Majority Voting in the Election of Directors

Most people would be surprised to learn that the corporation laws of most states, including Ohio, do not require the affirmative vote of a majority of the votes cast for the election of directors. In fact, the plurality system (the nominee with the most votes is elected, even if he runs unopposed and gets only one vote) is embedded in most state corporation laws, including that of Ohio, where the General Corporation Law provides “At all elections of directors, the candidates receiving the greatest number of votes shall be elected” (Section 1701.55(B)). The American Bar Association’s Model Business Corporation Act, which is used by most states to form their laws, also establishes plurality voting as the default standard.
Not surprisingly, the majority voting movement has become a significant issue with shareholder activists seeking to implement corporate governance improvements. Majority voting has become the biggest issue of the 2006 proxy season, with more than 140 corporations faced with shareholder proposals seeking to change the method of electing directors. These proponents believe that the majority vote standard will increase board members’ accountability to the shareholders by enabling them to give unpopular candidates a definitive “thumbs down.”
Those opposing majority voting fear it will destabilize companies, permitting parties with short-term interests (such as hedge funds) to sway board composition to favor their positions. They are also concerned that unexpected changes in board composition could result in unintended complications under state corporate laws, federal regulations, exchange listing standards, or existing employment or severance contracts. Both sides of the debate agree, however, that majority voting represents a change in corporate power dynamics. Since the board hires and fires the CEO and CFO, the majority voting question is ultimately about who runs the corporation.
Notwithstanding the growing momentum of the majority vote movement, corporate America remains split on how to respond. Some, like Pfizer, have taken a step toward majority voting by adopting policies that require directors to offer their resignations if they fail to get a majority of votes. Others, such as Dell and Intel, have gone further and officially changed their bylaws to support majority voting, but the vast majority of U.S. corporations have made no change at all, without publicly revealing their reason for ignoring the issue. In December, 2005, the powerful proxy advisory group and voice in corporate governance matters, Institutional Investors Services, issued a statement saying it would support only “true” majority voting standard policies, thus calling into question policies like Pfizer’s which retain plurality voting as the default.
Plurality voting, introduced in the 1980’s, was designed to prevent failed elections when more than one candidate ran for a single board seat. However, today most board candidates, nominated by management, run uncontested. Proxy fights are expensive, and therefore rare occurrences. Shareholders looking for change have limited options. They can organize a “withhold votes” campaign, but even a majority of withheld votes for a candidate has no legal authority under the plurality standard.
The American Bar Association, after a one-year study of the majority vote issue by its Corporation Laws Committee, concluded that the default plurality voting model should remain unchanged. However, that Committee did propose changes to the Model Business Corporation Act that would make it easier for corporations to institute majority voting, if they so chose, and to strengthen the enforceability of director resignation policies. While the ABA stance may mean that most state corporation laws will remain unchanged, legislation has been introduced in California which would require corporations organized there to have majority voting in uncontested elections. And in Delaware, the State Bar Association’s Corporate Law Section proposed draft legislation that, while not changing the default plurality voting rule, would allow shareholders to introduce an irrevocable change of bylaws for majority voting and require irrevocable resignation of directors who fail to get a majority of votes.
If in fact the Intel model of bylaw amendment becomes the “gold standard” in director voting, it would not be without some justification. When confronted with the issue after shareholder activists filed a majority voting proposal, Intel and the carpenters’ union formed a roundtable group to look at the details of implementing such a provision. Eventually, four unions and fifteen corporations participated in the discussions, following which Intel decided to adopt the bylaws revision. Since Intel’s bylaws are amendable, the company felt if the new voting model does not work as intended, it could amend the bylaws again. And as to the possibility that the new model could result in a failed election if a seat is unfilled, Intel opted not to deal with that issue in its bylaws, deeming it to be a sufficiently unlikely state of affairs.
Following Intel’s decision to adopt a majority vote bylaw in January of this year, there has been a clear upward trend in other companies adopting similar provisions. For example, Motorola, following news of Intel’s decision, changed its previous position to adopt the Pfizer policy approach, and amended its bylaws to adopt majority voting. “Our governance and nominating committee looked at the differences [between the Pfizer and Intel plans], looked at what the shareholder component was interested in and where we thought the vanguard of corporate governance was going,” says Motorola senior corporate counsel Jeffrey Brown. “Where we came out on balance was the Intel model.” Intel’s move, according to Brown, means that there is now a clear model out there from respected major technology companies. Clearly, this model is well on its way to becoming the new “gold standard”, supplanting the Pfizer model, and significantly advancing the interests of shareholders’ rights activists.
The majority voting standard is obviously most applicable in the context of public companies where voting is largely by proxy and the shareholders’ options limited to a “Withhold” or “For” vote on management’s slate of nominees. In the context of closely held private companies, application of majority voting could be more problematic, potentially resulting in failed elections in contests where no nominee achieves a majority of the votes. Thus private companies should consider adoption of majority voting with careful consideration of its implications, both intended and unintended, and then perhaps in conjunction with a carefully crafted shareholders’ voting agreement. This would certainly be the case in Ohio, where the plurality voting provision of the General Corporation Law will require a carefully crafted “work-around” in order to implement majority voting.