Shareholder democracy and the curious turn toward board primacy.

• Author: Hayden, Grant

ABSTRACT

Corporate law is consumed with a debate over shareholder democracy. The conventional wisdom counsels that shareholders should have more voice in corporate governance, in order to reduce agency costs and provide democratic legitimacy. A second set of theorists, described as "board primacists," advocates against greater shareholder democracy and in favor of increased board discretion. These theorists argue that shareholders need to delegate their authority in order to provide the board with the proper authority to manage the enterprise and avoid short-term decision making.

In the last few years, the classical economic underpinnings of corporate law have been destabilized by a growing recognition that shareholders are not a homogeneous group of wealth maximizers. This recognition has, among other things, undercut the arguments made in support of the typical corporate structure where shareholders alone possess the right to vote in corporate elections. Board primacy seems well-positioned to retheorize corporate law to adapt to this new reality. In their analyses of the issue, however, board primacy theorists have conflated two very different aspects of group decision processes: the responsiveness of the governance system and the composition of the electorate. This confusion ends up putting many board primacy theorists in the curious position of moving away from the public choice emphasis on preference aggregation toward a more civic republican model of less responsive, more deliberative decision making.

By restricting the franchise, board primacists have detached their governance structures from the underlying desires of their constituents without substituting anything in their place. We argue, however, that the breakdown of this particular distinction between shareholders and other constituents could mean that we should investigate treating other constituents more like shareholders, rather than the other way around.

TABLE OF CONTENTS INTRODUCTION I. CORPORATE GOVERNANCE IN A POLITICAL CONTEXT II. THE THEORIES OF BOARD PRIMACY A. The Traditional Story of Shareholder Primacy 1. Shareholder Primacy 2. Shareholder Homogeneity and the Right To Vote B. The Counter-Narratives of Board Primacy 1. The "Wise Ruler" Theorists 2. The "Long- Term Interests" Theorists III. BOARD PRIMACY, BOARD RESPONSIVENESS, AND THE COMPOSITION OF THE ELECTORATE A. System Responsiveness to the Electorate B. Board Primacy and Shareholder Homogeneity C. Board Primacy and the Corporate "Good" D. The Road Less Taken: Other Constituencies into Corporate Governance CONCLUSION INTRODUCTION

Shareholder democracy is back from the dead. Dating back to Berle and Means' autopsy of corporate democracy, (1) it had long been assumed that the shareholder franchise was relatively meaningless--a de jure power with little de facto effect. (2) Building on reforms from the 1970s, 1980s, and 1990s, however, scholars have taken an ever-more aggressive stance towards shareholder empowerment. (3) Institutional shareholders and the advocacy groups that represent them have become powerful players in corporate boardrooms and in the public markets. (4) With this new emphasis on the role of shareholders, it is only natural to focus on the power to vote--which is, after all, the power to select those who control the company. Given the course of corporate law scholarship, strengthening the shareholder franchise is the logical next step.

Corporate law centers on the relationship between the corporation, the board, and shareholders. And the primary concern of corporate law scholarship has been to reduce the agency costs imposed upon shareholders by delegating those powers to the board and its appointed officers. (5) Successive waves of scholarship have carried in new suggestions for reform, such as the facilitation of the takeover market, (6) the expanded use of independent directors, (7) and greater reliance on intermediaries. (8) It only makes sense for reformers to look to the franchise, as it is the direct structural power source for shareholders. Shareholders can vote out directors and officers; strengthening the franchise is the most meaningful way to fulfill the norm of shareholder primacy. (9)

Thus, much of corporate law scholarship of the past decade has focused on shareholder democracy. The most well-known shareholder democracy advocate in academia is Lucian Bebchuk. (10) In earlier work, Bebchuk advocated for pro-shareholder reforms such as eliminating staggered boards, (11) monitoring managerial pay more carefully, (12) and preventing boards from vetoing takeover bids that have been approved by shareholders. (13) Bebchuk's recent work has focused on fostering shareholder democracy as a way of effectuating shareholder primacy. (14) Other commentators in academia and the business press have also advocated for pro-democracy reforms. Institutional shareholders are taking their voting rights more seriously, and the proxy advisory sector continues to grow in size and importance. (15) The SEC has yet again proposed changes to the proxy that would allow for greater shareholder access, (16) and shareholders have also tried to take matters into their own hands with shareholder proposals and bylaw amendments that would facilitate their voting power. (17)

It may seem hard, as a rhetorical matter, to be against shareholder democracy. However, there are a set of commentators and theorists who remain committed to the old ways. (18) Instead of advocating for greater shareholder involvement, they advocate for greater board independence. (19) Rather than exposing the board to the will of the electorate, they believe the board should be insulated from such exposure. (20) Instead of shareholder primacy, they argue for some variant of board primacy--namely, that the board, not the shareholders, should be the focus of the corporation.

Theories of board primacy have developed relatively recently, perhaps in part because shareholder democracy has languished so long. These theories and their policy prescriptions represent an important body of thought about the nature and purpose of corporate structure. Rather than following the fairly intuitive notion that voters should have more power to choose their representatives, board primacists argue for a more insulated board. (21) They do so for a variety of reasons--some common, some variegated. But they all believe that facilitating shareholder democracy, and thereby shareholder power, would create costs that would outweigh the purported benefits. (22)

At this stage of our inquiry into the shareholder franchise, it is important to consider the counter-revolutionary turn toward board primacy. (23) This Article seeks to disentangle the various justifications for board primacy and thereby illustrate the underlying value judgments and practical assumptions made by board primacists. As a result, we argue that board primacists may in fact be a rather unstable coalition--one that might be best served by a reexamination of their underlying interests.

In Part I of this Article, we situate the corporate governance debate within the larger context of democratic theory, focusing on the basic distinction between public choice and civic republican approaches to social decision making. Part II of the Article is devoted to an examination of the standard law-and-economics underpinnings of shareholder primacy and the destabilization of those underpinnings by recent research showing that shareholders are not the homogeneous group of wealth maximizers they were once thought to be. The Article then turns to the approaches of board primacy theorists. These theorists, despite having a wide range of normative goals, all argue for governance structures that put greater distance between the shareholder electorate and the board.

The crux of the Article is in Part III, where we critically evaluate the resulting position of board primacy theorists in the context of democratic decision making. Initially, the arguments for many of their positions rely upon a conflation of two very different aspects of group decision-making processes: the responsiveness of the governance system and the composition of the electorate. This confusion ends up putting the board primacy theorists in the curious position of moving away from the public choice emphasis on preference aggregation toward a more civic republican model of less responsive, more deliberative decision making. But by restricting the franchise to shareholders, they have needlessly detached their governance structures from the underlying preferences of their constituents without substituting anything in their place. In other words, these theorists have become civic republicans without any meaningful sense of the public (or, in this case, corporate) good.

1. CORPORATE GOVERNANCE IN A POLITICAL CONTEXT

   Corporate governance scholarship has largely concerned itself with structuring corporations in a way that maximizes the utility of corporate constituents. (24) Corporate constituents are variously defined, but typically include shareholders, employees, suppliers, customers, and creditors. (25) Sometimes this list is expanded to include others who don't necessarily contract with corporations but are nonetheless affected by corporate decisions, such as neighbors, towns, or, even more generally, society. (26) A corporation should be organized in the way that allows it to best increase social welfare, however defined. (27)

   The mechanisms of corporate decision making are many, extending from the top to the bottom of a corporate hierarchy. As creatures of state law, corporations must follow the specific requirements set forth by each state for corporate formation. The corporation must have a person or set of persons who serve as the situs of responsibility and authority on behalf of the fictional corporate person. (28) In almost all corporations, this locus of power is the board of directors. (29) The board has the...