With the Securities and Exchange Commission's controversial shareholder proxy access proposal stalled, another corporate governance battle has come to the forefront: a majority-vote standard for director elections. There seems to be considerable momentum for making the change, with a number of stakeholder campaigns underway to encourage companies to require a majority vote of ballots cast in the election of directors. Under the plurality-vote standard that is now common, since director elections are usually uncontested, candidates win as long as they get a single affirmative vote, no matter how many votes are withheld.
An American Bar Association (ABA) task force is considering whether to amend the Model Business Corporation Act and a group of unions and corporations is looking at what a majority-vote standard would involve. During the current proxy season, shareholders at more than 60 companies will vote on resolutions calling for a majority-vote standard. The resolutions, put forward by a group of unions, have some powerful supporters, including Institutional Shareholder Services. In mid-April, majority-vote resolutions won 48% of the votes at Gannett Co. and 38% at Caterpillar Inc. That's a big improvement from 2004, when the best showing by similar resolutions was 18% in favor.
Critics question whether a change is necessary, claiming that withhold votes have evolved into an effective tool for dissatisfied shareholders. "There's ample evidence that nominating committees are carefully looking at any board member who receives a substantial withhold vote and not renominating them to a board," says David Hirschmann, a senior vice president at the U.S. Chamber of Commerce. In response, advocates of the change note that in 2004, a number of directors continued to serve on boards although they received less than 50% of the votes cast.
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One of the biggest sources of controversy relates to what would happen in cases where a candidate fails to win a majority of votes. Under current law, the board is responsible for filling vacancies, and failure to win enough votes in a one-candidate race would create such a vacancy, leaving it to the board to decide whether to appoint the failed candidate anyway or find another. Until the board decides on a replacement, under current rules, the director seeking re-election or the director being replaced must continue to serve.
In its criticism of the majority-vote resolution, the Caterpillar board said that if a candidate didn't get the necessary votes, the result could be "a less democratic process than the election of directors by plurality vote." In any event, critics contend that such uncertainty is problematic for companies.
The unions' resolution doesn't specify what boards should do when a candidate fails to get a majority of votes. Ed Durkin, director of corporate affairs at the Carpenters Union, says different companies may respond differently. "What we think will happen is you'll have a set of best practices developing," Durkin says. Any legal requirement would be imposed by state legislatures and not as a result of shareholder resolutions, which are rarely binding.
The route to changes in state laws runs through the ABA task force, and it may weigh in on what to do when an election doesn't produce a winner. State legislatures can choose to adopt changes made in the Model Business Corporation Act, but companies are expected to lobby against efforts to enact majority-vote standards, especially in the key state of Delaware.
At this point, it's not clear to what extent a majority vote would alter the balance of power between shareholders and the board. "If it ends up just falling back into the hands of the board to fill the vacancy, then I don't think we've accomplished much in terms of shareholder democracy," says Cindy Schipani, a professor of business law at the University of Michigan. "A mechanism for shareholders to have a voice in filling that vacancy would seem to be more in the spirit of what they're trying to accomplish."
But Cary Klafter, vice president of legal and government affairs and corporate secretary at Intel Corp., says a majority-vote standard would be a significant change even if the board retains the authority to replace or retain a director who does not receive a majority vote. Currently, if a candidate gets a majority of withhold votes, good governance calls for the board to take that seriously, but the board is not mandated to reject the candidate or even ask the director not to stand for re-election. The proposed standard "increases the seriousness of the situation," Klafter says; "It will require the directors to make a replace-or-retain decision and therefore forces what [advocates of the measure] hope to be a significant improvement in the process."
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