The notion of “shareholder democracy” has become a pervasive part of corporate rhetoric and woke media narrative. However, as a forthcoming article in the Florida Law Review argues, this concept is fundamentally a myth that obscures the realities of corporate governance. Understanding this fallacy is crucial for comprehending the dynamics of shareholder proposals and voting.
Sergio Alberto Gramitto Ricci, Daniel J.H. Greenwood, and Christina M. Sautter, in their forthcoming article, The Shareholder Democracy Lie, systematically “debunk the shareholder democracy myth” by analyzing the historical development of shareholding and the current state of corporate voting. They trace the origins of the term “shareholder democracy” back to the 1920s, when Wall Street firms and the NYSE used it to attract retail investors. Their historical analysis of proxy voting reveals how this system, despite its democratic framing, primarily facilitates management control and the influence of institutional investors.
The authors emphasize the current dominance of institutional investors like BlackRock, Vanguard, and State Street – the “Big Three” – who collectively represent the largest shareholder in almost all S&P 500 companies. This concentration of voting power is further amplified by the influence of proxy advisory firms such as ISS and Glass Lewis, which wield considerable sway despite lacking a direct financial stake in the companies they evaluate. Ultimately, the authors conclude that “shareholder democracy is a dangerous myth.”
Commenting on the paper, Stephen Bainbridge, a professor at UCLA School of Law, noted that he has long argued against the value of shareholder democracy, and he accordingly agrees with the premise of the new paper, which contends that “shareholder democracy is a lie.” However, Bainbridge celebrates this reality, stating that “corporations are not New England town meetings.” His view, articulated in his work Unocal at 20, emphasizes that we shouldn't inherently value corporate democracy simply because we value political democracy. For Bainbridge, the efficient management of a corporation requires a hierarchical structure, not a democratic one.
All of this is relevant to how we interpret shareholder proposal proxy voting. I recently reviewed the myriad reasons to be suspicious of claims that, for example, we should conclude that 98% of Costco shareholders support DEI when the National Center for Public Policy Research garners only roughly 2% of the votes in connection with its proposal requesting a report on DEI risks. (I work for NCPPR as Executive Director of its Free Enterprise Project.)
Without rehashing all the underlying arguments, it’s worth briefly noting that the actual proposal merely requested a report on the risks associated with Costco's DEI initiatives – something that it would be odd for 98% of fully-informed, unconflicted shareholders to be against given all the relevant risks existing today. What makes more sense is that the “against” votes were driven by the “Big 5” – BlackRock, Vanguard, State Street, Glass Lewis, and ISS – all of which suffer from perverse incentives on this issue. Additionally, Costco's management likely influenced a significant portion of the votes, and on that front, there is reason to be suspicious of what appear to be woke, value-destroying motivations behind the degree of hostility NCPPR’s proposal faced. It is also worth noting that the vast majority of individual retail shareholders don’t vote at all and accordingly have their voices drowned out by arguably biased and conflicted institutions. (As an aside, the Free Enterprise Project’s Proxy Navigator is working to end that.)
However, even if one assumes that all shareholder votes are cast legitimately and without undue influence, the fundamental structure of free-market capitalism places the primary decision-making authority in the hands of the board of directors. This board is elected by shareholders but is then entrusted with the responsibility of guiding the company in accordance with its fiduciary duties to act in the best interests of the corporation and its shareholders. Meanwhile, individual shareholders retain crucial rights, including the right to warn management and fellow shareholders about potential risks they perceive.
In other words, outside specific areas like elections, the question is not so much what shareholders want but what management is duty-bound to provide. And in the specific area of DEI, one thing directors and managers are duty-bound to do is not violate anti-discrimination law. Furthermore, they are generally duty-bound to not knowingly destroy shareholder value or make uninformed decisions. If any shareholder has good reason to believe one or more of these duties is being breached, that shareholder has various rights – including filing a proposal – that may be used to try to get the corporation back on track, even if every other voting shareholder is cheering on management’s self-destructive behavior.
The notion of shareholder democracy is a convenient but ultimately misleading metaphor. As Bainbridge and Gramitto Ricci et al. argue, the realities of corporate governance, including the dominance of institutional investors and the structure of corporate decision-making, demonstrate that corporations are not democratic institutions. Accordingly, one should not only be suspicious of pronouncements that proclaim things like, “98% of Costco shareholders support DEI,” but also be clear about the difference between what shareholders want and how corporate managers are duty-bound to act. In the end, keeping corporate management focused on maximizing shareholder value is the best way to generate a rising tide that lifts all boats.
