as the U.S. Supreme Court, the D.C. Circuit Court of Appeals and the Delaware state courts, "corporate democracy" is a capacious enough concept to justify both shareholders' say on pay and say on politics.
PART I. CORPORATE DEMOCRACY
In contrast to the argument raised by some businessmen and academics that corporations are not democratic institutions, American courts have held repeatedly that an important aspect of American corporations are their procedures of corporate democracy. The phrase "corporate democracy" appears in Justice Kennedy's opinion in Citizens United--a case that empowers corporations to spend money in American elections, but requires that that spending be transparent. (7) As Justice Kennedy wrote for the eight-person majority of the Supreme Court:
Shareholder objections raised through the procedures of corporate democracy ... can be more effective today because modern technology makes disclosures rapid and informative.... With the advent of the Internet, prompt disclosure of expenditures can provide shareholders and citizens with the information needed to hold corporations and elected officials accountable for their positions and supporters. (8) What Justice Kennedy meant by "procedures of corporate democracy" is not entirely self-evident as he neglected to provide a definition, but at the very least the quoted language above from Citizens United indicates that Justice Kennedy believes that shareholders' holding corporate managers accountable for their political spending is appropriate. Typically the way that shareholders hold managers accountable is through voting their proxy card at an annual or special meeting of shareholders.
As a matter of background, on a typical corporate proxy card there are four items that are subject to a shareholder vote on an annual basis: (1) the election of directors, (2) the appointment of auditors/accountants, (3) management proposals and (4) shareholder proposals. (9) As will be explained in more detail below, shareholders in publicly traded firms now have the right to vote on a fifth category of executive compensation. (10) And each of these five categories are properly a subject of "corporate democracy."
While Justice Kennedy used the term "corporate democracy" without providing a clear definition in Citizens United, other cases have articulated what the Supreme Court means by the phrase "corporate democracy." In 1964 in Borak, the Supreme Court noted that federal securities laws are meant to empower corporate democracy or what the Court referred to as "fair corporate suffrage." (11) Then in 1991, in Virginia Bankshares, the Supreme Court quoted the legislative history of the Securities Exchange Act of 1934 about the centrality of shareholders' voting rights: "[a]ccording to the House Report, Congress meant to promote the 'free exercise' of stockholders' voting rights, and protect '[f]air corporate suffrage,' from abuses exemplified by proxy solicitations that concealed what the Senate Report called the 'real nature' of the issues to be settled by the subsequent [shareholder] votes." (12)
Given Delaware's prominent role in American corporate law, another useful source for defining the meaning of "corporate democracy" is Delaware case law. (13) Delaware is the center of gravity for American corporate law because so many firms choose Delaware as their locus of incorporation. As the New York Times reported in 2012, "[n]early half of all public corporations in the United States are incorporated in Delaware. Last year, 133,297 businesses set up here. And, at last count, Delaware had more corporate entities, public and private, than people--945,326 to 897,934." (14)
Admittedly, directors occupy a place of primacy in U.S. corporate governance. (15) Nonetheless, the way directors get their authority within the corporate structure is through shareholder elections. Akin to the U.S. Supreme Court, the Delaware courts have been quite protective of the ability of shareholders to vote for new directors. (16) As one of the lower courts in Delaware noted, "shareholder franchise is the ideological underpinning upon which the legitimacy of [corporate] directorial power rests." (17) Or as the Supreme Court of Delaware once explained:
The Courts of this State will not allow the wrongful subversion of corporate democracy by manipulation of the corporate machinery or by machinations under the cloak of Delaware law. Accordingly, careful judicial scrutiny will be given a situation in which the right to vote for the election of successor directors has been effectively frustrated and denied. (18) A decade later, the Delaware Supreme Court made clear, "[b]ecause of the overriding importance of voting rights, this Court and the Court of Chancery have consistently acted to protect stockholders from unwarranted interference with such [voting] rights." (19)
In a 2012 case decided two years after Citizens United, the Delaware Supreme Court reaffirmed these earlier Delaware precedents, stating in no uncertain terms: "[s]hareholder voting rights are sacrosanct. The fundamental governance right possessed by shareholders is the ability to vote for the directors the shareholder wants to oversee the firm. Without that right, a shareholder would more closely resemble a creditor than an owner." (20) Other American courts agree protecting the right of shareholders to vote for directors of their choice is a vital role played by the judiciary. (21)
Meanwhile, the influential D.C. Circuit Court, which reviews many of the federal rules promulgated by the Securities and Exchange Commissions (SEC), has also had the opportunity to flesh out what it means by the concept of "corporate democracy" in the context of SEC Rule 14a, which governs corporate proxies at public firms. (22) The D.C. Circuit's views of corporate democracy includes the following iterations:
It is obvious to the point of banality to restate the proposition that Congress intended by its enactment of section 14 of the Securities Exchange Act of 1934 to give true vitality to the concept of corporate democracy. The depth of this commitment is reflected in the strong language employed in the legislative history: Even those who in former days managed great corporations were by reason of their personal contacts with their shareholders constantly aware of their responsibilities. But as management became divorced from ownership and came under the control of banking groups, men forgot that they were dealing with the savings of men and the making of profits became an impersonal thing. When men do not know the victims of their aggression they are not always conscious of their wrongs.... Fair corporate suffrage is an important right that should attach to every equity security bought on a public exchange. (23) The language above appeared in a case where shareholders at Dow (24) used a shareholder resolution to try to implore the firm to stop producing the chemical weapon napalm for the Vietnam War. (25) As the SEC Historical Society sums up the matter, "a shareholder of Dow Chemical sought inclusion in the company's proxy of a request to corporate directors for the company to stop selling napalm to any buyer unless there was a reasonable assurance that the product would not be used against any human being. Dow refused to include the statement and the SEC declined to take action to force the inclusion." (26) This led to the shareholders suing the SEC.
In the Dow case, the D.C. Circuit expounded upon the rights of shareholders in publicly traded firms under SEC Rule 14a to vote on political and social issues through shareholder resolutions on corporate proxy cards. As the Court explicated:
We think that there is a clear and compelling distinction between management's legitimate need for freedom to apply its expertise in matters of day-to-day business judgment, and management's patently illegitimate claim of power to treat modern corporations with their vast resources as personal satrapies implementing personal political or moral predilections. (27) This case proved to be a watershed moment for increasing the scope of permissible shareholder proposals. (28) Shortly thereafter, the SEC changed Rule 14a-8 to allow for shareholder proposals on social and political matters. (29)