It is never a good sign when a senator, no matter what party affiliation, decides to involve himself in the governance arrangements of our leading public companies. Yet here we are, with Senator Sherrod Brown introducing a joint resolution under the Congress Review Act seeking to void the Securities and Exchange Commission’s (SEC’s) new rule on shareholder proposals. If this filibuster-proof resolution is approved by both the Senate and the House and signed by the president, then the rule shall immediately have no force or effect and the SEC would also be prevented from putting into place a similar rule in the future. If so, this will support the continuation of a trend that shifts corporate decision-making away from the board of directors and management and to uninformed shareholders, leading to a loss in productivity and shareholder value.
Brown says that the new SEC rule makes it harder for small shareholders to submit proposals for consideration by all shareholders at corporate annual meetings. That is correct. For any shareholder meeting held on or after January 1, 2022, with some exceptions for meetings held in 2022, shareholders will not be able to submit shareholder proposals unless they are able to demonstrate continuous ownership of at least $2,000 of the company’s stock for at least three years, $15,000 of the company’s stock for at least two years, or $25,000 of the company’s securities for at least one year. The previous ownership threshold required a shareholder to hold at least $2,000 or 1 percent of a company’s shares for at least one year.
According to Brown, “Last year’s changes to the SEC shareholder proposal rule made it much harder for working families and investors to hold corporate management accountable.” This is quite a stunning statement, as the “working families and investors” whom the SEC rule will affect comprise primarily three households. According to Yaron Nili and Kobi Kastiel, in 2018, 41 percent of the shareholder proposals that made their way into the proxy statements of S&P 1500 companies were submitted by five individuals. Two of these individuals were related by marriage, and another two were a father-and-son team, William and Kenneth Steiner (William Steiner died in 2020). In 2018, individual shareholders altogether submitted a total of 48 percent of proposals. Why Senator Brown would want to spend his time and the time of the House and the Senate on the shareholder activism of three households is not clear.
But this is not the whole story. It is quite possible that if Brown’s resolution is passed, it will be combined with a new SEC policy, currently advocated for by the recent acting chairman of the SEC, that will make it harder for companies to exclude shareholder proposals from their proxy statements. If this comes to pass, it will not only increase the number of shareholder proposals threatened to be submitted or submitted per year, but it will also make the shareholder proposal a more effective weapon in forcing company management to comply with the demands of the three households.
The more shareholder proposals that are submitted to a public company, the greater the likelihood that more corporate decision-making will be done through the inefficient corporate governance mechanism of shareholder voting. It is inefficient because it creates a shift in decision-making from those who are the most informed about the governance of a public company to those who are much less informed. Not only can it be assumed that gadflies who submit shareholder proposals, especially those who submit them to a large number of companies, are uninformed about the operations of the companies that they submit proposals to; it can also be assumed that the overwhelming majority of shareholders who vote on these proposals, whether institutional or retail, will be uninformed as well.
As I discuss in my article “The Risks and Rewards of Shareholder Voting,” a “collective action” problem in shareholder voting (the costs of becoming informed are borne individually, but the benefits of an informed vote accrue to all shareholders) leads to uninformed investors. This is particularly true of the Big 3 investment advisors to passive index funds: BlackRock, Vanguard, and State Street Global Advisors. Such investment advisors have no incentive to become informed about the firms that are held in the portfolios of the index funds that they manage. This means that they will be uninformed when they are asked to vote on shareholder proposals. Therefore, keeping shareholder proposals, and potential voting on them, to a minimum must be considered desirable.
Nickolay Gantchev and Mariassunta Giannetti’s recent work supports this argument. They found that value-destroying shareholder proposals, typically submitted by high-volume proposal submitters, may actually go to a vote, receive majority support, and be implemented by management. According to Gantchev and Giannetti:
[O]n average the proposals submitted by the most active individual sponsors seem to be ill-conceived. These proposals receive less voting support and are less likely to be implemented by management, but they may nevertheless pass if they end up being supported by a majority of arguably uniformed shareholders. If they pass with a majority in the shareholder meeting, proposals by active individual sponsors trigger sales by informed mutual funds that voted against them and, arguably as a consequence, negative abnormal returns.
Without the SEC’s new rule on shareholder proposals being implemented, combined with the likelihood of the SEC implementing a more pro-shareholder proposal policy, there is a significant risk that the use of shareholder proposals will proliferate. If so, companies will be compelled to become increasingly reliant on shareholder voting as a mechanism for corporate decision-making, even though it would be much more efficient and value-enhancing for management to continue making those decisions.