Corporate shareholders elect their boards of directors.1 They do not, however, use anything like a conventional ballot. Instead, shareholders fill out a "proxy ballot" delivered to them by the incumbent board. This proxy ballot lists only the incumbent board's chosen nominees, which are very often the same board members themselves. If a shareholder wants to run for director or propose another nominee for the board, she needs to provide all other shareholders with a separate proxy ballot.2
Throughout the last decade, the Securities and Exchange Commission (SEC) has been at work developing a rule for allowing shareholders to have access to the corporate proxy ballot.3 In 2010, the agency finally passed Rule 14a-11, which would have required corporations to put shareholder-nominated candidates on the company's own proxy ballot (as long as certain conditions were met).4 The 2010 rule was the culmination of a process that included two previous incarnations, as well as legislation that specifically paved the way for the rule's creation.5 Less than a year after its passage, however, the U.S. Court of Appeals for the D.C. Circuit struck down the law, holding that the SEC violated the Administrative Procedure Act (APA) by failing to consider the rule's costs and benefits adequately.6 According to the court, the SEC's failure was so egregious that the Commission's decision to promulgate Rule 14a-11 was "arbitrary and capricious."7
Other commentators have noted that the D.C. Circuit's opinion rests on an extremely muscular version of judicial review-one that contravenes the traditional deference to administrative authority.8 Our concern, however, is with the court's misapplication of law and economics principles. The court's reasoning in Business Roundtable rests on flawed empirical and theoretical conclusions about proxy access and corporate governance. It ignores the benefits of facilitating shareholder democracy and focuses instead on costs that are routine for any functioning electoral system. As a result, its decision to strike down the regulation rests on a version of law and economics that contravenes the discipline's traditional principles and exacerbates agency costs.
Rule 14a-11 is open to debate on grounds of policy.9 But the Business Roundtable decision improperly sides with management by casting one side of the shareholder democracy debate as "arbitrary and capricious." It is, in fact, the court's opinion that uses economic and voting-rights principles in a capricious manner. Part II provides a brief overview of Rule 14a-11 and the Business Roundtable decision. Part III discusses the basic theory of voting rights and applies them to the shareholder franchise. Part IV explains how the D.C. Circuit misconstrued the dynamics of shareholder voting and the role of Rule 14a-11 in the process. Finally, Part V discusses the larger problem exemplified by the Business Roundtable decision-namely, the growing preference amongst some law and economics commentators for a Potemkin-Village version of shareholder democracy, one that undermines the very market principles that they purport to advance.
II. THE HISTORY OF PROXY ACCESS, FROM 1942 TO BUSINESS ROUNDTABLE V. SEC
The SEC's proxy access rule was not a lark; it was not a quick-draw policy change that came out of the darkness. Allowing shareholders direct access to the board's proxy ballot is, in many ways, an intuitive step. The proxy ballot is designed to look like an actual ballot-an instrument for casting one's vote in the election of directors. However, the proxy ballot is in fact simply an instruction to the board as to how one's shares should be voted at the annual meeting.
The board decides the nominees to be placed on its own ballot and oversees its distribution. It is much more akin to a letter or request to the board, made on a form that the board has provided for that purpose, as to how the shareholder's shares should be voted at the meeting. …