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With a once-in-a-generation tax reform secured, lawmakers can return their attention to issues that need to be addressed in the financial sector, and high on the list of priorities should be alleviating increasingly onerous shareholder proposal rule. Initially envisaged as a mechanism to encourage retail investors to make constructive contributions to the management of corporations, activist shareholders have since moved to exploit the system to push pet policy issues at the expense of the silent majority of shareholders solely concerned about the returns to their investment.
A root cause of the problem is the low threshold to submit a proposal for shareholders to consider. Introduced in the 1950s, the SEC’s shareholder proposal rule allows an investor to force a proposal onto a company’s proxy statement if they have owned $2,000 of stock for at least one year. Keeping the bar at this level has allowed activist shareholders to hijack corporate decision-making processes to advance issues that have a tenuous connection with the underlying business of the company. While most of these efforts are overwhelmingly rejected by shareholders, some have begun winning proposals that force a company to take a more concerted action with regard to climate change, which may be a worthy public policy goal but has no business being administered on an ad hoc basis by large publicly-traded corporations.
Last year’s proxy season is a case in point. In 2017, only 5 percent of shareholder proposals at Fortune 250 companies received majority support from shareholders. More than half of all proposals related to social or policy matters that had little relationship to shareholder value or corporate governance. The extent to which the current system can be easily manipulated is demonstrated by the fact that just three individuals and their family members generated 25 percent of all shareholder proposals at these companies.
Activist shareholders range from corporate gadflies and social justice warriors to major institutional shareholders such as union and government pension funds. These activists are not entirely of one political persuasion; fully one-quarter of proposals from 2008 to 2010 came from religious groups and their pension funds.
The shareholder proposal rule allows an activist with an economically insignificant interest in the company to impose the cost of considering their proposal on all other shareholders, which then forces the company to incur expenses associated with assessing the proposal’s legitimacy and challenging it if it fails to meet SEC requirements. There is also a cost arising from diverting the attention of management to consideration of an issue they have most likely already determined is not in the interests of shareholders.
These rules have broader ramifications that adversely affect the operation of investment markets. Regulation and the costs arising from public listing have contributed to the economy-wide reduction in the number of listed companies. The simplest structural defense to the threat of being targeted by activist shareholders is simply not to list publicly.
America is unique amongst advance economies in having a shrinking universe of listed companies. Stock market listings fell by around 50 percent over the two decades leading up to 2016, and there are fewer stocks listed now than in 1976, in spite of the economy being three times larger.
The smaller universe of investable companies limits the ability of investors to directly gain exposure to the complete US equity market. As a result, smaller investors miss out on the opportunities to share in the returns generated by companies that aren’t listed. Accredited investor rules constrain the ability of the public to invest in private equity, an avenue that might otherwise alleviate the constraint imposed by a company not being listed.