Saturday, August 12, 2017
Whenever new corporate governance terms are developed that function to diminish shareholder power – like arbitration provisions, or forum selection, or loser-pays – concern develops among (at least some) investors that these terms will become the norm. It’s not about one company that does or doesn’t adopt the term; it’s about the fear that several companies will adopt them, and eventually it will become standard, so that shareholders will not be able to exert discipline by avoiding companies with the disfavored provision.
In other words, companies will behave as though they’re in a cartel when selecting these terms, and they’ll be able to do it because they can easily coordinate with each other. There are a limited set of underwriters and white shoe law firms that will advise them, and those entities will propagate the new development throughout the system. Cf. Elisabeth de Fontenay, Law Firm Selection and the Value of Transactional Lawyering, 41 J. Corp. Law 393 (2015) (explaining the value-added by elite law firms – knowledge of the latest in deal technology); Roberta Romano & Sarath Sanga, The Private Ordering Solution to Multiforum Shareholder Litigation (finding that law firm advice is behind the adoption of forum-selection clauses at the IPO stage). Investors may prefer to coordinate with each other to boycott companies that adopt these terms, but investors are widely dispersed, and have no obvious coordination mechanism.
Except it seems they do. They have ISS, for one – which doesn’t help with buying, but does help with voting. ISS, according to The Power of Proxy Advisors: Myth or Reality? 59 Emory L.J. 869 (2010), by Jill E. Fisch, Stephen J. Choi, Marcel Kahan, bases its recommendations very much on the preferences of its clients, more so than other advisory services. In other words, ISS serves as a coordination point.
And now on the buying side, we have the indexes.
As I’m sure readers of this blog are aware, a couple of major indexes, under heavy pressure from investors, decided to exclude companies with certain multiple-class share structures. The investors’ concern was that if these companies were included, indexed investors would have to buy them even if they didn’t want to. And that’s an odd argument, of course, because nothing is stopping them from setting up their own index or buying according to a modified index, though we can agree that doing so would be at the very least impractical (though it’s fascinating to contemplate why). That said, the exclusion is unusual, because index investors aren’t supposed to be actively picking stock characteristics, and – until now – the indexes did not make specific governance characteristics part of the criteria for inclusion.
So this latest move suggests that as passive investing gains more power, the indexes have become – or have the potential to become – a kind of cartel mechanism. They are a means by which dispersed investors can coordinate their buying and thereby express preferences collectively.
What happens, for example, if a company accepts Michael Piwowar’s invitation and tries to eliminate class actions via arbitration at the IPO stage? Will we see investor pressure to keep those companies out of the index as well? Time will tell, but recent events suggest this is another tool that investors can use to coordinate with each other.