Are zombie directors a worry, a passing fad, something that needs regulation?

A zombie board? (Image from Night of the Living Dead. Direction and cinematography both by George A. Romero, Public domain, via Wikimedia Commons)

When shareholders vote – even overwhelmingly – for someone not to be a director of a company, the “life” of that directorship is over, right? Wrong.

The Financial Times raised an alarm as it reported on the phenomenon of directors – in the United States – who continue to sit on the boards of listed companies even after a majority of shareholders have nailed down the lid of their metaphorical coffins. Or thought they had. In Britain, changes to the listing rules this year open a different door – but one fashioned from the construction of US boards – that could lead shareholders into a similar predicament.

I’ve written about zombie companies before, but the companies in question here are very much alive. The ones with zombie directors are upstanding members of the Russell 3000 index and well known, and household – even wardrobe – names like Ralph Lauren.

What makes a director a zombie? It’s when a majority of shareholders voting have not voted for the candidate elected. Take a common case: A director stands for election or re-election to the board. Most of the time, they stand without a contest. The board simply nominate one person, who stands unopposed. Companies have two options:

• Majority voting: This approach is favoured by many institutional investors, including the pension funds that belong to the influential Council of Institutional Investors (CII). Count the number of votes for, then count the total number of votes cast. If 50 per cent are for the candidate, the election stands. If a majority votes “no”, the candidate isn’t elected and a seat on the board is empty. It’s the dominant approach, but only since the early 2000s.

• Plurality voting: But under the old system – which was commonplace before the governance shake-up after Enron, WorldCom and all the rest in the first years of the 21^st century – a candidate only needs a plurality of the votes cast, that is, the largest number of “yes” votes cast. In uncontested elections, the only candidate is a shoo-in. And could be a zombie.

For details, see the CII website, and follow the links.

The Financial Times article says that at the end of August there were 35 zombies serving as directors of 27 Russell 3000 companies, citing CII. That’s down from a year ago, but still surprising, given that CII and others have been lobbying for a change since even before Congress adopted the Sarbanes-Oxley Act (Library of Congress, 2002).

The backdoor to zombie directors comes with the growing use of unequal voting rights for shareholders. Britain’s Financial Conduct Authority approved new listing rules this year that allow companies to adopt dual class voting without damaging their standing for market indices. Much the way a lot of tech companies use.

Some shares – for example, those of company founders and early investors – may now carry two, five even ten times the number of votes of others. Multiple classes of shares are possible. This consolidates power in the hands of founders and early investors. In America the practice is often defended as ensuring that the people who create a business deserves more power over setting its direction and shaping its future. Think of Mark Zuckerberg at Meta.

But what happens when the company moves on? In Sweden, some companies with dual-class shares are several generations on from the founders. Family voting blocs also feature in many European and Asian listed companies, and they’re often regarded as being good for the business, because they care more for the long term. There are good arguments against the practice (Bebchuk & Kastiel, 2017; Govindarajan & Srivastava, 2018) as well as for (Anderson, Ottolenghi, & Reeb, 2017).

But mere economic arguments – whether empirical or theoretical – won’t halt the politicking over who control a company’s resources. And whether the directors are alive or walking dead.

What’s going to happen? It’s difficult to predict, especially about the future, a quip often attributed to the legendary quantum physicist Niels Bohr and the legendary baseball player, manager and interview-chair philosopher Yogi Berra. But let’s play the game.

• Pressure from CII and others may well lead more companies step back from plurality voting before the US Securities and Exchange Commission acts to ban it, which could happen if Kamala Harris wins the presidential election. But maybe not. Twenty-seven companies out of 3,000-odd in the Russell index is not that big a deal. And according to Statista, there are about 4,300 companies listed on the domestic markets of the New York Stock Exchange or Nasdaq.

• Pressure from institutional investors generally against dual class shares will run out of steam, again. Stock markets in Europe are too worried about losing business to the US, and markets in the US are too worried about private equity funds each their lunch with the directors who would join the living dead in public markets.

Anderson, R. C., Ottolenghi, E., & Reeb, D. M. (2017, July). The Dual Class Premium: A Family Affair. The Dual Class Premium: A Family Affair. Retrieved from https://ssrn.com/abstract=3006669

Bebchuk, L. A., & Kastiel, K. (2017). The untenable case for perpetual dual-class stock. Virginia Law Review, 103(4), 585-630. https://ssrn.com/abstract=2954630

Govindarajan, V., & Srivastava, A. (2018). Reexamining Dual-Class Stock. Business Horizons, 61(3), 461-466. doi:10.1016/j.bushor.2018.01.012

Library of Congress. (2002). H.R.3763, The Sarbanes-Oxley Act. Retrieved from http://frwebgate.access.gpo.gov/cgi-bin/getdoc.cgi?dbname=107_cong_bills&docid=f:h3763enr.txt.pdf