America’s governance reform must not be ducked

The winds of change that brought President Barack Obama into office will soon blow through US boardrooms. Unfortunately, executives are not welcoming this as a breath of fresh air but see it rather as a dangerous intrusion into their affairs. Storm clouds are gathering at the US Business Roundtable, while the US Chamber of Commerce and Republican commissioners on the Securities and Exchange Commission are straining to hold back corporate governance reforms that will tip the balance of power away from managers to owners – the shareholders.

The financial crisis exposed many boards as weak and incompetent. If boards failed to exercise effective oversight, why did shareholders not simply replace them? The answer is that US law and practice make it an uphill struggle for shareholders who want to hold boards to account.

Typically, when a director is put forward for election, investors cannot just vote No. The “default” provisions, used by nearly half of the biggest blue-chip companies, allow shareowners only to vote in favour of management’s nominees or to withhold their vote. This has allowed directors to be elected even if they do not command a majority of shareholders’ support. For those willing to invest the time and effort to challenge boards, restrictive rules adopted by the SEC make it fiendishly difficult and prohibitively expensive to put forward alternative candidates.

To add to the problem, many US boards have an alarming concentration of power through the combination of the roles of the chairman and chief executive. The chairman-CEO acts as judge and jury on critical issues, from board appointments to pay, risk management, strategy, audit and, yes, performance of the chief executive.

This is all about to change. Legislators and regulators are moving to tackle the governance deficit, which undoubtedly exacerbated the scale and depth of the financial crisis.

Senator Charles Schumer has just introduced a sweeping legislative proposal: the “Shareholder Bill of Rights”. This would give shareowners the power to vote No in board elections as a matter of routine. It would allow them to propose new directors, who would have to face shareholders annually. The bill would require separation of the chairman and chief executive roles and give the owners a “say on pay”. The Schumer bill also proposes the formation of risk committees to strengthen board oversight. There is political momentum behind the proposals and they are widely expected to end up in Congress’s reforms to strengthen corporate governance.

The mood of reform is abroad at the SEC too. Under the new leadership of Mary Schapiro, it has moved swiftly to recapture the investor agenda. It followed the Schumer proposals with proposed new rules for comment that would give shareholders the right to introduce board candidates on to the ballot paper, subject to thresholds intended to deter the frivolous and the short-termists.

Such eminently sensible reforms would go a long way to strengthening shareholder oversight and thereby tackling the governance flaws in the US. They will prove a test of resolve for the new administration, which is facing formidable opposition from business leaders. Shareholders and legislators will need to fix their sense of purpose in the face of opposition from those with something to lose in the new balancing of power and accountability in the boardroom.

In particular, the SEC will need to be shored up in its role as the protector of investors. Legislation empowering investors can only strengthen the workings of the market. The SEC must be left to do its work and be unhindered by those in Washington who want to slice and dice various parts of capital regulation into a new model.

The reforms will also pose challenges for shareholders, who need to embrace the new responsibilities that come with new powers. The capital markets require good governance on both sides. This is vital to achieving the common interest of directors and owners: wealth creation within a framework of proper risk management.

Capitalism without owners has been shown to fail. The dawning of a shareowner democracy in the US could be one of the most significant contributions of the new administration – one of global importance. Its advent cannot be taken for granted. The Obama administration would do well to focus on ensuring that these measures pass.

The writer is head of corporate governance and senior portfolio manager for global equities at the California Public Employees’ Retirement System