Where Was Wells Fargo's Board?
The scandal surrounding the opening of fake accounts at Wells Fargo illustrates a deeper dysfunction in the governance of U.S. companies: Corporate boards are failing at their job of overseeing management. If regulators can’t address the problem, shareholders can and should.
Despite years of evidence that a policy coming from the very top was driving illegal and abusive practices at Wells Fargo, the bank’s directors were notable mainly in their passivity. They did not act in 2013, when the Los Angeles Times reported that bank employees were opening phony accounts to meet unrealistic sales quotas. They did not act in September, when Wells Fargo agreed to pay a $187.5 million fine and admitted to creating more than 2 million fake accounts. Only after CEO John Stumpf was excoriated in congressional hearings did they decide to claw back some of his compensation. Still, they never fired him -- he resigned on his own.
Where do such directors come from? In U.S. companies they are typically chosen by shareholders, but in a system so rigged that it may be the closest Western analog to a Soviet election. The incumbent directors nominate all the candidates (usually themselves), severely limiting the voters’ freedom of choice. Withholding votes in protest is both useless and dangerous, because it has no effect on the outcome and -- if practiced by big investment firms -- can even elicit retaliation from management (which has the power, for example, to decide who invests the company’s pension money). Directors know that the quickest way to lose their well-paid positions is to criticize the CEO.
The result, as the shareholder activist Bob Monks famously argued more than 20 years ago in a full-page Wall Street Journal ad, is that boards are akin to “non-performing assets.” They tend to be loyal to management and not accountable for their mistakes.
Reforming the way corporate directors are elected could go a long way toward making them more vigilant and valuable. To that end, empowered by the 2010 Dodd-Frank Act, the Securities and Exchange Commission created a rule that, among other things, allowed investors who had owned at least 3 percent of a company’s shares for three years to nominate their own candidates. This very modest proposal proved so threatening to the status quo that two lobbying groups -- the Business Roundtable and the U.S. Chamber of Commerce -- mounted a legal challenge, ultimately convincing a court to block the rule on the grounds that the SEC had failed to perform an adequate cost-benefit analysis.
The court ruling, however, isn’t the last word. Individual shareholders can gain the power to nominate directors by amending corporate charters. In the last two years 165 such proposals have been submitted to a vote at public companies in the Russell 3000 index, and 92 have been approved. In December, Wells Fargo’s board actually approved a similar provision, though it limits shareholder nominations to a fraction of directors and has yet to affect the board’s composition.
Initially skeptical, big institutional investors have begun to lend their support to such reforms. As BlackRock put it: “Long-term shareholders should have the opportunity, when necessary and under reasonable conditions, to nominate individuals to stand for election to the boards of the companies they own and to have those nominees included on the company’s proxy card.”
These are legitimate investors, not barbarians at the gate. Giving them more influence on corporate boards will inevitably create some frictions, but the resulting system can hardly be worse than the current one. As repeated scandals suggest, corporate governance is broken. What better way to fix it than empower the true owners?
This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.
To contact the author of this story:
Luigi Zingales at Luigi.Zingales@chicagobooth.edu
To contact the editor responsible for this story:
Mark Whitehouse at firstname.lastname@example.org