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The Voting System Outline

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III. The Voting System

A. Corporate Voting and the Collective Action Problem
Public Corporations and the Voting system
- When and how do shareholders vote

o Special meetings - convene as prescribed by law/ written consent if permitted in co./ board called
- What do shareholders vote on

Election of directors

Things board cannot do on its own: merger, dissolution, changes to certificate of incorporation, action plan
 Cleansing acts: sometimes things that board cannot do on its own

In public co. - say on pay, a non-binding vote on executive compensation

Resolutions under rule 14A(a)
- How many votes

One share on vote in general
- Required votes for passage

General rule: mergers and charter amendment - majority of shares entitled to vote

Everything else (other than election of directors)  majority of shares voting

Election of directors: people with most votes get elected (but now most large co. requires majority of the votes)
- Record dates, record holders - how are votes collected

Proxy info given to shareholders  Votes collected

Some co. have lawyers that is in charge of the mechanics of vote, complaining purposes, lopsided 
90% would vote one way, hard task would be to get enough people to be bothered to vote

 Shareholders resolution 14A(a) - low level of complaining who gets to insert statement into the co. proxy statement
 Intents complaint
 Background

Record holders:
 Previously shareholders himself would be the record holder (if certificate is lost  can get another one)
 Nowadays if you buy shares through banks  no longer registered as the shareholder 
investment banks would act as intermediate record holders  and passes voting instructions from the company to the owner
 Record date - voting date  vote still counts even if you sell the shares on the day you voted
 you vote will still count
Collective Action problem: cost of meaningful collective action  paradigm/ model example
- Unlike co. wholly owned by a single shareholder (no costs of collective action)
- Co. held by 100,000 shareholders  collective action costs are likely to be preclusive  rational shareholders will never challenge board decisions/ inform themselves about co.'s performance beyond following the price of its stock  Voting system largely a formality

Too many shareholders, who would pay no attention to what's going on

So severe that it makes voting almost meaningless

Board likely to be dominated by top corporate officers (the insider directors), who control the board's agenda and info
- Cost of acquiring info
- Benefits depend on

Likelihood that info will change one's own vote

Likelihood that change in one's own vote will change outcome (vote pivotal)
1 III. The Voting System-o Change in value of stock if outcome is changed (= change in co. value x stake)
Example 1

Assume a co. with value of $10B  asked to vote on deal that may lower value by 5% (i.e. 500M)
o You are suspicious and think chances of this happening are 40%. If you decide to become 'informed',
you will know for sure

You own 0.1% of the stock (10M value)  a lot of money, few would own so many in a co.
o You think that likelihood that your vote is outcome determinative is 0.2%
o Benefit of becoming informed
 Likelihood deal is bad: 40%
 Expected loss to company from bad deal: $500M x 40% = $200M
 Your portion of expected loss: $200M x 0.1% = $200,000
 But you only benefit from casting informed vote if vote is pivotal.
 So expected benefit: $200,000 x 0.2% = 400  pretty low for $10 stake
 $400 (~30 mins legal advice)  most shareholders would not bother to vote
Example 2

Assume co. that you own 3%  other shareholders have raised questions about the deal, that you believe vote will be close and the likelihood that your vote is outcome determinative is 7%
o Benefit of becoming informed is now: 200M x 3% x 7% = 420,000

Less severe if less diverse; more severe if more diverse
S. 14(a) of the Securities Exchange Act (SEC) was designed to introduce more 'democracy'  by promulgating a set of proxy rules to encourage informed shareholders to be able to vote knowledgeably in corporate elections

As most do not attend shareholder meeting in person to cast their votes, but give proxies

Proxy = authorization to vote on their behalf for a certain candidate/ proposal
 vote authorisation to other people - to vote my share in a following way in the next AGM
 co. distribute proxy statements - disclosure statement relating to the vote, recommendation on how to vote
 seeking return of a proxy marked voting the way you want them to vote
 before AGM, vote is mostly settled

How has the paradigm changed? [11/1]
- Reasons:

1. Ownership structure changed

2. People have observe that shareholders do not vote in accordance to their paradigm
 Corporate election are less one-sided
- Changes relating to voting: considered more important now (than 30 years ago)
o Increased concentration of ownership
 companies are often held by large shareholders  less severe collective action problem

Increased institutionalization of voting:
 large banks, mutual fund companies (usually own 2-9% in a co.), own a lot of stocks in many companies
 With economies of scope, a company can be helpful to another company
 Professionally managed, with a lot of advisers
 ISS would issue voting recommendations to institutional investors
 Proxy advisors
Shareholders' precatory resolutions more likely to get implemented

Not all management proposals would get majority, sometimes it fails
- Hedge fund: unregulated mutual fund, smaller, only very rich people buy shares in them

Some are smaller and have more specialised investment strategies

2 III. The Voting System

Active hedge fund: figuring what co. will benefit from the input that would increase in stock price -
some are friendly and some are not
"Just say no" campaigns: shareholders vote against management
Voting is taken more seriously - ,ore contested issues:

1. Shareholders often win

2. Low no. of no votes will embarrass the board  motivate them to do things differently
 Board react to how shareholders vote  their votes would move the board
Voting is regulated by State law (how to vote) and federal law (solicitation)

Development of shareholders vote

1980s new shareholder's right movement allowing investors to exercise their power through voting system; SEC amended proxy rules in 1992 to further lower the organising costs of large investors

No longer have collective action costs that are either non-existing (co. only have controlling shareholders) or preclusive (stock held by thousands of small stockholders)
o For typical public corporation today, collective action costs may be large, but not large enough to prevent shareholders from monitoring managerial performance, depending on legal constraints, payoffs to shareholders, large culture of shareholder activism  structure of the proxy rules and state regulation of voting rights matters the most to these co.
o Voting standard in most director election
 Plurality voting: nominees with the most votes are elected as director, but need not be majority
 Uncontested election:
 Previously: if no. of nominees is equal to the no. of vacant seats, a nominee could be elected by a single shareholder (even if all other shareholders refused to vote for that nominee)
 Since 2006: companies shifted to majority voting, sometimes implemented via a bylaw or a corporate governance guideline
 Either case: nominee who receives an uncontested election more "against (or withhold)" votes than "for" votes is either not elected or is supposed to offer her resignation
 Where no. of nominees exceeds no. of vacant seat  plurality regimeVoting in Corporate Law - Frank Easterbrook & Daniel Fischel

Corporate form allows division of labor between people who have money but not managerial skills and those who have managerial skills but not capital

Legal rules serve as a standard form contract for issues of corporate structures - but structural rules and fiduciary principle together cover only the outline of the relationship and right to voting (including right to delegate such right) is needed to make all decisions that are not provided by the contract (e.g.
electing directors and give them discretionary powers over things voters otherwise could control)
o Delaware permits firms to give shareholders any no. of votes (including none), and give votes to bondholders in addition to (or instead of) shareholders

Firm may choose to cumulate votes: allowing shareholders to cast multiple votes
 [thus a candidate may be elected by less than a majority of the shares]
o Those with power to vote may
 choose to vote in person or by proxy,
 choose mangers directly or through mediation of the board, and
 permit directors/ managers to serve full terms or oust them for any or no reason in mid-term

Necessary quorum may be set at less than half of the votes, and the firm may require supermajority approval on selected questions

Any of these rules may be set/ altered at any time by those with power to vote

3 III. The Voting System


Similar situation in other states - though different states create different presumptive rules, e.g.
cumulative voting
 Almost all shares have one vote; only shares possess votes
 Preferred shares or bonds may acquire votes when the firm is in financial difficulty
 Cumulative votes/ nonvoting stock/ stocks with seriously limited voting rights are rare in publicly-held corporations


Statutory limits on the ability of firms to create a voting structure
 Investors may sell votes by selling the instrument to which the votes are attached
 But cannot sell the votes independent of the instrument
 Statute limit shareholders' ability to grant irrevocable proxies
 Proxy is revocable by the grant of a new proxy to someone else
 A proxy purporting to be irrevocable is binding only if coupled with an interest in the stock, e.g. pledge to secure a loan
 Voting trust: a form of irrevocable proxy in which several shareholders convey their shares and the attached votes to a trustee who must vote them as a bloc in accordance with instructions (unlawful in common law)
 Statute only authorise voting trust in close corporations + time limits + periodic renewal of the trustee's power


Most state statutes require votes on fundamental transactions:
 E.g. mergers, sales of substantially all the assets of the firm
 Board of director must submit other proposals to voters when a sufficient no. of voters/
directors request such a submission
 Business shall be managed by board of directors
 Shareholders do not vote on ordinary business judgement
 Unless extraordinary action - fundamental corporate change must be submitted to shareholders were a requisite % of shareholders must approve
 Rationale: reduction of agency cost
Counter argument: shareholders are merely passive financial investors who lack expertise and incentive to become involved in making business decisions  little need for additional and costly monitoring by shareholders who are will equipped to provide



Charter amendment - commonly require shareholder's approval
 Shark-repellent amendments to deter potential bidders from making a tender offer
 Amendments reduce the probability that the firms shareholder will be the beneficiaries of a tender offer at a significant premium over the market price  reduce shareholders' welfare
 Shareholders may vote to monitor the management' self-interested behaviour


Managers may submit issues for shareholders' approval because legal rules encourage them to do so,
despite not being required by law
 Shareholders' approval of a transaction decreases the probability of a successful judicial attack
 If the transaction is approved by a vote of shareholders  transactions between a director/
officer and a corporation will not be void/voidable, despite conflict of interest
 Merger will more likely survive a judicial challenge under the entire fairness test if it is approved by a majority of the minority
Shareholders cannot ratify fraud + court end to scrutinize whether self-interested transaction are beneficial to the firm
Survivorship principle: there is a net benefit of legal rules encouraging shareholders' approval of certain transactions

o o

4 III. The Voting SystemLimiting Contractual Freedom in Corporate law: the Desirable constraints on Charter Amendment Lucian Bebchuk

Shareholder approval will not ensure the value-decreasing amendment be defeated
 Though some might occasionally be defeated
 Many conspicuously value-decreasing amendments that could benefit the management would not be proposed, due to the unlikelihood of being approved

Main problem: lack of info [cannot be eliminated]
 Most shareholders don't know whether proposed amendment is value-decreasing or increasing
 Though some would easily be recognised as value-decreasing, e.g. allowing manager to purchase fraction of co.'s assets at a minimal price
 Most shareholders choose to remain ignorant - as they lack incentive to make necessary investment in acquisition and processing of info
 Decision on how to vote have very small chance of affecting the shareholder's interest 
often imperfectly informed [c.f. decision whether to buy shares would have greater effect on decision maker's interest]
o Even large, informed shareholders who have acquired and assessed the info bearing on the desirability of the amendment are often unlikely to disseminate effectively their info to smaller, uninformed shareholders
 Even if dissemination could be effective, large shareholders lack incentive - bear all costs despite benefits are shared by all shareholders
 Dissemination often ineffective as small shareholders lack incentive to read materials sent to them

Interest of shareholders and managers sufficiently overlap on many issues  so that shareholders can reasonably expect most amendments to be value-increasing
 Usually vote uniformly in favor of these proposals

B. Federal Regulation: The Proxy Rules
Securities Exchange Act of 1934
 Regulate activities by companies other than the issuance of securities [Securities Act 1933]
 Mostly apply only to publicly-held companies, with large no. of shareholders
 Supplemented by SEC Regulations - SEC is a federal agency that administer and enforce the federal securities law
 Exchange Act regulates the flow of info between companies and investors (and among investors)
 Exchange Act requires public companies to file periodic business activity reports

Lesser info on quarterly basis in 10-Q reports; more info on annual 10-K reports
 Additional requirements in certain special circumstances

General anti-fraud provision prohibiting 'false or misleading' statements on purchase/ sale of securities
(Rule 10b-5)
o Disclosure requirements applicable to solicitation of proxies (Rule 14a) and tender offers
Regulation 14A Questions - Definition of solicitation §240.14a-1(l)
 TarPERs holds 1% of NLS + 14 other institutions all own 1% of NLS each  15% in total
 Wants to replace the board  whether they need to file a proxy statement:
o Proxy statement is troublesome: distribute campaign materials to NLS shareholders, and seek endorsement from ISS (group that gives voting advice to institutional investors)
 Can TarPER avoid proxy statement (which entails lengthy disclosures)?
o If no solicitation  no need to file proxy  whether a solicitation
Broad definition of solicitation - §14a-1 The terms "solicit" and "solicitation" include:
 (i) Any request for a proxy whether or not accompanied by or included in a form of proxy:
 Proxy = consent/ authorisation of another person to vote on behalf 5 III. The Voting System

(ii) Any request to execute or not to execute, or to revoke, a proxy;
 (iii) The furnishing of a form of proxy or other communication to security holders under circumstances reasonably calculated to result in the procurement, withholding or revocation of a proxy;
 Giving people a proxy forms or other communication that result in proxy/ no proxy
 Very broad, unclear line
If there is solicitation  need to consider:
 Whether subject to 14a-9, which prohibits false and misleading communication  almost certainly yes
 Whether need to file proxy statement  which is costly and time consuming

oBroad Exceptions in §14a-2 (b)(1)
o Exceptions to Rules 14a-3 to 14a-6 (other than Rule 14a-6(g)),
Rule 14a-8, and Rule 14a-10 to Rule 14a-15 do not apply to the following:
 (b)(1) Any solicitation by or on behalf of any person
 who does not, at any time during such solicitation, seek directly or indirectly, either on its own or another's behalf, the power to act as proxy for a security holder and
 does not furnish or otherwise request, or
 act on behalf of a person who furnishes or requests, a form of revocation, abstention, consent or authorization.
 Provided, however, that the exemption set forth in this paragraph shall not apply to…
o Since
 §14a-1 definition  nth to comply with
 §14a-2 exemptions  only to companies  nth to comply with
 §14a-6(g) minimal filing requirement
 §14a-7 applies only to co. and not individual person  nth to comply with
 §14a-9 anti-fraud provisions  no false and misleading communication in a solicitation
If you fall under (b)(1)  don't need to file proxy statement (only need to comply with 14a-9 and 6(g))

How does 14a-2(b)(1) relate to the definition of solicitation 14a-1
 14a-1:

1. request for a proxy;

2. request to execute or not to execute, or to revoke, a proxy; or

3. furnishing of a form of proxy or other communication to security holders under circumstances reasonably calculated to result in the procurement, withholding or revocation of a proxy
 14a-2(b)(1)
 any solicitation by any person who does not seek the power to act as proxy for a security holder and does not furnish a proxy statement
 If you fall within (b)(1), don't need to file proxy statement
 Difference between 14a-1 and 14a-2(b)(1)
 E.g. NY Times is not seeking a proxy for itself, but someone else  (b)(1)
o Cannot say: give a proxy to me  would not be (b)(1)
 In order for the shareholders to vote, would need to distribute proxy
 Communication under (b)(1) only relevant if shareholders can have proxy where they can vote in accordance - e.g. happens when

6 III. The Voting System


o o

When the company distribute proxy that says you can vote +
recommendation on what to vote  shareholder can choose to vote for or against through proxy
If there is shareholders proposal  can for or against the proposal
To get someone affirmatively elected to a board  need to file a proxy

Rule 14a-2(b)(2)
o Rules 14a-3 to 14a-6 (other than Rule 14a-6(g)), Rule 14a-8, and Rule 14a-10 to
Rule 14a-15 do not apply to the following: …
o Any solicitation made otherwise than on behalf of the registrant where the total number of persons solicited is not more than ten

Rule 14a-2(b)(3)
o Rules 14a-3 to 14a-6 (other than Rule 14a-6(g)), Rule 14a-8, and Rule 14a-10 to
Rule 14a-15 do not apply to the following: …
o The furnishing of proxy voting advice by any person (the "advisor") to any other person with whom the advisor has a business relationship, if:
 The advisor renders financial advice in the ordinary course of his business;
 The advisor discloses to the recipient of the advice any significant relationship with the registrant or any of its affiliates, or a security holder proponent of the matter on which advice is given, as well as any material interests of the advisor in such matter
 The advisor receives no special commission or remuneration for furnishing the proxy voting advice from any person other than a recipient of the advice and other persons who receive similar advice under this subsection;
 The proxy voting advice is not furnished on behalf of any person soliciting proxies or on behalf of a participant in an election subject to the provisions of Rule 14a-12(c);

§14a-3(a) If you engage in solicitation but doesn't fall within the exception  need to comply

No solicitation subject to this regulation shall be made unless each person solicited is concurrently furnished or has previously been furnished with:
o A publicly-filed preliminary or definitive proxy statement, in the form and manner described in Rule 240.14a-16, containing the information specified in Schedule 14A
o If doesn't fall under  need to file proxy statement (costly, time consuming)

o Solicitations subject to Rule 14a-2(b)(1), any person who:
 Engages in a solicitation pursuant to Rule 14a-2(b)(1), and
 At the commencement of that solicitation owns beneficially securities of the class which is the subject of the solicitation with a market value of over
$5 million,
o Shall furnish or mail to the Commission, not later than three days after the date the written solicitation is first sent or given to any security holder, five copies of a statement containing the information specified in the Notice of Exempt
Solicitation (Rule 14a-103) which statement shall attach as an exhibit all written soliciting materials. Five copies of an amendment to such statement shall be


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