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Under the current system of electing corporate boards, directors can be chosen without the approval of a majority of the company’s shareholders. In fact, because shareholders can’t effectively vote against a director nominee, a director can even be selected against the wishes of most shareholders. The plurality rule in use at most U.S. corporations requires only that a director nominee receive more votes than any other nominee for the same seat to be elected. But this system may be about to change. The most likely alternative is to require a majority vote of all shareholders to elect corporate directors. This option is gaining support among investors as a way to hold directors accountable, and the idea has much to recommend it. THE ESTABLISHED DEFAULT The plurality standard in the United States emerged as a default standard over the first few centuries of American capitalism. The purpose of the standard was to ensure that somebody would be elected even when there were multiple candidates. Under the plurality rule, the director receiving the most votes for a particular board seat wins that seat. In the United States, directors typically run for individual seats, and, therefore, the plurality rule that awards a board seat to the director with the most votes means that a director needs only a single vote to win election to the board. The American Bar Association’s Model Business Corporation Act and Delaware’s General Corporation Law both describe plurality voting as the default rule for corporate-director elections. Yet today, the vast majority of corporate elections in the United States are uncontested, and the number of board seats available almost always matches the number of candidates up for election. Directors are nearly always nominated by the board of directors, with some suggestions from management and sometimes, but not often, with the input of shareholders. Most directors do not attend their first board meeting until they are elected by shareholders, though in some instances (such as the resignation or death of a sitting board member) a board seat may be filled months before an election. In such a circumstance a director may not face election until months after he has been appointed to the board. On a typical proxy ballot the shareholder is given the choice of voting “For,” or voting to “Withhold” or “Abstain” on, each individual nominee. Voting “No” is not an option. This leads to the possibility of a single vote electing a director. In essence, U.S. corporations can simply ignore the views of those shareholders who withhold their votes from a nominee, even if such withheld votes constitute a majority of all votes cast. The only recourse now afforded to shareholders involves an expensive proxy contest to try to elect an alternative slate of directors — an option available only to the most well-heeled opponents. These limitations on shareholder voting have raised concerns at the Securities and Exchange Commission. In October 2003 the SEC invited public comment on its proxy access initiative, designed to make it easier for shareholders to nominate their own candidates for board seats under certain circumstances. In an address to the American Enterprise Institute, in March 2004, SEC Commissioner Cynthia Glassman outlined the reasoning behind the proposal: “A closed nomination process dominated by powerful CEOs and entrenched directors led to an unhealthy coziness in some instances between ostensibly independent directors and the executives whose performance they were supposed to oversee. When the board acts as a rubber stamp for management, it does not necessarily act in the best interest of shareholders.” But this reform now seems unlikely to succeed, although the SEC’s proxy access plan is still technically on the table. Obstacles include potential state-law conflicts, the proposal’s perceived complexity, some ambiguity concerning penalties for noncompliance, and strident opposition by corporations. AVOIDING DISORDER But there should be far fewer objections to increasing director accountability through majority voting. The majority vote is a simple bright-line rule: If a director fails to earn a majority of shareholder votes (whether a majority of votes cast or votes outstanding is a question without a definitive answer at this time, though both methods have been adopted by different companies), the director cannot serve on the board. Though the details need to be worked out, a majority-vote standard boasts the advantage of relative simplicity, at least when compared with the SEC’s original proxy access proposal. Indeed, in most developed markets, where majority voting is the norm — including France, Germany, Japan, and the United Kingdom — such a system works smoothly. And Institutional Shareholder Services (ISS) data from 2004 proxy votes shows that only about one-tenth of 1 percent of all directors of U.S. corporations standing for election that year failed to receive a majority vote. Thus, a switch to majority voting is unlikely to bring corporate America to a screeching halt. Nonetheless, the main argument made against adopting a majority-vote standard is that such a rule will bring disorder and uncertainty to corporate elections. What would happen, plurality-rule supporters worry, if a director failed to be elected? In fact, nothing drastic. The director would leave the board, of course, but directors often do so for health, personal, or other reasons. And those leave-takings can be as abrupt as a failed majority vote. Prudent companies could plan for director succession with backup directors. They also could hold a special meeting to elect an alternative nominee within 90 days. This 90-day standard is mentioned in a discussion paper the ABA Committee on Corporate Laws issued in late June. The paper, which undertook a detailed analysis of possible changes to the Model Business Corporation Act relating to voting for directors, considers the adoption of majority voting as one possible way to avoid “holdover” directors who remain on a board despite majority opposition. The ABA has not yet made a recommendation on majority voting and is not expected to announce its opinion on the matter until 2006. In extremely rare circumstances, multiple board members or the whole board could fail to receive a majority vote, though such a circumstance would often signal a company with deeper problems than board dynamics. Shareholders would, of course, need to ponder the consequences of failed nominations for the company’s business prospects and the price of the stocks they hold. Some parties have argued that majority voting would give minority shareholders the power to play spoiler in board elections. But the very definition of a majority vote protects against a minority shareholder unduly influencing a board election. No minority shareholder would have the power to oust an individual director unless that shareholder persuaded many other shareholders to support this position. Another frequent argument is that majority voting would increase (sometimes negative) shareholder scrutiny of directors, and that would make people less willing to serve on corporate boards. Indeed, potential directors should take great care in deciding whether to join a board and should not accept a board nomination if they do not believe they can help that company create value for its shareholders. But no one is forced to be a director, and reticence by some corporate executives — who now take up the majority of board seats — may open up more board slots to qualified individuals in other professions. BUILDING SUPPORT Even now, support for majority voting is gathering steam. According to ISS data, majority-voting proposals are becoming increasingly popular. In 2004, 12 proxy proposals advocating the majority-voting standard gained support of less than 12 percent. From January through September 2005, nearly 60 such proposals have garnered average support of nearly 45 percent. Sixteen of these majority-voting proposals won majority support. At least 36 U.S. companies have already adopted some form of either majority voting or a modified plurality system that permits a director to be elected by plurality vote but imposes consequences on the failure to achieve a majority threshold. For example, Pfizer recently adopted a modified plurality system whereby directors are required to tender their board resignation if they fail to earn a majority vote — though the board can refuse this resignation. The pace of such voluntary adoption is expected to increase in 2006 and beyond, possibly pre-empting any future regulatory moves by state legislatures. It is conceivable that support for majority voting will reach a tipping point, after which it will be easier for shareholders to press for the majority standard as the default rule under the Model Business Corporation Act or Delaware law. Although the ABA is currently reviewing the Model Business Corporation Act and some parties have called for a change of Delaware corporate law to make majority voting the default rule, Delaware has not formally taken up the majority-voting issue. For now, corporations are facing more aggressive shareholder campaigns to change bylaws to require majority voting. Majority-voting language written into corporate bylaws and charters faces a higher hurdle, however, because support for binding changes to the voting standard lags behind the support given to voluntary adoption of a majority-voting standard. In October, for example, nearly 80 percent of Paychex shareholders voted against a binding shareholder resolution calling on the company to change its bylaws to adopt majority voting as a default standard. A NECESSARY CHANGE The fact is that shareholders are considering the arguments for majority voting on a company-by-company basis. But in the end there is only one right answer: A majority-voting standard in the election of directors gives shareholders an appropriate level of influence in electing board members who will act as true shareholder representatives. It increases director accountability and pushes the nominating committee to act in good faith in proposing suitable board candidates. That is why it is no longer a question of whether a majority-voting standard is coming; it is already here in its nascent stages. The only real question left is what level of momentum the standard will gather in the next few years. Whether driven by legislative change or by corporate or shareholder action on a company-by-company basis, fewer and fewer corporate board elections will be decided on a plurality basis. Ultimately, corporate America’s proposed directors will be approved — or rejected — by the majority vote of shareholders.
Kurt N. Schacht is a lawyer and the executive director of the CFA Centre for Financial Market Integrity, whose headquarters are in New York City. He also holds the Chartered Financial Analyst designation.

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