Regulatory trends and corporate governance

In addition to the new disclosure regime on executive compensation, the SEC has adopted a requirement that calls for a narrative explanation of the independence status of directors, and consolidated other disclosure requirements regarding director independence and board committees, including new disclosure requirements about the compensation committee.

The new rigour of compensation disclosures will not be applied to foreign private issuers. They can continue following their home country rules and practices. The SEC’s reluctance to level the playing field is understandable. The London market has no requirements that apply to foreign issuers on compensation disclosures, not even on a comply-or-explain basis. Transparency of remuneration arrangements in continental Europe is still at a very early stage and, as discussed earlier, EU action is limited to a recommendation. One still hears the argument that it is full disclosure of remuneration that has driven pay levels in the US and the UK to their current, some would say dizzying, heights.

Accountability

Under US law, ‘the board is king’. In contrast to the UK and most other European jurisdictions, shareholders in US companies do not have the power to initiate any corporate action nor do they have to be consulted on any action unless the articles of association so provide.42 In contrast, UK shareholders are called on to approve major transactions, while in some other EU countries shareholders have to approve certain related party transactions contrary to the EU mandatory regime established in the second company law directive. Increases in capital in the US are approved by the board, which can easily waive any pre-emption rights of existing shareholders. In all EU companies, shareholders representing anywhere from 5 to 20 per cent of the outstanding voting equity may call an extraordinary general meeting and pass resolutions, including the ousting of the board. In the US, most State company laws (including Delaware) do not grant such rights to shareholders and, at least until recently, companies could not provide for such rights in their articles of association. Many companies require a so-called supermajority vote making it very difficult for even a majority shareholder to influence the course of the company against the will of the incumbent board.43

The only way that shareholders can really influence board decision-making in the US is by electing suitable board members. Here too, the US law and practice differ from European countries. In Europe, shareholders, either individually or representing a minimum percentage, can propose candidates to the board at the general meeting. In the US, the only way shareholders have to propose candidates independently of the board slate is to request the approval of the SEC for the distribution of a separate proxy. Such a proxy fight with the incumbent

42See Robert Clark, Corporate Law, New York: Macmillan, 1986, pp. 21–4.

43In contrast, in Europe supermajority provisions are perceived by shareholders as a protection against abusive change of the ‘rules of the game’ by major shareholders.

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board and management entails enormous costs for the challenger. Importantly, in most US corporations shareholders are not allowed to vote against boardnominated candidates. Under the so-called plurality system, shareholders are given the possibility either to vote for a candidate or to withhold their vote. They cannot vote against a director since, in the absence of an alternative slate, there would be an empty seat if a candidate were voted down. Thus, a director can be elected even if only one vote is cast in his favour.

It follows that the power vested in the incumbents is enormous. Even though changing the board is the only way shareholders have to express their dissatisfaction with the management of the company, this option is not available unless a full change in control occurs. Incumbent boards are left with extensive powers to frustrate any such change. In addition to various forms of poison pills, many US companies have adopted staggered board provisions whereby only a certain percentage of directors can be replaced in any given year, thus making it extremely time consuming and costly to change the board, even as a result of a successful takeover bid or proxy fight.

Entrenchment is not only harmful in theory, but is also an empirically proven destroyer of value. According to Professor Clark,

studies about the impacts of the most costly reforms, those concerning audit practices and board independence, are fairly inconclusive or negative, while studies about proposals for shareholder empowerment and reduction of managerial entrenchment indicate that changes in these areas – which in general are only atmospherically supported by the SOX-related changes – could have significant positive impacts.44

The SEC put forward a modest proposal to give shareholders access to the corporate ballot and propose their own nominees without launching a full-scale proxy fight. In spite of the conditions for access being extremely stringent, US corporations fought bitterly against the proposal and it was withdrawn in 2005.

However, the objections to managerial entrenchment have started to get through and several large caps have retracted supermajority provisions and retreated from staggered boards, opting instead for UK-style annual elections of directors. More recently, in the face of growing investor opposition to the plurality system, some respected US companies have moved to address shareholder disenfranchisement in director nomination. For example, Pfizer, the pharmaceuticals giant, has amended its bylaws, making it mandatory for a director to resign if more than 50 per cent of the votes are withheld.

This emerging corporate change of heart can be largely explained by some of the market trends discussed in the first part of this chapter: the institutionalisation of the US equity market has made accountability to shareholders a

44Robert Clark, ‘Corporate Governance Change in the Wake of Sarbanes Oxley Act’, Discussion Paper 525, Harvard Law School Olin Center for Law, Economics and Business, September 2005, p. 2. Available at www.ssrn.com.

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