A Gadfly’s Perspective on “Gadflies at the Gate”

Individuals who submit shareholder proposals to companies for inclusion on their proxy statements are often characterized as nuisances. These shareholders often have little wealth at stake yet exert considerable effort and incur non-trivial expenses in order have a shareholder proposal put to a vote — which more often than not does not support the proponent’s proposal. David Larcker and Brian Tayan explore the motivations of these investors in a recent piece “Gadflies at the Gate: Why Do Individual Investors Sponsor Shareholder Resolutions?”

Larcker and Tayan (2016) struck my interest because in the 2016 proxy season I submitted 17 shareholder proposals (which I will refer to as the “project”) and by virtue of being an individual proponent — as opposed to an institutional proponent — I became a corporate gadfly.(1) I was not one of the individual proponents interviewed in Larcker & Tayan (2016). Whether gadfly is a pejorative label or not is debatable, but from my engagements with roughly half of the companies that received proposals, I generally did not walk away from those conversations feeling like the executives with whom I engaged with viewed me as a nuisance. Like many other proposals submitted by individuals the project’s proposals garnered exceedingly low support — generally a paltry one or two percent — but in a number of ways I view this project as a success. This article, written from the perspective of a gadfly, is intended to emphasize certain aspects in which a proposal put forth by an individual may be viewed as a success despite garnering low support.

My perspective is shaped by my experiences with the project and thus a little background about the project is necessary. The resolution of the project was to ask the board to “adopt and issue a general payout policy that gives preference to share repurchases (relative to cash dividends) as a method to return capital to shareholders.” The proposal is not a traditional ESG-type proposal in that payout policy is not environmental, or social in nature; and only tangentially related to governance. Despite this, the benefits I will describe should be applicable to shareholder proposals generally, including ESG-type proposals.

Negotiating Away a Proposal
If we believe that companies have unbiased expectations of the future, which is a standard assumption in academic finance, then the companies that received a proposal would have expected the project’s proposal to receive low support. If this was the case, then the fact that one company actually pre-adopted a capital allocation policy that sufficiently addressed the proposal’s intent is rather surprising. Either (1) the company was radically different than the rest of the companies in the project and expected considerable support for the proposal; (2) the executives at the company had a particularly strong aversion to presenting the proposal on the company’s proxy statement; or (3) the executives at the company thought the benefits of formalizing a capital allocation policy outweighed the costs. I suspect, based on the interactions I had with the executives, that it was a mix (2) and (3). Regardless of the motivation, the company pre-adopted a capital allocation policy and thus negotiated away the proposal.

The adopted capital allocation policy was a collaborative effort between the executives and myself. In this collaboration I was able to embed what I view as beneficial practices in the policy. I cannot be sure whether this policy actually changes the decision making processes of the company, or if it simply formalizes the existing practices of the company. Either way, there is now a publically available policy that gives investors guidance as to how the company’s resources will be put to use and how the proceeds from those corporate investments will be distributed to shareholders. This is beneficial to me as someone invested in the company, to other investors to the extent they care about capital allocation, and to future investors as they are considering investing in the company.

Giving due consideration to negotiated away proposals is crucial to understanding the costs and benefits of shareholder proposals. The adoption of the capital allocation policy at this company would not show up in standard datasets. If a researcher gauged the success of the project based on shareholder support, then she may conclude the project was an abject failure because these data would not include the negotiated away proposal. While it is possible that she may still conclude the project was a failure with the knowledge of the negotiated away proposal, without considering the full range of outcomes from a proposal her analysis would be far from complete.

The omission of negotiated away proposals from standard datasets is especially salient as the U.S. Securities and Exchange Commission (the “SEC”) becomes more empirically driven in its rulemakings. If the SEC is considering raising the ownership threshold necessary to properly submit a proposal, and the withdrawn proposals by shareholders who own shares worth more than $2,000 but less than a proposed threshold are not taken into consideration, then the SEC may inadvertently omit a key benefit in its economic analysis.

Expanding Executive Knowledge
In a number of the engagements with companies I found that the executives conveyed that they had a deep understanding of their large shareholders’ views on payout policy. This understanding may come from regular engagement with their large shareholders. On the other hand the executives’ understanding may have come about exactly because the company received a proposal, in that the proposal spurred the executives to engage with large shareholders to gather their views about payout policy.

Based on the engagements I had with these executives, I believe that both occurred. Some executives conveyed that they regularly discuss payout policy with large shareholders, and I would presume incorporate the large shareholders’ preferences into payout policy. Other executives did not convey that they discuss payout policy with large shareholders, which may or may not be indicative of a lack of knowledge about large shareholders’ preferences. In one particular case I was told that the proposal caused the executive to engage with the company’s five largest shareholders to get their views on what actions the company should take with regard to the proposal. In other words, the proposal caused the executive to expand his knowledge set with regard to investor preferences on payout policy.

For these latter companies, the companies that were not necessarily tuned in to their large shareholders’ preferences, I would assert that the project was beneficial because now corporate payout policy can evolve with those shareholders’ input.

Remedying executives’ lack of knowledge about investor preferences is part of a broader class of benefits of shareholder proposals. Executives are people, and as people they have both time and cognitive constraints. Executives have limited time to weigh the costs and benefits of their decisions about the future of the company. Moreover, executives have cognitive constraints in that they simply cannot be experts in everything. Some executives I engaged with had an unexpectedly deep knowledge of the costs and benefits of share repurchases relative to dividends. Other executives though, put politely, did not have the depth of knowledge that I would have expected. With regard to these latter executives, this is not to say that they are not talented executives, but simply that they cannot be experts in everything. The benefits of expanding an executive’s knowledge set should not be underestimated. For example, in a carefully designed field experiment Bloom, Eifert, Mahajan, McKenzie, & Roberts (2013) document a 11 percent increase in productivity by enhancing management’s knowledge of best practices in manufacturing.

Shareholder proposals provide an opportunity for these executives to be exposed to competing views on a topic, and provide an opportunity for knowledge gaps to be remedied. While sometimes engaging with proponents may not expand an executive’s knowledge set, other times it just might. Even if a specific proposal is not supported by the shareholder base, the executive’s knowledge set may be enhanced, which may result in better decision making in the future. That said, from a rulemaking standpoint, how to balance the benefit of an expanded knowledge set with the cost of an executive’s time must be carefully considered. In any potential economic analysis of a proposed rulemaking it is crucial to not make the assumption that executives have a complete knowledge set without support to ground it.

Education as an Externality
The shareholder proposals that were submitted as part of this project were intended to benefit the companies that received them. The project had a broader benefit though, in that it brought attention to certain nuances of the role of share repurchases. Because of the project I was interviewed by The Council of Institutional Investors (the “CII”) about the proposals. This interview resulted in an article that was distributed to the CII’s members that in part explained that many of the popular critiques of share repurchases (e.g., they are used to prop up compensation metrics, they come at the expense of long-term growth, etc.) are actually critiques of a failure of governance. Additionally, the article provided an opportunity to explain that other proponents’ proposals to limit the effect of share repurchases on executive compensation — for example by not using earning per share as a compensation metric — are not at odds with the project’s proposals, but rather are complimentary.

While it would be naïve to think that the project resulted in a fundamental change in the way certain investors think about share repurchases, it seems reasonable to conclude that there is sufficient institutional investor interest in a more complete conversation about share repurchases based on the CII taking notice and devoting resources to write about the project. As more and more capital is managed by a limited number of institutional investors, institutional investor exposure to competing perspectives and potentially remedying erroneous beliefs becomes more and more important to the efficient workings of capital markets.

Larcker & Tayan (2016) is quite interesting. This gadfly’s perspective on their article echoes much of the sentiment of the proponents interviewed and expands on certain benefits that I view as particularly salient to evaluating the overall benefits of shareholder proposals.

While I strongly doubt this project resulted in the economic gains of the 2015 Board Room Accountability Project(2)Bhandari, Iliev, & Kalodimos (2016) estimate that upon the announcement of the Boardroom Accountability Project over $10 billion in value was created. initiated by the New York City Comptroller’s office, there were sufficient benefits that resulted from this project that I believe it would be short-sighted to deem the project an exercise in wasted corporate resources simply because the proposals that went to a vote garnered low support. The outcome of the vote certainly matters for the actions that companies should or should not take, but from a rulemaking standpoint there are a much broader set of benefits that I believe should be considered.

Bhandari, T., Iliev, P., & Kalodimos, J. (2016). Governance Changes Through Shareholder Initiatives: The Case of Proxy Access. doi:10.2139/ssrn.2635695
Bloom, N., Eifert, B., Mahajan, A., McKenzie, D., & Roberts, J. (2013). Does Management Matter? Evidence from India. The Quarterly Journal of Economics.
Larcker, D. F., & Tayan, B. (2016, August). Gadflies at the Gate: Why Do Individual Investors Sponsor Shareholder Resolutions? Rock Center for Corporate Governance.

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