Shareholder Voice in Corporate Charter Amendments.

• Author: Min, Geeyoung

1. INTRODUCTION II. EXISTING THEORIES ON CHARTER AMENDMENTS A. Law: Checks and Balances in Charter Amendment Process B. Theoretical Concerns over Midstream Amendments 1. Board's Exclusive Right to Propose Charter Amendments 2. Failure of Shareholder Right to Veto Charter Amendments III. NEW EMPIRICAL EVIDENCE OF CHARTER AMENDMENTS A. Data Description B. The Change in Charter Amendment Trends 1. The Change in Frequency 2. The Change in Substance a. Declassification of The Board b. Majority Voting Requirement in Uncontested Director Election c. Shareholders' Right to Call a Special Meeting d. Elimination or Relaxation of State Anti-Takeover Statutes C. The New Dynamics in Charter Amendments 1. Institutional Shareholders as Pivotal Voters 2. The SEC's New Rule and No-Action Letters 3. Proxy Advisory Firms and Shareholder Pressure a. Internal Pressure: Shareholder Proposals b. External Pressure: Market Forces IV. COMPROMISED IMPLEMENTATION AS THE NEW BATTLEGROUND A. The Implementation of Compromised Proposals 1. Increase of Minimum Ownership Threshold 2. Addition of Procedural Requirements B. Managements' Preemption by Compromised Terms C. The Desirability of Compromised Implementation in Charters V. POLICY IMPLICATIONS FOR COMPROMISED IMPLEMENTATIONS A. Why do Compromised Implementations Deserve More Attention? B. Shareholders' Chance to Challenge Compromised Implementations 1. The SEC's Restrictive Application of Rule 14a-8(i)(10) 2. State "Opt-in" Default Law to Resolve Issues with Competing Proposals VI. CONCLUSION I. INTRODUCTION

   How has the recent rise of shareholder activism altered the dynamics of charter amendments? Can the new dynamic alleviate conventional concerns about managerial opportunism in charter amendment process? This Article tackles these two fundamental questions in corporate law and governance focusing on companies' most foundational governing documents: corporate charters. (1)

   In 2009, the majority of the shareholders of Raytheon Company ("Raytheon") approved a shareholder proposal asking the company to grant the right to call a special shareholders' meeting to holders of 10% or more of the company's stock. (2) During the following year, although the outcome of the vote had no legally binding effect on the company, Raytheon's board responded by making its own proposal to amend its corporate charter to grant such right, and the charter was amended accordingly. (3) Back in 2005, the company was in a similar situation. After shareholders passed a proposal demanding the declassification of the board in 2004, a management-sponsored proposal to declassify the board was approved by the majority of its shareholders. (4)

   As this episode demonstrates, over the past decade, shareholders have actively expressed their preferences on corporate governance arrangements manifested in the companies' charters and bylaws, and managers have become more responsive to their demands. In the process, corporate charters and bylaws have become an important battleground for shifting the relative rights of shareholders over those of managers.

   The existing literature on corporate charters has expressed concerns over managers' opportunistic charter amendments, particularly with respect to midstream amendments that take place after a firm's initial public offering. (5) Such concerns are bolstered by two important observations. First, directors' exclusive right to initiate a charter amendment allows directors to pursue an amendment only when it favors them. (6) Second, once the initial charter provisions are set, shareholder approval requirements cannot effectively check directors' opportunistic amendments. Dispersed shareholders often lack requisite information to properly evaluate the proposals and face a collective action problem since they feel their votes will not be likely to influence the voting outcome. (7) Due to such structural impediments, prior literature has argued that midstream charter amendments tend to favor directors over shareholders.

   Notwithstanding extensive theoretical literature, there has been no systematic empirical analysis to validate how such theories measure up to the current practice of corporate charter amendments. This Article offers the first comprehensive analysis of this issue, using an original dataset exclusively on corporate charters of the 221 largest publicly traded companies from 1994 to 2015. The new data, which is comprised of mostly midstream charters, uncovers a dramatic change both in frequency and substance of charter amendments. Charters were much more actively amended starting around 2005, and the number of amendments between 2005-2015 was almost five times larger than that between 1994-2004. More importantly, and contrary to the concerns expressed in the prior literature, the Article shows that recent charter amendments tend to empower shareholders. (8)

   Since 2000, changes in the corporate governance environment including the rise of shareholder activism in general and the increase of institutional investor ownership in large companies in particular, (9) do not fully explain why the shift in charter amendments was sudden, rather than gradual. Based on the data and interviews with practitioners, this Article shows that the SEC's new rule-making became the epicenter of the changes in charter amendments. The Commission promulgated a new rule in 2003 imposing fiduciary duty on mutual funds in proxy voting. (10) Further, two no-action letters in 2004, the SEC staff confirmed that relying on proxy advisory firms' recommendations would likely cleanse mutual fund of conflicts of interest and satisfy their fiduciary duty of loyalty to their investors. (11) The no-action letters significantly increased the influence of proxy advisory firms in proxy voting by giving mutual funds a strong incentive to rely on their voting recommendations. (12)

   At the same time, however, shareholder activism and the consequent charter amendments have not always produced the sought-after effects. In the Raytheon episode above, the management proposal made one modification to the minimum ownership threshold of the shareholder proposal: the right was given to those who owned 25% of the stock, rather than 10%. (13) Furthermore, another shareholder proposal with the 10% threshold, concurrently submitted in 2010, was excluded from the proxy ballot because it conflicted with company's proposal. (14) Regardless of this threshold increase, shareholders approved management's proposal and the company's charter was amended accordingly. The fact that the shareholders only have a choice of either approving or rejecting the management proposal significantly impedes shareholders' power to challenge compromised proposals. (15)

   The popularity of compromised implementation has been magnified by proxy advisory firms' voting recommendations and the no-action letters from the SEC. First, when it comes to the issue of granting a new right to shareholders, proxy advisory firms have not sufficiently alerted shareholders to vote against management proposals which place onerous restrictions on that right. For instance, ISS, by far the most influential proxy advisory firm, consistently recommends voting for management-modified proposals. (16) Second, the SEC staff has also contributed to the spread of management's compromised implementation by granting no-action relief to companies seeking to exclude shareholder proposals that challenge management's modifications.

   After laying out the institutional context and the analysis of the data, this Article suggests practical implications for compromised implementation. I argue that the SEC should allow shareholders to challenge managements' preemptively compromised implementation by granting no-action letters restrictively, in order to secure a more transparent bargaining dynamic between shareholders and directors. Additionally, an adoption of state "opt-in" default law provision making a shareholder proposal binding in two specific cases would mitigate the distortion created by a competing shareholder proposal when it receives sufficient votes to amend charters.

   This Article is organized in four parts. Part I introduces current state and federal laws on the charter amendment process, and theoretical concerns over managers' opportunistic behavior in midstream charter amendments. Part II provides the first systematic analysis of the new trend in charter amendments, using new, hand-collected data, and explains how the SEC's new rule and subsequent no-action letters have played an important role in substantially facilitating charter amendments that generally empower shareholders. Part III highlights managements' compromised implementation of shareholder requests. Finally, Part IV explores the normative implications on compromised implementation based on the foregoing theoretical and empirical analysis.

2. EXISTING THEORIES ON CHARTER AMENDMENTS

   A corporate charter is the most foundational document that governs how a company is organized and managed. (17) A corporate charter is the primary document because the charter supersedes other documents of the company, including its bylaws, which are invalid to the extent that they conflict with its charter. (18) Once a company files its charter with a state, the corporate law of the chosen state will automatically fill the gaps in the company's charter. Since state corporate laws are composed mostly of default rules, each company has ample discretion to customize its corporate charter. Particularly with a midstream charter amendment, which occurs after companies have gone public, there have been questions whether managers are enhancing their own agendas at the expense of shareholders by tailoring the charters in their favor. There has been little data to answer these questions. In order to better understand this debate as well as the recent trend in charter amendments, this Part first focuses on the procedural mechanics of the...