27 Pages Posted: 30 May 2012
Date Written: Spring 2004
This Article suggests a solution to what is perhaps the central problem of corporate law: the separation of ownership and control. Events of the last few years have shown how this system of separation can break down when boards of directors are unable or unwilling to monitor the management adequately. These boards lacked "independence" from management, either because of outright conflicts of interest, a network of social ties, or simply a general culture of board passivity.
Part I of the Article outlines the problems with the current method of board selection and functioning. Management or management-sympathetic board members often select the board nominees, who share social ties with other board members. Boards tend to avoid "rocking the boat" by questioning management's recommendations, and because of the way the proxy process is structured, shareholders cannot effectively use their votes to oust unsatisfactory board members.
Part II analyzes the SEC's recent proposals for reform, which center on granting shareholders more opportunities to nominate candidates to the board. These proposals attempt to give shareholders a greater voice in the election process, but do so circuitously. They require that nominating shareholders be independent from the candidates they nominate, missing the point that it is precisely those individuals with a stake in the corporation that will make the best monitors.
Part III presents the mechanics of the proposed solution, suggesting that the company offer the largest shareholder independent of management a spot on the company's slate of director candidates (an offer tantamount to a board seat, given the structure of the proxy process). If the largest such shareholder did not accept the position, it would be offered to the next-largest shareholder, and so on until the seat was filled. Because adoption of such a nomination process would be voluntary, only companies that strongly desired to signal their status as upstanding practitioners of responsible corporate governance would be likely to implement it. The Part concludes by pointing out that in the venture capital context, investors routinely sit on the board in order to monitor and protect their investments.
Part IV then explains how having a shareholder representative on the board solves many of the problems that other proposed reforms do not. Part IV responds to potential criticisms, chief among which is that the Sarbanes-Oxley Act and other corporate reforms render further action unnecessary. The Article's response is that regulators, like generals, always fight the last war. Sarbanes-Oxley, and the new listing rules instituted by NASDAQ and the NYSE, prohibit Enron- and WorldCom style problems, such as loans to corporate officers, off-balance sheet transactions, and conflicts of interest in company auditors. None of these reforms contemplate structural changes that will prevent new kinds of frauds in the future.
The Article concludes that it makes sense to let corporations, and therefore the market, decide whether putting a shareholder on the board is desirable.
Keywords: Corporation Law, Board of Directors, Board Selection, Corporate Governance, Board Independence, Independent Directors, Private Securities Litigation Reform Act of 1995, Sarbanes-Oxley Act, shareholder-director, SEC
JEL Classification: K22
Suggested Citation: Suggested Citation
Rodrigues, Usha, Let the Money Do the Governing: The Case for Reuniting Ownership and Control (Spring 2004). Stanford Journal of Law, Business, and Finance, Vol. 9, pp. 254-280, 2004; UGA Legal Studies Research Paper Forthcoming. Available at SSRN: https://ssrn.com/abstract=2070800