In July 2020, then–presidential candidate Joe Biden stated that “it’s way past time we put an end to the era of shareholder capitalism.” What precisely he meant by that was not entirely clear from the context of his remarks. But if now-President Biden meant that shareholders are the ones who drive publicly traded companies, his comments weren’t reflective of legal realities. In fact, corporate law does a great deal to limit the influence of shareholders on the companies they own, and the Securities and Exchange Commission (SEC) is now busy trying to restrict that influence on boards and company executives even more.
In very simple terms, shareholders in a company are regarded as the company’s “principals” insofar as they are the business’s owners. It is by virtue of their ownership that they are entitled to receive the company’s profits. The company’s “agents” are the board of directors, executives, and managers to whom the principals have delegated the responsibility of directing and managing the business in order to realize that profit.
There is a division of labor at work here. Like all divisions of labor, the principal-agent division gives us the benefits of specialization. The “agents” focus on organizing risk, capital, and employees in a manner they think will best realize profits for shareholders. Investors, by contrast, concern themselves with which companies and funds are likely to better realize a return on their investment. Much American corporate law reflects the importance of this division, not least by significantly limiting the influence of investors over board decision making. One reason for this is that boards need some autonomy to do what they think is in the overall company’s interests. Why even have a board of directors, the logic goes, if the directors only do whatever one or two major investors demand?
One significant downside of these arrangements is that it is difficult for investors (the principals) to confirm that boards, executives, and managers (the agents) will prioritize the investors’ interests over their own. The same division also makes it hard for investors to challenge—let alone remove—underperforming boards or executives more interested in promoting, say, whatever happens to be the latest fashionable woke cause than in maximizing shareholder value within the limits of just laws.
Now the SEC is proposing a series of rule changes that would effectively put even more obstacles in the way of investors’ ability to hold boards and executives of publicly traded companies accountable. The proposed changes would force investors both to disclose when they buy up shares above a certain percentage and to explain their intention in doing so.
The SEC claims this is necessary in the interest of preventing what’s called “information asymmetry.” These are situations in which one party to a transaction has better information than do others. This means, the argument goes, that one party will benefit more than all the other parties to the transaction, and more than they otherwise would. That, some believe, is unfair.
But the world in general and the stock market in particular is full of information asymmetries. There will always be some investors who know more about a given state of affairs or a company than others. These cannot be eliminated. Nor is it clear to me why these are necessarily unfair. Perhaps an investor has worked harder than others to discern with more accuracy what is going on in the market place than others. Why he should not profit from the results of such work escapes me. Indeed, his acquisition of such knowledge may actually improve efficiencies in the marketplace.
So what’s really going on? I’d suggest that the real objective of the SEC’s proposed rule changes is to inhibit investor activism. In other words, were one or more investors to begin worrying about the company’s performance, or to become convinced that the company should be delivering more shareholder value, they would be inhibited from acquiring a stake of sufficient size in the company such that the board and executives could no longer ignore such investors’ concerns.
By requiring activist investors to engage in such disclosures prematurely (i.e., making them tell everyone in the stock market why they are buying up shares), two things are likely to happen. First, other shareholders will surely jump on the bandwagon, especially if such activist investors have a successful track record of generating greater share value. This will push up the share price. That in turn will have the effect of reducing activist investors’ ability to build up the type of position they need if they are to force a publicly traded company to change its ways. The second result is that the board and executives will have time to start preparing their defenses of the (often mediocre) status quo.
The end result of all this is that activist investors determined to make a difference to a company’s ability to deliver shareholder value will be disincentivized from doing so. It simply won’t be financially worth their while. But it also means that underperforming boards and executives will continue to underperform. Ergo, the growth of shareholder value will not be what it should. That is to the disadvantage of all shareholders in a publicly traded company—not just large shareholders but also those whose share positions are not so big.
The job of the SEC is not to protect lazy and incompetent boards and executives. The SEC’s mandate is threefold: to maintain fair, orderly, and efficient markets; to encourage capital formation; and to protect the interests of investors. The proposed rule changes actively mitigate against realization of all three of these goals—which is all the more reason for the SEC to rethink these changes, if not abandon them altogether.
