This is a presentation I gave at the University of Auckland Faculty of Law on May 19, 2014. It is based on my paper Preserving Director Primacy by Managing Shareholder Interventions (August 27, 2013), which is available at SSRN: http://ssrn.com/abstract=2298415. Even though the primacy of the board of director primacy is deeply embedded in state corporate law, shareholder activism nevertheless has become an increasingly important feature of corporate governance in the United States. The financial crisis of 2008 and the ascendancy of the Democratic Party in Washington created an environment in which activists were able to considerably advance their agenda via the political process. At the same time, changes in managerial compensation, shareholder concentration, and board composition, outlook, and ideology, have also empowered activist shareholders. There are strong normative arguments for disempowering shareholders and, accordingly, for rolling back the gains shareholder activists have made. Whether that will prove possible in the long run or not, however, in the near term attention must be paid to the problem of managing shareholder interventions. This problem arises because not all shareholder interventions are created equally. Some are legitimately designed to improve corporate efficiency and performance, especially by holding poorly performing boards of directors and top management teams to account. But others are motivated by an activist’s belief that he or she has better ideas about how to run the company than the incumbents, which may be true sometimes but often seems dubious. Worse yet, some interventions are intended to advance an activist’s agenda that is not shared by other investors. This paper proposes managing shareholder interventions through changes to the federal proxy rules designed to make it more difficult for activists to effect operational changes, while encouraging shareholder efforts to hold directors and managers accountable.

1. Shareholder Activism
in the United States:
Managing
Shareholder
Interventions
Stephen M. Bainbridge
William D. Warren Distinguished Professor of Law, UCLA
2014 Cameron Visiting Fellow, University of Auckland Faculty
of Law

2. Introduction
Part I

3. Kamin v. American Express (N.Y. Sup. Ct. 1976)Bayer v. Beran (N.Y. Sup. Ct. 1944)
Smith v. Van Gorkom (Del. 1985). Manson v. Curtis (N.Y. 1918).
Marx v. Axers (N.Y. 1996).DGCL § 141(a)
Director Primacy:
USA Corporate Governance is Board Centric
 “The business and affairs of every corporation organized
under this chapter shall be managed by or under the
direction of a board of directors….”
 “the business judgment rule is the offspring of the
fundamental principle, codified in [Delaware General
Corporation Law] § 141(a),that the business and affairs of a
Delaware corporation are managed by or under its board of
directors. ... The business judgment rule exists to protect and
promote the full and free exercise of the managerial power
granted to Delaware directors.”
 “To encourage freedom of action on the part of directors,
or to put it another way, to discourage interference with
the exercise of their free and independent judgment,
there has grown up what is known as the “business
judgment rule.” “
 “By their very nature, shareholder derivative actions
infringe upon the managerial discretion of corporate
boards. . . . Consequently, we have historically been
reluctant to permit shareholder derivative suits, noting
that the power of courts to direct the management of a
corporation’s affairs should be “exercised with restraint”
 The board’s powers are “original and undelegated.”
 “The directors’ room rather than the courtroom is the
appropriate forum for thrashing out purely business
questions which will have an impact on profits, market
prices, competitive situations, or tax advantages.”
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4. Acquiring >5% of target company stock, File Schedule 13D disclosure
statement. Include critique of management and proposals.
Meet with target management to outline critique and proposals.
• If management resists, make stance public
SEC Rule 14a-8 allows shareholders to put proposals on company proxy
statement.
• Most must be non-binding
Certain proposals under Rule 14a-8 may be mandatory.
• Key: Certain mendments to bylaws
Seek board representation, but not control
Taking a Position
Negotiations
Precatory Proposals
Binding Proposals
Short Slate Proxy
Contest
But Shareholders are Not Powerless:
Mechanisms of Influencing Management

5. Corporate Social Responsibility Corporate Governance
 Concerned primarily with ensuring that their
investments are consistent with their values/
 Tend to be individuals, charitable and religious
organizations, government pension funds.
 Typically use non-binding shareholder proposals
• Request reports on topic
• Change corporate policy
• Review corporate policy
 Issue set has evolved over time
• Environmental (e.g., climate change)
• Human rights (e.g., divestment and boycott)
• Divest certain product lines (e.g., defense, tobacco,
nuclear power)
• Affirmative action (e.g., gay rights)
• Animal rights (e.g., no lab experiments)
• Tie executive pay to social benchmarks
• Labor rights
 Primarily concerned with increasing investment
value
 Union/government pension funds and hedge
funds dominate
 Activism form varies by type
• Union/government pension funds focus on non-
binding proposals
• Hedge funds use full arsenal
 Issue set:
• Takeover defenses
• Board diversity and independence
• CEO compensation
• Political contribution disclosure
• Separate CEO and Chair
Activist Types
5

6. Goals and Methods
The Emergence of Hedge Fund Activism

7. THE PLAYERS | Activist Hedge Funds
7 © Stephen M. Bainbridge 2014
Less likely to Publicly
Press for Change
More likely to Publicly
Press for Change
Constructive Activist
Operational Activist Reluctant Activist
Pure Activist

8. Identify
Undervalued
Stock
Examine
Corporate
Structure &
Governance
Review
Shareholder Base
Determine
Change Threshold
Buy More
Stock
Buy Stock
Contact Mgt. and
Request Change
Publicly
Discuss with
Others
Tagalong Investors Accumulate Positions
Buy More Stock
Threaten Proxy
Contest
Build Proxy
Platform
Launch Proxy
Contest
Negotiate
Settlement
Agreeable?
Settle
Shareholder Vote
Timeframe: 1 – 1.5 years
The Activist Process Model

9. Director versus Shareholder Primacy
Activism in a Theoretical
Framework

10. “A corporation is just a nexus of contracts, subject to rearrangement in many ways.”
--Central States, Southeast and Southwest Areas Pension Fund v. Sherwin-Williams Co., 71 F.3d 1338, 1341 (7th Cir. 1995)

11. The Central Office: “All corporate powers shall be exercised by or under the authority of, and the
business and affairs of the corporation managed under the direction of, its board of directors . . . .”
(DGCL § 141(a))
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12. 12 © Stephen M. Bainbridge 2008
On the necessity for a central office
Kenneth J. Arrow
Where constituents have
asymmetric information,
divergent interests, and face
collective action problems,
it is “cheaper and more efficient
to transmit all the pieces of
information to a central place”
that makes “the collective choice
and transmit it rather than
retransmit all the information on
which the decision is based”

13. 13 © Stephen M. Bainbridge 2008
On the necessity for a central office
Kenneth J. Arrow
Where constituents have
asymmetric information,
divergent interests, and face
collective action problems,
it is “cheaper and more efficient
to transmit all the pieces of
information to a central place”
that makes “the collective choice
and transmit it rather than
retransmit all the information on
which the decision is based”

14. 14 © Stephen M. Bainbridge 2008
On the necessity for a central office
Kenneth J. Arrow
Where constituents have
asymmetric information,
divergent interests, and face
collective action problems,
it is “cheaper and more efficient
to transmit all the pieces of
information to a central place”
that makes “the collective choice
and transmit it rather than
retransmit all the information on
which the decision is based”

15. 15
Directors are not agents of the
shareholders. Directors’ powers are
“original and undelegated”
Shareholder wealth
maximization
Contribute equity
capital

16. 16 © Stephen M. Bainbridge 2008
On the necessity for authority
Kenneth J. Arrow
“If every decision of
A is to be reviewed
by B, then all we
have really is a shift
in the locus of
authority from A to
B”

17. Managing Shareholder Interventions
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18. Goals of Governance Activism
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19. Beneficial
Most Controversial
Undesirable
Ranking Desirability of Shareholder Interventions
Directed at increasing director and manager accountability
Do we really think a hedge fund manager is systematically going to make
better decisions on issues such as the size of widgets a company should
make than are the company’s incumbent managers and directors?
Private rent-seeking
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20. Allowed Disallowed
Sorting
 Process-focused interventions:
• Shareholder interventions directed at
issues on which they are statutorily
entitled to a vote—election of directors,
removal of directors, approving mergers
or other changes of control, amending
the bylaws, and so on
• Interventions making use of existing
shareholder rights to communicate with
the board, to bring direct and derivative
litigation, or to acquire additional shares
and/or control of the company.
• Interventions designed to provide
procedures for effecting such
interventions—such as bylaw
amendments relating to nomination of
directors—likewise would be
permissible.
 Substantive interventions:
• If shareholders are not entitled to
a vote (or other form of
governance action) with respect to
a given issue under state corporate
law, however, that issue
presumptively would be deemed
substantive and thus
impermissible.
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21. Disclosure of
Holdings
Rule 14a-8
Eligibility
Rule 14a-8
Substantive
Specific Rule Changes
Amend Schedule 13D to require filing within 2 days after crossing
5% threshold
More rigorous definition of group activity
Current eligibility—lesser of $2000 or 1% of float—should be raised
Much higher limits on shareholder support necessary for proposals to be
repeated in future years
Expand and revitalize exemption allowing exclusion of proposals relating to
ordinary business matters
Proposals that are not a proper subject of shareholder action should be
disallowed, even if phrased as a recommendation
Allow companies to opt out
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