Cumulative Voting for Corporate Boards
Recently, there has been a growing skepticism about the nature of
corporate boards and their practices. In several prominent cases
including Enron, Tyco and WorldCom, corporate directors and officers
have been accused of malfeasance. One of the key problems cited
by critics has been the lack of accountability and transparency of
corporate dealings. With weak enforcement of existing laws and
inherent conflicts of interest in self regulation, structural reforms
are necessary to protect the average shareholder. Meaningful
reforms will also benefit corporations and directors themselves in so
far that it will potentially help them make better decisions thereby
reducing their liability. Around the world, many nations facing problems of corporate corruption and lack of corporate accountability have found a solution in the use of cumulative voting. Cumulative voting offers an alternative to the traditional voting system used to elect corporate board of directors. By using cumulative voting, minority shareholders garner a greater opportunity to have the board of directors accountable to all shareholders rather than a narrow majority. Cumulative voting is used by many major corporations to elect directors including Sears-Roebuck and Company, Hewlett-Packard, and Toys 'R' Us.
Historically, the use of cumulative voting for the election of corporate board of directors originated because of abuses of power by railroad corporation executives during the last century. It seems that these issues still exist in corporate settings today, and therefore the use of cumulative voting for corporate boards should be revisited.
Shareholder activists and socially conscious investment firms frequently support the use of cumulative voting. CalPERS, Parnassus Investments, Calvert and PAX World Fund all generally advocate for the adoption of cumulative voting for the election of directors.
The purpose of this report is to help citizens as well as activists gain a basic understanding of what cumulative voting is and how it can be used in the corporate world to give shareholders a greater voice and hopefully prevent corporate corruption.
The Case for Cumulative Voting
In most instances, a stockholder is entitled to cast one vote for each share of stock that he or she owns every time matters are brought before the stockholders for a vote. Voting for the corporate board of directors is no exception to this rule. Unfortunately, this one vote system frequently puts shareholders with a small amount of stock, termed minority shareholders, at a disadvantage. Since directors run for individual positions, minority shareholders are unable to exert influence over any of the elections. Their small number of votes translates to a very small sphere of influence, and frequently minority shareholders are unable to elect directors who care about the interests and priorities of minority shareholders.
By using an alternative electoral system, cumulative voting, minority shareholders can have greater input and involvement in the election of the corporate board of directors. Cumulative voting gives minority shareholders the chance be more fairly represented on the board of directors by allowing them to use all their voting power at one time. Historically, the use of cumulative voting for the election of corporate board of directors originated because of abuses of power by railroad corporation executives during the last century.
In a cumulative voting system, the number of votes available to a shareholder in any given election is equal to the number of shares outstanding held by the shareholder times the number of positions up for vote. All positions are voted on at the same time, and the person with the highest amount of votes wins the election. The key difference between cumulative voting and plurality voting is that these votes may be voted in any possible combination and may all be cast for the same director. For example, if shareholders were asked for five directors, each share would be entitled to five votes, which could all be cast for the same candidate. It is important to remember that cumulative voting will only be used to elect the board of directors, and is not applicable for other votes held by shareholders or the board of directors.
The outcome of cumulative voting is that minority shareholders are able to gain some representation on the board of directors of the corporation and thus, at least can have some say in the management of the corporation. In many cases, this enables shareholders to elect a nominee that has similar interests and priorities. This is accomplished by lowering the threshold needed to win one seat. However, cumulative voting will not impact majority rule or create a stalemate, as it preserves the right of the majority shareholders to control the corporation.
If a corporation does not use cumulative voting, the number of candidates running for the directorship positions is frequently equal to the number of positions to be filled, thus giving no alternatives to shareholders or purpose to the entire election process. In other instances, the shareholders may be forced to vote for or against an entire slate of nominees, leaving little space for individual preferences.
Although some critics fear that cumulative voting will result in a hostile takeover, there are ways to avoid this scenario. The corporation can adopt a poison pill amendment through their bylaws or charter that allows company to hold authorized, preferred voting stock, only to be issued in the event of a takeover. Such a provision would allow the majority shareholders to retain voting control of the company in such an event.
The Arguments in Opposition
Opponents of cumulative voting frequently cite common reasons for their opposition. Many believe that each director should represent all stockholders, and therefore feel that a plurality vote is the best way to achieve this goal. Others feel that cumulative voting allows for the election of a director who feels accountable only to a specific segment of the shareholders, and then may feel obligated to address their interests and desires first. We should note here though, that under the typical system, the entire board of directors is usually only accountable to 51% of the shareholders or those with vast shares of stock. Allowing the minority to hold one or two seats, even, will not dramatically affect the board's decisions, but can instead increase accountability and allow other perspectives to be at least heard in the boardroom.
Another argument complains that cumulative voting can be used as a hostile takeover tool by allowing the aggressor company to gain a foothold in the target company. However, this could be preempted by adoption of poison pill amendments or methods designed at preventing takeovers. Opponents feel that the practice of cumulative voting could lead to the election of incompetent directors or commercial espionage. This argument still exists for corporate boards elected with plurality voting. Critics also raise the issue that special interest factionalism can exist in a system that uses cumulative voting, which can hinder a company's performance. In fact, cumulative voting should help reduce the existence of special interest factionalism, giving minority shareholders a stronger voice in the governance of the corporation.
Additionally, the use of cumulative voting frequently leads to pre-meeting caucuses by the majority. Some would argue that these meetings generally result in a reduction in information flow to the board of directors as a whole, as well as in adversarial relationships between the majority and minority board members. Opponents believe that this tension interferes with effective board governance, and thus is a valid argument against the use of cumulative voting.
more on state regulations governing cumulative voting for corporate boards
more on cumulative voting