On January 2, 2007, Dean Henry Manne published a column in the WSJ regarding corporate democracy.  In this column, Manne takes a stab at shareholder voting and corporate democracy.  Manne maintains that shareholder activists are deluding themselves with the phrase “corporate democracy” in that only the controlling s/h have and will ever have a true voice in corporate matters (such that there never will be any “corporate democracy” as a practical matter).  It appears that Manne takes the position that corporate “democracy” does not and should not exist; shareholder activists misunderstand the shareholder vote from a “big picture perspective;” and there are other alternatives to a full shareholder vote.Â

Professor Steve Bainbridge’s commented on Manne’s column, noting that “[a]ll in all, it’s a brilliant spanking of the shareholder activists, which I highly commend to your attention.”  As a token radical shareholder primacist, I have to say that I felt more befuddled after reading Manne’s comments than “spanked.”Â

Setting aside any discussion of cumulative voting, Manne’s column left me wondering how he accounted for investor confidence.  Manne notes that, instead of holding meetings at which shareholders exercise their vote, one could (in theory) appoint a trustee to survey the controlling block to see who they want in leadership.  Yet it is unclear to me how Manne accounts for investors who pack up their money and walk away when denied a vote.  Adam Smith and the OPM concern:  it seems to me that voting is at least a small indication to shareholders that those managing their money are recognizing an accountability to the investors.  I have to believe that that impacts investor confidence, so how does Manne account for the longer term loss of investor confidence?Â

Additionally, “shareholder democracy” serves the purpose of signaling to directors whether shareholders are displeased.  For example, assume at a 1995 annual meeting that 19% of the Disney shareholders withheld their vote for Eisner as director.  Obviously Eisner would still be elected by a 81% vote, but my position would be that the 19% vote was useful because it conveyed to Disney management that investors had perhaps lost their confidence in Eisner’s ability to serve as a director.  This would mean that Disney management would have time (hopefully) to change things to avoid the 19% of displeased shareholders pulling their money out of Disney.  If investors have no voice and no sense that management takes note of their views, will there not be some sort of loss of confidence, reluctance to invest, and related market adjustments?Â

Manne might say “calling for a full vote was a big waste of time – the 19% block was always going to be stuck with the course charted by the 81%.  And if the complaining 19% pulled their money out of Disney stock such that the stock price slips, professional investors would snap up the Disney stock on the fall such that it would rebound.” Â

But does that reply – the market will right itself – fully account for the costs of the market righting itself?  How do L&E wonks like Manne completely account for the true, long-term cost of noisy trading when it is hard to identify what the market would have done in the absence of such?  Assume that noisy trading weeds out certain investors with a weak stomach, how much is the market losing in transactional costs or capital market strength (long term) with a volatile market?  Even if Manne assumes that the market will right itself, what are both the direct and the indirect costs of the market righting itself via a relatively large Disney minority shareholder exodus and extra market noise?  It is unclear to me how Manne accounts for those things.

In November of 2006, the Delaware Supreme Court issued an opinion in Stone v. Ritter dealing with a director’s fiduciary duties in cases where the complaining plaintiff-shareholder is maintaing that her directors did not sufficiently monitor their corporate charge. (I refer to these “oversight” cases loosely as “asleep at the wheel” cases.) There has been some excellent blogging on the topic by Eric Chiappinelli, Gordon Smith, and  Steve Bainbridge.  Though I was in the middle of moving such that I could not blog in the middle of that wonderful Ritter blog-fest, I am now ready to stake my blogging ground on Ritter.

Stone v. Ritter was an oversight case, in which the complaining shareholders maintained that the directors of AmSouth failed to maintain a sufficient monitoring and reporting program such that red flags (in this case pertaining to banking law violations) could be detected by the board. This, the shareholders maintained, was a violation of the directors’ fiduciary duties. The chancery court dismissed the plaintiff-shareholders’ claims, and the Delaware Supreme Court affirmed, saying “In the absence of red flags, good faith in the context of oversight must be measured by the directors’ actions ‘to assure a reasonable information and reporting system exists’. . . .”

What the court also says about the duty of loyalty, however, is more interesting to me that the good faith references.  The en banc panel says: “[T]he fiduciary duty of loyalty is not limited to cases involving a financial or other cognizable fiduciary conflict of interest. It also encompasses cases where the fiduciary fails to act in good faith. As the Court of Chancery aptly put it in Guttman, “[a] director cannot act loyally towards the corporation unless she acts in the good faith belief that her actions are in the corporation’s best interest.”

Enter Lyman Johnson and his article “After Enron: Remembering Loyalty Discourse in Corporate Law,” 28 Del. J. Corp. L. 27 (2003). In that article, Professor Johnson takes the position that “loyalty” in the context of a director’s “duty of loyalty” should be interpreted the same way the word is interpreted in daily life. Being loyal, as that term is normally used, covers conduct that we corporate law folk have always tried to finagle under the “duty of care.” We should expect directors to be loyal in the same way we expect others be loyal. That is to say, if I ask my loyal friend, Monica, to vote for me for state senate, I envision that Monica, my loyal friend, would march to the polling place and vote for me. How loyal is my friend if, after work, she decides on the spur of the moment and with no prior plans instead to go to “happy hour” somewhere?  Can I say “Monica is a loyal friend?” She is not a loyal friend, is she? It is not that she is a traitor. Rather, she is just not loyal.  I cannot look at Monica up on her stool at the bar for happy hour, not having voted for me, and say “Now THERE is a loyal friend.  That Monica is loyal.“

In his article, Lyman references “Christ’s famous charge to His apostle Peter to ‘take care of my sheep.’” If Peter is the loyal apostle, he will affirmatively care for the flock. If he is loyal. Not if he is “acting in good faith” or “acting with due care.” If he is truly a loyal disciple, he will affirmatively do whatever is needed to “take care of [the] sheep.” That, Lyman Johnson maintains, is what loyalty means.  Loyalty is that broad.  Asking if the actor is loyal subsumes the care and good faith inquiries.

Back to Ritter:  “[T]he fiduciary duty of loyalty is not limited to cases involving a financial or other cognizable fiduciary conflict of interest. It also encompasses cases where the fiduciary fails to act in good faith. As the Court of Chancery aptly put it in Guttman, “[a] director cannot act loyally towards the corporation unless she acts in the good faith belief that her actions are in the corporation’s best interest.”

With that language, it is almost as though the Delaware Supreme Court taking a position that is totally consistent with Professor Johnson’s very broad position on what “loyalty” in the phrase “duty of loyalty” should mean. To breach the duty of loyalty, the actor does not need a conflict of interest. Simply failing to act in “the good faith belief that her actions are in the corporation’s best interest” is enough. Simply failing to be “loyal,” as that term is used in common parlance, is enough.

I like that.