Pandemic Highlights Need To Reform Shareholder Rights

By Saad Alrayes
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Law360 (July 29, 2020, 5:34 PM EDT) --
Saad Alrayes
Saad Alrayes
The 2007–2008 global financial crisis presented the paradoxical question: Should shareholders be given greater influence over company activities?

The current pandemic, COVID-19, highlights again the need for review and reevaluation of corporate governance frameworks and the creation of a new regulatory framework aimed at increasing shareholders' control.[1]

The literature fails to identify a clear and coherent role for shareholders and clarify the role of shareholder empowerment in furthering and strengthening corporate governance structures, as per Martin Lipton of Wachtell Lipton Rosen & Katz. An examination of Delaware in the U.S, and the U.K., to determine ways in which increased shareholder control can more effectively scrutinize companies in their pursuit of risky activities, while remaining free to maintain and sustain their economic viability, is needed.

Such examination focuses specifically in the incidents of shareholder dissension, regarding remuneration policies, in 2012 of five U.S. and U.K. corporations such as Central Rand Gold Ltd, Aviva PLC, Barclays PLC, Glencore Xstrata PLC and Inmarsat PLC, focusing mainly on Barclays, Aviva and Stores Co. v. Bozic.

It seeks to examine whether, under the existing rules, shareholders exerting influence on the board are acting in the best interests of a company; and whether an extension of shareholder powers is desirable.

It shows that shareholder empowerment provides an effective means through which corporate activities can be regulated. Nonetheless, it suggested distinguishing between long-term and short-term investors to encourage shareholder engagement by responsible long-term investors to exercise their powers effectively and influence board decisions regarding executive compensation.

John Coffee, a professor of law and director of the Center on Corporate Governance at Columbia Law School, and Jennifer Hill, a professor of law at the University of Sydney and a research fellow of the European Corporate Governance Institute, describe the 2007–2008 financial crisis as the result of "untrammelled managerial power," the lack of regulation over risky behavior, the undertaking of unsound corporate activities by boards of directors, and the populist political response to articulate arguments in favor of greater powers for shareholders.

Lucian Bebchuk, a professor at Harvard Law School argued extensively in his research paper "Letting Shareholders Set the Rules" that shareholders should enjoy the "power to initiate, and approve by vote, major corporate decisions." Consequently, arguments for shareholder empowerment are likely to be "convincing" post 2007–2008.

Nevertheless, one of the principal dogmas expressed by Stephen Copp, an associate professor of law at Bournemouth University in the U.K., and Stephen Bainbridge, a professor of law at the University of California, Los Angeles, is that strengthening shareholders' powers is contrary to the entrenched corporate legal frameworks that distinguish clearly between a company's owners and management. Hence, distinguishing between the assessment of effectiveness by considering the difference between the theory of shareholder empowerment and the practical realities is needed.

Moreover, while Jonathan Mukwiri and Mathias Siems, legal academics at Durham Law School, argued in their research paper "The Financial Crisis: A Reason to Improve Shareholder Protection in the EU" that shareholder empowerment could ensure better monitoring of management and therefore better-run corporate activities, any positive effect on corporate outcomes is not self-evident.

Reinier Kraakman, a professor of law at Harvard Law School, and John Armour, a professor of law at Oxford University argue that shareholder empowerment is capable of controlling management behavior, but their analyses were largely theoretical. Therefore, a critical analysis of shareholder empowerment is essential.

Executive remuneration can be a controversial issue for shareholders, particularly when the company has demonstrated poor performance or there are unjustifiable discrepancies between executive pay and shareholder dividends, as in Barclays.

The issue here, however, is not whether such concerns are justified but whether shareholder empowerment might lead to effective regulation of corporate activities controlling remuneration levels before a shareholder vote or payout, thus avoiding situations whereby funds must be returned, such as in Aviva.

The U.K. Corporate Governance Code merely requires directors to communicate decisions about remuneration to shareholders. Indeed, such communication was not effectively undertaken, particularly in the case of Barclays and Aviva.

This arguably confirms the assertions made that despite shareholders' powers to hold the board to account, a lack of communication in practice, and a resulting lack of mechanism by which shareholders can exercise such powers, means that currently shareholders are unable to effectively hold the board to account.

The existing U.K. Corporate Governance Codes impose a duty on the board's chairman to maintain effective communication with shareholders regarding, inter alia, director remuneration levels. This shows a significant role that shareholders can play in ensuring that executive remuneration properly reflects a company's performance.

Failure by a company to ensure this could result in shareholder revolt, as witnessed in the case studies. Therefore, my recommendation is that long-term investors of more than five years should be given strengthened voting rights on important issues such as executive remuneration, and as an additional notion, that there is a minimum period during which shares cannot be sold.

According to Bebchuk, shareholders may be reluctant to use any greater powers granted to them for fear of economic consequences. However, the Aviva case study reveals that shareholders will be prepared to use powers to control the board, and thus one might take the view that extending shareholder powers is unnecessary.

Section 439 of the U.K.'s Companies Act 2006 does not give shareholders the power to prevent payouts made under remuneration policies, simply to state their disapproval; however, the Aviva case study demonstrates that mere disapproval itself will be sufficient to prevent payouts and indeed control corporate activities.

While this adds further support to Bebchuk's argument that the threat of action can be enough to ensure boards behave responsibly and that further empowering of shareholders is unnecessary, caution is advised.

While the Aviva scandal did appear to lead to reduction in executive pay as a result of shareholder action, excessive payouts continue to be made, suggesting that Aviva is something of an anomaly and that shareholders may be more likely to simply accept remuneration policies — knowing that they could be adopted without shareholder approval — and thus not get involved.

Again, this suggests that reform is required to ensure a consistent impetus for shareholders to use such powers.

Former Delaware Chief Justice Leo E. Strine Jr. argues in his research paper "Towards a True Corporate Republic: A Traditionalist Response to Bebchuk Solution for Improving Corporate America" that establishing a legal framework that allows shareholders to have greater influence over corporate decision making will prevent the company from being as economically effective and profitable as possible.

Indeed, such argument appears supported by a key justification for the maintenance of the separation between ownership and control, namely, that shareholder interests equate to maximization of profits. Furthermore, a key cause of the 2007–2008 financial crisis was the lack of regulation of risky behavior and the undertaking of unsound corporate activities by directors.

James McConvill, an Australian lawyer, justified in his research paper "The Separation of Ownership and Control Under a Happiness-Based Theory of the Corporation" the separation of ownership and control by stating that it is "rational for investors in a public company to be apathetic about managerial issues and to leave it to corporate executives to run the business," because the latter are more capable of generating the profits.

If true, it follows that where engagement in risky corporate behavior renders such profits unsustainable, the justification for maintaining such a distinction does not hold. As such, the Delaware model might not reflect the aims of shareholders and should not be retained in favor of shareholder empowerment, which could allow the regulation of corporate activities in line with the desire of shareholders to receive a maximum return on their investment.

It therefore seems that despite problems with Bebchuk's proposed reforms in terms of whether empowering shareholders to take a role in the management of the company is a means of effective regulation of corporate activities, there is little justification in maintaining the separation between ownership and control, at least where there is the potential for directors to engage in risky behavior, and thus reduce the potential for maximum sustainable profit generation for shareholders.

Where shareholder profit through dividends is paid in proportions far smaller than executive remuneration, as in Barclays, it cannot be accepted that unpopular executive decisions are simply "good faith actions which are in the long-term best interests of stockholders, even if that means forsaking other tactics that might increase stock value in the short term."

However, Andrew Keay, a professor of law at the University of Leeds, states in his research paper "Moving Towards Stakeholderism? Constituency Statutes, Enlightened Shareholder Value and All That: Much Ado About Little?" that they are, rather, examples of the board being able to act in an almost unfettered manner, at the expense of shareholder value.

Empowering shareholders in the manner envisaged may serve as an effective means of regulating corporate activity and avoiding shareholder revolt. Despite powers being held by shareholders during the lead-up to the financial crisis, they were largely unused.

In reality, shareholders may be unlikely to use increased powers to hold the board to account, due to associated economic risks or because many multinational corporations now have an enormous number of shareholders who have no practical prospect of influencing the board, despite an increase in powers.

Nevertheless, it found that amendments to the provisions might increase shareholder power and that this power can be an effective means of regulating corporate activities. For example, long-term shareholders are likely to have an interest in "good quality governance and risk management regimes" due to their long-term interest in the company.

However, it seems indefensible that wider use of the internet has not been made to improve shareholder engagement. From this, it is a small step to argue that shareholder empowerment through the increased use of technology would be an effective means of managing corporate activities.

To conclude, case studies from the two jurisdictions show that shareholders might be able to control executive and director actions, and that reform is needed to ensure that shareholders are able to exercise their powers effectively in this respect and have an influence on the board's decision to award executive compensation.

The corporate governance rules applicable in the U.S. are more extensive than those adopted in the U.K. The U.S. rules adequately cover the requisite areas to empower shareholders sufficiently to place them in a position to influence a board. In particular, the U.S. corporate governance regime regarding institutional investors appears more refined and comprehensive than the U.K. equivalent.

The U.K. should adopt some of the U.S. policies to strengthen the rights of institutional shareholders to enable them to play a more prominent role in regulating activities of U.K. companies.

Strengthening the role of shareholders under the "comply or explain" approach will be beneficial. Empowering oversight by monitoring bodies has been proposed as a way of gauging the adequacy of company disclosures.

Nonetheless, further responsibilities in support of shareholders are needed to ensure that the chairperson introduces corporate governance statements or standardized disclosure forms on the company's website, which would significantly improve disclosure quality.

This would improve compliance with code provisions and reduce investor apathy by making the stewardship corporate and governance Codes legally binding.



Saad Alrayes, Ph.D., is a researcher at Queen's University Belfast, an academic visitor at the University of Oxford and a fellow of the Commercial Law Centre at Harris Manchester College.

The opinions expressed are those of the author(s) and do not necessarily reflect the views of the organization, or Portfolio Media Inc., or any of its or their respective affiliates. This article is for general information purposes and is not intended to be and should not be taken as legal advice.

[1] "Shareholder Empowerment, Steps Forward and Steps Back: Comparative Analysis of the US and UK Regulations" (27) 2 Journal of Financial Regulation and Compliance: https://doi.org/10.1108/JFRC-03-2018-0054 and https://pure.qub.ac.uk/en/publications/shareholder-empowerment-steps-forward-and-steps-back-comparative-.

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