Advice and Consent: An Alternative Mechanism for Shareholder Participation in the Nomination and Election of Corporate Directors

Abstract

There is cause to believe that institutional investors have a comparative advantage in identifying suboptimal governance structures, but that incumbent boards have a comparative advantage in rectifying those shortcomings, provided that the incumbents concur that the shortcomings are material. It follows that a desirable governance mechanism would simultaneously allow shareholders to specialize in the area of their comparative advantage (i.e., the identification of governance problems) and boards to specialize in their area of comparative advantage (i.e., the crafting of solutions to identified problems), while forcing boards to take shareholder criticism seriously. The direct shareholder access proposals under consideration by the SEC lack the significant benefits that can result from such functional specialization. The "advice and consent" procedure defined by Article II Section 2 of the United States Constitution provides a model of functional specialization within the structure of a representative democracy. This article adapts that "advice and consent" mechanism to the corporate context. Under the proposed mechanism, any director who is elected despite the fact that a majority of shareholders withhold authority for that director's election would suffer a variety of material disabilities imposed under SEC or SRO regulations. For example, the director might not be deemed independent for purposes of listing standards, and might be prohibited from voting on any matter required by SRO or SEC rules. Such directors could also be subject to rules that would call into question a corporation's ability to insure or indemnify them for violations of federal securities laws. Directors are unlikely to be enthusiastic about serving subject to such disabilities. Boards are also unlikely to be enthusiastic about the continued service of such directors. The proposed advice and consent mechanism can thereby create significant incentives for boards and shareholders to reach a compromise regarding acceptable board structures and candidates. An advice and consent mechanism has several clear advantages over the Commission's proposed shareholder access initiatives. An advice and consent mechanism seeks to promote cooperation between shareholders and incumbent boards rather than to provoke confrontation. It greatly reduces the danger that shareholders will resort to the proxy mechanism as a device for promoting special interest agendas, and also greatly diminishes the dangers of factionalization that can arise from the election of dissident directors to a board. The proposal eliminates the need for the Commission to adopt complex and potentially arbitrary rules defining "trigger conditions" and "qualified shareholders." There is also far less risk that the mechanism could be pre-empted by conflicting state legislation.