A friend of mine who teaches constitutional law took an interest in more important matters when he read about the recent proxy fight at ExxonMobil. He asks:
Why is it legal for Exxon’s management or the majority of Exxon’s current board to spend shareholder dollars to tell shareholders not to vote for other candidates?
On level, the answer is "because the courts say so." As I explain in my book Corporate Law (Concepts and Insights):
In theory, incumbent directors do not have unbridled access to the corporate treasury. In practice, however, incumbents rarely pay their own expenses. Under state law, the board of directors may use corporate funds to pay for expenses incurred in opposing the insurgent, provided the amounts are reasonable and the contest involves policy questions rather than just a “purely personal power struggle.” [E.g., Rosenfeld v. Fairchild Engine & Airplane Corp., 128 N.E.2d 291 (N.Y.1955), reh’g denied, 130 N.E.2d 610 (N.Y.1955).] Only the most poorly advised of incumbents find it difficult to meet this standard. The board merely needs have its lawyers parse the insurgent’s proxy materials for policy questions on which they differ. Such a search is bound to be successful: if the insurgent agrees with all of management’s policies, why is it trying to oust them?
In contrast, insurgents initially must bear their own costs. Insurgents have no right to reimbursement out of corporate funds. Rather, an insurgent will be reimbursed only if an appropriate resolution is approved by a majority of both the board of directors and the shareholders. [E.g., Steinberg v. Adams, 90 F.Supp. 604 (S.D.N.Y.1950); Grodetsky v. McCrory Corp., 267 N.Y.S.2d 356 (Sup.Ct.1966).] If the incumbents prevail, of course, they are unlikely to look kindly on an insurgent’s request for reimbursement of expenses. In effect, the insurgent must win to have any hope of getting reimbursed.
On a deeper level, the question is why have the courts so held? The Rosenfeld court explained that:
If directors of a corporation may not in good faith incur reasonable and proper expenses in soliciting proxies in these days of giant corporations with vast numbers of stockholders, the corporate business might be seriously interfered with because of stockholder indifference and the difficulty of procuring a quorum, where there is no contest. In the event of a proxy contest, if the directors may not freely answer the challenges of outside groups and in good faith defend their actions with respect to corporate policy for the information of the stockholders, they and the corporation may be at the mercy of persons seeking to wrest control for their own purposes, so long as such persons have ample funds to conduct a proxy contest.
Id. at 293.
The Delaware Chancery Court similarly explains that:
The report of the case of Pell v. London & North Western Ry. Co., [1907] 1 Ch. Div. 5, contains discussions by the three Lord Justices who sat in the case, which very persuasively demonstrate that such expenditures are entirely proper. The underlying reason is given by them as this-that inasmuch as the stockholders are called upon to express their judgment upon the soundness of a questioned policy, it is in the interest of an intelligent decision by them that they should be advised by the responsible managers of the corporation who formulated the policy what were the considerations which induced their approval; and that it would be highly unreasonable to require that the directors should personally defray the expense incident to the performance of a duty which rested upon them to lay before the stockholders the information which is requisite for an informed decision in turn on their part. Where the question in one of a policy to be adopted, the judges in the English case just cited took the view, and very reasonably so, that the corporation was under a duty to advise the stockholders, whose approbation or disapproval was to be determinative, of the reasons for the policy's adoption, and that in such a case the directors are to be regarded as having that corporate duty laid upon them. Any expense incident and reasonably necessary to perform that duty, is an expense incurred in the interest of the corporation and therefore properly chargeable to it.
Hall v. Trans-Lux Daylight Picture Screen Corp., 171 A. 226, 227 (Del. Ch. 1934).
Professor Melvin Eisenberg offered a slightly different explanation:
In considering this problem two economic facts must be viewed in conjunction: (1) Proxy fights involve a lot of money ... and most of the expenses are probably incurred in connection with just those techniques that have the least informational content; (2) While corporate directorships are unquestionably valuable, in themselves they do not normally pay very much money. ... Putting these two facts together, most outside directors and many inside directors ordinarily could not be expected to defend a proxy fight out of their own pockets. Thus a rule which precluded management from using corporate resources for such campaigns might tend to drive corporate offices into the hands of those who are ready and able to pay for such campaigns. Management access to the corporate proxy machinery may therefore be justified, not because the election of directors is a board function — it is not; and not because typically the issues are policy issues and the expenses are incurred for the purpose of informing the shareholders on these issues — they are not; but because in the long run the shareholders and the entire economy might suffer if management had to choose between paying for proxy campaigns out of its own pocket or throwing in the towel.
Melvin Aron Eisenberg, Access to the Corporate Proxy Machinery, 83 Harv. L. Rev. 1489, 1499–500 (1970).
So take your pick:
- Allowing the board to spend corporate funds allows them to defend the corporation from potential bad actors.
- It ensures that shareholders are fully informed.
- It allows persons of modest means to serve as directors.
