Editorial
More Democracy for Corporations
by Fred E. Foldvary, Senior EditorCorporations can become more democratic by making the voting by shareholders more decentralized. The way it works now is that the shareholders vote for members of the board of directors. The corporation sends the shareholders some information about the board candidates, as well as any issues to be voted on. The shareholder's votes equal the number of shares held, and the vote can be submitted by mail, on the Internet, or in person at the annual meeting.
Most shareholders know little or nothing about the board candidates. They get a report on the operations of the company, but very few shareholders read or understand the detailed accounting and footnotes. The board candidates are typically picked by the current board members, and often the chief executive officer will be influential in selecting candidates. The result is too often a self-perpetuating clique that indulges in excessively high rewards for the corporate chiefs at the expense of the shareholders.
Corporate governance is only formally democratic. In substance, the governance of a typical corporation is an oligarchy, ruled by a few powerful men. The main power of a shareholder is the ability to sell the shares rather than vote for the board which is supposed to represent him.
Corporate democracy can be strengthened by making it more indirect and decentralized. Instead of directly electing the board members, the shareholders would vote for delegates, who would then elect the board. It would be like the U.S. voting method for president. Voters do not directly elect the president, but rather vote for members of an electoral college, who then elect the president. The U.S. system has changed into a direct election of the president in substance, since the electoral college has become a rubber stamp. The corporate delegates would instead operate the way the U.S. electoral college was originally intended.
The corporate electoral delegates would represent particular types of shareholders. If there are shareholders who hold more than five percent of the shares, they would be their own delegates. Mutual Funds that own shares in the firm would elect delegates that would represent them. Other institutions such as insurance companies would have institutional delegates. Individual shareholders would vote for delegates who represent the small shareholders.
Any shareholder could nominate himself as a candidate to be a delegate. The delegates would have or obtain expertise in the firm's board candidates and the operations of the company. Delegates would have personal liability for being ethical, such as not having conflicts of interest. The delegates would meet personally and discuss the candidates, and then elect the board by majority vote.
The delegates would continue to represent the shareholders until the next election. With a two-thirds majority, the delegates would be able to unseat a board member. The delegates could also issue reports to the shareholders on how well the firm is doing, supplementing and interpreting corporate reports as well as news about the firm.
This indirect democracy would be more democratic than today's direct elections. The delegates would provide leverage for the voter. As it is today, the shareholder's votes are almost meaningless. The descriptions of the board members do not really inform the shareholder about the dedication and competence of the board member. Few shareholders have the knowledge to understand complicated issues such as stock options. Electing independent expert electoral delegates would bring real shareholder control to corporations.
There are many problems with corporations besides the lack of real democracy. Legislation making it more difficult to take over inefficient corporations has increased the power of the corporate chiefs. Despite recent reforms, corporate accounting still does not fully reflect economic reality such as liability for pensions. The corporate income tax is an illogical mess.
Some critics think the very concept of the corporation creates an evil privilege. These critics are mistaken. Limited liability is not unique to corporations. There are also partnerships with limited partner liability Anyone who lends money to a company or government has limited liability. If the firm goes broke, lenders lose no more than the value of the bonds.
There are "preferred" stock shares that earn dividends based on profits, but whose owners cannot vote in corporate elections. Such shares of stock are essentially bonds whose return is based on the profits of a corporation rather than some fixed rate. "Common" shares do have voting power, but are otherwise similar to preferred shares, the main difference being that if the firm goes broke, preferred shares will have priority over common shares.
Shareholders are essentially lending money to a firm rather than being real owners, since those who control the firm are self-perpetuating board members. With indirect democracy, shareholders will have more power over the board, but they would still be essentially lenders with voting power. Limited liability is not an arbitrary privilege but an inescapable fact of life.
If you lend money to a fellow who later gets sued, should you as lender also be sued? No, it would not be fair. The lender cannot control the action of the borrower. You as lender should not have full liability for the faults of others just because you loan them money. It is a fact of life that bad things will be done by people who do not have the resources to compensate the victims. That is what insurance is for. If shareholders lose limited liability, they will just become explicit bondholders instead. If those who own bonds also have unlimited liability, then the whole structure of market economies will collapse.
Better corporate democracy would make corporations more accountable to the shareholders. Then concerns over corporate policy, such as their treatment of workers and the environment, would be much more sensitive to shareholders's wishes. The indirect election of board members would require new legislation. That is certainly a field worthy of study and action.
Copyright 2003 by Fred E. Foldvary. All rights reserved. No part of this material may be reproduced or transmitted in any form or by any means, electronic or mechanical, which includes but is not limited to facsimile transmission, photocopying, recording, rekeying, or using any information storage or retrieval system, without giving full credit to Fred Foldvary and The Progress Report.
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