Nonbinding Voting for Shareholder Proposals

Shareholder proposals are a common form of shareholder activism. Voting for shareholder proposals, however, is nonbinding since management has the authority to reject the proposal even if it received majority support from shareholders. We analyze whether nonbinding voting is an effective mechanism for conveying shareholder expectations. We show that, unlike binding voting, nonbinding voting generally fails to convey shareholder views when manager and shareholder interests are not aligned. Surprisingly, the presence of an activist investor who can discipline the manager may enhance the advisory role of nonbinding voting only if conflicts of interest between shareholders and the activist are substantial. ACCORDING TO SECURITY and Exchange Commission (SEC) Rule 14a-8, shareholders of a public company are permitted to submit a proposal to be voted on at the annual shareholder meeting. Unlike voting for management-initiated proposals, the resolutions of votes on shareholder-initiated proposals are nonbinding in the following sense: the company’s board can make its own determination as to whether adoption of all or any part of a shareholder proposal is in the company’s best interest, even if the proposal received substantial majority support from shareholders.1,2 Nonbinding shareholder proposals have become increasingly common in recent years, especially in the post-Enron era. While the number of governancerelated proposals in the United States was about 270 per year over the period 1997 to 2002, it spiked to more than 400 per year over 2003 to 2006 (see, Ertimur, Ferri, and Stubben (2010) and Buchanan, Netter, and Yang (2010)).3 ∗Doron Levit is from the Wharton School, University of Pennsylvania; Nadya Malenko is from Boston College’s Carroll School of Management. The authors thank Anat Admati, Peter DeMarzo, Fabrizio Ferri, Campbell Harvey (the editor), Dirk Jenter, Eugene Kandel, Ilan Kremer, Andrey Malenko, Ernst Maug, Michael Ostrovsky, Paul Pfleiderer, Ilya Strebulaev, Bilge Yilmaz, Jeffrey Zwiebel, an anonymous associate editor, an anonymous referee, and seminar participants at Hebrew University and Stanford University for helpful comments. 1More specifically, Rule 14a-8 allows companies to exclude most binding proposals as “not a proper subject for action by shareholders” under the corporate law of the company’s state of incorporation. On the other hand, proposals that are cast as recommendations are usually considered to be proper under state law. For these reasons, the vast majority of shareholder proposals in the United States are precatory and therefore nonbinding: according to the 2007 Institutional Shareholder Services report (ISS (2007)), nonbinding proposals accounted for 98% of the total shareholder resolutions in the United States in 2007. 2Shareholder proposals are not universally nonbinding. In the U.K. and most of continental Europe, voting for shareholder proposals is binding (see, e.g., Cziraki, Renneboog, and Szilagyi (2010)). 3For comparison, the number of management-initiated proposals in the United States was about 1,450 per year over the period 1994 to 2003 (see, e.g., Maug and Rydqvist (2009)). This large number