Shareholders Of The World: Sue!
By Geoffrey Colvin

(FORTUNE Magazine) – Who's really in charge of your company? I don't mean in routine day-to-day matters, I mean ultimately, when the gloves come off, who's got the juice to outmuscle everyone else? The CEO? The board? The shareholders?

The amazing fact is that the answer to this question--defining one of the most important and fundamental realities of U.S. business--is a big muddle. An answer could come soon if this proxy season yields an appropriate court case; legal scholars have been expecting one for the past three years. Any court decision will be bound up in a lot of legal language that most of us nonlawyers will be tempted to turn past. I urge you not to be tempted: A decision on this landmark question would affect your investments and maybe even your job.

Here's how a controversy over ultimate corporate power can happen: A shareholder submits a resolution to be included in a company's proxy statement and voted on by shareholders. It's on a significant corporate matter, proposing, let's say, to get rid of a company's poison pill. It isn't just an advisory resolution, like most; it's a formal proposal to change the company's bylaws. Suppose the CEO and board oppose the resolution--poison pills deter takeovers, which might cost them their jobs--yet it still passes with 70% of the vote, because shareholders know poison pills reduce a company's value. Is the bylaw changed?

This situation really occurred at insurer Chubb not long ago, and the answer--surprising to those who think owners should have some control over what they own--is that the bylaw did not change. Chubb's management ignored the vote. Management argued that the law of New Jersey, where the company is incorporated, prohibited the company from changing a bylaw solely on the basis of a shareholder vote. The shareholder who proposed the change took the case to court, but the case was thrown out on an administrative foul-up, so management's decision was allowed to stand.

The larger point is that what happens in a situation like Chubb's simply isn't established. "I was stunned when I got into this," says professor Lawrence A. Hamermesh of Widener University law school, a leading scholar on the subject. "It's so basic."

What's needed to clear up the who's-in-charge quandary is a decision from the big kahuna of American corporate law, Delaware's five-judge Court of Chancery. (Delaware is where most major U.S. companies are incorporated.) But you can't have a decision without a case, and the court hasn't received one. "It's amazing to me that this is still unresolved," says one of the court's judges, vice chancellor Leo Strine, who has thought deeply about the matter and who seems ready to give shareholders at least a sympathetic hearing. The corporate argument against letting shareholders vote on binding resolutions is that it could lead to chaos. It would be like asking citizens to vote on every question that comes before the city council, goes the reasoning; to avoid that, we elect representatives and let them decide most matters. The trouble with that argument is that in political life we have real elections with opposing candidates. By contrast, says Strine, "in the corporate context you don't have real elections"--there's typically just one candidate for each board seat--"so owners have to use direct referenda."

Strine has so far found little opportunity to apply such ideas in a real-world case, to his puzzlement. "For the life of me, I can't figure it out," he says. "I'd think someone would want a decision."

Now I'm no mind reader, but it sounds to me as if the court would welcome a case on this highly significant question. I also get the feeling that shareholders might like the result. It wouldn't immediately end the matter--appeal to the Delaware Supreme Court would be inevitable, followed by pressure on the legislature to pass some kind of law. Time was when you figured shareholders were doomed in a state legislature, since corporate managements could exert so much pressure there. Remember all the anti-takeover laws that got passed in the '80s? But now that big institutions like pension and mutual funds own some $20 trillion of equities, they would be a potent counterforce.

A court case would get the ball rolling. And the issue is overwhelmingly important. As Hamermesh says, "It's absolutely basic: Who runs the show?"

So, shareholder advocates and institutional owners, how about it? Where's the case? You've revolutionized the power relationship in publicly held companies, but the job isn't done. If you really want to establish shareholder power, this is the issue you'll have to get resolved. It's time to step up to the plate and take your biggest swing yet.