Shareholder proposals are one of the most effective forms of shareholder voice in corporate America. It is one of the main channels through which small shareholders can influence the governance of the corporations in which they own shares. However, recent changes to the minimum ownership thresholds for shareholder proposals threaten to take that voice away.
Shareholder proposals have become a key instrument of shareholder voice in corporate America. Yet recent rule changes passed by the SEC—increasing the barriers to shareholder proposal submission—risk severely muting that voice. Not only does this harm shareholders, but the muting of shareholders’ voice has detrimental impacts to both stakeholders and our overall corporate governance system.
Why is that the case? In a typical widely-held large US corporation, shareholders don’t get much of a voice. Management often runs the corporation as it sees fit, and directors are rarely subject to any threat to their board seats. Retail investors in particular face limited opportunities to influence corporate governance because, unlike larger institutional investors, they often do not have the clout of a large investment to gain informal access to the board or the management team.
Yet, one way where every shareholder voice could be heard in a true and meaningful way is through the ability to submit a shareholder proposal for all other shareholders to vote on at the company’s annual meeting. Forcing an item on the corporate agenda despite management’s objection has been one way to ensure that matters of importance to shareholders see the light of day, both by other shareholders and management itself. While shareholder proposals have been around for many decades (the initial rule allowing them was incepted in 1942), the last two decades have seen a significant shift in their impact.
With the rise of proxy advisors, a shareholder proposal is no longer just a PR attempt to direct attention to the issue at stake. Indeed, despite most often being drafted as non-binding resolutions, these proposals have become binding in practice with the power to implement important corporate governance policies. This is because proxy advisers such as ISS and Glass Lewis have made it clear that companies that do not act on shareholder proposals that receive a majority support will suffer voting consequences.
The large influence that proxy advisers have through their voting recommendations presents a significant risk to directors’ approval rates, and as a result, it is rare for companies to ignore passed shareholder proposals, even if they are not legally obligated to do so. Furthermore, even proposals that fail to achieve the requisite majority but come close are likely to generate a reaction from management, and management has consequently become increasingly incentivized to communicate and settle with shareholder proposal proponents.
Importantly, as Tel Aviv University professor Kobi Kastiel and I highlight in a recent study, shareholder proposals are one of the few areas in corporate governance that had not been ceded to large institutional investors, hedge funds, and the uber-rich. While many retail investors don’t even vote, individual investors submit the majority of shareholder proposals. In fact, in 2018, just five individuals accounted for close to 40 percent of all shareholder proposals submitted to S&P 1500 companies, and these same individuals submitted more than half of the proposals that received a majority of shareholder support in the same index.
Institutional investors, on the other hand, submit almost no shareholder proposals, and in fact, a recent review by Harvard professor Lucian Bebchuk and Boston University professor Scott Hirst of almost 4,000 shareholder proposals submitted between 2008 and 2017 revealed that the Big Three did not submit a single proposal in those years. Instead, while these large investors have left this particular power to individual investors, they oftentimes support the proposals submitted by investors barely meeting the previously low minimum ownership thresholds.
The SEC, however, has significantly restricted this important channel through which many governance changes took place over the last 20 years. After consistent and enduring effort from corporations and their lobbyists to make it harder for shareholders to use the corporation’s own proxy machine to induce change, on September 23, the SEC voted 3-to-2 to amend Rule 14a-8. The rule grants shareholders the formal ability to have their proposals included on a company’s annual proxy statement for all other shareholders to consider and vote.
Since its inception in 1942, the ability to submit shareholder proposals has become a widely utilized tool through which shareholders can pressure management to adopt certain best practice governance and social standards. Though an amendment in 1998 did impose basic threshold requirements on shareholders wishing to submit a proposal, this year, the commission voted to heighten those requirements significantly in a way that would “price out” many existing proponents.
Under the new rules, shareholders wishing to submit a proposal for inclusion on the company’s annual proxy statement will be required to meet one of the following criteria: maintain at least $2,000 in securities for at least three years; $15,000 for at least two years; or at least $25,000 for at least one year. Previously, the rule required a shareholder to hold at least $2,000 or one percent of a company’s securities for at least one year. Importantly, the new rule changes also forbid shareholders from aggregating their shares in order to meet threshold requirements, a practice that has been used by some of the more active and successful shareholder proposal proponents.
The amendments to Rule 14a-8(b) also requires more clarity in delegating representatives for submitting shareholder proposals. In line with this requirement, Rule 14a-8(c) strengthens the rule limiting each shareholder to only one proposal per company by specifying that a shareholder submitting their own proposal may not additionally act as a representative for a different proposal to the same company.
Finally, the amendments to Rule 14a-8(i)(12) strengthen the barriers to resubmission for unsuccessful proposals. Proposals previously included on the company’s proxy statement once need to achieve at least five percent of the votes in favor in order for a substantially similar proposal to be re-submitted to the company within three years. Proposals submitted two and three times within five years need to obtain 15 percent and 25 percent support, respectively, in order to be eligible for resubmission in the following three years. These thresholds are increased from three percent, six percent, and 10 percent, respectively.
SEC Chairman Jay Clayton, acknowledged that shareholder proposals play an important role in improving transparency and corporate governance, explaining that the amendments aim to merely balance the costs companies experience with the interests of shareholder-proponents. Yet this marks a departure from the commission’s previously articulated goal of rule 14a-8: to provide an avenue of communication for smaller shareholders.
As Commissioner Allison Herren Lee noted, this “huge, unprecedented hike in the eligibility thresholds” will disproportionately affect individual shareholders, largely shutting them out of the shareholder proposal arena. Given that the average shareholder ownership value for 90 percent of Americans is less than $150,000, most potential shareholder proponents must decide whether to invest a substantial portion of their portfolio into a single company or be forced to give up active management of their portfolio by remaining invested in a single company for years. Simply put, “it is unreasonable to expect an investor who identifies an existing problem, but cannot afford to invest $25,000, to wait three years to suggest a solution.”
Though Chairman Clayton touts these amendments as “modest,” their effects will be anything but. And while companies and the SEC still cling to a myth of a group of small shareholders harassing companies on esoteric topics, the reality is that is simply not the case.
In our recent study, Kastiel and I deep dived into the role of small retail investors, often termed as “gadflies” in the corporate governance landscape. Our empirical evidence shows that the narrative promoted by companies and the SEC rulemaking is simply not true. Rather than supporting esoteric personal agendas, as companies and the SEC would have the public believe, gadflies initiate shareholder proposals focused primarily on governance terms that institutional investors and proxy advisors publicly endorse in their guidelines. Indeed, gadflies’ governance-related proposals attracted, on average, 47.8 percent shareholder support between 2005 and 2018 and accounted for a large portion of all passed proposals. For example, in 2018, gadflies submitted over 53 percent of the passed proposals, which means that these individuals are receiving widespread support from the larger investors who fail to submit proposals of their own.
Why do large investors refrain from submitting any proposals, even if they support the underlying question at stake? Ostensibly, the natural candidates for submitting shareholder proposals are the largest institutional investors, in particular the so-called “Big Three” indexing giants of Wall Street: Vanguard, BlackRock, and State Street. Several factors, however, including fear regarding regulatory compliance, political, and corporate backlash have left these institutions on the sidelines. It is therefore gadflies and other small organizations that have been left to carry the burden of bringing forth valuable proposals for other shareholders to consider. The SEC, however, has now risked driving them out by making the barriers to submission higher and more costly, which may lead to significant reduction in the adoption of good governance practices by publicly traded companies.
The recent SEC amendments overlook the larger, more important issue of how and why companies implement good governance policies. The recent reform looked at shareholder proposals in a vacuum and failed to examine shareholder proposals against a broader understanding of the systemic legal, financial, and structural constraints that prevent large institutional investors from utilizing the shareholder proposal tool to advance governance terms they publicly support.
The SEC also failed to consider the role that small retail investors currently play as “governance facilitators” by initiating important governance changes that large institutional investors overwhelmingly support at annual meetings. Considering this symbiotic relationship between gadflies and large institutional investors, any effort to silence retail investors that does not address the systemic constraints that large institutional investors face, or that does not empower a replacement mechanism, effectively “kills the messenger”—hindering the adoption of governance policies that investors as a whole strongly support.
This is not only the case for shareholders alone. The recent reform may also directly impact other stakeholders’ interests in companies. In the last few years, both shareholders and stakeholders increasingly demanded that companies take social and environmental issues seriously. Companies themselves have indicated that they aim to pursue these policies—the Business Roundtable, a group of over 180 large companies, has vowed to consider and promote not only shareholders’ but also other stakeholders’ interests.
Despite these promises, in a research with University of Virginia Professor Cathy Hwang, we demonstrate that ESG-related policies and disclosures are shareholder-driven. Shareholders’ impact can be direct or indirect. Most commonly, companies adopt these policies and disclosures in direct response to shareholder proposals, suggestions, or demands. Shareholders also influence the adoption of these policies indirectly, nudging companies to adopt stakeholder friendly policies preemptively, in order to fend off potential shareholder pressure. Consequently, reducing the ability of shareholders to pressure companies to adopt these policies also stand to reduce the likelihood that companies stay true to their statements and promote stakeholder interests in a meaningful way.
Taken together, the new rules make it significantly harder for small retail investors to submit proposals to begin with, while also making it more challenging to submit proposals that require more time to build momentum. The SEC has potentially taken away one of the last tools that small retail investors had for a meaningful voice, and the price might be born out not only by shareholders, but by society as a whole.