A Deeply Flawed CFA Institute Report on Shareholder Empowerment

This post by Bernard S. Sharfman (Adjunct Professor of Business Law at the George Mason University School of Business) and R.J. Lehmann (Co-Founder of the R Street Institute) was originally published on RealClearMarkets. 

Over the past year and a half, the shareholder-empowerment movement has been deeply enamored with an August 2014 CFA Institute report that called for mandatory proxy access - that is, the ability of shareholders to have their own slates of nominees to corporate boards included in the proxy materials companies must distribute ahead of their annual meetings.

Shareholder activists who advocate shifting decision-making authority to themselves, and away from corporate boards of directors and executive management, have used the report to support their claims that proxy access will create value for shareholders.

Unfortunately, as outlined in a recent policy brief authored by Bernard Sharfman and published by the R Street Institute, the CFA Institute report was deeply flawed in ways that should disqualify its use as support for mandatory proxy access; for shareholder proposals on proxy access; for board discussions about whether a proxy-access bylaw should be implemented; and, perhaps most importantly, for board discussions about whether a proxy-access bylaw needs to be rescinded.

So far, the silence from those same shareholder activists - either to defend the CFA Institute report or apologize for using it - has been deafening.

The importance of the CFA Institute report in the debate over proxy access can't be overstated, given its prominence in proxy-access proposals that continue to appear in corporate proxy statements. Shareholder proposals on proxy access - of which, some 200 are expected to be voted on by shareholders of U.S. companies in 2016 - typically have included a supporting statement noting the CFA Institute's finding that mandatory proxy access could raise overall U.S. market capitalization by up to $140.3 billion, if it were adopted market-wide.

This would be wonderful if it were true, but it is not. The report is full of errors, contradictions and practices of questionable methodology. The study excluded the results of two papers that appeared in esteemed journals which found mandatory proxy access actually produced negative shareholder value. While citing the "methodological shortcomings" of those studies as the reason they were excluded, the report's authors included another study that used much of the same methodology. In another case, they misused the results of a study in a way that produced an absurdly inflated estimate of the market value of mandatory proxy access.

These flaws are big and they are obvious. The report's persistent use by those in the shareholder-empowerment movement suggests either that some in the movement are intellectually dishonest or that they are, at the least, reckless in their arguments. A close reading, even by one who hasn't read the underlying empirical studies used to come up with the $140.3 billion figure, should have raised concerns about its value. Nevertheless, it has been full speed ahead in using it to support implementing proxy access.

The real problem this episode exposes is that those who advocate for "shareholder empowerment" are proceeding almost unchallenged in the debate over what constitutes good corporate governance. A rigorous vetting of the report's flaws should have been done long ago, probably within the first three months after its publication. Where was the intellectual firepower or even the interest on the other side of the debate when the report first came out?

The deeper implications of this dereliction of duties to vet and verify is that those who advocate for shareholder empowerment will be able to continue do so with intentional or reckless disregard for the truth, unless resources are committed to hold such disregard in check.

Determining good corporate governance is not about winning or losing, or about whether shareholders gain or lose power in corporate decision-making. The point is to find those corporate-governance arrangements that maximize shareholder value. If one side is intellectually dishonest or reckless in its arguments, while the other fails to offer reasoned objections and rigorous analysis in a timely fashion, then it's not just shareholder value we put at risk - it's the very health of our economy.

Bernard S. Sharfman is an Ajdunct Professor of Business Law at the George Mason School of Business, and an Associate Fellow of the R Street Institute. R.J. Lehmann is Senior Fellow, Editor-in-Chief, and Co-Founder of the R Street Institute.