Shareholder meetings, board meetings, and democracy: Thoughts on shareholder proposals
Do you know the movie, Twelve Angry Men? It’s a famous American movie from 1957. The plot line is that 12 men on a jury for the murder trial of a boy from the poor part of town — who are totally unrelated to each other, with different jobs, different upbringings, and different personalities — engage in heated arguments during their deliberations and eventually arrive at a verdict of not guilty. I first saw this movie as part of a high school class more than 30 years ago. Everything about the movie deeply affected me: the plot development, the drama, the jury system, the concept of democracy. I don’t remember how many times I went back to see this movie. I was recently on a long haul flight, and the movie was in the library, so I watched it again after so many years, and I was once again duly impressed. There’s really nothing like a good movie. Almost the entire movie takes place in one room and was filmed in one shot on one set. It’s a masterpiece.
You are probably wondering why I’m talking about a movie when this piece is titled, “Shareholder meetings, board meetings, and democracy.” I feel that one of the basic thrusts of this movie sheds light on many of the problems that Japan has recently been facing, such as the “conjecture” that the recent problems in the relationship between the government (prime minister’s office) and the bureaucracy are a matter of distance; governance issues at publicly listed corporations, which have been a subject of controversy for several years; the increasing number of shareholder proposals at annual shareholder meetings; and the sudden involvement of major shareholder (parent company) in corporate board personnel decisions which used to have been handled behind the closed doors. The following are my own personal opinions, so please bear this in mind as you read on.
I will take a roundabout way. First, what is democracy?
The Bureau of International Information Programs’ “Principles of Democracy” summarizes democracy as follows: “Democracy rests upon the principles of majority rule, coupled with individual and minority rights. All democracies, while respecting the will of the majority, zealously protect the fundamental rights of individuals and minority groups.” In other words, democracy is a framework for the institutionalization of human freedom.
Now that true communism has virtually disappeared from the real world, we take this kind of democracy for granted, but when this movie was made in the 1950s, the U.S.had recently gone through the Red Scare, and the truth and attributes of democracy were at the forefront of people’s awareness.
The U.S. still uses the jury system even now, and it is a system that takes democratic ideal principles to their limits. Since some cases determine people’s fates, it’s not surprising that verdicts must be reached not by majority vote, but by a unanimous vote by all 12 jurors. In the movie, 11 jurors argued that the defendant was guilty, but Juror #8, played by Henry Fonda, insisted that the defendant was not guilty due to the lack of conclusive evidence. It is the concept of “being innocent until being proven guilty”. The heated arguments that follow are the highlight of the movie. We all know how hard it is to argue against the general consensus and to act contrary to convention. At that time when the film was made, racial prejudice was ingrained in society, and all of those who were chosen as jurors were white males. Such a situation would make it very difficult for one person to argue in favor of innocence. There is probably a very low chance that one person could be so persuasive as to get everyone else to change their opinions in a few hours, as happened in this film. Even so, the robustness of the jury system and of the democracy that underpins it is that these are systems that possess the flexibility for such things to happen.
So, Juror #8 voted not guilty because of his conscience and because he felt that he was right. He had no financial incentive to stick with his opinion. Also, as the movie proceeds, it shows almost all of the human failings that exist: people’s egos, ethnic discrimination, preconceptions, prejudice developed from life experiences, feelings of being bothered by unpleasant details, etc. (These are depicted one by one through each of the other jurors.) The overarching message of this opus is that, even though overcoming such feelings is difficult, overcoming them shows that democracy works for real and forever.
Then suddenly I realized.
Even though these are not arguments among 12 peers, the same applies to the decisions made by corporate boards or shareholders’ meetings, which consist of a limited number of people in a closed room (participation in which is restricted and must meet certain criteria).
To be sure, many aspects are different, and the idea is somewhat far-fetched, but I would like to try plotting the points a bit. Below, I have attempted to create a table showing the similarities and differences among these bodies.
I am especially interested in the following two items in the table: decision-making criteria and the right to voice opinions and make proposals.
The problem of decision-making criteria.
With respect to decision-making criteria, although juries and boards are in different situations, these two bodies have many similarities. The most important but also the riskiest is that their decision-making relies on somewhat abstract definitions of right and wrong that vary from member to member. The basic premise (of both Jury system and Board system) is the hypothesis that each member is a citizen who has been instilled with a sense of right and wrong that is based on honesty and common sense. These people of good moral fiber will engage in discussions so that they arrive at the proper conclusion as a unified body. It is the belief that human nature is basically good.
What do we need for this hypothesis to work?
Let’s first look at the jury. The members of a jury are basically chosen at random, so they include people of diverse educational backgrounds and from walks of life ranging from laborers to corporate executives. This diverse group of people needs to demonstrate a moral awareness that will properly punishes a murderer but avoid condemning someone unjustly. For this, each member must realize that he or she is responsible for their decisions. This is the awareness that safety and justice are the legal rights, as well as obligations, of citizens with respect to the existence and livelihoods of their families. It’s the group consciousness, or feeling of pressure, accompanied by the concept of time, that if one does not do the right thing, it could ultimately have an adverse impact on oneself, or even on one’s family or descendants.
What about the board? What is required for people who were originally in a hierarchical relationship within a company to demonstrate a high moral awareness in implementing the long-term decisions that are best for shareholders? Some say that people on corporate boards should be those who will do whatever they can to increase the value of the corporation. This is certainly one requirement, but it is not enough. This is a common perception, because it would be problematic if the company failed, but it is quite possible that some unnecessary assumptions are at work behind the scenes. In my opinion, the closest thing to a sufficient condition is that board members to become shareholders and that as shareholders, the value of the ownership will comprise a significant portion of board members’ personal wealth. If I may ask, are there any OTHER way board would feel that behaving improperly will ultimately lead to one’s downfall? In some countries, board members’ wrong doing is charged with crimes against the nation. I have a hard time going along with the idea that a management action could become a national issue, as this seems excessive, but maybe these countries had some bad experiences in the past.
Now let’s look at shareholder meetings and the jury system.
Some people may feel that it is strange to compare the two because they are so different. But I think that an awareness of the differences can yield some very interesting observations.
First, regarding decision-making criteria, shareholders are not asked to share any common perception in taking part of capitalism. They act in their own interests independently and that is it. Nowadays, shareholders are becoming more institutional in nature, so it is hard to say that they are really behaving autonomously in this capitalism ecosystem. But I will leave it at that, as I am digressing from the point of this essay. The next major difference is that shareholders can expand their right to voice opinions and make proposals at shareholder meetings by buying up more shares so that they have more votes or more of a say-so (a capital majority). Furthermore, unlike jurors or corporate directors, shareholders who have gained more of a voice by buying up shares are not especially required to take a high moral ground similarly to the cases in the jury or in the board room. All they have to do is follow the rules (and act selfishly!). Why is this permissible?
It is simply because they are bound up in a common destiny by the principle of shareholder equality. For example, if a certain shareholder submits a shareholder proposal calling for a doubling of the dividend this year, this proposal will automatically apply to all shareholders. The shareholder does not act only for his or her own benefit.
This illustrates something that is very important. If you think about it, there appears to be a complementary relationship between the attributes of human behavior engendered within a corporate board of directors and the attributes of behavior exhibited at shareholder meetings or by shareholders (it is thus significant that share ownership puts shareholders and directors on the same wave length). But this it merely theoretical. Of course, shareholders do not know what is going on in the heads and hearts of each and every director, and they cannot have access to the minutes of board meetings unless they go through considerable red tape. Also, conversely, even though the ultimate form of a capitalistic economy is for shareholders to be acting in their own interest, this is merely an academic discussion for a world that has no concept of time. The fact of the matter is that the concept of self-interest is swirling around on various temporal axes.
Therefore, even though the general framework has been set, human society ultimately remains incomplete. In the final analysis, the jury system, corporate boards, and shareholder meetings all rely on the morals of each individual. Filling in the missing parts, the jury system operates according to the principle of unanimity after hearing all the arguments; it is commonly accepted that corporate directors should have substantial shareholdings in their companies, as is already customary in the U.S. and other countries (it’s not a rule, but is only “common sense,” while in Japan, it has yet to become common sense); and shareholder meetings are designed to limit the types of proposals and restrict who can present a shareholder proposal based on the number of shares held and for how long, the aim being to keep the meeting on track so that the agenda will not be filled with frivolous shareholder proposals that take up time and money.
Activist investors and major shareholders have recently starting submitting shareholder proposals again here in Japan. Some corporate managements must be feeling a bit uneasy. Lastly, allow me to state the following personal opinion in related to such shareholder proposals.
If managements cannot agree to the shareholder proposals submitted to the shareholder meetings, it may mean conflicts and disputes which is stressful. There will be times when the proposals are conscientious and fair, like those of Juror #8 in the movie, and there will be times when they are not. Fairness is not a particular requirement, so we do need to live with such situation.
Yet, I think that very few shareholders are not thinking about fairness and good faith when they are in the process of submitting a proposal. Shareholders who have owned a certain number of shares for a certain period of time will have the proper awareness and confidence in any action they take when they recognize a problem and consider the possibility of upsetting the harmony, yet take the time, expense, and nerve to make a proposal in the realization that even if it causes problems, not only they but all the shareholders will benefit in the end. We can also say that the situation itself generates juror #8 circumstance.
In my opinion, the other shareholders and the board of directors should both sympathyse the background where a certain shareholder is making a proposal even with the understanding he or she may create major friction, then discuss and deal with shareholder proposals in good faith. Unfortunately, I feel that grandstanding behavior at shareholder meetings is never going stop, and we will just have to embrace (and ignore) it as it is one of those noise that comes with the system. For board meetings and shareholder meetings to function properly, there need to be sense of constructive tension within the board (among directors) and between the board and the shareholder meeting, and more individuals need to act with as much courage as possible, as did Juror #8. I think that should be the ultimate goal.
Recently, Dalton Investments, my former employer, submitted a proposal to Shinsei Bank. To me, their proposal requesting for a major increase in the ceiling on stock compensation for directors seems like an interesting and legitimate proposal that addresses what I said above and would be able to stimulate discussion.
Just as democracy is a framework for the institutionalization of human freedom, the equity markets, which constitute the foundation of capitalism, allow so much freedom to do things or not do things. These range from corporate fund raising, frequent trading by investors to the amount of shares ownership (from one share to a total 100% acquisition via a takeover bid), to deciding whether to make a shareholder proposal or not, based on the minimum rules. Indeed, such freedom is the source and strength of the market’s liquidity and capitalism itself.
Sustaining the foundation of democracy requires an election system that is transparent, a system for selecting political leaders, and a huge amount of energy like that of the jury system. The system will be reinforced when people develop an awareness that they belong to it and can benefit from it. The same goes for capitalism. Undeniably, most of the current generation, including myself, and which is the generation that took the post-World War II capitalist economic system for granted, feels that this is the natural state of affairs and not think too much about it.
Juror #8 certainly showed people like us that in democracies and capitalist economies there is one ideal for employees (people who work in companies in the broad sense of the term), directors, and shareholders. Those who have not seen this movie yet should really see it, and those who have not seen it recently should definitely see it again. You may feel something about what is going on around you now in Japan.
May 8, 2018
Chief Investment Officer
Hibiki Path Advisors Pte. Ltd.