Shareholder Activism and the SEC

There has been a lively debate in the editorial pages of our financial newspapers on whether the shareholder activism practiced by modern private equity funds, hedge funds, and public pension plans is healthy for American business.  On one side are the traditional republicans (with a small "r") that believe shareholders should delegate management details to their boards of directors and then let them do their work.  Shareholders who are displeased should replace the poorly performing managers or sell their shares.  On the other side are investors that believe the board should listen to their specific strategies to increase stock value. Many of the strategies include leverage (stock buy-backs or extraordinary dividends) or unbundling the business (spin-offs or bust-up buyouts).  The debate is complicated by a side-bar debate (the activism debate does not inherently depend on the side-bar debate) on the shareholder primacy principle.  Those who are not comfortable with shareholder value as the primary concern of a board of directors are new-found republicans; a board with maximum discretion can favor non-shareholder constituencies. 

The SEC in a very unusual move, promulgated two mutually contradictory rules on shareholder voting (one re-affirming the traditional view and one giving major shareholders access to the firm's board nomination procedure), to see what public comment it would generate.  I doubt either side is correct or, if one side is correct, that it will be correct for very long.  Firms should be able to choose their internal structure (a division of power between shareholders and firms included), publicize it to the markets, and suffer or enjoy the consequences of their choices.  Those firms that choose well will lower their costs of capital and have a competitive advantage.  In other words, the danger is for the SEC to attempt to try and pick a winner in the debate.  The best position for the SEC is an enabling position:  the proxy machinery regulated by the SEC should act in furtherance of whatever state law allows.  Far-sighted states (and/or exchanges) should enable firms to opt into various internal control systems, no one system is mandatory.  Let the investment market, not the political (or academic) market, decide on optimal firm governance procedure.