Wednesday, March 16, 2011

The Appearance of Reality: Board Elections

The Appearance of Reality: Elect

What do we mean when we talk about electing directors? 

2010 culminated a period of years during which the fundamental dynamics of Corporate Governance were diluted into virtual meaninglessness.  Recently, I’ve been thinking about words that that seem straightforward but whose meanings has become less and less clear to me (see Appearance of Reality post 3/13/11).  We all know what these words mean in a literal sense but in the context of governance, of business and of our post-crash world do they still mean the same thing? 

Over the next few weeks we invite your input on some core governance concepts.  We hope to better understand what is meant when we use these terms in relation to governance and business and even politics.  I look forward to your thoughts -- comment on the site or write to me at 


To start, the process by which directors are chosen is described as an election. And yet, virtually no one would describe the reality of how individuals accede to board membership as an election in the sense that word is generally understood by political scientists. Without pausing overlong to describe the actualities, it is at least clear that no individual appears on the company’s proxy statement for election to a vacancy except with the approval of the chief executive officer and the incumbent board members. It is equally clear that there are only as many individuals enumerated on the proxy card as there are vacancies.

All of this compels the conclusion that the election is a ritual without meaning in the corporate world. Why then do we insist on using a word that plainly does not describe what actually happens?  This evokes the marvelous novels describing “double think” – 1984 and Brave New World

“This was where “doublethink” came into play, minds were trained to hold contradictory positions simultaneously and unquestioningly- for example you had to believe at one and the same time that Democracy was impossible and that the Party was the guardian of democracy.” (Orwell, Nineteen Eighty-Four)

Here are my questions:

  1. What does election mean in the context of governance and corporations?
  2. Does a corporation function optimally under democratic or autocratic leadership?  In other words, is it clear that centralized leadership is essential for maximizing corporate values and that "democratic" influence is distracting?  Can centralization be harmonized with accountability?

  3. Is there some justification for the deliberate misuse of a word that is an important part of corporate governance?

March 16, 2011 in corporate governance , management , ownership , shareholder resolutions , shareholder rights , Disinformation  |  11 comments  | 

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Posted by Bob Monks on Mar 25, 2011 at 2:19 PM
Alex -- Possibly, the problem could be put in better focus either if the government or a private litigant brought suit against an Institutional Fiduciary based on negligence in discharging their responsibilities with respect to portfolio securities. In many cases, this suit could also allege a conflict of interest. Why have such suits not been brought ?

Dean -- The consistent question is the accountability of power conferred on to corporations to any kind of public entity – shareholders, government, ngo – motivated to monitor, capable of evaluation, and powerful enough to require enforcement.
Posted by Alex Todd on Mar 22, 2011 at 9:11 PM
I just ran across this blog posting by Ian Fraser on, entitled "The UK government is wrong; investors cannot be relied upon to police corporate behaviour" (see that supports my concerns about current shareholder-based approaches to attaining board accountability. It goes one step further, by criticizing popular (including my own) emphasis on public pension funds to act in the long term interests of corporations and society.

I share his concern, since structural problems within such institutions would have to be addressed before one can realistically expect requisite reform in their investment policies.

Although "money talks" and institutional investors have a strong voice, a more direct approach may ultimately be required. I believe Shann Turnbull provides the most sound recommendations for reforming corporate governance practices for optimal board accountability when he recommends "network governance". Even so, I am not sure what would be an effective catalyst for any meaningful structural change, given institutionalized vested interests.

If we apply the "might is right" principle as a guide to identifying the catalyst, perhaps emerging economies will have the biggest long-term influence on corporate governance reforms. Given their stronger government influence on corporate governance practices and board accountability, as Bob mentioned in his earlier comment, which would be difficult for U.S. companies to accept, Shann Trunbull may offer a viable compromise that facilitates corporate self-governance, while improving board accountability.

In summary, I believe we are barking up the wrong tree when calling for board accountability to shareholders alone. However, I fear we have a long, winding, and slippery road ahead in transforming corporate governance accountability to a more viable and sustainable system.
Posted by Dean Bouridis on Mar 22, 2011 at 6:13 PM
Board governance, executive roles and responsibilites of Board member change and accomodate any influences exerted by local, regional, continental and global economic conditions and demands.

Board governance varies by global region. One finds the ethics, practices and laws governing a sovereign state often reflect the principles by which a corporation, NGO or governing body is governed and monitored within that jurisdiction.
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Posted by Alex Todd on Mar 22, 2011 at 11:52 AM
Bob and Jim,

Thank you for your responses to my initial comments.

Let me be clear. I totally agree that boards must be accountable to society and not be allowed to become entrenched, self-perpetuating sources of corporate power.

In my mind, the primary question to be resolved is the means by which boards are controlled by society. As Bob mentions, in many countries, boards are accountable to governments, which is philosophically undesirable in the United States. However, there are other options, such as having multiple boards, as is the case in Germany, and more generally with network governance, as recommended by Shann Turnbull.

When I say I favor director primacy, I am applying the principle that an accountable and effective board should be given the benefit of the doubt by shareholders and other stakeholders. Shareholder meddling in board affairs is counterproductive. We should either trust the board and allow them to apply good business judgment or replace them through an appropriate process. As a matter of principle, I am therefore not in favor of shareholder "say-on-anything," whether non-binding or binding votes.

Society either trusts the board to do its job, or it does not. The level of trust can be measured by the extent to which legitimate stakeholders (typically shareholders) choose to exercise their rights to establish trust in the board. Current trends that give increasing voice and rights to shareholders indicate that boards have lost the trust of shareholders and their government.

We will know that corporations are being well governed when corporate boards are given respect and latitude to independently exercise good business judgment in a business environment that holds them fully accountable for their actions, but where stakeholders choose not to interfere with the board's work.

We need to find a way to restore dignity to the role of board membership rather than perpetuating the process of discrediting the role through adversity and polarization. I believe public pension funds can play a key leadership role in affecting these changes. The Canadian Coalition for Good Governance appears to have embarked on this course. Nevertheless, I remain vigilant for signs of institutional entrenchment through lack of transparency and objectivity that may result from informal engagement processes designed to influence while saving face.
Posted by Bob Monks on Mar 21, 2011 at 12:29 PM

Thanks for your comments.

The paramount question, in my view, is the accountability of those having the unelected power of corporate officials within a democratic society. Government authorizes the creation of corporations. It does not, thereby, contemplate creating sources of power that are independent of, and not accountable, to the public good as defined in the democratic process. Therefore, directors who are given plenary powers to direct the allocation of corporate resources should be accountable to someone and not simply part of a self perpetuating and self referential process. In most jurisdictions outside the United States, the accountability of corporate officials to public authority is straight forward – state ownership and influence in the largest companies has been common practice. In the United States, where government direct involvement – notwithstanding the recent heroics caused by the Financial Crisis – is anecdotal, some (other than government) form of accountability is necessary. Requiring that directors actually be “elected” by shareholders is a way of trying to fill that gap.
Posted by James McRitchie on Mar 20, 2011 at 12:20 AM
Do corporations function better when shareholders really exercise the power to designate directors or when their power is nominal and real authority for director selection remains in the hands of others? Can centralization be harmonized with accountability? Key here is the word “better” or your original term “optimally.” Better or optimally for whom?

My educated guess is that if you work for a company, it would probably be in your best interest if you had a voice in who is nominated. There have been lots of studies showing that companies where employees are also owners and are given opportunities to participate in meaningful decision-making are significantly more productive and profitable. Such employees are also more active in their community and politics. Empowerment at work transfers to other spheres of life.

Although there is less scientific evidence regarding what happens when shareowners exercise the power to nominate board members, there are several studies, including some done by The Corporate Library and Governance Metrics International, that firms with stronger shareowner rights have higher firm value and higher profits.

It is also clear that when boards have been ineffective, external corporate takeovers are expensive. Even after much of the wealth has been destroyed, the takeover and transition back to profitability is also expensive…generally ranging between 2-4% of the value of the firm. That doesn’t count the cost of layoffs, lost wages, as well as to communities in the form of lost taxes and charitable contributions. The cost of proxy driven changeovers has run “considerably below” 1%, according to Institutional Shareholder Services.

One might ask, if democratic companies both at the shop floor and at the boardroom levels are more productive, why don’t we see more of them?

We can take an interesting lesson in power relations from professional sports. The Green Bay Packers are the only major league professional team owned by its community. The Packers will never move; their owners won’t let them. Concession stands are regularly rotated among community-based organizations.

Joan Kroc tried to donate the Padres baseball team to the city of San Diego but the rules forbid public team ownership. If communities own teams, owners can’t threaten to move unless the city ponies up a new stadium.

Just like the rules prohibit communities from owning major league sports teams (except the Packers that have been grandfathered in), the rules are also stacked against the more democratic operation of corporations.

About 70 years ago the Gilbert brothers won the right of shareowners to have their resolutions placed in corporate proxies. After decades of struggle, just when shareowners were beginning to win near majority votes, the SEC reinterpreted one of its rules to deny resolutions that would allow shareowners proxy access for their board nominees. (See AFSCME v AIG)

Just as behavioral and other schools of economics are finally beginning to overturn the notion that all people are calculating unemotional maximizers of their own wealth, we are now also seeing those in the field of corporate governance begin to realize corporate frameworks are social constructions.

It is no longer assumed that a structure where a single CEO/Chair dominates is in the best interest of shareowners or the larger society. Although I have every respect for Alex Todd, I think we will find an “aspirational corporate governance,” to use a term he is fond of, will result in expanding real power well beyond the board.

One of my professors in the sociology of knowledge, Peter Berger, espoused that it is “futile to try to apply normative principles to technological production, to try to run a factory as if it were a Gemeinschaft, or to try to apply participatory democracy to the bureaucratic structures of the national state.” To him, coercion is inevitable in all spheres of life. Socialization not only prepares one for this reality but also provides a self-fulfilling prophecy for later life.

During the 1970s there were many experiments creating participatory workplaces. I was involved in one of these at what was the world’s largest meatpacking facility in Waterloo Iowa. Many of these experiments were wildly successful in increasing production but were shut down by management whose status was derived from dominating subordinates.

Authoritarian corporate governance, in most cases, is neither legitimate nor efficient for shareowners or societies. In a world where knowledge creation is key, cognitive respect is crucial. We are unlikely to get the diversity of brainpower we need by vesting corporate governance with a self-replicating corporate board.
Posted by Alex Todd on Mar 17, 2011 at 8:10 PM
I believe it is misleading to associate the election of board directors with the notion of elections in a representative democracy. In my mind, they are quite distinct concepts, with a somewhat different purpose and characteristics.

The fundamental difference is that the former is designed to give citizens a voice in their government. There is an expectation that the elected representative will "represent" his/her constituents' interests in the legislature.

Board directors, although elected by shareholders, are not expected to represent the interests of the shareholder groups that elected them. Instead, board directors are supposed to be independently minded, and represent the interests of the corporation above all, while considering and balancing the interests of all stakeholders, including (but not necessarily favouring) shareholders.

Although I am not aware of any Delaware court decisions along these lines, the law often lags business best practices. Differences also exist between legal jurisdictions, with more progressive ones setting trends, such as recent corporate governance guidance in the U.K. and last year's Supreme Court interpretation of Canadian corporate law.

As a general rule, shareholders have no role in the boardroom, including mature privately-held companies and family-owned businesses. Mature corporations should be governed by "professional" boards, not entitled interest groups.

Although, shareholder controlled companies enjoyed higher share prices in the 1990s, the shares of such issuers have significantly underperformed in the past decade.

I believe director primacy (or director centralization) is the optimal model for mature companies and that shareholder influence is generally counterproductive. However, the operative word here is "mature" or "evolved", a condition we must aspire to achieving. With today's somewhat crude corporate governance methods, a valid case can be made for temporarily limiting the powers of corporate boards with regulations and shareholder empowerment.
Posted by Chris MacDonald on Mar 17, 2011 at 7:24 PM
With regard to question #2, it might be more useful to ask whether there are a) at least some corporations that function optimally under (relatively) democratic leadership, and b) at least some corporations that function optimally under (relatively) autocratic leadership. I would think that some firms benefit from at least a bit of shareholder input, while others may function better under a more autocratic model. So we might not want to assume that there is a *general* answer to your question.

Chris MacDonald
Posted by Bob Monks on Mar 17, 2011 at 6:12 PM
Jim: The enduring question remains – irrespective of nomenclature, do corporations function better when shareholders really exercise the power to designate directors or when their power is nominal and real authority for director selection remains in the hands of others. Thanks for being the first to venture in on these questions.
Posted by James McRitchie on Mar 17, 2011 at 5:06 PM
Just a brief note in hopes of getting comments started. The word election certainly has a more legitimate ring to those who live in democracies than does the word appointment. However, I certainly wouldn't favor switching to appointment just because it may better reflect reality. Better to look at the word election as an aspitational term. When Jefferson wrote "all men are created equal" many didn't believe it and of course other provisions or law contradicted that statement. However, it certainly became something that people all around the world could point to in an aspirational sense.

Even in corporate governance I think use of the term election has made it much less difficult to win majority vote provisions at most of the large companies (it still hasn't filtered down to smaller firms). With the term election, it became very difficult to argue that a candidate should win if most shares were cast in a way that rejected the candidate.

Still, we are a long way from true elections, even with majority vote requirements, since Tweedle Dee can easily be replaced with Tweedle Dumb.
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