Shareholder Proposals, Board Composition, and Leadership Structure

Separation of ownership and control epitomizes the corporate form of business. Shareowners invest while forfeiting the right to directly manage resources, creating an agency relationship between owners and managers. Managers may act in their self-interest to the detriment of shareowner value, a situation referred to as an agency problem. The Board of Directors is responsible for representing the owners through oversight of the corporation and prevention of self-dealing by the managers who control the invested capital. Two corporate governance factors, board composition (more independent directors) and leadership structure (split CEO and Chairman of the Board), may further serve to reduce the agency problem. Despite the mechanisms in place to mitigate the agency problem, corporate boards and company management often fail to act in the owners' best interests. Several remedies are available to shareowners. The simplest action is for owners to sell their shares. However, this remedy is problematic for large institutional investors (public and private pension funds and mutual funds) who own so much stock that selling their shares drives down the price. A second and more difficult path is to look to state and federal governments to develop legal remedies such as the Sarbanes-Oxley Act of 2002. The third recourse is through shareowner lawsuits against the board or the corporation when the board or management behaves illegally. The fourth option, and the focus of this paper, is for owners to file shareholder proposals to the Board to communicate their interests in changing corporate practices or by-laws. Corporate governance is a frequent topic of shareholder proposals. The volume of corporate governance shareholder proposals has been increasing. Gillan and Starks (2000) indicate that over the 1990-1994 period, an average of 307 shareowner proposals were submitted. According to the 2006 Georgeson Shareholder Annual Survey of all U.S. corporations holding annual meetings in the 2002-2006 period, the number of proposals submitted averaged 648, while the number voted on averaged 375. Theoretically, good corporate governance should benefit shareowners through improved financial results. However, research literature reports tenuous, if any, connections between financial performance and two components of corporate governance, board composition and leadership structure. Given these equivocal results, this paper explores another indication of corporate governance effectiveness, shareholder satisfaction. The increasing number of shareholder proposals submitted to boards of directors during the past decade indicates declining shareholder satisfaction and thus declining corporate governance effectiveness. This study examines whether the likelihood of a corporate governance shareholder proposal being filed varies with other corporate governance components, specifically leadership structure and/or board composition. The next section reviews the literature, the following sections develop the research question and detail the data utilized, and the last two sections discuss the results and provide a summary and concluding remarks. CORPORATE GOVERNANCE, BOARD COMPOSITION, AND LEADERSHIP STRUCTURE Corporate Governance Berle and Means (1932) were among the first to recognize the conflicts of interest that arise between principal (owner) and agent (management) in the corporate setting. Incentive alignment and monitoring are two ways by which the agency problem can be mitigated. Monitoring by the board of directors and aligning the interests of owners and managers form part of corporate governance and the primary means by which shareholders exercise control of top management (John and Senbet, 1998). Two corporate governance factors, board composition and leadership structure, may reduce agency problems by enhancing corporate boards' monitoring capabilities. Board composition is "independent" if the majority of the members are outside directors and "non-independent" if the majority of the board is composed of inside directors. …