The Dodd-Frank Act, which President Barack Obama signed on July 21, doesn't just change the rules of the road for banks and Wall Street powerhouses. It also continues and accelerates the trend toward providing more information, and ultimately more power through enhanced voting opportunities, to the shareholders of all public companies in the United States.
Although there are risks, if used wisely, these changes may help many of these companies achieve better corporate governance and better performance over the long run.
The additional public disclosure requirements of the new law, especially regarding executive compensation, continue an ongoing and accelerating trend. Public companies were already required to publish a comprehensive discussion and analysis of executive compensation. The new law will require them to provide more and clearer disclosures regarding the relationship between executive compensation actually paid and the issuer's financial performance and also comparative compensation information highlighting the ratio of the median annual total compensation of all employees except the CEO to the annual total compensation of the CEO.
The law also will increase the independence standards for compensation committees and their advisors, require that public companies recover any excess incentive compensation that resulted from financial statements that were later restated, prohibit stock brokers from voting their clients' shares without directions from the clients, and encourage public companies to prohibit executives and other employees from acquiring financial instruments designed to hedge or offset any declines in the market price of the company securities they own.
The enhanced compensation disclosures are especially significant, because those disclosures and other information will be used by shareholders in exercising their new right to participate in an advisory vote on executive compensation at least once every three years beginning in 2011.
The public company's board will not be bound by the advisory vote on executive compensation, but the directors are very likely to pay close attention to shareholder views on this and other issues because of another new shareholder power: the Dodd-Frank Act authorizes the SEC to adopt rules permitting shareholders to include director nominees in the company's proxy statement, and the SEC apparently intends to adopt such rules in time for most 2011 shareholder meetings.
Before this change, few shareholders nominated their own director candidates because of the high costs of soliciting proxies. Now that those costs may be eliminated (or shifted to the public company itself), shareholders may be much more likely to nominate and vote for new candidates for the board if the shareholders are unhappy with the policies and performance of the company and its current directors.
The most important effects of these changes will not necessarily be the result of direct shareholder nominations of new director candidates or of negative shareholder advisory votes on executive compensation. The new shareholder powers and increased public company disclosures send a message to the public companies and their directors that they will be "graded" by shareholders like never before. Even honor students are more likely to work hard on an important project that is being graded than on one that isn't. If this encourages public companies and their directors to be careful and diligent in establishing company governance and compensation practices and in explaining them clearly in public filings, everyone will be a winner. If it encourages more dialog about important matters between shareholders and the companies they own, that's even better. If it improves the financial performance of public companies, it could be a home run.
Still, I believe shareholders should be cautious when using the increased power that the Dodd-Frank Act provides. The goals of better governance and enhanced company performance are not likely to be attained if director elections degenerate into partisan style campaigns with public mudslinging and personal attacks. If good directors begin to fear that they will be publicly maligned by anyone who may disagree with their good faith decisions, some of them will choose to retire or resign from the board rather than fight or risk injury to their personal reputation. Losing good directors in this way would weaken corporate governance rather than improving it.
The Dodd-Frank Act and the regulations soon to follow will provide more information and shift more power to the shareholders than ever before. Whether that will lead to improvements in company performance will depend upon the wisdom and skill with which the information and power is actually used.