Only 53 percent of management teams recommended annual votes, and 42 percent recommended the maximum triennial votes citing the need for extra time to evaluate the programs, review shareholder input and implement changes.

At the time of GMI’s study, 40 percent of companies had not yet decided which voting frequency to use, 10 percent adopted a triennial policy, 50 percent adopted a annual schedule and only 0.37 percent chose biennial.

“The fact that the management of 42% of companies recommended that the Say on Pay vote take place every three years stands in stark contrast to how 72% of shareholders voted on the issue,” said Greg Ruel, Research Associate at GMI, in a statement on the report’s findings.  “That gap shows a real disconnect between how management and boards believe companies should be run and the way shareholders want their companies to be run. We’ll be watching closely to see which policies the remaining 40% decide to adopt.”

The Dodd-Frank Act requires companies poll shareholders at least every six years on whether they want to vote on compensation plans every one, two or three years, or abstain. GMI’s study looks at Annaly Capital Management as a case study, where the board opted to institute a triennial voting policy though the annual option received over 70 percent of non-binding shareholder votes. Almost three-quarters of the company’s investors approved the compensation packages.

GMI analyzed the results of say on frequency votes at 2,176 companies in the Russell 3000, of which 907 companies recommended triennial votes. About half of those 907 companies have not yet announced the official voting frequency, while 23 percent confirmed the triennial policy and 29 percent implemented annual votes. Less than one percent of these companies chose a biennial policy.

For more on the GMI say on pay voting frequency study, please click here.

Senator Tim Johnson

The Senator recently responded to questions submitted by NACD Directorship’s Jeffrey M. Cunningham on his efforts to improve the economy, protect Dodd-Frank and reform the U.S. housing finance structure.

What did the 2010 elections mean from a political perspective?
The 2010 election was obviously not the best cycle for Democrats as a whole, but these things swing back and forth. Voters elected a Republican House of Representatives and a Democratic Senate, so neither party has a mandate. I don’t know what 2012 will bring, but I know that the American people expect their elected officials to work together to help get the economy back on track and create jobs instead of playing partisan political games.

What do you make of the House efforts to repeal or change Dodd-Frank?
Despite the fact that Americans lost millions of jobs, millions of homes and trillions of dollars in wealth, Republicans apparently believe we were adequately protected during the financial crisis. Efforts to tear down Dodd-Frank are attempts to go back to the days of too big to fail banks, backroom derivatives deals and risky subprime mortgages. I think the American people want Congress to focus on the future and on creating new jobs, rather than trying to dismantle this historic reform.

You have said: “I hope that in the great tradition of this body we can disagree without being disagreeable.” How?
I have always believed that part of my job as a Senator is to work to build consensus, and with a divided Congress that is more important than ever. Neither party has a monopoly on good ideas. The American public wants us to find common ground that creates jobs, grows the economy and deals with the real challenges we’re faced with.

Why was proxy access a controversial measure even in committee?
As with many parts of the bill, there was a lot of disagreement over proxy access because there were legitimate concerns raised on both sides of the issue. In the end, Congress gave the authority to set proxy access rules to the SEC. The SEC’s proposed rule is currently the subject of litigation, and I am closely monitoring the situation. It’s important that a balance be struck between shareholder rights and board autonomy.

To what extent is Fannie Mae and Freddie Mac a focus for the SBC?
Housing finance reform is a top priority, and I have already held three hearings on the topic. It is a very complex issue, so we need to examine it thoroughly and build bipartisan consensus in order to move forward on legislation.

How do you feel about the Financial Stability Oversight Council and its “too big to fail” law?
Dodd-Frank ended too big to fail and ensured that American taxpayers will never again be forced to throw billions of dollars at Wall Street to save firms that run the risk of bringing down our entire economy. The Financial Stability Oversight Council (FSOC) is an essential component of the law, because the systemic problems we saw in the financial crisis cut across the traditional boundaries between regulators. The FSOC has improved coordination and increased transparency between agencies, and I am confident it will help better protect the stability of our financial system.

It’s important that shareholders have a say on executive compensation, and Dodd-Frank ensures that they do. I have no doubt that talented and successful executives who deliver value to shareholders will be appropriately compensated.

We hear that public accounting firms will be a focus of your efforts.
Reliable, accurate and transparent accounting is clearly vital for investor protection and confidence. This is an important issue that the Committee has and will continue to monitor, most recently at a subcommittee hearing in April.

Do you feel the Dodd-Frank ‘say on pay’ provision gives investors adequate safeguards?
The SEC’s final rules regarding shareholder votes on executive compensation are only a few months old at this point. We should give the new rules adequate time to work before jumping to conclusions or introducing new legislation.

What suggestions do you have for setting CEO compensation?
It’s important that shareholders have a say on executive compensation, and Dodd-Frank ensures that they do. I have no doubt that talented and successful executives who deliver value to shareholders will be appropriately compensated.

What concerns you most about funding for the SEC?
It is vitally important that both the SEC and CFTC get the resources they need – the 2008 economic crisis showed us the dangers of regulatory shortfalls. The Wall Street reform bill strengthened regulators ability to police the financial system and help prevent another financial crisis. These two important regulators serve on the front lines investigating fraud and abuse, and it is imperative that they are provided with the necessary resources to do their jobs and protect American taxpayers and investors.

What do you hope your legacy as banking chair will be?
I am focused on doing the best job I can. My top priority for the Committee is to support the nation’s economic recovery and promote job growth, and my agenda as chair reflects that.

In March, and again on April 15, prominent law firm Wachtell, Lipton, Rosen & Katz proposed in its comment letters to the SEC that the current 10-day reporting deadline be shortened and the definition of beneficial ownership be expanded. “We believe that the current reporting regime fails to fulfill its stated purposes,” Wachtel lawyers wrote in the letter filed with the SEC on April 15. The law firm believes that investors, issuers and the market as a whole would benefit from such changes.

“There is no valid policy-based or pragmatic reason the purchases of significant ownership stakes in public companies should be permitted to hide their actions from other shareholders, the investment community and the issuer; indeed the need for transparency, fairness and equality of information in our financial markets has never been higher,” Wachtell reasoned.

“Changing the 10-day disclosure rule is part of the larger project that the SEC is undertaking to modernize the rules. Dodd-Frank has a provision that gives the SEC the authority to close the reporting window and it is on the slate. We propose that the period is changed to one-day. Our most recent comment letter reaffirms our call for a broader review of the shareholder disclosure system,” says Eric Robinson, Partner in the corporate practice at Wachtell.

This argument is not new. In fact, many different groups have raised concerns over the 43-year-old reporting rules, including the SEC. Michele Anderson, chief of the SEC’s Office of Mergers & Acquisitions, told MarketWatch that she has plans to recommend that the number of days activist investors have before they must publicly disclose they have a five percent stake in the company be shortened. Existing timeframes for disclosure have been in place since 1968 as part of the Williams Act.

“The staff believes that period may be outdated, it has been in place for over 40 years now, and we have concerns that it may provide opportunities for investors to obtain a sizeable stake in the company before they are obliged to make any public disclosure,” Anderson said in February.

Investors are now able to execute trades in seconds and it is possible to prepare ownership reports in very short periods of time. Many investors can—and do— exploit the 10-day reporting gap to secretly acquire more stock in the company, hidden from the issuer and market at large.

Bruce Goldfarb, founder and CEO of Okapi Partners, a proxy solicitation firm, sees pros and cons on both sides. “I think it will mean activists will find that it is harder to quickly accumulate a position and for investors to build up an investment before there is additional market movement. Some investors purport this to be a real issue with activism. I think there is some truth to that.”

Some market participants complain that the lag in reporting requirements allows an investor to accumulate large voting interests before disclosure is made that would impact the price of the stock and that this is not fair.

“I think it will impact some investors in their interest and ability to rapidly accumulate shares at a price they believe to be good value. I agree with investors that say expediting the reporting timeframe will impact their ability to accumulate a large position. Without a value judgment of whether that is a good thing or a bad thing there is absolute truth that faster reporting will move markets. We have already seen that when people file a 13D. It has an effect depending on who the investor is and what position they are taking. So if you are accelerating that follow-on effect it is going to have an impact,” explains Goldfarb.

With changes to the director election process these reporting requirements can be of real and significant importance to directors. “I have empathy for companies that are trying to figure out who owns their shares. The process as it stands now does not help issuing companies or other investors to have an understanding of who the owners are of a company. If you are a director and trying to act in the best interest of shareholders yet you don’t always know who those holders are, it creates a serious conundrum.”

Changing the system is not without problems. Some investors feel that the current reporting regime is burdensome and compliance too time consuming. Even though trading platforms have accelerated and news is distributed faster, the 13D process hasn’t kept pace. It is, in the eyes of some investors, faster to accumulate the shares than it is to report exactly what holdings they have.

“I have empathy on both sides and I think that while the board may appreciate the changes, I don’t know how well received it will be by the investors community. Not just by activist funds but by traditional investment management firms that are heavily burdened sometimes by the reporting requirements,” cautions Goldfarb.

In an April 15 release the Commission left unchanged reporting requirements under 13D(c) for derivatives such as convertible instruments (that can result in accumulating a “stealth” voting position).

While the SEC made no change at this stage to security-backed swaps it is still considering shorting the disclosure window as part of a broader review of beneficial ownership disclosure.

Brendan Sheehan is the editorial director of NACD Directorship and Directorship.com

Yonat Assayag

New federal regulations under the Dodd-Frank Act require companies to hold non-binding shareholder votes on their executive pay programs (say on pay), the frequency of future say-on-pay votes (say on frequency) and golden parachute payments in the event of a transaction (say on golden parachutes). The say-on-pay and say-on-frequency votes are required for all publicly-traded companies with annual shareholder meetings held after Jan. 21, 2011.  The say on golden parachutes requirement is effective for proxies filed on or after April 25, 2011.  Smaller reporting companies (less than $75 million in public float) are granted a two-year delay until these votes are effective.

As the proxy season progresses and say-on-pay vote results filter in, new learnings for boards continue to surface. One theme is clear: companies that perform, and successfully demonstrate that their pay programs support and drive performance, are more likely to win shareholders’ votes.

Program Changes

Russell Miller

This year’s filings indicate that in 2010, companies focused on minimizing non-performance-based pay and enhancing shareholder alignment:

• Excise tax gross-ups: Nearly 40 companies, including companies such as AT&T and OfficeMax, eliminated excise tax gross-ups (either from existing or future arrangements).

• Severance multiples: Three companies reduced severance multiples for the CEO from 3x cash compensation to 2x cash compensation.  Six companies have a policy requiring shareholder approval of any payouts greater than 2.99x cash compensation, including one company (Bank of New York Mellon) that adopted the policy in 2010.

• Clawbacks: Of 79 companies disclosing clawback provisions for their named executive officers, 34 adopted or enhanced these provisions recently.

• Ownership guidelines: While CEO stock ownership guidelines of 5x salary is most common among the first 100 companies (45 companies), a growing number of companies are increasing their guidelines beyond 5x.  In 2010, six companies increased their guidelines from 5x to 6x, resulting in 24 total companies with guidelines greater than 5x.

The first 100 companies focused their disclosure on their pay-for-performance story:

• Many companies took a “layered” approach and highlighted key program features and the alignment between pay and performance early in their disclosure.
  • Prevalence of executive summaries more than doubled, from 30 companies last year to 64 companies this year.  Companies focused their executive summaries on their pay-for-performance relationships, often enhancing disclosure from 2009 through graphical representations of pay and performance.
  • A few companies, including General Electric, took this disclosure a step further by including a summary of the compensation program and why shareholders should vote for it at the very beginning of the proxy statement.  This disclosure focused primarily on 2010 compensation decisions and 2010 company performance.

• Several companies, including Kimberly Clark and Lockheed Martin, enhanced their pay-for-performance discussion by adding a comparison of Total Shareholder Return (TSR) vs. CEO pay at the beginning of the CD&A.   This level of disclosure may be a preview to the pending pay/performance disclosure requirement under Dodd-Frank, which won’t likely be effective until 2012.

• Some companies have re-introduced the proxy performance graph, which compares the company’s TSR to TSR of an index and peers over a multi-year period and is now required 10-K disclosure.  Variations of this performance graph were included in proxy statements for BB&T, Goodrich Corp and Honeywell International.

• While companies discussed their performance in terms of various financial, operating, and stock-based measures, graphical analysis of performance tended to focus on TSR.  However, some companies, including Eli Lilly, provided graphical analysis of pay-and-performance based on measures such as revenue and earnings per share growth.

According to Daly, retail shareholder engagement is down significantly and despite a rash of regulatory changes designed to empower investors and increase transparency, only a very small percentage of shareholders actually vote.  “In 2010, just one in 20 individual retail investors voiced their opinions about the companies they invested in by exercising their fundamental shareholder right. That compares to recent historical levels four to five times as high.”

Richard Daly

Daly called on corporate CEOs and directors to address this decline in voting and examine ways to bring shareholders—especially employee shareholders—back into the fold. “Public companies need to understand the seriousness of this issue and act to reverse this troubling decline to get each of their individual investors—and all individual investors generally—engaged with their companies,” he said.

Broadridge and Daly have been pushing investors and companies to increase individual shareholders voting and he encouraged public company CEOs to “join with us in launching a nationwide effort to encourage their employees—numbering in the tens of millions—to exercise a fundamental shareholder right, and need, to vote their proxy ballots, whether it be proxies relating to their employer or proxies relating to other companies in which they invest.”

As part of the effort, Daly said he is contacting the chief executives of America’s top 1,000 public companies to encourage them to motivate their employee shareholders to vote their shares.

In order to increase engagement and to reverse the decline in individual voter participation companies may need to realize greater efficiency in the distribution and collection of proxy voting materials. To this end, Broadridge is informing shareholders, within the constraints of regulatory boundaries, of the ability to receive and act on communications through digital channels. Investors are now able to, in many cases, access proxy and annual meeting materials online and even cast votes through electronic methods including the internet, mobile devices and cell phones.

With increased disclosure requirements on director skills and compensation, communicating with investors and telling the company story is more important than ever. Beyond securing the vote for the board, there are other, strategic reasons to advance shareholder participation.

“Companies that can distinguish their investors’ opinions from others’ will more easily have the strength and confidence to stay on course and create value. There is no greater show of support than the ballot, or in this case, the proxy,” Daly concluded.

Click here for a full transcript of Daly’s comments to the National Press Association.

While I had planned on a football theme with eleven players on either (take your pick) the U.S. gridiron or the rest-of-the-world’s pitch, the governance guru/gambler’s remark required research. After a Google and a few Wikis, I learned that initial rolls of the dice that add up to either seven or eleven are “natural” winners at the craps table. Eleven is called out at the table as “yo-leven” (or “yo”) due to the potential for confusion given the similar sound of seven.

As I pictured the bevy of boardroom requirements tumbling out of the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank), it hit me that a roll of the dice would more than suffice as the 2011 season’s symbol. While directors will not imagine that they are in the Nevada desert once the say-on-pay tsunami makes landfall, they may feel like riverboat gamblers—slightly queasy and desperately seeking terra firma. The deal-sealer was an obscure Wiki factoid: craps devolved from an old English dice game called “hazard.”

So without further ado, here is a list of seven potentially hazardous points that directors should prepare to roll when they step up to the boardroom craps table for the yo-leven proxy season.

Democrats’ Snake Eyes Roll May Roil Directors
The 2010 annual meeting season was quiet thanks to all of the noisemaking in the nation’s capital. In the wake of the Wall Street-driven market meltdown, all eyes locked onto K Street and Capitol Hill. Many activists actually down shifted their 2010 annual meeting efforts in favor of a march on Washington D.C.

This capital investment paid dividends as Dodd-Frank looked like it would tip the governance table in activists’ direction for 2011 and beyond. Reformers were on a hot steak last summer as Congressional stick men Senator Chris Dodd and Representative Barney Frank passed loaded dice over to the Securities and Exchange Commission (SEC). With the long-coveted cover of Congressional authorization, the Commission adopted its proxy access rules in August 2010 and began implementing Dodd-Frank’s say-on-pay mandates.

Before the winning chips were pushed across the table, however, the U.S. Chamber of Commerce and the Business Roundtable asked the U.S. Court of Appeals for the D.C. Circuit to invalidate the SEC’s access rule. In October 2010, the Commission shocked the good-governance crowd by staying the effectiveness of the rules pending resolution of the legal challenge.

Next, in early November 2010, Washington’s reign as the epicenter of the governance universe abruptly ended when Congressional Democrats rolled snake eyes in the mid-term elections. The subsequent musical chairmen game led to an ideological sea change in the U.S. House of Representatives as Alabama Republican Spencer Bachus replaced Massachusetts Democrat Barney Frank as chair of the House Financial Services Committee. Rep. Bachus promised to go title-by-title through his predecessor’s namesake Act to “correct, replace or repeal the job killing provisions that unnecessarily punish small business and community banks that did nothing to cause the financial crisis.”

The odds of Dodd-Frank’s repeal are low since Democrats still control both the U.S. Senate and the White House. Undaunted, newly installed Republican committee chairs have already begun to harass agency rule writers—via tough oversight—and to starve—via slow, low or zero appropriations—the SEC and the various new bureaucracies envisioned by Dodd-Frank.

Without the promise of further governance changes via Federal fiat and with proxy access offline, directors should prepare for bumper crops of shareholder proposals, letter-writing campaigns, “just vote ‘no’” efforts and old-school proxy fights this year. Notably, activists have turned their attention to the leftovers—especially majority threshold voting (MTV) in uncontested elections—from last year’s Congressional chow down at the governance buffet.

Boards Weigh Odds of Activists Rolling Hard Six
As a result of the SEC’s stay, the Commission’s rule (14a-11), which would have become effective on Nov. 15, 2010, sits in limbo. Even assuming the Federal courts uphold the rule, implementation will not come in time to impact the 2011 proxy campaign. The SEC stay also delays amendments to Rule 14a-8 that would have allowed investors to file bylaw proposals creating more permissive access procedures.

While 14a-11 nominees and 14a-8 bylaws will not appear on 2011 ballots, some activists have begun to build the infrastructure that will allow them to exploit access once it is up and running. The rule, if implemented, will require wannabe shareholder nominators to roll six the hard way—owning at least three percent of a public company’s voting stock for at least three years. That means only big players need apply. Some mega-money managers tell us that they have already received feelers from activists who seek to gauge their future interest in joining coalitions to clear the three-percent/three-year hurdle.

Two of the market’s highest rollers, the $220 billion California Public Employees Retirement System (CalPERS) and the $140 billion California State Teachers’ Retirement System (CalSTRS), are rounding up possible candidates for boards. The two fund giants partnered in 2010 to develop a database of potential shareholder-friendly director candidates with diverse talents. This “Diverse Director Database,” or 3D, opened last year and the funds are fielding resumes.

Let it be said that Brian Breheny is a good sport. He gamely agreed to present his own view of the agency’s recharged agenda under Chairman Mary Schapiro before being questioned by the panel of former SEC commissioners. In introductory remarks, Breheny implored directors to engage shareholders and not be fettered by Regulation FD, which he said, “was never intended to stand in the way of those conversations. Are people using the regulation as an excuse? Are you okay with that?”

To open the panel discussion, Edwin S. Maynard asked for reaction to what was then proposed financial reform legislation. What’s being promulgated is what Paul Atkins called a “trade union agenda” and the federalization of governance initiatives such as say on pay, majority voting, clawbacks of executive compensation and proxy access that are best left to the discretion of the states. Atkins warned that increased regulation could thwart the creation of jobs by constraining investors. “Will we finally reach the straw that breaks the camel’s back with respect to public markets, where it’s just completely unattractive to become a public company anymore, or it’s cheaper and easier to go elsewhere to raise funds?”

The best hope, said Annette Nazareth, is “that we end up with legislative provisions that are not so prescriptive that they can be dialed up or down by regulators through notice and comment rulemaking. Frankly, if you look at some of these provisions and you reverse engineer where some of the banks are today, about two thirds of them would not be in compliance. So that’s a real problem. We have to hope that through the conference process that some rationality prevails.”

“Everyone now knows the SEC and that has made the environment more difficult for directors,” Richard Roberts said. “When I worked at the SEC–and I’m from Alabama, originally–nobody knew who the SEC was. Now, everybody knows who the SEC is, and it’s not necessarily a good thing…but that’s the environment that we’re all in. Directors are thrown into that environment, too.  So folks know who you are.  Your responsibilities are going to be much more difficult.”

Part of that changed environment relates to proxy advisors. In response to a question from the audience, Breheny said that the SEC intends early next year to issue its study and concept release on proxy advisory services and whether they should be further regulated: “We can disagree on the role that people play and the cost and how the process is working, but I really do hope that when it gets out that we’ll have at least educated everybody so we can focus on the issues.”

Today, this notion of shareholder primacy is under attack from two directions.

The Legislative Attack
First is the legislative attack. The present economic crisis has precipitated a federal governmental response that may be harmful to this philosophy and ultimately  results in a scarcity of capital necessary to the success of our system. Regulators have been weakening the alignment of executive pay to stock price performance—a critical component in shareholder primacy. The economic stimulus bill signed into law by President Obama last year included a curb on performance-based pay for the most highly paid executives in firms receiving funds from the Troubled Assets Relief Program (TARP). Such pay cannot be more than one-third of the executive’s total compensation. To be sure, there are exemptions, including one for long-term restricted stock. Still, the law erodes shareholder primacy by weakening the link between executive pay and stock price performance. In doing so, a primary tenet of modern compensation philosophy has been upended—to relate executive pay to corporate performance to effectively align management and shareholder interests to result in ultimate corporate profitability and greater shareholder return. Limiting compensation in this manner suggests that the corporate goal is no longer greater shareholder value and return to the investor, but the preservation of the corporate status quo, ultimately harmful to investor interests.

The Academic Attack
Second is the intellectual attack. There has been some prominent academic support for the notion that corporate directors serve multiple stakeholders to an equivalent degree, rather than shareholders first and foremost. This school of thought says that directors serve the corporation, not its owners, and as such, directors serve multiple constituencies, including employees, customers and communities.

The legislators and scholars who are challenging shareholder primacy offer some intrinsically appealing ideas. One might be tempted to cheer for the legislators’ TARP restrictions, for who would not want to put an end to outrageously excessive compensation during a time of economic depression? And one might be easily drawn to give a sympathetic ear to scholars’ arguments for the stakeholder model of governance. After all, who does not want to honor those who toil for companies or who buy company goods? Who would cavalierly overlook the interests of one’s own hometown?

Why Preserve Primacy?
These attacks may be well armed with attractive arguments, but they are all the more dangerous.  In my view as a director and as a shareholder, it is urgently important to preserve the notion of shareholder primacy for five reasons.

1. Shareholder primacy is key to our entire capital system. Simply put, companies have three sources of capital: earnings, debt and equity. Weakening equity as a source of capital will force com-panies to rely increasingly on earnings or debt. Reliance on earnings has its limits, particularly for long-term investment, as earnings can be volatile and have a natural size limit. As for debt, it has its place, but the effects of overleverage can be disastrous. Equity is the answer for many corporations at various points in their life cycles.

2. Unless shareholders are protected, they will not invest and the economy will stagnate, contract, and ultimately grind to a halt. If we didn’t put shareholders’ interests first, investors simply would not invest and we would lose the capital vital to U.S. economic success.

3. The stakeholder system has numerous problems. As a famous corporate commentator used to say, “Even a broken watch gets the time right twice a day.” If boards of directors are responsible to multiple constituencies, directors will make decisions that will always benefit someone, but at the expense of the health of the corporation.

Furthermore, while the other stakeholders can protect themselves contractually, shareholders cannot—that is why we have a board that is elected by the shareholders. Shareholders are indeed the last “residual claimants” and in this lies their primacy from both a legal and economic perspective. Finally, obligations to multiple constituencies lessens managerial accountability, as even a bad   decision may please someone— leading to inadequate management and corporate disaster.

4.  The argument and conflict between the shareholder primacy and stakeholder theories is more apparent than real. To maximize shareholder value, all of the stakeholders need to be content with corporate direction.

5. We have met the enemy and it is us. The investment class in this country is broad. In today’s world, most taxpayers are investors and every investor is a taxpayer. Most stakeholders are in fact shareholders. The largest owners of many companies are the employees, through their      retirement plans.

Significance of Equity Pay
Perhaps the greatest proof of the importance of shareholder primacy comes from the realm of director compensation. Numerous studies have shown a correlation between good corporate performance and the receipt of director pay in stock. This was true two decades ago when I wrote about it in the Boston College Law Review, and it remains true today, as Sanjai Bhagat of the University of Colorado has confirmed with his extensive current studies—notably his December 2008 Columbia Law Review article (with co-authors) on “The Promise and Peril of Corporate Governance Indices.” Professor Bhagat and team ran every commonly measured governance variable and found only one that correlated to financial performance—and that was paying directors in stock. They wrote: “In sum, of all the measures of governance quality evaluated…only the outside directors’ stock ownership measure was related to multiple measures of performance, firms’ future accounting profitability and disciplinary management turnover upon poor performance.”

The image of battle may seem extreme, but much is at stake.  Looking back to eras before our own, we see investor protection as a motivating force in much of modern economic history, dating back at least as far as the era of joint stock-trading companies 400 years ago. Without exaggeration, one could say that the new world of America itself was founded on the principles that make equity capital possible. Do we want to cast this vital legacy aside for     political expediency or correctness, however well meaning?

Independent, equity-holding boards, accountable first and foremost to investors in free elections, are the ultimate solution to the compensation controversy and the key to effective investor protection. As independent directors elected by shareholders and serving their collective interests, we are both the proof and the prize of shareholder primacy. We must  defend and serve this concept vigorously for the good of free enterprise and the future vibrancy of the American economy.

Charles M. Elson is the Edgar S. Woolard Jr. chair in corporate governance and director of the John L. Weinberg Center for Corporate Governance at the University of Delaware. He is a director of HealthSouth Corp.

Web hits prove the point. In early 2010, a web search yielded nearly 4 million hits for the word-for-word phrase: “Shareholders are the owners of the company.” By contrast, the wishful notion that “Osama bin Laden is dead” appeared only 410,000 times, and the happier belief that “Elvis is alive” appeared merely 52,200 times. It’s obvious many people believe shareholders own com-panies. But is that belief correct?

The answer is: No, shareholders do not own the corporation. Rather, they own  (or in some  cases, temporarily hold) a type of security commonly called stock.  Both corporate law and economic reasoning support the limited   nature of this ownership, and also undermine the claim that directors should always strive to maximize shareholder value.

The Legal Case
Although it can be difficult for non-lawyers to wrap their heads around the idea, no human being can own a corporation. This is  because corporations are legal persons—independent entities with their own rights, including the right to hold property in the corporate name. In effect, corporations, like human beings, own themselves.

As a legal matter, shareholders who purchase shares of stock in a  corporation own nothing more than that—shares of stock. Simi-larly, bondholders own only bonds, and executives with employment contracts own their contracts. None of these types of ownership give shareholders, bondholders or executives the right to control the firm. The right to control the firm’s assets and actions rests in the hands of its board of directors, and only when they act as a body and follow proper board procedures.

An important consequence of this governance structure is that shareholders not only have no legal right to control the firm, they also have no legal right to help themselves to the corporation’s    assets. In fact, the only time shareholders receive any funds directly from the corporation’s coffers is when they receive a dividend or the corporation repurchases their shares. This only happens when the directors vote to declare a dividend or a corporate repurchase.

In judicial opinions, directors are usually described as owing    fiduciary duties “to the corporation and its shareholders”—implying the two are not the same, and that directors’ duties are broader than just duties to shareholders. Even more important, under the doctrine known as the business judgment rule, a shareholder can’t successfully sue a board for failing to maximize shareholder value. To the contrary, directors enjoy wide legal discretion to sacrifice “shareholder value” in order to protect employees, customers, creditors and the community.

This is why fans of shareholder primacy almost always cite the nearly century old case of Dodge v. Ford as their primary legal support for the idea of shareholder primacy. But Dodge v. Ford was really a shareholder-versus-shareholder dispute in a close corporation. Similarly, the second case typically cited—Revlon v. Mac- Andrews & Forbes Holdings, Inc., is also legally irrelevent. In Revlon, the Delaware Supreme Court held that an end-game situation where the directors of a publicly traded firm had decided to sell the company with a controlling shareholder—in effect, terminating the corporation’s existence as a public firm—the board had a duty to maximize shareholder wealth. But subsequent Delaware cases have made it clear that if the directors of the firm decide not to sell at all, or prefer to do a stock-for-stock exchange with another public company, the infamous Revlon doctrine no longer applies. For example, in Paramount Communications, Inc. v. Time, Inc., the Delaware Supreme Court upheld directors’ right to “just say no” to a hostile offer, even though the offer was at a premium over the market price for the company’s stock.

The Economic Case
Paying attention to the realities of corporate law should also put the kibosh on two other sub-legends surrounding the idea of shareholders as owners. The first is the false notion, favored by economists, that shareholders are the “principals” in public corporations and that directors are shareholders’ “agents.” As we have just seen, this agency metaphor misstates the real legal status of shareholders and directors. At law, a principal has a right to control her agent. But shareholders can’t exercise direct control over corporate directors. Moreover, case law describes corporate directors not as “agents” but as fiduciaries with a wide range of discretion, who owe duties not just to shareholders but also to the firm as a whole.

The second mistaken sub-legend is the claim that shareholders are the sole “residual claimants” in the corporation, entitled to each and every penny of profit the firm earns after it pays its expenses. This  sub-legend ignores the legal reality that in a public company, the board of directors controls not only whether the shareholders receive dividends out of earnings—the board controls whether the firm has earnings at all. This is because the board controls corporate expenses. If a company is  doing extremely well, the directors can pay a dividend, but they can also raise employees’ salaries, improve customer service or work toward a lower debt-equity ratio for creditors.

It is thus wildly misleading to describe shareholders as the sole residual claimants in companies that aren’t actually in bankruptcy.

To the contrary, while shareholders typically share in the wealth when the corporation does well and suffer when the firm does poorly, so do employees, creditors and other “stakeholders.” Many different groups are potential residual claimants and residual risk-bearers in public firms, just as many different groups— not just shareholders—contribute to the firm’s success. Thus, from an economic perspective, it doesn’t make sense to focus only on shareholders. While shareholders are important participants in firms and deserve to be protected, corporations give more value to society when directors look out for the interests of customers, creditors, employees and other stakeholders as well.

This idea is supported by modern options theory. In effect, bondholders own the right to access cash flow but have sold a call to shareholders, while shareholders own the right to access the cash flow but have sold a put to bondholders. Neither shareholders nor bondholders can claim an exclusive right to “own” the company’s cash flow, much less the company.

Why Should Directors Care?
These legal and economic arguments against shareholder primacy have practical importance. Shareholder primacy thinking pressures directors to make business decisions that they know, intuitively, are not in the best interests of their firms. In the mistaken   belief that both law and economic efficiency demand they “maximize shareholder value,” directors may fire valuable employees, cut customer support, limit research and development and sell off valuable assets and divisions.

In contrast, once directors understand that shareholders do not in fact own the corporation and that they need not respond to shareholders’ every whim, they can focus instead on getting the best possible corporate performance—on behalf of all stakeholders. In the end, shareholders only stand to benefit.

Lynn A. Stout is professor of law at the University of California Los Angeles School of Law.

The SEC addresses that classified boards must continue to disclose a director’s experience, qualifications and skills that led the board to conclude that the individual is qualified to serve on the board. The grant-date fair value of an equity award must be included even if the award is forfeited during the same year it is granted. The SEC also recommended that companies disclose their compensation policies and practices as they relate to the registrant’s risk management and be presented with the registrant’s other item 402 disclosure. Any compensation paid to directors for “additional services” must be explained and boards must be prepared to provide facts to back up any proposals to increase compensation.

“People are struggling with the timing of the new rules,” says Pat Quick, a partner in law firm Foley & Lardner’s transactional and securities practice. Quick notes that the rules were first proposed in July 2009 but were not implemented until December. “You could have approached your boards and committees in July but the rules weren’t final and you didn’t know when they’d be finalized,” Quick says. The timing of the new rules leaves some boards wrestling with new compensation restrictions as well as rules for director qualifications, diversity and board structure.

Companies are also preparing for “say on pay” to be mandatory in proxy disclosures in 2011. “Directors aren’t accustomed to putting shareholder advisory votes on their proxy,” adds Linda A. Wilkins, founder and managing partner of the Law Offices of Linda A. Wilkins. “They’re trying to keep it short. Very few clients (of mine) are putting additional shareholder disclosures this year—we’re just trying to adjust.” Wilkins believes boards are looking at risk assessments already performed and are having some poignant discussions tying together any “excessive compensation practices.”

Not all directors feel the new rules are a challenge. Sam Coats, an aviation consultant and director who sits on the compensation, governance and executive committees for Texas Industries, believes boards need to embrace transparency. “I used to think having a job on the audit committee was the worst but that was before I joined a comp committee,” Coats quips. Coats says comp committees aren’t only focused on basic compensation concerns but also perquisites, such as club comps and other items that at one time were standard fare in the executive suite. “I’ve clashed with more than one CEO over the years,” says Coats. “I think pay should be 50 percent salary, 15 percent short-term performance and 35 percent long-term performance—and that long-term performance should be in line with the long-term performance of the company.”

The decision by the SEC may leave some companies attempting to “catch up,” but Quick notes that the rules highlight some key subjects, which are likely to appear during this year’s proxy season. “The SEC cannot directly affect how companies are governed. Instead, it steers people through its disclosure,” Quick says.

Goldman Sachs’ decision in December to voluntarily offer a shareholder pay vote should not be taken as a sign that other companies will follow suit. “I think other companies (not in the financial services industry) are holding back in part just to see what rules unfold,” Quick says. “The public eye had such a glare on their pay practices because they were publicly tied to the fact that it was government money—low and behold, they were using that government money to pay bonuses.”

“Even though things aren’t mandatory (yet),” says Coats. “I think you will see boards being proactive. I think it’s going to be very important to articulate the comp philosophy of the company that we will go to great lengths to do that.” Coats emphasized that most boards are already sensitive to how their interests are aligned with those of long-term shareholders.

“More and more shareholders are going to insist that companies don’t have that entitlement mentality,” Coats says. Having a voice in the boardroom that reverberates into the C-suite and challenges CEOs to recognize the difference between shareholder groups will result in comp practices that are more aligned with shareholder expectations.

The search was stymied until I attended a conference where the previous evening’s social event had been bowling. As I mentally slipped on my rented shoes and imagined the large overhead electronic scorecard, the ten-frames format hit me like the thunderous crash of a bowling ball knocking down ten pins.

Beyond mere calendar-scorecard confluence, however, bowling may be the perfect vehicle to channel the 2010 proxy season’s likely ups and downs. Believe it or not, there are around six quintillion (that’s six billion billion for those directors who do not qualify as audit committee financial experts) possible outcomes in your typical ten-frame game of bowling. Considering all the moving parts in the current governance environment, the possible outcomes for the upcoming proxy season may be just as numerous.

Legislation/Regulation
To comprehend the complexity of the upcoming season, take a quick glance around the noisy Beltway Lanes venue. If the alley appears both familiar and crowded, it should. For the second straight season, all eyes will be on Washington, D.C., where members of Congress, staffers from the Securities and Exchange Commission (SEC) and Obama Administration appointees will be looking to make marks in every frame.

The legislative train has already left the station. On Dec. 11, 2009, the U.S. House of Representatives   voted 223-202 to approve the Wall Street Reform and Consumer Protection Act of 2009, sponsored by    U.S. Rep. Barney Frank (D-Mass.), chairman of the Financial Services Committee. The wide-ranging bill, which includes an annual say-on-pay mandate and authorization for the SEC to promulgate proxy- access rules, was pushed to passage solely by the Democrat’s House majority; 175 Republicans and 27 Democrats voted against the bill.

Chairman Frank’s bill will have to be reconciled with any financial-reform legislation that emerges from the U.S. Senate. There, Banking Committee Chairman Christopher Dodd (D-Conn.) backs a somewhat beefier banking reform initiative that includes most of the same governance goodies as Frank’s bill, plus an activist wish list that, among other things, would mandate majority voting in director elections and also force snap votes on retaining classified board structures.

Dodd’s bill has encountered stiff opposition and remains mired before his panel, but governance issues are the least of his concerns. While Frank and Dodd, who recently announced that he will skip a tough re-election campaign this year, will likely fuss over many aspects of the revamp of the regulatory oversight of the financial-services sector, there will be a love fest when it comes to governance. The resulting legislation—half-Frank/ half-Dodd or “FRA-DO”—could do to members of boardroom pay and nominating panels what Sarbanes-Oxley (SOX) did to their audit- panel brethren.

Just a few days after passage of Frank’s bill, the SEC voted 4-1 to finalize a set of new proxy-disclosure rules. “By adopting these rules, we will improve the disclosure around risk, compensation, and corporate governance, thereby increasing accountability and directly benefiting investors,” SEC Chair Mary Schapiro said during the Dec. 16, 2009 open meeting. The SEC made sure that its 129-page set of rules will take effect in time to apply to most issuers during the 2010 proxy season.