The Myth of Corporate Democracy

...Under current corporate law, the only real chance to nominate directors belongs to the incumbent management...

...The result has often been irrational decisions, hurried decisions, decisions based upon inadequate factual analysis or executive self-favoritism Surveying a decade that had seen .the wreck of the Penn Central, cost overrun catastrophes at both Lockheed and Douglas Aircraft, the slow, resistible decline of A&P, and a host of conglomerate stock collapses, J. Irwin Miller, president of Cummings Engine, concluded, “I think we’ve just gone through a decade of rather surprisingly bad decisions by businessmen worldwide...

...Professor Myles Mace of the Harvard Business School, in Directors: Myth and Reality, has summarized hundreds of interviews with corporate officers and directors and concluded that boards perform none of their legally implied roles...

...Pension and retirement benefits have also swollen...

...shall be managed by...

...Because the chief executive ,effectively selects the new members of a board, it does not establish the basic policies of a firm, does not select the president or other chief executive officers, and does not serve as disciplinarian of the corpbration...

...This widely held view is only half right...

...Directors,” William 0. Douglas complained as early as 1934, “do not direct...

...They didn’t know the factual picture and they didn’t try to find out...

...State corporation law has done nothing to offset this imbalance of corporate resources...

...Nor is it likely that the Project or any other outside shareholder could have matched Gh4’s ability to hire “professional” proxy solicitors, such as Georgeson and Company, which can deploy up to 100 solicitors throughout the country to contact shareholders personally, give them campaign speeches, and urge them to mail in their proxies...

...Why has corporate law failed to keep corporations law-abiding...

...Norton in September...

...In the years that I’ve spent on various boards,” says Robert Townsend, businessman and former chairman of Avis, “I’ve never heard a single suggestion from a director [made as a director at a board meeting] that produced any result at all...

...Walker Dance, Jack Parker, and Herman Weiss, the next three highest-paid executives, each received $400,000...

...All of this,” concluded the House Banking and Currency Committee, “raises the serious -question as to whether giant corporations affecting the everyday lives of our population . . . should continue to be governed in the traditional fashion or whether a new system of corporate directorships should be devised...

...Clerical help and clerical facilities, including printing presses, p hoto-copying machines, and computer addressing machines, are invariably called into action...

...Our survey of the 200 largest industrial corporations indicates that the practice is very widespread...

...54 ously titled the President, or the Chairman of the Board, or the Chief Executive Officer-or a small coterie of men have unquestioned operational control...

...Nowhere in the report was any mention made of the foreign currency speculation or improvident real estate loans which four months later caused the bank’s demise...

...Unfortunately, management reports are frequently “false and misleading...

...And the victims of corporate malfeasanceworkers, consumers, local communities, shareholders, and small businessmenshould be accorded greater access to the court system to redress their complaints...

...Yet, whether or not the board formally delegates authority to an executive cowittee, the managers who choose both board and committee always exercise control...

...As Professor Ernest Folk, the leading commentator on Delaware’s General Corporation Law, explains: “Given Delaware’s presumption of sound business judgment with respect to board decisions, the courts, will try to determine whether the decision can be attributed to any rational business purpose, and if so, there will be no judicial preemption of the decision...

...Although Penn Central was desperate for capital, the directors paid out nearly $100 million in dividends...

...In nearly every large American business corporation, one man-variThe co-authors are members o the Corporate Accountability Researchf Group in Washington...

...The board was definitely responsible for the trouble,” says E. Clayton Gengras, one of the “outside” (non-management) members of the board...

...and d) establishes pension plans, profitsharing plans, stock bonuses, retirement, benefit, incentive, and compen-sation plans...

...Since almost no one goes, the stockholders are represented only by their mailed-in proxy votes...

...Management’s “army” in a proxy war also includes: attorneys, who can distract the opposition with costly litigation...

...And company insiders have so totally dominated the proxy machinery that corporate elections have come to resemble the Soviet Union’s “Communist ballot,” on which only one slate of candidates appears...

...The legal basis for such a consolidation of power is the proxy election...

...As the Penn Central rushed towards its monumental crack-up, the board routinely approved every proposal forwarded by management...

...Yet if that same executive simply raised his salary by $500,000 and could point to similar salary increases in his industry, Delaware court would probably call this “fair...

...These options allow executives to buy shares of stock in their corporation at a fixed price at any time or at specified times-often with the help of companysecured, low-interest or interestfree loans-and subsequently sell them at the most advantageous moment...

...The chief executive or executive clique chooses the board, and, with its acquiescence, controls the corporation...

...du Pont’s executive committee consists of the company’s chairman of the board, president, and six senior vice presidents...

...Nearly every large industrial corporation offers its top executives stock options...

...3) Illegality-There is also, of course, the wave of corporate illegality which now fills our business pages and even front pages...

...In many corp o r ations,” Professor Melvin Eisenberg found, “the executives go so far as to wholly deny the boardsupposedly entrusted with supreme power over the corporation-access to certain categories of information...

...The more they do so the more the value of other stockholders’ shares is diluted...

...at Bristol Meyers, with 60,000 shareholders, 25 shareholders appeared...

...Even such seemingly “unreasonable” expenditures as publicrelations counsel, “entertainments,” chartered airlines, limousines, and the indirect cost to the corporation of using officers and employees on behalf of an incumbent director slate, have survived judicial scrutiny...

...Their book, Tamin the Giant Corporation, will be publishej by W.W...

...Much of that time is consumed by a pro forma review of operations by the president or vice presidents and equally routine approvals of the capital appropriations that management wants...

...c) loans money-on a secured or unsecured basis...

...Troubled by Northern’s record on knvironmental ‘ and consumer issues, a broadly basqd coalition of public interest groups called the Citjzens’ Advocate for Public Utility Responsibili~ nominated Alpha Snaby, a former Minnesota state legislator, for a seat on the board...

...The section provides that a director shall “be fully protected in relying in good faith upon...

...The fust provision is exemplified by the corporation law in Delaware...

...Besides the formal proxy statement, these reports usually embody the only detailed information shareholders receive about their corporation...

...At that time Northern States Power voluntarily empfoyed the “cumulative” voting system, which meant that only 7.2 per cent of outstanding shares was necessary’ to elect one director to Northern’s 14-person board...

...Over time, executives are able to build up a substantial fortune in corporate stock without personal risk...

...Equally important is ownership income...

...If this is the way it is chosen, it is no surprise that the board of directors has ceased to perform its statutory function of “managing the business and affairs of every corporation...

...The reports, however, “may be in any form deemed suitable by the management” and are not subject to the same standards of truthfulness that the text of a proxy solicitation is subjected to...

...The next 107 highest were paid an average of $121,240 in salary alone, with none of the extra benefits taken into account...

...Because that state’s corporate statues, and its jbdicial interpretations of them, so favor management interests, one half of Fortune’s top 5 00 industrials have chartered there...

...By contrast, state courts have firmly established the rule that insurgents, unlike management, are not entitled to reimbursement of any campaign expenses as a matter of right...

...Indeed, it is often hard to tell whether the boards of many corporations perform any independent function at all-other than mirroring managers’ desires...

...Of course, executives also reap a whole range of other perquisites: life and medical insurance, free medical service, educational grants for their children, indemnification insurance, country club memberships, free legal or tax counseling, expense accounts, and other amenities...

...The cost of printing a document comparable to GM‘s 21-page booklet and mailing it out, accompanied by a proxy statement, a proxy card, and a stamped return envelope might have cost half a million dollars...

...In theory, this small group of managers is selected by the board of directors to run the corporation...

...We have repeatedly mentioned Delaware corporate law for the same reason that law school corporations courses inevitably revolve around that self-proclaimed “little home of big The Washington Monthly/July-August 1976 business...

...This is roughly as much in one year as many of their employees earn in a lifetime, and two-and-one-half times the equivalent executive pay rate in 1963...

...Emphasizing the Positive Larger, more experienced corporations are usually less heavy-handed...

...Consider, for example, the techniques of the Northern States Power Co...

...No decision since 1907 in either Delaware or New York, the two leading chartering states, has denied management the power to expend corporate funds or use corporate personnel exactly as management chooses...

...In corporate elections we have to go to someplace like Wilmington, Delaware...

...Leon Sullivan, GMs recently appointed Negro director, supporting the Episcopal Church’s efforts to get the company out of South Africa...

...Exceptions to this pattern become news events...

...The meaning of this provision is very simple...

...Directors have no “duty to know...

...Redesigning rights and obligations between shareholders, boards of directors, and executives can encourage giant companies to be both more efficient and law-abiding...

...Every year, the shareholders of each publicly held corporation are invited to attend a meeting where directors will be nominated and elected...

...Typically, they will soften up the opposition with a series of “build-up” letters...

...In 1974 (after eliminating from consideration the seven chief executives whose stock holdings were either largely inherited or largely “founder’s shares”) the 43 highest-paid chief executives at the 50 largest industrial firms owned an average of $1,566,009 of the corporation’s stock...

...It entails serious economic and social costs-in terms of self-dealing, inefficiency and illegality...

...Federal chartering is a vehicle to bring the kind of democracy and probity to corporate governance that has been so glaringly absent...

...The aggregate costs to management of all these approaches to stockholders can easily exceed $1 million...

...A second provision of the Delaware General Corporation Law accomplishes the same result by allowing the board to formally delegate responsibility for most corporate business to a committee dominated by inside directors...

...2) Inefficiency -Business defenders enjoy ridiculing a Post Office or Department of Health, Education and Welfare as examples of big government inefficiency...

...Over a period of years, people just’sat there...

...Within a twoyear period, shareholders watched their shares plummet from 86% to 2...

...The result is that few stockholders attend these meetings...

...How, then, can one reconcile the grand imperative, “The business and affairs of every corporation...

...That study emphasizes that national standards for aational corporations are essential to reverse the historic flow of power to an executive cliqueand that corporate autocracy is not a necessary attribute of a productive economy...

...his can be a very expensive form of decorum, as the Penn Central’s shareholders painfully discovered...

...During the past decade, only in the MGM proxy contest of 1967 were the insurgents able to match management’s expenses in a costly struggle for control...

...By soliciting proxies a second and then a third time, the Power Company was able to persuade (or confuse) those who cast 71 per cent of Ms...

...Management’s grip on company power is tightened by its authority to print and distribute annual, quarterly, and other reports to shareholders...

...That poor man from the University of Pennsylvania [President Gaylord P. Harnwell], he never opened his mouth...

...To help accomplish this goal involves a full-time outside board of directors, selected by “cumulative voting” of beneficial owners in entirely company-funded elections...

...Even ‘Campaign GM,’ the most publicized shareholder challenge of the past two decades, attracted no more than 3,000 of General Motors’ 1,400,000 shareholders, or roughly two tenths of one per cent...

...Of the 6,744 cor: porations required to file data with the Securities and Exchange Commission in 1973, incumbent management retained control in at least 6,734 companies, or 99.9 per cent...

...These groups then successfully solicited the votes of over 14 per cent of all shareholders, or more than twice the votes necessary to elect her to the board...

...In the past 25 years there have been no more than a dozen cases in which insurgents have been able to match management expenses in a major proxy fight...

...That corporate democracy has been an illusion for nearly 100 years has not deterred businessmen and the New York Stock Exchange from annually proclaiming its viability...

...According to Professor Wilbur Lewellen of Purdue, the mean salary for the top executive at 50 large manufacturing corporations increased steadily during every year of the recent recession, from $251,867 in 1970 to $287,759 in 1971, $323,802 in 1972, and 60 $389,277 in 1973...

...01976 Ralph Nader...

...reports made to the corporation by any of its officers...

...Of all the corporations which reported, two thirds had transferred directorial powers from the full board to an executive committee, at least half of whose members were insiders...

...Management can also exploit corporate personnel and resources on its own behalf...

...As corporate operations have grown more complex and technologies more sophisticated, checks upon senior management have all but disappeared...

...They are often written in an upbeat public relations jargon which emphasizes “positive” aspects of the past business year while rationalizing or ignoring management mistakes, financial losses, corporate or executive criminal violations, or civil actions successfully prosecuted against the corporation...

...Attorney John A. McMullen has described several examples: “At IBM-four directors, all top level officers of the corporation, control the all-important executive and finance committees...

...In a 1975 survey of 394 of the country ’ s 1 a r ge s t corporations, Kdm/Ferry International (a New York executive recruitment firm) found that boards averaged only seven meetings per year...

...When all the stock bonuses, insurance policies, and benefit programs are taken into account, the executives’ incomes rise by 50 to 75 per cent above the nominal average level of $400,000, to an average of $600,000 to $700,000 each year...

...It was the first time that a GM director had ever spoken against management at an annual meeting...

...They need not anticipate problems or verify the accuracy of reports upon which they rely...

...In most large corporations, the board meetings have withered, through neglect, into a ritualized one- to three-hour ceremony...

...The board never saw a capital expenditures budget...

...Management control has overwhelmed the rule of law...

...For example, although subsequent congressional testimony made clear that Lockheed would have gone bankrupt unless it received an emergency loan guarantee from the federal government, Lockheed’s 1969 annual report managed to ignore the prominent debate in Congress over whether the federal government should “bail out” the firm And just a few months before the comptroller declared the Franklin National Bank insolvent, the corporation’s management reported to its shareholders that “in 1973 Franklin crossed an important threshold so that it is now in a position to move forward in establishing itself as a major worldwide financial institution and a leading money center banking operation...

...and ,public relations advisors, who will create advertisements for trade journals and the financial 56 sections of major newspapers...

...The prominent exposure of these crimes makes it unnecessary for us to recite them in detail...

...b) sells or purchases property from corporate executives...

...From the shareholders’ point of view, the result is a classic case of “heads we lose, tails you win...

...Consequently, though every word of an insurgent shareholder’s communications with other shareholders may be challenged if it is arguably “false or misleading,” most management reports are subject to no textual regulation whatever...

...And two provisions found in most state corporation laws further erode authority...

...In theory, at least, corporations seem very much like “the little republics” 1 9th-century legislators imagined them to be...

...But, in Delaware, “fairness” is presumed by the law...

...accountants and statisticians, who will prepare the most self-serving financial analysis allowable...

...Sylvia Silver, a Reuters correspondent who covers over 100 Wilmington annual meetings each year, described representative 1974 meetings: “At Cities Service Company, the 77th largest industrial corporation with some 135,000 shareholders, 25 shareholders actually at- tended the meeting...

...Self-Dealing Autocratic corporate government is not a phenomenon of interest only to corporate law professors...

...Worse, other states have followed Delaware’s lead and weakened their corporate laws so as not to lose too much chartering business to this “corporate Reno...

...These and other proposals are spelled out in detail in our report, “Constitutionalizing” the Corporation: The Case for the Federal Chartering of Giant Corporations...

...We found in a survey that 21 chief executives of the 50 largest corporations (the rest did not report dollar figures) looked forward to retirement benefits of $133,9 10 each year...

...Unless something occurs to make them suspicious that something is wrong, directors are not required to “put into effect a system of watchfulness...

...The Project, of course, could never afford to respond to GMs pamphlet-postage alone for soliciting GMs 1.4 million shareholders would have exceeded $100,000...

...They took their fees and they didn’t do anything...

...But the recent rash of corporate crimeover 100 companies have so far acknowledged illegal payoffs at home or abroad-raises important questions about who governs the largest corporations...

...At General Electric, the chairman of the board, Reginald Jones, received direct remuneration of $501,200 in 1974...

...At GM, four of five men, all inside directors of the company, dominate the executive and finance committees of the board as well as the administration committee comprised of key officers and directors...

...High levels of pay are not limited to the chief executive...

...In the 500 largest industrial corporationscorporations which account for some 66 per cent of the sales of all industrial corporations in the United Statesno incumbent management was even challenged in 1973...

...with or without interestto corporate executives...

...Not only does the Delaware law permit such self-dealing, but it also renders shareholders virtually powerless to call a halt...

...Hence, national minimum standards were essential...

...Federal Chartering In other areas-employment discrimination, unfair labor practices, pollution -Congress has understood how states would compete among themselves for plant sitings by offering high-pollution, low-wage environments...

...Directors do not even ask rough or knowing questions...

...in addition, three of them are members of the powerful Corporate Office...

...But salary, bonus, and deferred income are only the most obvious benefits...

...1) SeZFdeaZiFg-Curren t Delaware law permits the chief executive of a corporation and other senior corporate executives to serve on the board of directors or compensation committee which: a) sets executive salaries...

...What is the scope of management power and what are the checks upon it...

...M 1974 the executive compensation (salary, bonus, deferred income, and directors’ fees) of the highest paid executives at the 50 largest industrial corporations averaged about $400,000...

...With practically unlimited power to use corporate funds in the elections, the management simply overpowers opponents, who must prepare separate proxies and campaign literature at their own expense...

...But it is important to understand how the existing system of corporate governance tolerates or encourages corrupt decisions...

...In reporting on General Motors’ 197 1 annual shareholders’ meeting, The Wall Street Journal noted that, “The meeting’s dramatic highlight was an impassioned and unprecedented speech by the Rev...

...a board of directors,” with the reality of this nondecisionmaking body...

...Just six hours before the corporation filed its bankruptcy petition, the board routinely approved new contracts for eight corporate executives, apparently unaware even then of the dimensions of the Penn Central’s crisis...

...in 1973...

...The key to what British law Professor L. C. B. Gower calls “this solemn farce” is money-specifically , the cost of mounting a proxy challenge...

...Often these salaries don’t go down even when sales or profits do...

...There are few practical limits to this doctrine...

...in reality it is just the reverse...

...Some of them so bad that nobody would have guessed it...

...Inefficiency & Illegality With no law to hold it back, excessive remuneration has become the norm...

...The fashionable response is that the board is a legal fiction...

...No rule within modem corporation statutes prohibits management from nominating and serving as directors...

...The meetings are so infrequent, the inquiry so tame, that the boards canflot hope to “manage” their corporation...

...The shareholders (electorate) choose directors (legislature) who in turn select the managers (executive branch) to administer the enterprise day to day...

...For example, if a corporate chief executive were so graceless as to embezzle $500,000, even in Delaware he would probably be required to return the money and perhaps to go to jail...

...But recent history has demonstrated that corporate autocracy itself is inefficient...

...Senior executives invariably call the shots, which is why corporate law today is a hopelessly inaccurate reflection of corporate realities...

...Any contract or transaction between the corporation and an interested executive is permissible as long as it is “fair...

...Inner-Directed Why...

...A smaller number of corporations accomplish a comparable result by delegating authority to an insider-dominated finance committee...

...It never understood the inaccuracies published in Penn Central’s annual reports...

...Northern States then, in effect, bought the election back...

...Snaby’s votes to change their minds...

...In political elections we can go a few steps down the street to vote...

...El Paso Natural Gas, with 125,000 shareholders, had 50 shareholders...

...Yet it is considered “discourteous,” a breach of “corporate manners,” for directors to “challenge” the resident or other corporate officers...

...In the 1971 ‘Campaign GM contest, General Motors raised this strategy to a new plateau by encasing the Project on Corporate Responsibility’s single 100-word proxy solicitation within a 21-page booklet specifically rebutting each of the F’roiect’s charges...

...As Roderick Hills, chairman of the Securities and Exchange Commission, said, “The problem as we see it is the breakdown of corporate accountability...

...As Professor Bayless Manning, the former dean ,of Stanford Law School, put it, ‘We have nothing left but our great empty corporation statues-towering skyscrapers internally welded together and containing nothing but wind...

...Management has deposed the board of directors-but it has done so with the law’s approval...

...So too for the system of state chartering, especially since it’s so much easier to move a piece of paper to Delaware than relocate a plant in Alabama...

...At the time of its collapse in June 1970, Penn Central was the largest railroad in the country and the sixth largest industri58 a1 corporation overall...