The House Wants to Squelch Voices of ‘Small’ Shareholders. Research Shows Those Voices Matter.

 
 
Company management frequently seeks to exclude investor proposals even though some ultimately win shareholder support, according to new research by Eugene F. Soltes, Suraj Srinivasan, and Rajesh Vijayaraghavan.
 
 
by Carmen Nobel
Source: iStock

In June 2017, the US House of Representatives passed the Financial CHOICE Act, a 589-page bill designed to repeal many of the regulations in the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010. Buried on page 461 of the bill: a rule designed to prevent the majority of America’s shareholders from voicing their concerns.

When a shareholder has a beef with a company’s business practices, they can submit a formal proposal to suggest a policy change. The company can respond to the proposal in one of three ways: choose to include the proposal in its annual proxy statement, in which case shareholders can vote on whether the company should adopt the change; negotiate with the shareholder to come up with a mutually acceptable solution to the beef; or formally contest the shareholder’s proposal by asking the Securities and Exchange Commission for permission to exclude it from the annual proxy statement. The SEC, however, reserves the right to deny the request—in which case the proposal is included in the statement and put forth for a vote after all.

Source: What Else Do Shareholders Want? Shareholder Proposals Contested by Firm Management.
Graphic created by Blair Storie-Johnson

Right now, the eligibility requirements to submit a shareholder proposal are fairly nonrestrictive: A shareholder must hold either a mere $2,000 of stock in a company or at least 1 percent of a company’s shares. “Even if you have $500,000 of company stock, you’re probably not going to get a sit-down with the CEO,” says Eugene F. Soltes, the Jakurski Family Associate Professor of Business Administration at Harvard Business School, whose research focuses on corporate misconduct and compliance systems. “So these proposals have been a way to give a voice to the other relatively smaller shareholders.”

Under the CHOICE Act, shareholders would not be able to submit proposals unless they owned at least 1 percent of a company’s shares, period. For America’s largest firms that rule change would allow management to ignore the vast majority of shareholders.

For example: If the House version of the CHOICE Act were passed into law, an individual investor in Exxon Mobil would need to own at least $3.49 billion of stock in order to be permitted to submit a proposal for shareholder consideration, based on the company’s market cap of $349.6 billion. So while more than 1,800 of Exxon’s institutional investors would be eligible to submit shareholder proposals under the current law, only 7 (at the time of this writing) would meet the 1 percent threshold.

In high tech, the thresholds grow even higher: Owning 1 percent of Apple stock, for example, requires holdings of more than $8 billion.

Proponents of the proposed rule argue that it would prevent companies from having to consider frivolous proposals from small investors who don’t have much stake in a company’s success. After all, it takes a lot of time and effort for a manager to reject a proposal and beseech the SEC to reject it, too.

“It turns out that shareholders have many different views, and it’s not only the largest shareholders whose proposals have widespread appeal”

The House Financial Services Committee explained it this way in its April 2017 proposal, citing former SEC Commissioner Daniel Gallagher: “The SEC’s shareholder proposal rule…is being abused by special interest groups to advance idiosyncratic goals that may directly conflict with the interests of most shareholders. A proponent, often with little to no skin in the game, can force a company to include in its proxy a proposal, which can touch on any of a wide range of issues, including immaterial social and political matters.”But a new study suggests that small investors actually submit a lot of proposals that are not frivolous at all. Rather, these proposals are respected enough to win widespread shareholder support—despite a firm’s initial attempts to suppress them.

“It turns out that shareholders have many different views, and it’s not only the largest shareholders whose proposals have widespread appeal,” says Soltes, who coauthored the study, titled What Else Do Shareholders Want? Shareholder Proposals Contested by Firm Management, with Suraj Srinivasan, the Philip J. Stomberg Professor of Business Administration at HBS, and Rajesh Vijayaraghavan , an assistant professor at the University of British Columbia’s Sauder School of Business.

A deep dive into shareholder proposals

The researchers hand-collected the 12,627 shareholder proposals submitted to public companies between 2003 and 2015, and then analyzed those proposals that firms had sought to exclude from a proxy vote. They found that firms had contested and sought to exclude 38 percent of the shareholder proposals they received, and that the SEC had disallowed the firms from excluding 27 percent of those. Of those 1,332 proposals that the SEC had allowed to be included on the annual proxy statement despite a firm’s objections, some 21 percent had gone on to win shareholder or firm support.

In short, they found that managers frequently seek to exclude proposals that are actually viewed as legitimate by the majority of the firm’s shareholders.

For example, in 2011, activist investor Ken Steiner issued a proposal to allow Allstate Corp. shareholders to act via written consent rather than only at annual meetings. The SEC declined Allstate’s request to exclude the proposal from the annual proxy. Forced to present the proposal for a vote, Allstate recommended that shareholders vote against it. But the proposal passed anyway—208,979,502 votes for, 188,767,763 against.

Allstate’s annual market cap in 2011 was about $15.74 billion. Steiner owned some 2,100 shares in Allstate, which would have been worth around $200,000—100 times the minimum requirement of $2,000 to issue a shareholder proposal, but well below the 1 percent holding requirement proposed in the CHOICE Act.

“Our analysis shows how such changes would allow firms, especially larger firms, to effectively exclude many—and, in some instances, nearly all—proposals that they receive,” the authors write. “Additionally, we show that many proposals created by smaller, but still substantive shareholders, do win shareholder support. Yet, under the heightened requirements in the proposed revisions to the Dodd-Frank Act, such proposals would never be brought to shareholders for a vote, as they would be excluded.”

Over the sample period of 2003–2015, the researchers identified 280 proposals that gained eventual shareholder support despite the firms initially trying to contest them. (The nature of those proposals varied, but most frequently they focused on executive compensation and issues related to corporate takeover efforts.) Among those, the researchers identified 155 proposals that would have been automatically deemed ineligible under the CHOICE Act, because the shareholders didn’t meet the 1-percent-minimum holding requirement.

At the same time, the researchers found that firms had sought to exclude proposals from small and large investors alike. So it wasn’t as if only the small fish were trying to make waves. Despite the arguably low eligibility threshold of $2,000 worth of holdings, shareholders who submitted contested proposals had median shareholdings of $39,000, the data showed. The mean amount, meanwhile, was $10.7 million in shares, owing to proposals from pension funds, hedge funds, and other large institutional investors.

“Thus, the shareholders whose proposals are contested are often not marginal holders of the firm’s securities,” the researchers write.

Next steps

Soltes hastens to acknowledge that the shareholder proposal process is due for an upgrade. The current rules are based on decades-old regulation. But the research indicates that Congress must be more thoughtful about how to amend the minimum eligibility requirements for shareholder proposals.

“I would certainly not argue with those who say $2,000 is too low a requirement,” Soltes allows. “But I also think we need some common sense; $5- or $6 billion is clearly too high.”

The researchers have shared their study with the SEC, and are hopeful that lawmakers will consider the findings if or when the CHOICE Act makes its way through the Senate.

“It would be nice, when people debate this in legislation, before it’s finally voted on, that people think a little more carefully about how it’s designed,” Soltes says. “The intention for revising the legislation is well past due, but I think it can be done in a bit more balanced way—to protect shareholders while at the same time making sure that people who make proposals have a significant stake in the firm.”

About the Author

Carmen Nobel is the senior editor of Harvard Business School Working Knowledge.

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