Ideas from Kara M. Stein’s (US Securities and Exchange Commissioner) speech on mutualism in modern corporate governance

“Mutualism: Reimagining the Role of Shareholders in Modern Corporate Governance”

Remarks at Stanford University

So, I thought I would start off our discussion tonight by talking a bit about the science of “mutualism.” For those of you not familiar with the concept, mutualism is a symbiotic relationship between individuals of different species in which both benefit from the association. One example of mutualism is the relationship between bees and flowers. Bees fly from flower to flower gathering nectar to make food. By flying from flower to flower, bees pollinate the plants on which they land. Bees get to eat, and the flowering plants get to reproduce. Bees help plants grow, thus supporting other animals, including us humans. The bee-flower relationship is integral to our entire food chain, and our larger ecosystem.

The relationship between a company and its shareholders is rooted in a similar form of mutualism. Shareholders invest their savings or capital in a company. The company then deploys the capital to fund its operations. This allows the corporation and its shareholders’ investments to grow. This corporation-shareholder relationship is likewise part of a larger ecosystem. When all goes well, more employees and managers get hired, and the company produces more products or provides more services, all of which benefits the entire economy.

Board Composition

The composition of corporate boards provides another example of how the concept of mutualism is informative. Boards can and should be a bridge to investors, but too often they are a wall. Board composition is vitally important as directors play a meaningful role in helping companies make productive investments and good decisions going forward. However, boards remain far from diverse or reflective of shareholders’ views despite evidence pointing to the value of such diversity in their composition.

Gender diversity on boards provides a notable example. This is not about making people feel good—it is about dollars and cents. Studies suggest that women may be better monitors of executives, a central function of boards of directors.[20] Research has also shown that companies with strong female leadership generated higher returns on equity compared to those without.[21] This may be because having a diverse board helps the company better understand purchasing and usage decisions by its clients or customers. Studies have found, after all, that women drive 70% to 80% of purchasing in the United States.[22] As I have remarked in the past, diverse boards also appear to deter “groupthink” and help reduce instances of fraud, forms of corruption, and shareholder contests.[23] The Commission and regulators across the globe have also echoed the importance of gender diversity on boards.[24]

Despite all of this, gender diversity on boards remains elusive.[25] The percentage of women on boards is currently at approximately 20%, an increase of only 5% since 2011.[26] This is striking when you consider that women make up 50.5% of the U.S. population[27] and approximately 47% of the U.S. labor force.[28] Indeed, the United States lags behind many advanced economies in terms of women’s representation on corporate boards.[29]

More striking still, it is not just academics and think tanks that support gender diversity on boards. Shareholders, too, expect the companies they own to have diverse board membership. For example, State Street Global Advisors[30] and BlackRock[31] have adopted policies or guidance with respect to increasing gender diversity on boards, and indicated their willingness to use their voting power to effect change, if necessary.

Yet, despite the documented benefit of diverse boards, many board members do not believe that board diversity enhances company performance.[32] Further, more than half of directors believe that their boards are already sufficiently diverse.[33]

It is one thing for boards to ignore scholarly research, but it is quite another for boards to ignore their companies’ shareholders or owners. Especially when it can affect everyone’s bottom line. Although we have come a long way since the 18th

Century, we still have a long way to go. How can technology help this process? Can it be used to better connect a company and its board with its shareholders? How can a corporation capitalize on mutualism and benefit from the best ideas of its shareholders for the benefit of all?

Dual-Class Capital Structures

Another place where the concept of mutualism needs to be considered is in regard to dual-class capital structures, where certain shareholders are starting to be disenfranchised by design.

As you know, in typical dual-class capital structures, corporate insiders receive common stock with multiple votes per share while public shareholders receive shares with one vote per share.[41] This structure allows these corporate insiders to control a majority of the votes of the corporation even though they own a minority of its stock.[42] While dual-class capital structures have existed for many years,[43] much has been written about them recently. This may be in part because of an upsurge in dual-class IPOs—from Google in 2004 to Manchester United in 2012. And we all have heard about Snap and its IPO of non-voting shares in 2017.[44]

Many, including myself, see dual-class capital structures as inherently undemocratic, disconnecting the interests of a company’s controlling shareholders from its other shareholders.[45] The disassociation of interests can grow over time when certain shareholders, but not others, have the right to vote over fundamental corporate matters—like board members.[46] It is not surprising, then, that critics include shareholder groups, asset managers, and stock indices.[47] Or that they are prohibited by some countries.[48] Yet, we are still inexplicably letting dual-class share structures persist.[49]

Why does the appetite for dual-class capital structures exist despite wide investor disapproval of such structures? Where is the symbiosis? Can investors afford not to invest in another Google, even if they do not agree with the share structure? What leverage do they have? What happens when the interests of a company’s controlling shareholders continue to diverge from its other shareholders? Is there a risk that a company’s controlling shareholders will acquire conflicts of interest so large that the company cannot act in the best interests of all of its shareholders?

While some say dual-class capital structures are designed to prevent a takeover or shareholder activism, they also may provide a means to evade management and board accountability. Structures where a minority of insiders lock out the interests and rights of the majority may also have collateral effects on our capital markets. They may be harmful not just for those companies, their shareholders, and their employees, but for the economy as a whole. Dual-class capital structures, in effect, turn the mutualism underlying the corporation-shareholder relationship on its head.

Full speech following the link: Original source:

Scholarly insight on gender diversity and shareholder activism.