The Harvard Law School Shareholders Rights Project recently issued joint press releases with five institutional investors announcing the submission during the 2012 proxy season of proposals to more than 80 S&P 500 companies with staggered boards, urging that their boards be declassified, according to an article by Martin Lipton and Theodore Mirvis posted on the Harvard law School Forum on Corporate Governance and Financial Regulation. This is interesting for a couple of reasons. First, it is unusual to see a disagreement of this nature aired out on two competing Harvard Law School public forums. Second, in my opinion, Martin Lipton and Theodore Mirvis are exactly right, and the Harvard Law School Shareholders Rights Project is dead wrong on the issue of declassified boards.
The Shareholder Rights Project is actively seeking to eliminate staggered or classified boards in favor of boards that are up for re-election and replacement annually. The arguments pro and con are not as simple as frequently represented. Classified boards make hostile takeovers more difficult, and promote board continuity, but can entrench boards and make them less responsive to shareholders, and the Harvard professors running the Shareholder Rights Project argue that they reduce the value received by shareholders in hostile takeovers.
In their article “Harvard’s Shareholder Rights Program is Wrong“, Lipton and Mirvis point out:
“There is no persuasive evidence that declassifying boards enhance stockholder value over the long-term, and it is our experience that the absence of a staggered board makes it significantly harder for a public company to fend off an inadequate, opportunistic takeover bid, and is harmful to companies that focus on long-term value creation. It is surprising that a major legal institution would countenance the formation of a clinical program to advance a narrow agenda that would exacerbate the short-term pressures under which American companies are forced to operate.”
Declassifying all public company boards to remedy unquantifiable complaints that some boards are unresponsive and some shareholders might have received more in a hostile takeover is like using a shotgun to kill a mosquito – on your own arm! Corporations do not exist solely to report increased quarterly earnings. Corporations and other business entities provide jobs, pay taxes (or at least pay money to people who pay taxes), support charities and make countless tangible and intangible contributions to the economy and society in general. They provide a limited liability platform for investors and inventors to research, develop and launch new ideas, technologies, and developments.
Eliminating classified boards turns directors into politicians, campaigning to be elected every year. In business as in politics, the more frequent the elections the more difficult it is to conceive and implement long term solutions and sustainable growth. Directors sometimes have to make difficult decisions. Good directors know their company and its industry, its market, its employees and the challenges, obstacles and opportunities the company faces. Most shareholders have very little or no insight into these things – what they know is the stock price and the dividends. And with public corporations, who are the voters who elect directors? According to the Harvard Shareholder Rights Project, their project is representing “institutional investors”. Institutional investors are public pension funds like CalPERs, and include vulture capital funds, private equity funds and investment banks like Goldman Sachs and its clients. What do CalPERs, Goldman Sachs and other institutional investors want? Quarterly profits and quarterly growth, so they can show rapid and dramatic returns on their investments and pay out their investors at the end of their investment horizon – anywhere between two to seven years. Long term growth, jobs, sustainable tax bases, community development, charitable contributions, and other stakeholders are not their concern.
Eliminating classified boards is just another step in the elimination of small and individual investors from the stock market. The pressure to report quarterly earnings growth, quarter after quarter, contributed to the Enron, Qwest, Global Crossing and countless other financial reporting frauds in the last decade – none of those companies exist any longer, and their jobs, tax payments, lease payments, charitable contributions, and contributions to the economies of their communities are gone – but for a couple of years, shareholders who were smart enough to sell based on false quarterly earnings reports made out like bandits.
Now the Harvard Law School Shareholder Rights Project wants to institutionalize the annual election of directors by institutional shareholders, giving control of corporations to large investors whose main interest is short-term profit. Efforts to promote “shareholder rights” that provide incentives to directors to pay attention and not be careless or complacent should be applauded. Efforts to turn corporations into profit generators for institutional investors who have short-term investment horizons are dangerous. Corporations owe duties to their shareholders, but shareholders are not their only stakeholders. Long term sustainable growth serves the community and its taxpayers, and promotes the economic well-being of the country, as well as serving shareholders. Perhaps the students at the Harvard Law School Shareholder Rights Project are more interested in getting jobs on Wall Street after graduation, than they are in making positive changes in corporate governance.