Institutional investors and their role in corporate governance: reflections by a 'recovering' corporate governance lawyer.

• Author: Porter, David P.
• Position: Institutional Investors in Corporate Governance: Heroes or Villains

The Symposium's title question "Institutional Investors in Corporate Governance: Heroes or Villains?" is intentionally so broad that it leaves wide open the limits of discussion. In this Article, I will focus my remarks on my perceptions, based on my experiences over twenty-seven and one-half years of practice, about the intersection between institutional investors and corporate governance in the corporate, non-litigation setting.

To put my comments in perspective, I'll begin with some comments on the role of the corporate governance practitioner. I'll then discuss my views concerning "corporate governance," including the differences between what I term "procedural corporate governance" and "substantive corporate governance," and point out the fundamental difference in the corporate governance model here in Ohio, which is a "constituency state," from that of Delaware, which is not. I'll provide my thoughts on what good corporate governance is in practice, which necessarily includes some of my biases toward corporate control issues in general. With that background in place, I will then discuss how I believe institutional investors have influenced corporate governance, mostly for the good but sometimes for the bad, by examining:

* their role in establishing the current baseline of corporate governance practices in the primary U.S. public capital markets,

* their role in the Rule 14a-8 shareholder proposal process,

* the already large impact of proxy voting advisory services, and the potential game changing impact from the impending revocation of broker discretionary voting authority,

* the hidden world of shareholder "jawboning,"

* the somewhat recent emergence of "hedge fund attacks," and

* the role of institutional investors in the ultimate battleground of corporate governance: takeover fights.

1. THE CORPORATE LAWYER'S ROLE IN CORPORATE GOVERNANCE

   I come to this Symposium as a "recovering" corporate governance lawyer, someone who has only recently moved from active practice into the academic world. Until January 1, 2009, I was a partner in a major global law firm, representing numerous publicly-traded U.S. corporate clients, and advising management teams and boards about corporate matters across a broad spectrum of issues. Those issues frequently involved the relationships of corporate executives or Boards of Directors with the corporation's shareholders and with each other--interactions commonly recognized today as corporate governance issues.

   I am also an active participant in developing Ohio's corporate governance law. As a member of the Corporation Law Committee of the Ohio State Bar Association, which monitors developments in corporate law and is the primary source for Ohio legislation in the corporation law field, I have led or participated in numerous drafting assignments and chaired various subcommittees, ultimately serving as Vice Chair (2005-2007) and Chair (2007-2009) of the Committee. In those capacities, I have testified numerous times before committees of the Ohio General Assembly on proposed corporate legislation, including a number of measures directly affecting corporate governance. (1)

   Throughout my years of practice, and as I heard echoed in some of the remarks earlier in this Symposium, I have observed a tendency by some observers of corporate governance to view corporate lawyers, especially those at large firms, as primarily "defenders of management" and presumptive enemies of good corporate governance. I vehemently disagree. I'll start off by discussing what I see as the proper role of corporate governance lawyers.

   My perspective is that of a corporate lawyer, a non-litigator. In the corporate governance arena, the corporate lawyer serves primarily as an "advisor." Under the Model Rule of Professional Conduct (the "Model Rules"), (2) and their Ohio analog ("Ohio Rules"), (3) an advisor is one who "provides a client with an informed understanding of the client's legal rights and obligations and explains their practical implications." (4) While at times a corporate governance lawyer may also be an advocate, negotiator, or evaluator, (5) the corporate governance lawyer's principal role is to counsel the Board of Directors and officers about corporate governance laws, rules, and related matters, their implications for the corporation's behavior, and the relationships among various corporate constituencies. As a counselor, the primary task is to propose practical, workable solutions to relational issues, and to minimize litigation risks for the client.

   But in the lawyer's role as an advisor on corporate governance matters, who is the client? The short answer, under ethics rules (6) and the securities regulations that are often applicable to corporate governance lawyers, (7) is the entity--the corporation itself. Of course, in representing an entity, there must be some human representatives to whom the lawyer reports and from whom the lawyer receives instructions. (8) In a corporate setting, the representative will sometimes be a member of the Board of Directors, especially in special counsel assignments. More typically, however, the relationship is conducted primarily through the general counsel, the chief executive officer or another executive officer, or some combination of those officers. As is vitally important for both the lawyer and the officers to understand, the corporate lawyer is ultimately a servant of the Board of Directors, just as the officers are. The Board (the group of directors collectively, not individually) is legally recognized to be the highest day-to-day decision-making authority for the entity. (9) Therefore, in a fight between the Board and the officers, or the Board and individual shareholders, the corporate lawyer must take his instructions from, and owes his allegiance to, the Board. (10)

   In most corporate work, such as corporate finance or mergers and acquisitions, there is no tension between management and the Board, because they are working together to achieve a common corporate goal. But conflicts can, and do, arise whenever the interests of the officers conflict with those of the entity. The greatest ethical test for the corporate governance lawyer is to recognize when a conflict exists between the interests of individual officers or individual directors and the interests of the entity. (11) It is then that the lawyer must understand that his duty is to the entity, and be prepared to give his best advice to the Board. Such a scenario is almost always the situation when one speaks of corporate governance.

2. WHAT IS "CORPORATE GOVERNANCE"?: PROCEDURE VS. SUBSTANCE

   It has been accurately stated that "[until the 1990s the phrase] corporate governance was rarely uttered outside the arcane world of law school texts and academic treatises." (12) Although I practiced what we today call "corporate governance law" in the 1980s, we then called it "corporate counseling." Surprisingly, given all of the attention (13) that has been given to "corporate governance" during the last two decades, the term itself is still not well-defined. It has been variously described as "the system by which companies are directed and controlled" (14) or more fulsomely as "the set of processes, customs, policies, laws, and institutions affecting the way a corporation is directed, administered, or controlled. Corporate governance also includes the relationships among the many stakeholders involved and the goals for which the corporation is governed." (15) Robert A.G. Monks and Neil Minow, in their excellent treatise entitled Corporate Governance, now in its fourth edition, (16) define corporate governance aspirationally, as "the structure that is intended to make sure that the right questions get asked and that checks and balances are in place to make sure that the answers reflect what is best for the creation of long-term, sustainable value." (17) While closer to the mark, even this fails to capture what I think people mean when they refer to "corporate governance."

   A broader, more complete, definition is simply how a corporation is run. I see corporate governance as actually constituting two vastly different matters. The first is procedural in nature--that is, what is the system by which the corporation makes fundamental decisions? The second is substantive--who makes the decisions and did what they decide actually result in a good outcome for the corporation? The process is readily measurable by third parties against objective standards, while the substance is largely immeasurable, at least in real time. This is because the true outcome of the decision-making cannot actually be known until sometime in the future, and any present day evaluation requires at least some degree of crystal-bailing as well as a high degree of subjectivity. Process also yields itself readily to lawyer intervention (we are architects and engineers of a sort, quite able to design and implement systems, policies, and procedures). (18) Substance, on the other hand, does not. Nevertheless, some Boards or management may choose to involve lawyers in matters of substance, although in such cases the lawyer is acting more in the capacity of a sophisticated business counselor or wise man (i.e., someone who can intelligently tell a Board or CEO that what they plan to do is stupid). (19) This is not the normal role of most corporate lawyers, though many may aspire to become so regarded by their clients.

   Certainly, when lawyers speak of corporate governance, they mostly mean procedural corporate governance. And as I'll discuss, many of the activities of institutional shareholders are focused primarily on procedure as well. Yet what I think most shareholders really care about, and really mean by corporate governance, is not "how does the corporation make its decisions?" but "do the people running my corporation produce good outcomes?" (20) The answer to "is it well run?" is best measured by financial results, not...