+(,121/,1(

Citation: 31 Bus. Law. 621 1975-1976

Content downloaded/printed from HeinOnline

Wed Apr 26 02:35:35 2017

-- Your use of this HeinOnline PDF indicates your acceptance

of HeinOnline's Terms and Conditions of the license
agreement available at http://heinonline.org/HOL/License

-- The search text of this PDF is generated from

uncorrected OCR text.

-- To obtain permission to use this article beyond the scope

of your HeinOnline license, please use:

Copyright Information
Is Shareholder Democracy Attainable?
By WILLIAM J. FEIS*

ONE OF the platitudes of American corporate life is that the business and
affairs of a corporation are managed by its board of directors, and that the
board is subject to the ultimate control of the shareholders. It follows that
every shareholder has a voice, however faint, in the selection of management.
While there are indeed a number of publicly held corporations in which a
single shareholder or control group has sufficient voting power to influence
the election process, it has long been recognized that shareholder democracy
is a fiction in most public corporations.' In most cases inside management,
sometimes with the backing of a control group, selects the persons who will
serve on the board of directors. Management tends to avoid choosing per-
sons who are unlikely to support them. Thus, the directors serve at the plea-
sure of inside management.
State corporation laws prescribe the rules and procedures by which the
shareholders of any corporation in theory can translate voting power into
action. Yet it is clear that the outcome of elections in a public corporation is
largely determined by the nominating process, over which the incumbents
have firm control. Periodically concern is expressed about this situation,
caused as much by specific incidents of management abuse or incompetence
as by an abstract sense that the owners of corporations ought to have more
power. Some observers suggest that a shareholder of a public corporation
need not be viewed as an "owner," since his economic interest is that of a
purchaser of a liquid investment, free to move in and out of a corporation
for the purpose of maximizing his income and appreciation of his capital.
This investor accepts the existing management, generally without any ex-
pectation that he can change management if doing so would further his profit
objectives. 2 The SEC has not shown great interest in promoting shareholder
participation in the nomination of directors; rather, the thrust of the federal
proxy rules has been to furnish pertinent information about the nominees, on
which supposedly intelligent shareholder decisions can be based.
It is apparent, as one surveys the constant stream of shareholder suits,
massive write-cowns of assets, criticism of corporate financial reporting, news
about illegal and immoral political contributions, international bribery, kick-
back and payoff arrangements, that too many managements exercise un-
* Member of the California Bar.
1. See, e.g., A. Berle & G. Means, The Modern Corporation and Private Property
(1932); Eisenberg, The Legal Roles of Shareholders and Management in Modern Cor-
porate Decisionmaking, 57 Calif. L. Rev. 1, 23-33 (1969); Moscow, The Independent,
Director,28 Bus. Law. 9 (1972).
2. See, e.g., Eisenberg, supra note 1, at 44-46; Moscow, supra note 1, at 10.
622 The Business Lawyer; Vol. 31, January 1976

controlled power and take unfair advantage of the shareholders they purport
to serve. Although it can be conceded that the managers of most public cor-
pora-tions are conscientious and essentially honest, the incidents that come
to light undoubtedly represent only a fraction of the problem. These recent
corporate scandals suggest that there are serious shortcomings in the mech-
anisms for overseeing managements and holding them more accountable to
the shareholders and the public at large.
In response to a climate of broader public exposure fostered by corporate
counsel, the SEC, the plaintiffs' bar, securities analysts, commentators, the
financial press and aroused shareholders, increasing recognition is being given
to the fiduciary responsibility of corporate insiders to the shareholders. Ju-
dicial decisions emphasize the principle that the control group cannot take
unfair advantage of other shareholders who lack sufficient power to block
their actions. 3 The SEC is urging that stock repurchases by corporations
must be conducted fairly, at a fair price, for a valid business purpose and not
primarily to benefit the controlling majority. 4 Self-dealing by directors and
officers, long a subject of mandatory disclosure under the SEC proxy rules,
has been further discouraged by the vigor of SEC enforcement actions and
shareholder protests and lawsuits. Despite the spotlight of such exposure,
there continue to be a surprising number of power plays by incumbent man-
agements, accomplished largely through their control over the proxy ma-
chinery. In some cases, managements of marginally profitable corporations
have obtained authorization for unreasonably large executive compensation,
option arrangements, or loans to finance bargain stock purchases by officers,
in the face of stormy shareholder objections that such actions are unfair. If
such incidents seem more surprising today than they used to, this may indi-
cate that our awareness of the need for fairness is becoming more rigorous,
and perhaps that such incidents are becoming less common. A growing body
of public opinion decries the unbridled power of insiders.
Perhaps it is time to change the way directors are chosen. Is it a bad thing
that the "owners" of large corporations have no real power? This article ex-
plores some of the factors bearing on this question and discusses a number
of suggestions, some feasible and some impractical, for opening up the board
of directors.
MORE OPEN ELECTIONS
A number of corporate procedures, regulatory suggestions, extraordinary
remedial sanctions, and other techniques are in use or are proposed to enable
3. See, e.g., Jones v. H. F. Ahmanson & Co., 1 Cal.3d 93, 460 P.2d 464, 81 Cal.
Rptr. 592 (1969). But see Cary, Federalism and Corporate Lawj Reflections Upon
Delaware, 83 Yale L.J. 663 (1974); Cary, A Proposed Federal Corporate Minimum
Standards Act, 29 Bus. Law. 1101 (1974).
4. See Securities Exchange Act Release No. 11231 [1974-75 Transfer Binder] CCH
Fed. Sec. L. Rep. 80,104, at 85,089 (Feb. 6, 1975), which proposes alternative Rules
13e-3A and 13e-3B for comment. 2 CCH Fed. Sec. L. Rep. 23,704, Id. 23,705.
 Is Shareholder Democracy Attainable? 623

shareholders to select members of the board, or at least to reduce the power

of entrenched management.
1. Cumulative Voting. The cumulative voting procedure makes it more
feasible for minority shareholders to obtain representation on the board. The
appeal of cumulative voting depends upon how seriously one views the exist-
ing power of management. Presently cumulative voting is required by the
constitutions or statutes of twenty states, including California, Illinois, Michi-
gan and Ohio. 5 The remaining states do not require corporations to provide
cumulative voting; this is one of the attractions a Delaware domicile offers
to corporate organizers in many states." Many observers regard cumulative
voting as a significant force for good, while others argue that it is disruptive
7 s
and does not furnish any real power to the minority. A recent article sug-
gests that cumulative voting may actually be counterproductive to the inter-
ests of the small shareholder, reasoning that it encourages each director to
represent his own particular constituency; whereas, where there is no cumu-
lative voting and the board is elected without the concurrence of the minority,
each director has a more obvious duty to represent the interests of all the
shareholders. Availability of the cumulative voting device may serve to ap-
pease those who feel that a noncumulative, "winner take all" system unfairly
solidifies the control of incumbent management. As a practical matter, how-
ever, cumulative voting has little significance to the small shareholder of a
large corporation 9 unless some substantial shareholder or determined group
takes the initiative in nominating one or more candidates and soliciting prox-
ies; and the choice then offered to the small shareholder is often between the
pro-management slate and the candidates who will support the special inter-
ests of the persons or groups nominating them.
2. Large shareholder. Often a holder of a large block of stock, while not
possessing enough shares to elect himself to the board, will be asked to join
management's slate. Management may seek his support and loyalty to fore-
stall possible opposition and to obtain the additional votes needed to assure
election of its nominees and passage of its proposals. This is more likely to

5. See compilation appearing at 1 ABA Model Bus. Corp. Act'Ann. 33 Par. 4, 3

(2d ed. 1971).
6. A complete revision of the California General Corporation Law was enacted in
September 1975 and will become effective January 1, 1977. Section 2115 of the new
law will impose a mandatory cumulative voting requirement on any foreign corporation
if the average of its California property factor, payroll factor and sales factor (as
defined in the California Revenue and Taxation Code) is more than 50% during its
latest full taxable year and if more than one-half of its outstanding voting securities
are held of record by persons having addresses in California.
7. Axley, The Case Against Cumulative Voting, 1950 Wis. L. Rev. 278; Sturdy,
Mandatory Cumulative Voting; An Anachronism, 16 Bus. Law. 550 (1961).
8. Mattes, The Burden of the Corporate Director Elected Noncumulatively, 63
Calif. L. Rev. 463 (1975).
9. At the 1975 annual meeting of stockholders of International Business Machines
Corporation, for example, a stockholder proposal to consider providing for cumulative
voting received less than 2.2% of the votes cast.
624 The Business Lawyer; Vol. 31, January 1976

be the case where the directors are elected cumulatively, and less likely where
the controlling group already has assurance of sufficient votes for its purposes.
When such a shareholder asks for a seat on the board, management recog-
nizes that refusal can turn a friendly shareholder into a disgruntled one. Al-
though election of such a shareholder to the board does not directly improve
the representation of small minority shareholders, the presence on the board
of an outsider with a substantial economic interest in monitoring manage-
ment's performance can be a significant safeguard for the minority.
3. Election Contests. Attempts by small minority shareholders to nomi-
nate and elect their own candidates are not often successful. Where there is
cumulative voting, technically it is possible to win a seat on the board with-
out a full scale proxy fight. Even a relatively limited proxy solicitation, how-
ever, subjects the participants to the SEC proxy rules (assuming no exemp-
tion is available) and involves legal complication and expense that may out-
weigh any interest in seeking a seat. 10 This consideration may not deter spe-
cial interest groups who want to have certain issues brought before the share-
holders, but it is likely to dissuade individuals with small holdings. Mounting
a major proxy fight involves great expense. The prospect of garnering more
votes than management is a discouraging one, not often promising except
against a management that has already been proven to be corrupt or incom-
petent.
4. Outside Directors.Increasing emphasis is centering on the use of "out-
side" directors as a force to keep management honest and responsive to the
interests of the shareholders. 1 1 A common proposal is that at least a majority
of the board should be persons who are not involved in the daily operations of
the company. A commonly accepted definition of outside directors would
include persons who are not and for a specified number of years have not
been officers or employees of the company, and who do not have a close fam-
ily relationship to any of its officers. A broader definition, perhaps stressing
the attribute of independence, might also exclude persons who represent con-
centrated or family holdings of the company's shares. 1 2 The rationale is that
independent directors can guard against many of the abuses that insiders have
the power to perpetrate. Although in most cases the insiders genuinely be-
lieve such concerns are unwarranted, they are coming around to the view
that outside directors are at least a cosmetic necessity. The "independence"
of such persons is often more technical than real; the company's investment

10. See Rule 14a-11 and Schedule 14B under the Securities Exchange Act of 1934.
17 C.F.R. 240.14a-l and 240.14a-102 (1975).
11. See, e.g., Blumberg, The Politicalizationof the Coporation, 26 Bus. Law. 1551,
1585 (1971); Eisenberg, Legal Models of Management Structure in the Modern Cor-
poration: Officers, Directors, and Accountants, 63 Calif. L. Rev. 375 (1975); Com-
ment, Equitable Remedies in SEC Enforcement Actions, 123 U. Pa. L. Rev. 1188
(1975).
12. See note 39 infra; see, e.g., American Stock Exchange Company Guide 122
(1970).
 Is Shareholder Democracy Attainable? * 625

banker, lawyer or major customer who serves on the board of directors is

likely to be responsive to subtle pressure to support incumbent management
with whom he hopes to have future dealings. Observers report that most out-
side directors continue to be relatively complaisant, giving inside manage-
ment a free hand except in the rare instances when a serious management
crisis makes decisive action inescapable. 13 And even where such persons in
fact function independently, it may never be possible to determine reliably
whether they serve a useful purpose in most cases. In the ideal case, the out-
side director can serve as the shareholders' ombudsman, investigating their
complaints and obtaining redress and reform. While we should not place too
much reliance on directors who may be little more than window dressing,
they have the potential to become the counterbalance to the power of incum-
bent management.
Appointing a substantial number, or perhaps a majority, of unaffiliated
persons to the board may become the norm for public corporations. Federal
statutes regulate the composition of certain boards by providing that no more
than 60 percent of the directors of a registered investment company shall be'
"interested persons;"'1 4 by prohibiting public utility holding companies or
their subsidiaries from having any officer or director with certain bank con-
nections;15 and by prohibiting interlocking directorates of banks and of cer-
tain corporations.' 6 Nearly all state securities administrators have adopted
a policy that a majority of the trustees of a real estate investment trust must
be unaffiliated with its investment adviser. 1 7 The SEC has the means to influ-
ence the selection of board nominees through its public pronouncements, or
through expansion of the scope of proxy disclosures in Schedule 14A by re-
quiring some express statement concerning a board's ratio of insiders and out-
siders. As with the recent amendment of the proxy rules that requires an ex-
press statement in the proxy materials if a corporation has no audit or similar
committee,' s the SEC might require an'affirmative statement if the company
does not adhere to the practice of having a predominantly unaffiliated board.
Investment bankers, who in many respects have interests which parallel those

13. Mace, Directors: Myth and Reality 47-48 (1971); Eisenberg, supra note 11,
at 376-77.
14. Section 10(a) of the Investment Company Act, 15 U.S.C. 80a-10a (1970).
15. Section 17(c) of the Public Utility Holding Company Act, 15 U.S.C. 79q(c)
(1970), and Rule 70 thereunder, 17 C.F.R. 250.70, 3 CCH Fed. See. L. Rep. 38,042,
at 28,053-3.
16. Section 8 of the Clayton Act, 15 U.S.C. 19 (1970).
17. Most states follow the Statement of Policy on Real Estate Investment Trusts,
adopted by Midwest Securities Commissioners Association on July 16, 1970. 1 Blue
Sky L. Rep. 4801, at 619.
18. Item 8(e) of Schedule 14A, as amended by SEC Accounting Series Release
No. 165, 5 CCH Fed. See. L. Rep. 72, 187 at 62,426 (Dec. 20, 1974). In SEC Ac-
counting Series Release No. 123, March 23, 1972, the SEC strongly recommended the
establishment of audit committees composed of outside directors. 5 CCH Fed. Sec. L.
Rep. 72,145, at 62,339.
626 The Business Lawyer; Vol. 31, January 1976

of the investing public, often recommend to clients that they select a reason-
able number of outside directors, feeling that this tends to broaden the out-
look of the board and also that it will appear more palatable to the public.
When they underwrite offerings of securities, investment bankers are in a
position to influence issuers to establish boards with more outsiders than in-
siders, and to organize committees of the board with authority to oversee
management. The SEC, in performing its prescribed functions in the registra-
tion of public offerings, may in the future make persuasive suggestions to
registrants that such a policy should be implemented. Stock exchanges also
promote the use of outside directors; the New York Stock Exchange recom-
mends that each listed company should have at least three independent di-
rectors, and the American Stock Exchange recommends a minimum of two. 19
There has been a noticeable shift in emphasis as the SEC, which seemed
to rely mainly on the prophylactic effects of disclosure to improve the quality
and integrity of directors, has moved more directly to bring about reforms
and changes in management. The courts and the SEC have in special in-
stances ordered corporations to name a majority of independent, SEC-
approved directors to their boards, or to appoint special independent com-
mittees or hire counsel and accountants to investigate wrongdoing. 20 These
remedies go beyond, and do not depend upon, the concept that management
has usurped the role theoretically assigned to the shareholders to choose the
directors. These sanctions seem to rest on the notion that even if the share-
holders really possessed this power, affairs have become so chaotic that the
shareholders can no longer be relied upon to promote goals society deems
most desirable. In some cases the corporate wrongdoing has consisted of acts,
such as illegal political campaign contributions, that arguably could benefit
the corporation's financial success, while in other cases management has
taken advantage of the shareholders and the investing public through false
financial statements and reports. The court-ordered housecleanings seek to
protect not only the shareholders, but also the investing public and beyond
them the public at large and the American political and economic system.
Partly in response to public and Commission pressure, outside directors
are assuming a new substantive role in the supervision of management. They
are making more diligent inquiry on their own, becoming more skeptical of
the information furnished to them by company personnel, reviewing cor-
porate disclosures more thoroughly, and seeking to foster scrupulous honesty
and accountability. To this end they are forming themselves into committees

19. New York Stock Exchange, Recommendations and Comments on Financial Re-
porting to Shareholders and Related Matters 5-6 (1973); American Stock Exchange
Company Guide 122 (1970).
20. See, e.g., SEC v. Mattel, Inc., SEC Litigation Releases No. 6531 and 6532,
October 2 and 3, 1974, (5 SEC Docket No. 8, October 16, 1974); SEC v. Coastal States
Gas Corporation, Civil No. 73-H-1262 (S.D. Tex., Sept. 11, 1973); SEC v. Vesco, 72
Civ. 5001 (S.D.N.Y. Mar. 16, 1973). See generally Comment, Equitable Remedies in
SEC, note 11 supra.
 Is Shareholder Democracy Attainable? 627

with defined responsibilities, independently reviewing such matters as ac-

counting policy, financial planning and executive compensation. In many
cases an audit committee of the board has regular, direct communication with
the company's auditors in meetings at which no members of inside manage-
ment are present to inhibit the discussion. Suggestions for the future, some
of which are foreshadowed by extraordinary sanctions implemented by the
SEC or the courts, include giving outside directors the authority to employ a
staff, to hire special counsel, and perhaps eventually to make separate reports
to the shareholders somewhat in the manner of the president's letter to share'
holders contained in the annual report.
Expanding the role of outside directors is expensive. The intensive review,
the potential duplication of effort, the possible employment of second sets of
attorneys, accountants and other professionals, the burden on inside manage-
ment of reporting and responding to an activist board, will result in a con-
siderable cost increase from the previously nominal cost of directors' fees.
The shareholders ultimately will bear this cost. One of the potential benefits
is the possibility of improved profits through cost savings, new approaches to
business planning, and detection of insider. frauds and self-dealing-but it is
difficult to predict whether, in the average large corporation, this benefit will
outweigh the cost. Other possible results include the inculcation of greater
responsibility to the public at large, the improvement of corporate morality
and reduction of business corruption, and the bolstering of investor confi-
dence in American business generally; these benefits do not readily translate
into earnings per share, and indeed they may narrow certain avenues of cor-
porate profit maximization. It may never be possible to determine with cer-
tainty whether actively functioning outside directors are worth the extra cost.
2
A new tactic has been taken in this area by the SEC in a significant report '
which demonstrates that the Commission is determined to influence the law
regarding the duties and role of outside directors. The report, issued in July
1975, criticizes the two outside directors of Stirling Homex Corporation. The
report notes that they were intentionally deceived by inside management, that
they relied in part upon the company's auditors, and that the alleged fraudu-
lent activities of the company occurred despite the association of lawyers,
bankers and investment counsel. The outside directors, one of whom is a
prominent attorney, were aware (and one of them protested about the fact)
that management was not consulting with them or providing them with certain
material information. Only seven board meetings, largely perfunctory, were
held during a period of more than two years preceding the company's bank-
ruptcy. There were no committees of the board and no written agenda for
board meetings. The report specifies a number of instances in which, in its

21. Report of Investigation in the Matter of Stirling Homex Corporation Relating

to Activities of the Board of Directors of Stirling Homex Corporation, Securities Ex-
change Act Release No. 11516, [Current Binder] CCH Fed. Sec. L. Rep. 1 80,219
(July 2, 1975).
628 The Business Lawyer; Vol. 31, January 1976

opinion, the performance of the outside directors was not adequate. For ex-
ample, they did not investigate the company's change of auditors, and they
acquiesced in the ongoing relationship which kept them insufficiently in-
formed. Their conduct with respect to the company's registration statement is
criticized, although, as the Commission is no doubt aware, it was typical of
outside directors of most corporations; they signed the registration statement
but did not raise questions about business operations or accounting practices,
did not consult with the auditors or investment bankers, and were not in-
formed of the SEC staff comments on the registration statement. The purpose
of the report purportedly is not primarily to criticize their conduct, but to
illustrate "an instance where outside directors did not -play any significant
role in the direction of a company's affairs even though they possessed con-
siderable business experience and sophistication .... [T]hese directors, in
the opinion of the Commission, did not provide the shareholders with any
significant protection in fact, nor did their presence on the Board have the
impact upon the company's operations which shareholders and others might
reasonably have expected."
Thus, the Commission has moved directly into an area which may be be-
yond its statutory authority, as it outlines some minimum standards which
directors should follow. These are uniform standards, apparently transcend-
ing state laws that would allow directors to rely, for example, on management
or accountants' reports. The SEC might respond that its report is consistent
with state law, since such reliance is justifiable only where the directors have
acted in good faith, after reasonable inquiry when the need therefor is indi-
cated by the circumstances, and without knowledge that would cause such
reliance to be unwarranted. 22 Nevertheless, it is clear that the Commission
perceives a need and an opportunity to establish some further federal cor-
poration law.
The message to outside directors is that the shareholders and others rely,
or are entitled to rely, upon their credentials. Outside directors have affirma-
tive duties to make inquiry, to insist upon certain kinds of information from
management, to investigate suspicious circumstances, and to take action
when it becomes clear that they are being bypassed in areas in which they
have responsibility. One possibly unintended implication of the report may
be that, if shareholders can place extra reliance upon outside directors who
have special ability and expertise in certain areas, then directors who are less
qualified perhaps should be held to a lesser standard of care and duty. We
can expect to hear more about the duties of outside directors as the SEC takes
the initiative and adds such "public reports" to its arsenal of enforcement
techniques.
A further complication in the changing patterns of corporate boards has

22. This standard appears in haec verba in Section 309(b) of the new California
General Corporation Law, which will become effective January 1, 1977.
 Is Shareholder Democracy Attainable? 629

been the attempt to "round out" the board, partly as a concession to pressure
from special interest groups. Corporations are enlisting blacks, women, en-
vironmental protectionists, academics and others to serve on their boards. 23
While companies may have some reservations about the ability of these new
directors to contribute to the corporation in the same way as "establishment"
directors, they hope that the new directors can anticipate problems and pro-
pose corrective action in specialized areas where business might otherwise
unwittingly offend or harm the public. As a side benefit for the corporations,
such demonstrations of openness and awareness to their social responsibilities
may quiet their more vocal critics. The legal duties of such directors are still
in flux, and it is not yet clear whether they will be held to a different standard
of care and liability than the other "outside" directors, or whether indeed they
can serve a truly useful function.
5. Minimum Qualifications for Directors. Most corporate lawyers have
dealt with corporations controlled by a single individual who has populated
the board with persons of his own choosing. His transparent expectation is
that they will vote as he tells them. Where they have some experience, ability
or judgment, there is a possibility that if action becomes inescapable, they
will reluctantly take action to replace management, or at least will resign
from the board. But often he appoints his spouse, children or other relatives
who are plainly unqualified to serve as directors of a public corporation.
A director who lacks the business sense or background properly to under-
stand and appreciate the corporation's affairs serves only to give incumbent
management an extra vote on every issue.
Some statutes have imposed certain minimum standards for directors.
Some state corporation laws still specify age, residence and share ownership
requirements for directors. 24 Each director of a national bank is required to
own a specified amount of the bank's stock and to be a U.S. citizen, and two-
thirds of the directors must reside within a specified locale. 25 Under Chap-
ter X of the Bankruptcy Act 26 the judge can refuse to confirm a plan of reor-
ganization unless he is satisfied that the choice of the directors and officers is
equitable, compatible with the interests of the creditors and stockholders and
consistent with public policy. ,
One indirect consequence of the disclosures about nominees for director
required by the proxy rules is that companies may be encouraged to appoint
suitably qualified directors, since they may be embarrassed to propose can-
didates who have fairly weak credentials. If this is one of the SEC's objec-
tives, the disclosure requirement could be improved in some respects. For
example, the rules require, for each nominee for whom proxies are solicited,

23. See, e.g., Blumberg, Corporate Responsibility and the Social Crisis, 50 B.U. L.
Rev. 157 (1970); Bus. & Society, Mar. 4, 1971, at 3.
24. See 1 ABA Model Bus. Corp. Act Ann. 35, 3.03 (2d ed. 1971).
25. 12 U.S.C. 72 (1970).
26. Section 221(5), 11 U.S.C. 621(5) (1970).
630 The Business Lawyer; Vol. 31, January 1976

a description of the nominee's principal occupations or employments for the

past five years. 27 However, there is an exception, that with respect to an
incumbent director for whom such information was given in an earlier year,
such disclosures can be omitted; this exception seems to depend on the invalid
rationale that this information is not needed annually since the shareholders
28
of a company do not change greatly from year to year. Other SEC forms
call for additional information, including a brief account of the business ex-
perience of each director during the past five years (including, but not limited
to, his principal occupations, and indicating the nature of the individual's
responsibilities in prior positions during that time period), any bankruptcy
or insolvency proceeding in which he was sigtificantly involved, any criminal
conviction or pending criminal proceeding, and any order, judgment or decree
relating to securities violations, during the past ten years; since some directors
may have come on to the board since the company's last registration state-
ment, and since Instruction H to Form 10-K permits this information to be
omitted from the annual report if the company has filed with the SEC a
definitive proxy statement (which is not required to include such matters),
there is a gap in the disclosure pattern. These matters, if not previously filed
with the SEC and disclosed to the shareholders, would seem to be material
facts to be considered in electing the directors.
Both the SEC staff and some state securities administrators have been
known to suggest or require an express warning in a prospectus to the effect
that the directors and officers of a new enterprise have little direct experience
in operating a business in this field.
Going beyond the formal regulatory requirements, counsel would recom-
mend or insist upon disclosure in a proxy statement of pending litigation
against nominees for the board, if such litigation has a significant bearing on
their competence, motives or integrity. 29 Each of these matters could be sig-
nificant to the shareholders, but the proxy rules do not require mention of
them.
6. Proxy Description of Candidates. A possibly undesirable contrast to
insufficient disclosure is the proxy statement that lists the backgroufds of the
management nominees at length, possibly making more of their resumes than
they deserve. On any matter other than the election of directors, counsel
would advise the company to make a more conservative presentation in its
proxy statement in order to avoid the contention that a distorted picture was
given. Certain changes in the proxy rules might improve the adequacy of dis-
closures about management nominees, and may even encourage the nomina-
27. Item 6(a)(2) of Schedule 14A, 17 C.F.R. 240.14a-101 (1975).
28. See Item 16 of Form S-1 registration statement under the Securities Act of
1933; Item 6 of Form 10 registration statement under the Securities Exchange Act of
1934; Item 12 of Form 10-K annual report.
29. See, e.g., Rafal v. Geneen, [1972-73 Transfer Binder] CCH Fed. Sec. L. Rep.
93,505 (E.D. Pa. 1972); Robinson v. Penn Central Co., 336 F. Supp. 655 (E.D. Pa.
1971); Beatty v. Bright, 318 F. Supp. 169 (S.D. Iowa 1970).
 Is Shareholder Democracy Attainable? - 631

tion of more qualified people. As suggested above, paragraph (a) (2) of

Item 6 of the proxy rules could be amended to require that the principal oc-
cupations and employments during the last five years of every nominee must
be disclosed, whether or not such disclosure has been made in an earlier proxy
statement. In describing a nominee's present employment, there could be
some explanation of his employer's business, where it is located, and other
pertinent information so long as it does not overemphasize the favorable
aspects of that business. Registrants should avoid listing credentials of nomi-
nees that have no bearing on their qualifications to serve as directors of the
particular enterprise. Item 7 (f) of the proxy rules, which requires disclosure
of certain transactions between the director and the company, does not reach
transactions which occurred prior to the beginning of the last fiscal year, nor
in many cases does it require any mention of the fact that a nominee has been
suggested by his employer, such as a lender with a real influence over the com-
pany, to serve on the board-yet such facts may be of great significance to the
shareholders. 30
If a practical procedure is found for nominating more candidates than
there are seats, so that shareholders are given a genuine choice, some com-
panies may find it helpful to describe in their solicitation material the ad-
vantages that each nominee could bring to the board. There is no prohibition
against a straightforward statement pointing out the value of a candidate's
experience in banking, law, accounting, real estate or science. An even more
radical departure from present practice would be an explanation giving the
real reasons why these particular candidates have been chosen. The crucial
reasons may not be apparent to most shareholders. Imagine how meaningful
a proxy statement might be if it included the following paragraph:
In addition to their business experience and other attributes which
management believes qualify these candidates to be directors of the com-
pany, shareholders should be advised of certain special reasons for their
candidacy. Mr. A was selected primarily because he is the largest share-
holder of the company, owning 300,000 shares (8%) of the company's
outstanding common stock. Mr. B is president of Baker Distributing
Company, the largest single customer of the company, which accounted
for approximately 16% of the company's total revenues during the past
three years. Mr. C is a vice president of Caldwell and Company, which
was managing underwriter in the public offering of the company's com-
mon stock in 1967 and which has rendered financial advice to the com-
pany without compensation from time to time since 1967. Mr. D is
president of Davis Capital Corporation, a small business investment cor-
30. Instruction 3 to Item 7(f) of Schedule 14A points out that a nominee for the
corporation's board might have an indirect interest in a material transaction by reason
of his position with the other party to the transaction; however, if his interest is not
deemed material, disclosure is not required. Similarly, the relationship may not con-
stitute an arrangement or understanding within the scope of Item 6(b).
632 The Business Lawyer; Vol. 31, January 1976

poration, from which the company may borrow on a long term basis at
some time in the future, depending on the needs of the business and on
whether favorable terms can be arranged. Mr. E has had a long associa-
tion with Mr. Smith, the president of this company; the two men were
college classmates, have invested together in several business ventures,
and serve on the board of directors of Evans Corp., of which Mr. E is
chairman and founder. Mr. F is a partner of the company's principal
outside law firm. Mr. G was formerly Assistant Secretary of Defense and
has special knowledge and experience useful to the company in its deal-
ings with government agencies. Mr. H is a professor at the Harvard
Business School, serves on the boards of two other public corporations,
and brings a different perspective toward long range planning which
makes him useful to the board.

Disclosure documents frequently are mired in ritualistic verbiage that ob-

scures from shareholders and others the essential information that they ought
to have about a company and its management. The underlying reasons for the
selection of particular candidates might be understood by an insider or by an
intuitive reader who cares to wade through the proxy statement. These undis-
closed reasons are the sort of facts that might eventually come to light too
late in a Wall Street Journal article exposing wrongdoing by management, or
in discovery proceedings following the filing of a class action by aggrieved
shareholders. Securities lawyers perhaps should concentrate less on technical
compliance with the proxy rules and more on the overall quality of the dis-
closures about the candidates.
7. Open Up the Nominating Process. Since it is usually preordained that
corporate elections will be won by the persons nominated in management's
proxy statement, an obvious way to increase shareholder participation is to
reform the methods of nominating directors. Various steps might be imple-
mented.
a. The board can designate a nominating committee composed largely
or entirely of outside directors. A number of companies have standing or
ad hoc nominating committees, usually to search for qualified persons when
a vacancy exists. It is unlikely that such a committee would initiate drastic
changes on its own or pass over competent incumbent directors who wish
to remain on the board. But if management were persuaded to broaden its
mandate to the committee to find genuinely independent candidates, there
might be significant changes.
b. In order to give the shareholders a choice, management could nomi-
nate more candidates than there are positions to be filled. The extra candi-
dates would be selected by management or by a nominating committee. It
must be noted that the offer of a directorship is regarded in many quarters
as a distinct honor, and management therefore may find it very difficult to
approach more individuals than there are openings.
 Is Shareholder Democracy Attainable? 633

c. Management could include in its proxy material, without charge,

additional nominations made by shareholders, perhaps upon the request of
the holder or holders of, say, 3 percent of the outstanding shares. 3 ' This would
go a long way toward making proxy solicitations more open, and would help
put outside groups on a more equal footing with inside management. If it is
felt that this approach should be mandatory rather than voluntary, Schedule
14A could be revised to require management to include such nominees in its
proxy material, together with the same breadth of background information
that management gives about its own nominees. Of course the proponents
of the shareholder nominees would have to furnish the information called for
by the applicable SEC forms, and some means would need to be devised to
protect management against liability for misstatements regarding matters
beyond its knowledge. It would not seem unfair for management to identify
which candidates are its favored nominees, and to disclose the identity of the
principal supporters of the other candidates. Any discussion by management
of the relative merits of the nominees, however, other than a short statement
that does no more than recommend a vote for designated persons, may bring
the solicitation within Rule 14a-11 and Schedule 14B governing election
contests. Of course, if the outside group conducts any independent proxy
solicitation, other than through management's proxy statement, Rule 14a-1 1
would be applicable to all the participants.
d. As a refinement of the concept of proposing more nominees than
there are vacancies, the balloting could classify the candidates as either inside
or outside directors, and provide for separate voting for each group in order
to assure an appropriate ratio on the board. For example, if there are nine
seats on the board, the rules of the election could call for four persons to be
chosen from a slate of six insider nominees, and -five to be chosen from a
slate of eight outsiders. Such a procedure would probably require amend-
ment of the state corporation law. Where the shareholders have cumulative
voting rights, this procedure would make it more difficult for the minority
to elect any directors since each shareholder would be required to split his
votes at least between two candidates (an insider and an outsider), rather
than casting all his votes for a single candidate.
e. Quasi-political pressures are bringing about the appointment of di-
rectors who represent special interest groups such as environmentalists, labor,
minority groups and consumer organizations. This is a recent phenomenon
accomplished by forces largely outside the -usual corporate mechanisms, al-
though it is generally one or more shareholders who raise the issue. As in the
case of reforms brought about by SEC enforcement actions in aid of the small
shareholder, a powerful outside influence turns the impotence of the small

31. Note Rule 14a-8(c)(4)(i), relating to proposals of security holders, which per-
mits management to omit a proposal if substantially the same proposal was submitted
to shareholders in management's proxy material at a previous meeting and received
less than 3% of the total votes cast on the matter.
634 * The Business Lawyer; Vol. 31, January 1976

shareholder into a force that can achieve results. In some cases the goal of the
special interest group is advanced directly by its representative on the board;
for example, an environmentalist on the board of a lumber company can have
a direct effect on company conservation programs. In other cases, the group's
objective may be only indirectly met by board membership; while electing a
woman to the board may sometimes influence the company's employment
policies, often it serves mainly as a symbolic demonstration that women are
capable and acceptable in a top-level business context. Although the social
goals of many of these groups are commendable, "opening up" the board in
this manner may be illusory and may actually reduce the remaining "outside"
positions on the board available to the minority shareholders, whose principal
immediate concern is profit maximization. The directors supported by spe-
cial interest advocates often have outstanding judgment and ability, but man-
agement is likely to look upon them as advisers mainly on problems within
their special expertise, and to discount their advice on general business mat-
ters. Thus they are not in an ideal position to promote the general interests
of the shareholders against controlling management.
8. Report of Previous Meeting. With the exception of a minority of public
corporations and other than the occasional meeting reported in the news-
papers, shareholders and the public receive virtually no information about
events at the annual meeting. Meetings are poorly attended. Most share-
holders have little interest, and the broad geographic dispersal of shares
makes attendance impractical for most people. Most meetings are routine,
but some involve general criticism of management, detailed grievances about
specific matters, questions and proposals from the floor, and discussion that
seldom is recorded anywhere or reported to the shareholders. The annual
meeting is an ineffective forum for the shareholders partly because there is
scant publicity given to any criticism voiced by the handful of shareholders
who are able to attend. Management already holds more than enough
proxies for its purposes, and typically regards the solicitation process as a
distraction, the meeting as an ordeal, and a number of the shareholders who
32
attend as a bother that must be tolerated.
The shareholders do not usually know the results of the voting on the
various proposals. Nor do they learn the extent of opposition to such matters
as management incentive plans. This gives centralized management a fur-
ther advantage over the disorganized mass of shareholders who have no idea
whether effective opposition could be mustered against certain management
policies. If corporations made it a practice to mail a report of the annual
meeting to their shareholders, this might help correct this imbalance of power.
Many corporations do in fact send a summary report and some offer to send
a complete transcript to any shareholder upon request. Shareholders have
presented proposals that such reports be mailed; while not victorious in the

32. See Cary, A Proposed Federal CorporateMinimum, supra note 3, at 699.

 Is Shareholder Democracy Attainable? -. 635

balloting, such proposals have generated enough support that a number of

companies have voluntarily adopted this policy.
This kind of report would not need to bring about a grass roots uprising
by shareholders in order to have an affirmative impact. Merely having to
report to the shareholders that, for example, an executive stock bonus plan
received only 73 percent support might be enough to persuade management
that the plan, although validly authorized, should not be implemented. Sig-
nificant opposition to a particular candidate for the board might cause man-
agement to change its slate the next time around. Management ought to be
able to stand this light of day.
It is more likely that such reports would be mailed voluntarily by manage-
ments which operate aboveboard, and are relatively unscathed by shareholder
criticism, than by companies where shareholders urgently need the additional
protection of such reports. The SEC could require such reports by broadening
the information requirements of Rule 14a-3 (b) of the proxy rules. The ob-
vious difficulties of preparing a balanced and impartial report are no greater
than a company faces in giving a full and fair description of its business. A
summary report should probably be sent to shareholders as soon as practi-
cable after the meeting, although there is some rationale for delaying it so
that it will accompany or shortly precede the mailing of the proxy material for
the next annual meeting. Such a report could have the twofold effect of mak-
ing management more responsive to the shareholders and getting shareholders
more interested in following corporate affairs.
9. Conduct of Election. Management's control is further strengthened be-
cause it conducts the meeting at which the board is elected. Parliamentary
rules give the chairman considerable latitude in controlling floor discussion
and determining when and whether to cut off debate, call for a vote or ad-
journ. The chairman or the incumbent board also selects the inspectors of
election. These powers are most significant in proxy fights, and can also make
the crucial difference where cumulative voting places one directorship in the
balance. Most state corporation laws do little to alleviate this situation except
in the extreme instance where shareholders can persuade a court that injunc-
tive relief and court-imposed election procedures are needed to protect the
interests of the minority. Enactment of a state law provision which would
give the holders of a reasonable percentage of shares (15 percent or 20 per-
cent) the right to demand that an impartial chairman be selected for the meet-
ing, and that such chairman choose the inspectors of election, might reduce
the power of the insiders to perpetuate themselves in office.
10. Voting Power of Institutions. The significant power of mutual funds
and other institutional shareholders which customarily vote their shares as a
block in favor of each of management's recommendations obviously increases
the leverage of management. 33 Brokerage firms are required to vote street
33. See, 2 L. Loss, Securities Regulation 924-25 (2d ed. 1961); Id. at 2869-71 (Supp.
1969).
636 The Business Lawyer; Vol. 31, January 1976

name shares as directed by the beneficial owners, but in the absence of any
instruction by the beneficial owners they may vote the shares in their discre-
tion so long as they have no knowledge of any contest (i.e. a solicitation in
opposition to management) and so long as the action does not involve a
merger or have a substantial effect on the rights or privileges of such shares a 4
If a practice of nominating more candidates for the board than there are
vacancies becomes accepted, brokerage firms and institutions would have the
potential to determine the outcome of the election. The fairest practice in
that event, with respect to shares not voted by the beneficial owners, may
turn out to be a spreading of the votes evenly among the various candidates
on the slate. This would improve the ability of the individual beneficial owners
to influence the result, while the remaining institutional shares would be rep-
resented at the meeting primarily for the purpose of assuring that a quorum
is present.
11. Remedial Sanctions to Democratize the Board. The past two years
have seen the extraordinary development of changes forced upon boards'
through litigation and SEC enforcement actions. Generally such changes have
been incorporated into consent decrees. In SEC v. Mattel, Inc.,35 Mattel con-
sented to orders which required the company to name a majority of inde-
pendent (i.e., not affiliated with Mattel) directors satisfactory to the SEC and
approved by the court. Mattel also agreed to form special committees to su-
pervise the accuracy of the company's financial reports and to investigate the
possibility of bringing legal action against past or present officers of the com-
pany. Although literally such a remedy "temporarily suspends the traditional
power of the stockholders (at least with respect to these directors) to choose
the management of their company, '3 6 it recognizes that the so-called "power"
of the smaller shareholders to choose management is illusory. By requiring
SEC and court approval of the particular appointees, the remedy clearly im-
plies that not all outside directors have sufficient independence or inclination
to protect the outside shareholders and reform the company's business prac-
tices. Left alone, inside management tends to choose the entire board, and
whether or not such a board includes outside directors, the board will be
friendly to inside management.
Several other recent consent decrees have provided for the appointment of
new directors satisfactory to the SEC and approved by the court. American 37
Ship Building Company recently negotiated a consent decree with the SEC
which included the formation of a special review committee composed of

34. Id. See, e.g., New York Stock Exchange Rule 452, CCH New York Stock Ex-
change Guide 2452; American Stock Exchange Rule 577, CCH American Stock
Exchange Guide 9529.
35. See note 20 supra.
36. Comment, Equitable Remedies in SEC, supra note 11 at 1204.
37. SEC v. American Ship Building, Litigation Release No. 6534, October 4, 1974
(5 SEC Docket No. 8, Oct. 16, 1974).
 Is Shareholder Democracy Attainable? 637

independent directors to investigate misused corporate funds and file a report

with the SEC.
As part of a settlement of a shareholder class action involving alleged mis-
38
use of corporate funds, Northrop Corporation signed an undertaking that
it will replace its president, appoint three new directors who are independent
and are approved by the court as "being qualified in terms of experience,
independence, integrity and ability to make significant contributions as di-
rectors of Northrop," and recommend and solicit proxies for the election at
the next annual meeting of those three directors and a fourth new director,
also to be approved by the court. In selecting the four new directors, Northrop
agreed to consider up to six candidates proposed by the plaintiffs. The com-
pany agreed to provide that its board must include at least 60 percent Inde-
pendent Outside Directors, 39 from whom all of the members of the Audit and
Nominating Committees will be selected. A by-law was adopted disqualifying
any lawyer associated with the company's outside legal counsel from serving
on the board. The Executive Committee was directed to inquire into rela-
tionships with outside consultants and commission agents and make a report
to the board, the plaintiffs and the shareholders detailing its finding and rec-
ommendations; the report was completed in July 1975. In an effort to reduce
the power of inside management, the Nominating Committee was given the
express responsibility of nominating the management candidates for the
board and supervising the conduct of the proxy solicitation. The company
also agreed to place certain protective provisions in its Articles of Incor-
poration, including the establishment of the Executive, Audit and Nominat-
ing Committees, and a requirement that a specified percentage of each of
these committees and of the full board be Independent Outside Directors, so
that these provisions cannot be altered without shareholder action. The court
retained jurisdiction of the proceedings in order to allow the court and the
plaintiffs to monitor the company's performance of its undertakings.
12. Other Proposals.Many other proposals are being aired, some largely
for the sake of discussion. Some suggestions would radically change the na-
ture and focus of corporate power. Among the ideas that have been advanced
are:
(a) Creation of a roster of eligible and suitable independent directors,
perhaps compiled by a federal agency, from which the major U. S. corpora-

38. Springer v. Jones, Civil No. 74-1455-F (C.D.Cal. Jan. 20, 1975).
39. "Independent Outside Directors" is defined in the undertaking to mean "any
person who (i) is not an officer of the Company; (ii) has not individually received from
the Company in any of the preceding four (4) years or is not presently proposed to
receive in the next year in excess of $25,000 (other than fees as a director) for services
rendered or from the sale of material; and (iii) is not associated with a company
or firm which has in any of the four (4) preceding years received or is not presently
proposed to receive in the next year in excess of one percentum (1% ) of its gross sales
from transactions with the Company."
638 The Business Lawyer; Vol. 31, January 1976

tions would be required to select one or more directors who would represent
40
the public interest.
(b) Election of "professional directors," whose principal occupation and
orientation would be to serve on boards of public corporations. 41
(c) Election of full-time outside directors, who would be appropriately
compensated and would devote their time and efforts to continuous review,
42
supervision and direction of management and policy.
(d) Employment of a full staff to serve the outside directors, including
accounting, legal, financial and technical experts. 43
(e) Variations of the European two-tier system, with a managing board
composed of insiders, who are appointed and supervised by a supervisory
44
board of outsiders.
(f) Allocation of some board representation to government, industry-or
other factions. 45 There has been some implementation of this idea in quasi-
national American corporations such as Communications Satellite Corpora-
47
tion (Comsat) 46 and Securities Investor Protection Corporation.
(g) Nationwide popular election of directors of the largest American cor-
48
porations.
Discussion of every possible way to change the composition of the board
and the concentration of power is beyond the purpose of this article. The nu-
merous ideas that continue to be heard, and the revolutionary nature of many
of them, are indicative of the ferment in this area and the felt need for some
shift of power away from inside management.
DRAWBACKS OF COMPETITIVE ELECTIONS
The development of practical systems that would permit freer nominations
of candidates for the board and a choice between qualified nominees is, on
the face of it, a desirable public policy objective. Open and competitive elec-
tions would tend to promote greater responsiveness to the shareholders and
facilitate meaningful consideration of issues and policies. There are, however,
some negative considerations to be considered also.
1. A Meaningless Choice. If management could be persuaded to propose
more candidates than there are vacancies, the alternate nominees are likely
to be just as supportive of the insiders as the existing board members. In most
corporations the outside directors do not ordinarily initiate policy or actions,
40. See Moscow, supra note 1, at 12.
41. See Eisenberg, supra note 11, at 385-87.
42. Id. at 387-88.
43. Id. at 389-90.
44. Vagts, Reforming the "Modern" Corporation:Perspectives from the German,
80 Harv. L. Rev. 23, 50 (1966).
45. Id. at 65-89.
46. See 47 U.S.C. 733 (1970).
47. See 15 U.S.C. 78ccc(c) (1970).
48. See, e.g., the proposals of Mr. Ralph Nader, N.Y. Times, Jan. 24, 1971, 3, at
1, col. 6.
 Is Shareholder Democracy Attainable? 639

but rather they react to proposals by inside management. The additional

nominees selected by the existing management, while not necessarily carbon
copies of the other candidates, are no more likely to challenge or replace
existing executives than the incumbent directors.
2. Imbalance of Inside-Outside Ratio. If, for example, one believes that
the ideal nine-member board should be composed of four members from in-
side management and five independent directors, the nomination of a larger
slate could well result in the election of five insiders, or six outsiders, or a
more drastic shift in the balance of the board. The present custom of propos-
ing a limited list of nine nominees is more likely to assure that the four-five
split will be achieved.
3. Loss of Continuity. Greater democratization entails the risk that a
company can lose the background and knowledge of directors who have a
long familiarity with the company's affairs. Yet many companies have ex-
perienced rapid turnover on the board, or a complete change of directors
(particularly following a takeover, sale of control or financial crisis), and
have survived and prospered. Even if an expanded slate of nominees is of-
fered, most of the incumbents are likely to be reelected. In order to guard
against a drastic change in the makeup of the board, it might seem tempting
to provide for the classification of directors with staggered three-year terms. 49
But on balance this seems to be an unnecessary precaution, and in any event
is inconsistent with the goal of enhancing the power of the shareholders to
elect directors.
4. Defeat of Best Directors. Every board has its leaders, its experts, its
wise counsellors, and some who are best described as followers. If the slate
contains more candidates than there are vacancies to be filled, there is a real
possibility that the most essential directors will not be re-elected. However,
even with an expanded slate, management has means by which it can exert
its influence to elect the crucial people. Particularly where there is cumulative
voting, it is relatively easy for management to assure the election of specified
persons, leaving the remaining seats within the reach of the sometimes erratic
power of the scattered public shareholders.
5. Wasteful Electioneering.There are some things to be said for the pres-
ent system in which management presents its slate as a fait accompli, without
discussion, excuse or campaign rhetoric. Because of the expense and manage-
ment time that might be diverted to a contested campaign, only in limited
instances would a full scale contest for control be in the best interests of the
corporation and its shareholders. More competitive elections could cause
directors and officers to devote excessive attention to the approaching annual
meeting. Even though no criticism of the present board is expressed (which
would ordinarily bring into play the contest procedures of Rule 14a-11),
management may feel constrained to spend time and resources on symbolic

49. See, e.g., 1 ABA Model Bus. Corp. Act Ann. 37 (2d ed. 1971).
640 The Business Lawyer; Vol. 31, January 1976

projects that will look.good to shareholders, and on activities that will trans-
late quickly into affirmative results, rather than on matters that will produce
a less direct or immediate benefit to the company. Management might be
forced to pay even greater attention to operating results than it does now,
to the neglect of other socially desirable objectives. As in government and
other contexts in which office holders must periodically stand before their
constituency, one has some sympathy for executives who feel that they could
best manage affairs if only their public had no voice. Yet it is precisely this
free hand, this lack of accountability, that has led many critics to conclude
that more stringent controls are needed. Hopefully, more competitive proxy
solicitation and corporate campaigning will help to air useful issues without
proving too wasteful.
6. Discouragementof Good Candidates. Corporations report difficulty in
inducing qualified persons to serve on their boards. The reason most often
given is the growing extent to which directors are becoming the targets of
lawsuits. This imposes on any director both a major financial risk and a re-
quirement that he protect himself by devoting greater time and attention to
task than in the past. If, in addition to these burdens, directors will be sub-
jected to a critical annual review in which their diligence, motives and ability
may be questioned, outsiders will hesitate even further to join boards. A prac-
tice of nominating more persons than there are seats to be filled might present
the risk that the election process could degenerate into unfair or partisan
criticism of capable outside directors, who may prefer to resign rather than
defend their integrity.
7. Can the Shareholders Be Trusted? Our traditions make us reluctant to
question the notion that all things democratic are good. The corporation is
organized as a miniature form of representative government in which the
electorate chooses the officials who will implement the company's policies
and objectives. Is it heresy to ask whether the shareholders are competent to
make this selection? Most shareholders do not seem to be clamoring for
greater right to select their leaders. Shareholder apathy is reported to be
prevalent.5" As in governmental elections, a large portion of the electorate
leaves the decision to others by neglecting to vote. Despite the relative ease
of voting, simply by signing and returning a proxy, many shareholders are less
interested in participating in a corporate election than in a governmental elec-
tion, perhaps since, as shareholders, they have an alternative not available
to ordinary citizens-they can sell their shares if matters become intolerable.
Nor can one conclude that the shareholders will, even under a perfectly demo-
cratic system, choose the best directors. In part this depends on one's concept
of what principles a director should stand for. Statistical studies seem to
support the suspicion that shareholders would, for example, prefer to reduce

50. See Moscow, supra note 1, at 9.

 Is Shareholder Democracy Attainable? 641

community involvement and charitable donations by corporations."' It is also

quite probable that a great many shareholders would be in favor of illegal
political campaign contributions, commercial bribery or international payoffs
by their company's executives if the effect would be to improve revenues and
profits. Can shareholders, whose profit motive may predominate over their
interest in general societal objectives, be expected to promote corporate re-
form? In at least one significant area, shareholders and social reformers
clearly have a common interest: exposing management to a more rigorous
election process can reduce the risk that the control group might take eco-
nomic advantage of the shareholders. As for other abuses of authority and
illegal or immoral activities which do not harm the shareholders financially,
the past two years have seen the manifestation of a renewed morality, rein-
forced by notably successful civil, criminal and enforcement actions against
corporations and their officers and directors, which will probably do more
than the shareholders could to remind management of its responsibilities to
society and the general public.
8. The Maverick Director.One disadvantage of cumulative voting, which
could become-more of a problem if elections were freer or if additional can-
didates could be nominated, is the possibility that factionalism will develop
on the board. A more democratic process increases the likelihood that uncon-
ventional or dissident directors might be elected. This sort of risk exists in
any democratic institution. A director who is not a team player can be dis-
tasteful to a board that operates according to certain philosophies and func-
tional procedures. In some cases unqualified or abrasive individuals who
control a substantial block of stock are impossible to unseat. Such directors
waste time with worthless proposals and inquiries, obstruct discussion, and
confuse the orderly conduct of board meetings. Thus, it is not a necessary
conclusion that a system which permits easier election of such individuals is,
on balance, desirable merely because it seems consistent with shareholder
democracy.
There are instances in which management itself will nominate a maverick
director who has been detrimental to the corporation, since under cumulative
voting he has the support of enough shares to elect himself to the board in any
event. If the company were to adopt a policy of nominating more candidates
than there are seats, it might be feasible for management to explain in its
proxy material why it does not recommend the reelection of this particular
individual. But even an aberrant director can be a wholesome influence. He is
an observer who, by his presence, may exert a dampening effect on manage-
ment actions. He may see himself as the unorthodox champion of the share-
holders against management's solidarity. The risk that such nonconformists
can complicate the functioning of the corporation may simply be one of the
costs necessarily incurred in opening up the nominating process.
51. CI. Eisenberg, supra note 1, at 16; Manne, ShareholderSocial Proposals Viewed
by an Opponent, 24 Stan. L. Rev. 481 (1972).
642 The Business Lawyer; Vol. 31, January 1976

9. A Spoils System. Any arrangement that weakens established manage-

ment carries with it the possibility that newly elected directors will replace
the operating executives with persons of their own choosing. Their interest
may be primarily selfish, even though they may also sincerely believe that the
company will benefit from the change. Frequently one of the new directors
will become the chief executive officer. A spoils system, in which the winners
could overturn the professional executive staff of the corporation, is often
undesirable if there is not otherwise a sound business reason to replace the
insiders. One of the reasons given by management for erecting defensive ob-
stacles, such as a classified board in which directors have staggered three-year
terms, is the supposed need to discourage self-interested takeover attempts by
outsiders. There is indeed a possibility that greater democratization of cor-
porate elections would give considerable aid to groups which seek to obtain
control of suitable target companies.
10. Shifting Standards of Care. The developing law dealing with the re-
sponsibilities of outside directors as compared to inside directors is creating a
further practical impediment to opening up the board. Most people still re-
gard an offer to serve as a director as a token of recognition, an opportunity
to perform gratifying work in an interesting context, while at the same time
to enhance one's stature in business and community and perhaps obtain some
financial benefit as well. Operating executives see an invitation to join the
board as a significant prize. Increasingly, however, an offer to join a board is
met by concern about the risk of personal liability for negligence in the event
the managers commit serious errors of judgment or engage in intentional
wrongdoing without the knowledge of the directors. Today there are few
reliable guidelines establishing the duty of care of outside directors. Although
the SEC has declined to formulate such guidelines, its recent Stirling Homex
report5 2 stands as a clear warning that it may step into this vacuum. To the
extent outside directors are expected to exercise the same diligence and ob-
tain nearly as much familiarity with corporate affairs as inside directors, this
responsibility tends to discourage outsiders from joining the board. On the
other hand, to the extent that outsiders, particularly those appointed primarily
to represent a special interest such as environmental protection, are permitted
to rely on company information furnished to them and are held to a lesser
standard of care than inside directors, it can be argued that the shareholders
are less well protected.
Some commentators, critical of what they perceive to be generally lax
moral and legal corporate standards, contend that the progressive liberaliza-
tion of state laws to expand indemnification provisions and streamline cor-
porate procedures is giving greater power to incumbent managements at a
time when flagrant abuses call for new restraints on their power. They argue
that there should be a stronger standard of accountability of directors to the
shareholders. Such criticism may be largely counterproductive. More restric-

52. See note 21 supra.

 Is Shareholder Democracy Attainable? 643

tive indemnification provisions will not prevent dishonest insiders from abus-
ing their trust, but will discourage truly independent people from serving;
those outsiders who accept such substantial personal risks will tend to be per-
sons who hope to derive a personal benefit, such as an ongoing business rela-
tionship with the company. Eliminating outmoded restraints on board flexi-
bility enables business to respond more quickly to rapid developments, but
probably does not significantly enable management to deprive shareholders of
their ability (which is more theoretical than real) to control corporate affairs.
Expanding the remedies against directors by narrowly limiting their right to
rely on management reports, and requiring them by law to make extensive
independent investigation of information furnished to them by management
regardless of their confidence in the integrity of management, may result in
mediocre talents on the board rather than in careful conduct by the directors.
In order to attract the best talent to board membership, state laws should
encourage the streamlining of corporate mechanisms, and directors should
be given clearer guidelines of responsibility so that they can act with some
confidence that they are performing their work properly. To the extent that
the law operates vindictively against outside directors who have acted con-
scientiously, in good faith, and for no personal gain, truly independent can-
didates will be reluctant to serve.
CONCLUSION
Since 1932, when Berle and Means"3 definitively described the structure
of power in large corporations, shareholders have not moved much closer
to choosing the persons who will serve as directors. Our political and philo-
sophical tradition's, as well as glaring incidents of corporate corruption, con-
tinue to generate protests that management should not have uncontrolled
power to perpetuate itself-but management still holds this power. Recent
changes in public attitudes, shareholder assertiveness and regulatory em-
phasis appear to have had some influence in making management more re-
sponsive to the shareholders.
It is apparent, however, that there is also increasing pressure to make fun-
damental changes in the system of choosing directors. Investor confidence
has been badly shaken by unimaginably massive corporate frauds, and the
public appraisal of the ethics, morality and social responsibility of business
has dropped significantly. Some of the more modest suggestions discussed
above are feasible, and have the potential to bring about a better balance of
power without seriously handicapping the activities of good, conscientious
operating managements. Most importantly, such reforms may be urgently
needed if corporations wish to head off some of the more radical proposals
being advanced. The issues presented here should be discussed openly, the
disadvantages should be weighed along with the potential benefits, and busi-
ness should stop waiting for change to be forced upon it from the outside.

53. See note 1 supra.