Remember that moment during one of the 2016 presidential debates when the candidates engaged in a deep and provocative discussion about the laws and regulations that apply to public companies? For days, the country was swept up in matters of corporate governance. You couldn’t hop into a taxi or drop by the water cooler without engaging in a debate over board declassification, total shareholder return, proxy advisory firms, or Item 201(e) of Regulation S-K – and how we had to get those issues right in order to secure the future of the republic.
OK, OK, that never really happened. Corporate governance is not on the top of most Americans’ minds when they think about the most pressing issues facing the country. But it doesn’t mean these issues are unimportant to the economic livelihood of Americans from all walks of life.
In fact, the way public companies are run – and the laws and regulations that apply to them – are integral to America’s capital markets and their ability to drive economic growth for individuals across this country.
Corporations are creatures of state law, but if they are publicly traded and register their shares with the Securities and Exchange Commission (SEC), they become subject to a host of disclosures and other rules. Regrettably, in recent years, the level of regulation and the micromanagement of corporate affairs at the federal level have steadily increased – a phenomenon some refer to as the “federalization” of corporate governance. The end result? It is now costlier, more risky, and less attractive to be a public company, which impacts the ability of families to save for the future using publicly traded stocks.
Here are a few reasons why Americans should care about corporate governance.
For the vast majority of Americans, the only way to invest in stocks is through the public markets
The beauty of America’s capital markets is that they democratize opportunities to invest in and own growing businesses—the backbone of our economy. Unfortunately, due to the SEC’s accredited investor rules 90% of Americans are deemed to be not wealthy enough to invest in early stage private offerings. As a result, the only way for everyday Americans to invest in stocks is through public markets.
For Americans who choose to stake hard-earned money in the public market, it’s important to consider the rules that govern public companies and how they impact potential returns. A few years ago, the SEC estimated that the average cost per company for SEC compliance is $2.5 million up front, with ongoing costs of $1.5 million per year. That number has only grown as rules from the Dodd-Frank Act have taken hold. Mandates like the pay-ratio rule, which costs companies $1.3 billion up front and about $500 million per year, have inserted the federal government into boardrooms in an unprecedented way, costing investors.
Rules meant to advance a political agenda such as pay ratio do nothing to protect shareholders, but the money used to comply with them comes directly from investors’ pockets. Considering the opportunities wealthy Americans have to invest in private companies that don’t have to comply with these mandates, the burden of these rules points to a phenomenon all too common: middle and lower-income households getting stuck with the bill as they simply try to earn a decent return, save for retirement, or send a kid to college.
Many special-interest groups that “speak” for all shareholders don’t really have investors’ best interests in mind
Efforts by special-interest activists to use corporate governance laws and regulations to push idiosyncratic agendas have increased in recent years. This is a troubling development.
For example, SEC rules governing shareholder proposals were established to ensure that a good idea put forth by a shareholder received fair consideration. But activists have figured out that they can use these rules to draw attention to their pet issues, even if they have nothing do with enhancing the underlying value of a company’s stock or long-term profitability. Due in large part to the SEC’s complacency, companies are routinely forced to grapple with proposals about social or political issues that the vast majority of investors have no interest in.
The lunch here isn’t free, either. A U.S. Chamber report from several years ago noted that cost for dealing with each proposal is has been estimated to be $87,000, and that the total cost to shareholders for dealing with proposals is over $90 million per year. But the most significant threat to shareholders is the distraction many of these proposals create for the boards and management of public companies. In an economy that is rapidly changing, do you want the leadership of a company you are invested in worrying about how to stay competitive and innovate, or do you want them spending time thinking about whether the company uses cage-free eggs or how much water flows through each shower head in the hotels they operate? (Yes, these were both actual proposals in recent years.) Wasting the time of boards and management to deal with such frivolous issues only threatens their ability to think about the long term best interests of the company.
Who are these activists that enjoy making fellow shareholders pay to advance their agenda? Some of them are “gadflies” that own just enough stock to be eligible to submit socially or politically oriented proposals. But increasingly, state and local public pension funds are using shareholder proposals to target companies and industries they don’t like. The Chamber has long called for reform of the shareholder proposal rules so that they actually serve the interest of investors as a whole, not just those of a vocal minority.
One-size-fits-all regulation is a bad approach, but that’s exactly what our capital markets face now
With the federalization of corporate governance comes one-size-fits-all regulations, which inhibit the ability of companies to grow. The 2012 Jumpstart our Business Startups (“JOBS”) Act was passed in order to tackle this problem by scaling back certain regulations for businesses that are defined as “emerging growth companies.” By many measures, the JOBS Act has been successful and has helped a number of companies complete an IPO. However, not enough has been done to turn the trend of declining public IPO’s over the last twenty years. A 2011 report from the IPO Task Force found that CEOs overwhelmingly believe the SEC’s compliance regime is a significant barrier to going public. The tragedy lies in the fact that fewer public companies means fewer opportunities for Americans to invest – and fewer choices when they do. Dodd-Frank and other efforts by Congress and the SEC are largely to blame, and we must do more to ensure regulation doesn’t inhibit Americans from investing for their futures.
Public company shareholders deserve to have policymakers that look out for their best interests. While these issues may not make it on the evening news anytime soon, tackling them should be a top priority for those who care about providing all American households with more and better opportunities for financial security.