Is Corporate ‘Democracy’ a Valid Issue in Sacramento?

California politicians get ridiculed so often for not doing anything that it feels almost churlish to criticize them for trying to do too much, especially for a good cause.

In this case, the cause is shareholder democracy. Secretary of State Kevin Shelley has injected himself into one of the most contentious issues in corporate America by sponsoring a bill purporting to regulate how public companies respond to discontented investors. (The measure is being carried by Democratic Assemblywoman Judy Chu of Monterey Park.)

Shelley’s bill would require any company doing business in the state to allow any individual or group of shareholders owning at least 2% of a company’s shares for at least two years to nominate their own candidates for the board of directors. Companies would also have to implement any shareholder resolution that won a majority of votes at an annual meeting. Violators would be subject to lawsuits from the state or from California investors and to stiff financial penalties.

Many investor advocates think these are great ideas, and most corporate managements hate them (which in itself might count as a mark in their favor). But beyond the issue of where to set the terms and limits of shareholder democracy, Shelley’s proposal prompts another question: How is this the state of California’s business?

Shelley, who sponsored a corporate disclosure and investor anti-fraud law as Assembly majority leader in 2002, says his role as overseer of state elections intensified his interest in shareholder rights.

“In the same way we want democracy at the public polls, there should be democracy in corporate America,” he told me.

It’s important to note that the bill in its current form wouldn’t apply only to companies doing business with the state of California or incorporated under state law; it would apply to any company that sold so much as a bag of potato chips on this side of the state line.

But it’s doubtful that the state has the authority under the U.S. Constitution to regulate the policies of a non-California corporation. What’s more, it’s a mystery how the state could enforce such a law even if it was judged constitutional.

“California’s ability to regulate out-of-state corporations is constitutionally suspect,” says Stephen M. Bainbridge, a UCLA law professor who thinks the very word “democracy” is misapplied to public corporations.

Bainbridge contends that many shareholder rights proposals today are based on a fanciful notion of some prelapsarian golden age during which shareholders both owned and controlled their companies, and that such an ideal deserves to be restored. In reality, he says, the separation of ownership and control blamed today for allowing executives and directors to entrench themselves dates to Colonial times. Giving shareholders a more direct voice will be costly and distracting for management, he believes, without necessarily producing better corporate performance.

“Corporations have never been New England town meetings,” he says. “They’re hierarchies.”

Bainbridge also notes that California’s regulatory effort could soon be preempted by the Securities and Exchange Commission, which posted its own proposal for expanding the voice of shareholders in the boardroom several months ago and has barely borne up under the resulting onslaught of learned opinion, pro and con.

Under the SEC proposal, if at least 35% of the votes cast by stockholders are withheld from a nominee for director, individuals or groups representing at least 5% of a company’s shares can put up their own candidate the following year. (Customarily, board candidates are nominated by management or a committee of the existing board.)

Whether one considers the SEC proposal to be a dramatic expansion of shareholder rights or a begrudging crumb depends on where one stands on the broader issues of shareholder democracy. Corporate managements tend to complain that the triggering thresholds are so low that they will subject even well-managed companies to burdensome electoral campaigns.

Critics of the SEC proposal also note that shareholders have always had a means of expressing disaffection that doesn’t involve interfering with the judgment of management or the board: selling their shares.

Shareholder advocates, including the California Public Employees’ Retirement System, the nation’s biggest pension fund, say that wholesale selling is no longer realistic for many. The holdings of public pension funds are often too large to sell without driving share prices sharply down. Many funds also keep huge percentages of their portfolios in indexed investments, which require them to own shares in a broad range of companies regardless of management performance. That means they need a tool to pressure underperforming managements by threatening them with a change in the board.

Under the circumstances, they say, the SEC’s thresholds are set too high. Before Walt Disney Co. experienced an epochal 43% withhold vote against Chairman and CEO Michael Eisner last month, CalPERS told the SEC that no director of a Fortune 100 company had experienced a withhold vote of as much as 35%. CalPERS wants the threshold lowered to 20%, which it says would affect 15% of major public corporations.

CalPERS and other institutions also say the 5% threshold would put nominating rights out of the reach of even the largest investors. Last year, the nation’s three largest institutional investors -- CalPERS, the California State Teachers’ Retirement System, and a New York state public retirement fund -- said they held a combined stake of 2% in only one public corporation, but combined stakes of 1.5% in 12 companies.

Shelley’s proposal is far more liberal than the SEC’s in almost every particular. His bill dispenses with triggering votes and one-year delays, and allows a 2% clique of shareholders to nominate candidates for up to 40% of a board’s seats. Critics foresee an annual electoral free-for-all if anything of the kind ever got enacted.

“They want to transform corporate elections into the California recall,” says UCLA’s Bainbridge. “You’d have multiple candidates, directors being elected with voting minorities. It would turn the corporate election into an expensive, complicated process that’s not in the best interest of the shareholders.”

So it may not be surprising that the bill has been moving through the legislative digestive system rather slowly; a committee hearing on the measure isn’t expected until late this month. Shelley himself doesn’t sound too sanguine about its prospects for getting enacted in anything resembling its present form. He seems almost resigned to its being seen as a sort of goad to federal regulators to open the boardroom more to common shareholders.

“You’d hope there would be a nationwide regulatory approach,” he says. “Maybe this will help prod the SEC to do something.”

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Golden State appears every Monday and Thursday. You can reach Michael Hiltzik at golden.state@latimes.com.