Direct Nomination of Directors: The Beginning of Democracy for U.S. Shareholders?
By Kazuaki Fujita in New york

Nikkei Financial Daily
June 6, 2003

Hanover Compressor Co., a leading Houston-based machinery manufacturer, on May 13 announced a groundbreaking agreement that represented a victory for the company's shareholders.  In a class-action suit against management revolving around falsified financial statements, the plaintiff shareholders won a financial settlement of $80 million.  They also snatched another big prize.  Management agreed to give shareholders the right to select members of the board of directors.

Darren Robbins, of Milberg Weiss Bershad Hynes & Lerach LLP, the firm that represents the plaintiffs, stresses that it's fair to say that this is the first time that a democratic method has been put in place for shareholders to directly select members of a board of directors.  The settlement reaches beyond the corporate reform measures that the U.S. congress and regulatory agencies have been working on in the wake of incidents at Enron Corp. and other companies.

Hanover plans to add two new directors by 2004, bringing the total to 11.  Shareholders holding more than 1% of the company's outstanding shares will nominate the candidates for these two new directorships, and the selections will be approved at a general shareholders meeting.  The company still needs to firm up the details of the scheme, but shareholders are already searching out candidates.

Robert Monks has been behind the scenes in drawing up this scheme.  Beginning with forcefully exercising shareholder voting rights, he has led his life as a forerunner in the U.S. movement for shareholder rights.  In the Hanover settlement his firm, Lens Governance Advisors, P.A., negotiated with the company on behalf of the shareholders, providing advice on a new system of corporate governance.

According to Monks, the agreement will help bring about a new age where boards of directors will have the independence to serve their true function (representing shareholders).

Up to now, shareholders have only confirmed director candidates selected by management.  The Enron and WorldCom Inc. incidents proved that boards of directors--who depend on the patronage of management--are incapable of keeping management from running amok.  Hanover is another example of this.  The original role of corporate boards was to monitor the business on behalf of shareholders.  Under this agreement, shareholders will be involved from the selection process onwards, so representatives of the shareholders will be sent to the board.

The agreement contains additional provisions that will allow shareholders to be heavily involved in corporate governance:

1.  Two-thirds or more of the members of the board of directors will be independent, outside directors.

2.  The leader selected by the outside directors will be given broad powers.

3.  The auditing firm will be changed every five years.

4.  Trading in the firm's shares by the management team will be severely restricted.

Going forward, attention will be focused on whether these measures are taken at only this one company that was involved in wrongdoing, or whether they will spread throughout many companies.  Henry Hu, a professor at the University of Texas, doesn't think that these measures will become the norm at all companies.

Many points are subject to debate.  The details of the mechanism to be used by shareholders to elect directors are still fuzzy.  It remains to be seen whether the candidates picked by certain major shareholders will represent the interests of the other many shareholders.  The direct involvement of shareholders would result in additional costs and administrative work.  And could efficient corporate governance--the original goal--really be achieved?

In fact, the prevailing sentiment in the U.S. is to treat Hanover as an anomaly.  But as pressure from shareholders gradually grows, these measures may not end with Hanover.

On April 14 the U.S. Securities and Exchange Commission announced that it was launching a review of the rules for the election of corporate board members.  The time has come for a review to ensure that they are serving the interests of investors, according to Chairman William Donaldson.  The commission will be looking at shareholder proposals for director elections.  It is slated to give an indication of its inclinations by July 15.

During the current meeting season, the American Federation of State, County and Municipal Employees' Pension Plan (AFSCME) has asked Citigroup Inc. to allow shareholders holding more than 3% of the company's stock to make shareholder proposals for its director elections.  It is getting to the point where companies can no longer ignore this movement.

The Dow Jones Industrial Average has rebounded to the 9,000 level for the first time in nine months, but it still remains trapped in a box.  As long as many investors do not have confidence on corporate executives, the stock market will have a difficult time luring money back for real.  With corporate executives and the powers that own the companies (shareholders) increasingly locked in battle, corporate governance reform may have entered a new phase.

Chart: [translator's note: one year chart of share price of Hanover Compressor vs. DJIA]