Speech by SEC Staff:
The Securities and Exchange Commission, as a matter of policy, disclaims responsibility for any private publication or statement by any of its employees. The views expressed herein are those of the author and do not necessarily reflect those of the Commission, the Commissioners or of the author's colleagues on the staff of the Commission.
Dean Kramer, thank you so much for that very generous introduction.
And now I want, first of all, to take this opportunity to congratulate you, Dean Kramer, along with President Hennessy, Co-Directors Daines and Grundfest, and most importantly of all, Arthur and Toni Rock as well as everyone else present here tonight for the important and auspicious accomplishment the creation of this new Center represents.
Your new Center promises to become a distinguished source of path-breaking scholarship in the field of corporate governance and related studies. But it is also destined to do much more than that. As we've all heard earlier this evening, the Center will develop course materials for use in law, business and engineering schools, and well as in undergraduate programs. It will generate books, articles, online resources and databases. Its goal is to be a significant resource for policymakers and the press on matters of corporate governance. In short, it promises to be an intellectual beacon for the improvement of the practice of corporate governance here in the United States and abroad.
I now have to pause for just a moment to point out that the views I express this evening are my views alone, and not necessarily those of the Securities and Exchange Commission or any of its other staff members. As general counsel, I'd be setting a very poor example indeed, if I were to forget that standard disclaimer!
The Securities and Exchange Commission, my new employer, is the investor's advocate. Our mission at the SEC is to protect investors, maintain fair, orderly, and efficient markets, and facilitate capital formation. And widespread understanding and adoption of good corporate governance practices is an important element in the protection of investors.
To be sure, matters of corporate governance are largely within the domain of the state corporation codes, rather than governed by the federal securities laws the SEC administers. The SEC can, however, require clear disclosure, in plain English, of corporate governance practices, good and bad. And, as Justice Brandeis famously said, "Sunlight is the best disinfectant." As just one example, we've got an executive compensation proposal under consideration at the SEC right now that could shine some bright light in some previously dark corners.
But I'm not here today to talk about what we hope to accomplish at the SEC, as excited as I am about that. I'm here today to talk about the bright future of this new Center you're creating. It brings together so many themes that have fascinated me throughout my professional life: science and technology, venture capital and the financial markets, corporate and securities law and most of all the power of ideas and scholarship. Ideas indeed do matter. And better ideas are what this new Center is all about.
I believe this is a time when scholars focusing on corporate governance and related matters have an extraordinary opportunity to make signal contributions. In a moment, I'm going to be a bit presumptuous and ask some questions I think may suggest possible avenues for future research and analysis. It's indeed irksome one lifetime is so short. I'd love to be a young assistant professor looking to make my mark by writing in this field. I think it's wide open. And, as Arthur Rock's career more than amply demonstrates, good new ideas can change the world.
In fact, the very idea of the corporation is a good example. There was, after all, a time when the corporation had not yet been invented. In medieval times, you already could buy part interests in ventures like mills and mines, and historians have suggested the idea of being able to resell your share in such an enterprise dates back to the 1200s. Scholars report that the idea of limited liability came a little later: it apparently dates back to the "chartered companies," like the famous East India Company, that flowered during the age of exploration in the 1500s and 1600s. The royal sponsors of those ventures evidently came to recognize that, with the ever-present threat of debtors prison, the only way you could raise the large sums needed was to offer the protection of limited liability.
But modern corporation law offering the opportunity to conduct business with limited liability simply by signing up to do so was largely a creation of Victorian Britain and, for example, the British Joint Stock Company's Act of 1862 though we Americans also were involved in similar developments at about the same time. In fact, this early example of modern corporation law was celebrated in one of Gilbert & Sullivan's deservedly less well known operettas entitled remarkably enough Utopia Limited. Allow me to quote from the libretto (I promise I will not sing). These are the last lines of the climactic finale of Act I: "All hail, astonishing Fact! / All hail, Invention new / The Joint Stock Company's Act of Parliament Sixty-Two / The Act of Sixty-Two! / The Act of Sixty-Two!"1
The point is: as much as the laser or the transistor, the modern corporation is an invention, a liberating product of human thought and innovation. And like the ideas of the laser and the transistor, the notion that you could have the right to create at will an artificial person that could transact business like a real one, with freely tradable shares that could be issued in any amount to investors with limited liability that notion had explosive power. Today, there is no developed economy in the world that doesn't have some readily available form of corporation with these essential characteristics. I suspect the only more common form of human organization today is the family.
The technology behind the business plans of the companies that Arthur Rock helped found and finance changed the world and much for the better. But that change could not have been achieved without the form of organization we now so take for granted: the corporation. And that form of organization is itself an idea.
Sometime after the idea of the modern corporation became a commonplace, scholars began thinking seriously about corporate governance. But not so long ago, ideas about the governance of corporations and, in particular, the public company subspecies thereof were mostly of interest to a few academics with limited readership in law reviews and economics journals. Now, ideas about the governance of public corporations are standard fare in mass market newspapers of general circulation. We should all welcome this development.
Unfortunately, of course, this change in affairs has been driven in part by all the well known scandals I need not enumerate. But at a deeper level, other forces also are at work. And it's that deeper level that I think could use a good deal more attention. So let's think about what's changed since Arthur Rock first started investing in new technology companies.
Let's begin by asking, as a pragmatic, empirical matter alone, how you would describe the governance of most public companies back in the late 1950s and 1960s. Or ten years ago, for that matter.
I think you would have to say that most public companies then were operated in a way perhaps analogous to a kind of trust. An unelected, self-perpetuating group of trustees called the board of directors was responsible for the management of this trust-like entity. I say "unelected," though I'm fully aware, of course, that these corporations held annual stockholders meetings at which elections for director were conducted. But as a pragmatic, empirical matter, you would almost be more likely to win the proverbial lottery than to lose an election for director, once you had been nominated for a seat by the sitting board. The election of directors was the most formal of mere formalities.
Nor did stockholders play much of a role in the conduct of the affairs of the corporation otherwise. Until very recently, for example, the odds of a stockholder proposal pursuant to the SEC's Rule 14a-8 garnering majority support were similarly close to nil, if the board opposed the proposal.
From a pragmatic, empirical point of view, then, the stockholders were much like the beneficiaries of a trust, with almost no ability to influence the affairs of the corporation. Stockholders merely held beneficial interests in the corporation representing residual claims on the income and assets of the corporation after all other claimants had been satisfied first. Stockholders could buy or sell these interests. But essentially their only recourse if they did not like the way the corporation was being managed, other than simply selling their shares, was to bring an action in the courts of the state of incorporation for breach of fiduciary duty by their quasi-trustees, the board of directors.
Not entirely in accordance with present day notions of good corporate governance! We do appear to have made at least some progress.
And yet, to be fair, this approach to corporate governance nonetheless produced remarkable economic results. The U.S. economy, with some fits and starts, flourished over this period. And innovation flourished as well. To point to just a few of the developments and Mr. Rock's fingerprints are all over most of these it was American enterprise during this period that commercialized transistor technology, that developed the integrated circuit, and then the large-scale integrated circuit, and then the very large scale integrated circuit, and then complementary symmetry metal-oxide semiconductor technology, and then the microprocessor, and then the personal computer, and then well, you get the picture. Whatever their governance weaknesses, public corporations that wished to survive were forced by the chastening effects of vigorous competition in their labor, capital and product markets to function efficiently and productively. And it didn't hurt that they were constantly prodded by the smaller private companies funded by venture capitalists like Arthur Rock that kept up a constant stream of disruptive innovations. As a result, our public corporations succeeded in producing remarkable prosperity for Americans.
So what has changed now? Well, probably the greatest single change is that for decades now Americans have been investing less and less directly in the stocks of public corporations, and more and more through intermediaries such as mutual funds and pension plans. In an article last year in the Wall Street Journal entitled "The Amazing Disappearance of the Individual Stockholder," John Bogle, the founder and former chairman of The Vanguard Group, pointed out that, while 91% of stocks were owned by individuals in 1950, that percentage has declined to only 32% today.
He also reported that America's 100 largest money managers alone now hold 58% of all stocks. Think about what that means: Suppose you could get a decision maker with authority from each of those money managers to attend a meeting. You would not need a very big room. Ten rows of ten seats each would be enough. And with their 58% stake in the entire public company universe, those 100 decision makers could, if they chose to act together, wield remarkable influence.
So, not surprisingly, they or at least some of them are starting to flex their muscles.
Which means the old trust-like governance of public companies is coming under considerable pressure. And that's what we all have been reading about in the papers on a daily basis. There are now stockholders with large enough stakes and, on occasion, an apparent willingness to act, if not in concert, at least with awareness of how others are acting.
And they are being heard. The reality of the board member as self-perpetuating, unelected trustee appears to be weakening, as more and more companies begin to adopt majority vote requirements and withhold vote campaigns gain traction. And it is no longer a rarity for stockholder proposals put forth under Rule 14a-8 to gain majority votes. The ground is shifting. It is a time of change and ferment.
Which makes this a particularly propitious moment to establish this Center devoted to the study of the governance of our corporations. For all this change raises many new questions. If our public corporations, the engines of our economy, are to be governed by increasingly powerful intermediary institutions, isn't it time to begin examining in turn the governance of those intermediaries and questioning whether they are sufficiently faithful to the interests of those they represent, the ordinary Americans who are the pension plan beneficiaries and the owners of interests in mutual funds? What if, just as governance is beginning to improve at the level of the individual corporation, the locus of influence in fact is shifting away from those corporations to the intermediaries who invest in them? And what if unprecedented economic power appears to be increasingly concentrated in the hands of a remarkably small number of such intermediaries? What implications do these trends suggest?
A significant body of scholarship is now available analyzing the various agency costs and other issues associated with the governance of public corporations. But now may be the time for scholars, journalists and other interested parties even regulators to begin to turn attention to the organization and conduct of the institutions that are just now beginning to dominate the equation. If individuals increasingly own their interests in corporations through pension plan and mutual fund intermediaries, protection of the ordinary American investor increasingly will require closer attention to these intermediaries.
Which raises a host of fertile questions for scholarship to explore:
I suggest to you that these questions and many others urgently need answers.
And where better to find them then at the Arthur and Toni Rembe Rock Center for Corporate Governance? I applaud this great venture you have launched. And I eagerly look forward to reading and studying your publications.
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