December 22, 2003

Security Holder Director Nominations; Proposed Rule

Key materials
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Stated Purpose:

The SEC seeks to enhance the ability of shareholders to participate in the proxy process for nomination and election of directors.

Summary of RSP Comment:

While some boards of directors have acted contrary to the interests of shareholders, the SEC has provided no quantitative or even qualitative data to support its assertions that this problem of misalignment is widespread enough to warrant a federal regulation or that the proposed rule will address the problem. The SEC is correct that the rule may improve principal-agent interest alignment, but in the absence of data or analysis, it is equally true that the rule may not provide such an alignment.

The fundamental problem may be the presumption that principles of political democracy can be effectively applied to corporate governance. There is no economic foundation for supposing that such an application to the company boardroom will produce desirable results. An investing world characterized by diverse preferences and opportunities, by frequent (i.e., annual) elections, as well as by a low-cost forms of exit, may be especially ill suited to rules patterned on tenets of political democracy--where the diversity of interests still exists but the frequency of elections is less and the costs of exit are quite high.

Economically rational shareholders are more likely to sell shares in underperforming companies rather than avail themselves of the proposed rule’s provisions because of the time, cost, and uncertainty involved in the rule’s application. Moreover, even if the proposed rules were successfully applied, the likelihood of an outside director having significant influence on management decisions is small.

Evidence from academic studies of the roughly analogous 14a-8 process (in which shareholders may offer proposals to be voted on during annual meetings) indicates that such proposals rarely produce any improvement in share values. This evidence should cause the SEC to consider whether it is wise to move forward with another rule that builds on essentially the same procedures.