Shareholders are the owners of American corporations, with a claim on a company’s earnings and assets that does not exist for investors in corporate debt or preferred stock. As owners, shareholders also bear the ultimate financial risks for corporate success or failure.

This ownership role should guarantee shareholders certain basic rights in corporate affairs, such as the right to freely vote their shares in corporate elections. Unfortunately, the current system sharply limits the ability of shareholders to have a voice in how companies are run. Making corporate democracy more than just a hollow promise requires major reforms.

Attaining these reforms will ensure that corporate management works for shareholders. This increased responsiveness of management will create a more productive, competitive and vibrant American economy.

A Brief History

Much of the loss that shareholders have suffered has been a result of management reaction to corporate takeovers. These entrenched managers have turned to the political process in an effort to even further entrench themselves.

Some shareholders are under the impression that the rash of “takeovers” in the 1980s is a new game. But this is not the first time that a rash of takeover activity spawned restrictive legislation.

The 1960s saw the emergence of the “hostile takeover,” which can be defined as a bidding company going over the heads of target management and making acquisition offers directly to the shareholders. These takeovers were generally accomplished through the use of “Saturday Night Specials”—a first-come, first-served offer of short duration and high premiums offered to those shareholders who responded quickly. Under these conditions, management perceived themselves vulnerable because they could be replaced with virtually no notice. These perceived fears led management to influence the leaders in Washington to such an extent that eventually the Williams Act was passed in 1968. This law imposed disclosure and delay regulations on cash-only tender offers.

In 1970, after the takeover community began to use various financing techniques in lieu of cash for takeovers, the Williams Act was amended to extend its reach to cover all tender offers, cash or otherwise. The act had the cumulative effect of reducing the number of tender offers, but had little to no effect on eliminating “hostile” offers. Actually, by providing additional time requirements on bidders and by doing away with the Saturday Night Special approach, the Williams Act effectively made tender offers for companies a full-fledged battleground by drawing out the contests for control.

Embattled managements then sought relief by persuading 36 states to adopt statutes governing takeover activity. Typically, state laws provide for longer offering periods and more liberal withdrawal rights.

The role of the courts, on the other hand, has changed somewhat. During the 1960s and 1970s, long and protracted legal battles effectively prevented many takeovers from occurring. In the 1980s, however, courts began to resent the constant pressure from target management to serve as regulators of takeover activity. From 1980 to 1985, few takeovers were halted by litigation itself. The courts’ attitude progressed to the point where, in 1982, the Supreme Court struck down Illinois takeover legislation, and by precedent invalidated all other state anti-takeover laws.

The Current Battle

Starting in 1987, five years after the Supreme Court ruling, states once again began buckling to the pressure. This pressure is being applied with no regard for the owners of corporations. Management would rather entrench itself by fortifying the wall between itself and its owners than by running efficient, more profitable operations. Shareholders have been cut off from management by a number of actions, including: the creation of classes of stock with unequal voting rights; the lack of confidentiality in the proxy voting process; management’s virtual monopoly over the proxy initiative; the use of poison pills, golden parachutes and greenmail to discourage attempted takeovers; and antitakeover legislation.

Not one of those initiatives or actions is of benefit to the owners. Instead, they have cost stockholders billions of dollars in profit and will continue to cost billions of dollars unless owners adopt an activist attitude. Let’s examine each issue.

One Share, One Vote: One share, one vote is the fundamental democratic principle intended to ensure accountability by the managers of America’s public corporations to the shareholders who own the corporations. Underlying the principle is the fact that each share of common stock carries equal risk. Under a democratic system of corporate governance, shareholders should be entitled to a vote equal to the size of their ownership in the corporation.

But one share, one vote has been abandoned by nearly 300 companies that have adopted unequal voting rights plans, including 34 Fortune 500 firms and 52 corporations listed on the New York Stock Exchange. These plans disenfranchise public shareholders, while granting control to company insiders who often have small levels of equity ownership in the company.

Insiders at Texas Air, Media General and Resorts International all adopted unequal voting rights after hearing news that outsiders were acquiring large blocks of publicly owned stock.

A recent study by the U.S. Securities and Exchange Commission’s (SEC) Office of the Chief Economist reported “significant negative wealth effects” from the adoption of unequal voting rights plans.

Economic rights depend on voting strength, and these rights of shareholders must be protected by maintaining a strong one share, one vote standard.

[Editor’s Note: In July 1998, the SEC voted 4-1 to approve a one-share, one-vote rule.]

Confidential Proxy Voting: Corporate elections are the only elections in America where the incumbents prepare the ballot, send it to voters, count the returns and reveal the results. The absence of a confidential ballot leaves the corporate elections system open to abuse. Some corporate managers have used pressure tactics to intimidate shareholders who vote against management’s recommendations. A confidential vote in corporate elections will guarantee that the proxy system allows shareholders to express their ownership interests, without fear of repercussion if their vote is not favorable to management.

As part of a confidential voting procedure, corporations should be required to submit proxy voting results for independent tabulation. Without such verification, shareholders have no assurance that the vote reported by management on proxy initiatives is accurate.

Confidential proxy voting would not be difficult to implement. Several major companies, including AT&T, IBM, Exxon and General Electric, already have limited confidential voting. Two companies, Aluminum Company of America and Minnesota Mining and Manufacturing, recently agreed to institute confidential balloting when faced with shareholder proposals calling for a confidential vote. Similar shareholder proposals are pending at several other companies.

Shareholder Access to the Proxy: It is virtually impossible for a shareholder to effectively oppose a management-sponsored proxy initiative. When it comes to the election of directors, the only choice shareholders now have is to accept or reject management’s nominees. At the same time, management opposition to actions such as shareholder proposals nearly always succeeds.

Why? Currently, corporate management has an unlimited ability to make its case through the proxy statement and other written communications, while shareholders are severely limited in their access to the proxy.

To communicate with other shareholders, an owner opposing a management initiative or nominating alternatives to management’s director candidates must launch a full-scale proxy contest, a prohibitively expensive undertaking for most shareholders. A sponsor of a shareholder proposal is currently limited to 500 words in the proxy statement, while there is no limitation imposed on the length of the statements of management opposing the proposal.

Subject to ownership limitations that prevent abuse of the system, shareholders should have equal access to the proxy statement and all of management’s written communications to nominate directors, and they should have the ability to state their opposition to management initiatives and to provide shareholder proposals.

Abusive Tender Offer Defenses: Many corporate executives feel threatened by the need to enhance value for their shareholders. In their quest to maintain their powerful, high-paying corporate positions, they resort to abusive defensive tactics such as greenmail, poison pills and golden parachutes. These defenses, which reduce stock values and squander shareholder assets, should be prohibited.

One of the most flagrant abuses of shareholders is greenmail, the payment by management of a share price premium unavailable to other shareholders to buy off a major investor whom it considers threatening. Not only are all other shareholders excluded from the share-price premium but, in addition, a common reaction to payment of greenmail is a sharp reduction in stock prices as the market reassesses the value of the company absent a prospective change in control.

Poison pills are intended to make unwanted tender offers prohibitively expensive for the purchaser; they have been adopted by nearly 600 companies, all without shareholder approval. Poison pills “are not in the best interests of shareholders,” an SEC study found. The SEC concluded that evidence from 30 cases where pills were adopted in response to a bid for control “sharply contradicts the popular pill rationale—that they protect shareholders against ‘coercive’ bidder tactics.” It was far more likely, according to the SEC, that the pills would defeat a bid rather than encourage a higher offer, as many managements claim.

Golden parachutes, which are lucrative severance contracts for senior executives, are a blatant misuse of corporate funds. They are often adopted by corporations to be unfurled in case of a “hostile” acquisition, under the guise of maintaining the stability of the management team. In fact, however, golden parachutes are an extravagant waste of assets. They give special bonuses—usually two to three times annual salary—to managers who are replaced because they have failed to perform for shareholders. Outrageous examples from 1987 that have been disclosed: Terrence Elkes, former CEO of Viacom, pulled the rip cord on a $25 million parachute when the company was acquired by Sumner Redstone, while former E.F. Hutton chairman Robert Fomon’s fall to earth after the firm’s merger with Shearson was nicely cushioned by $16.6 million in cash.

Anti-Shareholder State Statutes: A total of more than 30 states have adopted tender offer laws in recent years that further widen the gap of accountability between management and shareholders. These undemocratic state statutes sharply restrict the role of shareholders in deciding who will run their companies.

A 1987 Supreme Court decision found some of the state laws constitutional, although Justice Antonin Scalia noted that the legislation was still “economic folly.” The passage of harshly restrictive legislation earlier this year by Delaware, where a majority of major U.S. companies are incorporated, threatened to touch off a wild stampede of new state legislation. Recent events, however, give some measure of hope that reason may yet prevail.

With several legislators noting that the primary beneficiaries of the proposal were senior corporate executives seeking job protection, the Colorado House of Representatives early in 1988 became the first state legislative body to defeat a restrictive tender offer bill.

In California, meanwhile, a blue-ribbon commission appointed by the state Senate has recommended that the state legislature seek federal legislation to set minimum standards for the state statutes. The recommendation was adopted by senior members of the California legislature, who have written key members of Congress to urge the passage of legislation guaranteeing shareholder voting rights. Federal legislation such as that proposed by California will restore shareholder rights while preserving the traditional state role in regulating corporate governance.

Returning Earnings to Shareholders

Making management more accountable to shareholders will help achieve another important goal: ensuring that management returns a fair share of corporate earnings to shareholders in the form of dividends. Recent reports on corporate results for 1987 show that profits at major companies rose substantially, yet shareholder returns were stagnant. Dividend yields remain at a paltry level of 2% to 3% of stock prices.

This means that many major U.S. corporations are retaining large portions of their earnings rather than pushing the cash out to shareholders. Corporate executives speak of seeking investment opportunities with these cash reserves. Unfortunately, history shows that managers of large corporations in mature industries are notoriously poor investors of shareholders’ money.

In the past, the primary purpose of retaining profits was based on tax consequences, not investment needs. When the top marginal tax rate applied to dividends approached 90% and capital gains received preferential treatment, retained profits sheltered shareholders from taxes. At that time, most shareholders could realize greater value by selling appreciated stock than they could from dividend payments.

With the top marginal tax rate now at 28%, and the preference on capital gains eliminated, there is no longer any valid reason for corporations to retain earnings.

[Editor’s Note: The tax rates mentioned are those that were in place in the late 1980s.]

Share value is enhanced when earnings are returned to shareholders. That way, shareholders themselves decide how best to reinvest their money, and corporations can turn to the financial markets to fund their investment programs.

This article was written by T. Boone Pickens Jr. and Guy W. Courtney for the July 1988 issue of the AAII Journal. At the time, Pickens was a general partner in Mesa Limited Partnership, an independent oil company, and Courtney was a senior vice president of David A. Noyes & Co., a Chicago-based brokerage firm and chairman of United Shareholders Association Chicago Chapter. Pickens founded the United Shareholders Association.