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Clearly this year’s hot-button corporate governance issue, majority voting is spurring a wave of shareholder proxy proposals, in large part because the Securities and Exchange Commission (SEC) has made clear that it will no longer permit managements to omit these proposals. As a result, we may be at the dawn of a new era, as the existing system of plurality voting gives way to a new system under which only those candidates receiving a majority of the votes cast would be elected. But major transitions are seldom seamless, and some sizable bumps remain ahead on this rocky road. Although majority voting has united a broad coalition of shareholder activists, strains and tensions within this unstable coalition seem likely to arise in the near future. Put bluntly, shareholder activists fall into three basic groups: diversified investors-such as mutual funds and pension funds-which hold large portfolios that include hundreds of stocks; ideological investors-such as some union funds and some “corporate social responsibility” funds-which have relatively small holdings but which typically draft and submit these proxy proposals; and undiversified investors-such as hedge funds and other money managers-which concentrate their investments on a limited number of stocks. The first and second groups tend to support “issue specific” reforms, while the third group is interested only in “firm specific” reforms that it expects to increase share value at a specific portfolio firm. Because the first group holds very large portfolios with few, if any, individual companies being important to their overall investment performance, its members cannot evaluate each proxy proposal on its special merits but rather need a decision rule that they can easily apply to all cases. Accordingly, they tend to rely, sometimes reflexively, on proxy advisors, such as Institutional Shareholder Services, which recommend to them a voting policy on a particular issue that can be applied across a broad range of cases. In contrast, the undiversified investors will only support reforms that they expect will enhance the share prices of the specific companies in which they have made major investments. Typically, they support proposals that remove takeover defenses or increase the likelihood of a control contest. An unorthodox marriage with different expectations Why then have they formed a coalition over majority voting? For the issue-specific, diversified investors, majority voting is a “motherhood” issue that arises across a broad spectrum of companies and that they can support without the need for any context-specific analysis. From their perspective, majority voting is desirable because it gives shareholders a greater voice-an abstract, but noncontroversial goal. Their support for majority voting will be predictable, but not passionate. In contrast, hedge funds and other undiversified investors will only support majority voting based on a context-specific analysis, but their support could be intense. The likely goal of these investors will be to use majority voting to target the chief executive officer and encourage a control change. Thus, the union of these different groups represents an unorthodox marriage with very different expectations: One group sees majority voting as a “good governance” reform with largely symbolic significance, while the other sees it as a means of destabilizing lackluster managers and provoking control fights. To date, corporate managements have been willing to accommodate majority voting in order to placate the “good governance” diversified investors. One motivation has been that such a strategy can block the use of majority voting to target the CEO or management directors. That is, management’s standard response has lately been to adopt a nonbinding majority voting governance policy under which incumbent directors receiving more “withheld” votes than “for” votes are expected to tender their resignations to the board, or a committee thereof, which would accept the resignation, unless “urgent circumstances”-or some similarly vague standard-caused the board to decline it. Because this compromise works to protect the CEO, and possibly a few other “key” directors, at least 30 companies adopted this basic position in 2005. The tactical legal advantage underlying this approach is that these corporations can then assert that any shareholder proposal seeking to adopt a stronger, more mandatory position could be omitted from their proxy statement under SEC Rule 14a-8(i)(10). That rule entitles the corporation to omit any otherwise qualified shareholder proposal “if the company has already substantially implemented the proposal.” In short, the issuer hopes to pre-empt the shareholders by adopting a nonbinding governance policy with broad escape clauses. This strategy looked promising until last month, when the SEC’s Division of Corporation Finance declined to grant Hewlett-Packard Co.’s “no action” request to exclude a shareholder proposal from its proxy statement on this ground. The proposal requested the company to amend its corporate governance documents “to provide that director nominees shall be elected by the affirmative vote of the majority of the votes cast at an annual meeting of shareholders.” See Hewlett-Packard Co., 2006 SEC No-Act. Lexis 8, at 1. Hewlett-Packard had already adopted an elaborate, but nonbinding, majority-voting policy that gave the board discretion as to whether to accept or decline proferred resignations from directors. As a result, the SEC’s action may have opened the door for the undiversified activists to attempt to use majority voting to unseat the CEO. But this will require a change in shareholder tactics. Virtually all the shareholder proposals submitted to date for majority voting have been precatory proposals that simply request management to change its policy. Management is, of course, free to ignore such requests. In response, shareholders could then seek to take stronger action, either by conducting a proxy fight, possibly to elect a “short slate” of one or two directors, or by proposing a mandatory bylaw amendment. The first step is costly and may not win the support of diversified investors, who almost certainly would not contribute to the costs of a proxy fight. Thus, the more likely strategy is a mandatory bylaw amendment seeking to impose majority voting. A long debate has surrounded the legality of such mandatory bylaw amendments under state law. Compare John C. Coffee, “The Bylaw Battlefield: Can Institutions Chance the Outcome of Corporate Control Contests?,” 51 U. Miami L. Rev. 605 (1997), with Lawrence Hamermesh, “Corporate Democracy and Stockholder-Adopted By-laws: Taking Back the Street?,” 23 Tulane L. Rev. 409 (1998). But a recent Delaware case suggests that such an amendment could impose majority voting consistent with Delaware law. In Hollinger International Inc. v. Black, 844 A.2d 1022, 1078-1080 (Del. Ch. 2004), Vice Chancellor Leo Strine found that shareholders had the inherent power under � 109 of the Delaware General Corporation Law to adopt a bylaw that abolished a critical board committee and to regulate generally the processes by which the board acts. Thus, even if it remains an open question whether a mandatory bylaw amendment can redeem or cancel a poison pill, bylaw amendments should be able to adopt a majority voting system that allowed the board no discretion to reappoint a defeated CEO as a director. But here there is a special wrinkle in the law, both in Delaware and elsewhere. Although an incumbent director who does not receive a majority of the votes cast would not be re-elected, such an incumbent would still become a “holdover” director. Under � 141(b) of the Delaware General Corporation Law, “[e]ach director shall hold office until . . . [a] successor is elected and qualified or until such director’s earlier resignation or removal.” In short, although a director denied a majority vote may be humiliated and undercut, he or she remains in office unless he or she resigns or is removed. Bylaw amendments could allow for director removal Does this mean that mandatory bylaws cannot be used to unseat the CEO? Not necessarily! More controversial bylaw amendments can be imagined. Under � 141(k), subject to some exceptions, any director may be removed without cause “by the holders of a majority of the shares then entitled to vote at an election of directors.” Arguably, a bylaw amendment could provide that “withheld” votes shall be deemed to be a vote for the director’s removal. Or it could provide that shareholders be given a choice of three votes on every director: “for,” “withheld,” or “negative”-with the last category implying a vote for removal. Still another option might be a bylaw amendment that automatically reduced the size of the board by one seat, within the parameters permitted by the certificate of incorporation, on the defeat of an incumbent director who failed to receive a majority vote. Finally, a charter amendment would likely be respected by the Delaware courts if it set up a procedure for removing directors by, for example, eliminating the seat of a director denied a majority vote. But this would require the consent of the board. Although there are legal issues surrounding all these options, the greater problem with these proposals is that they fracture the alliance that has developed between diversified and undiversified investors. While hedge funds might back such a firm-specific campaign, it is more doubtful that mutual funds and pension funds would do so, because they are no longer supporting an issue-specific good-governance campaign. These difficulties probably explain why most shareholder proxy proposals have been framed in a precatory format. Once campaigns move from precatory proposals to mandatory ones, the current marriage of convenience among different classes of institutional investors may be headed for divorce. John C. Coffee Jr. is the Adolf A. Berle Professor of Law at Columbia University Law School and director of its Center on Corporate Governance.

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