These Elections Are Rigged

As the November elections draw near, there are a lot of things that remind us how imperfect our system of democracy is. Anyone who's watched TV in a state that's not Utah is probably at least a little put off by the ad-nauseam ads that insist the other candidate makes unflattering faces, has occasional bad-hair days, and shouts in slow motion.

But there's plenty to be proud of too—lines of people waiting to register to vote; sharp questions from citizens at debates and town halls across America. We have a system that is fair, more or less, and that has provided for the peaceful transition of power for nearly two-and-a-quarter centuries. (Cue “America the Beautiful” here.)

There is another system of voting in America, however, that makes Iranian elections look like a Papal conclave. In this system, incumbent candidates almost always run unopposed; they get all the funding they need, while opponents—in rare cases when there are any—must fund their candidacy from their own pockets; some voters get extra votes, cast votes for others, or even borrow votes; candidates don't always need to get the most votes to win; and even when they lose, in some cases they keep their jobs anyway. Welcome to the system of director elections where shareholders pick the individuals that will represent them on the board, or at least they try to.

It's no secret that the playing field is tilted in board elections. I was talking recently with Jon Lukomnik, a governance expert and Compliance Week columnist, who said that board elections are the most troubling aspect of corporate governance today. He said the fact that they are undemocratic is one of those “open secrets” that everyone knows, but progress to make them better is slow and many companies still use director election methods that are downright deceitful.

And here's the amazing part, even while director elections are remarkably undemocratic, unfair, and often unenforced, they have actually gotten a lot better over the last 10 years. Until fairly recently, the default system of voting was the plurality voting standard. Under this standard, the nominees for director receiving the highest number of votes, up to the number of directors to be elected, win seats on the board. In an uncontested election, that means a director need only receive one affirmative vote to be placed on the board. Isn't that how Nikita Khrushchev came to power in the Soviet Union?

In 2005, the Council of Institutional Investors launched a letter-writing campaign calling on the 1,500 of the largest U.S. companies to consider adopting a majority voting standard. Under this standard, directors need to win the approval of more than 50 percent of votes cast to be elected or reelected. The campaign has been a success and many large companies have come around to adopt majority voting or have been forced to by—you guessed it—a shareholder resolution vote. Still, according to ISS, 20 percent of the S&P 500 have yet to adopt majority voting, meaning they still have rubber-stamp director elections. At smaller companies the numbers are much higher. In ISS' latest assessment, just 15 percent of small-cap public companies have adopted majority voting.

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What really galls shareholders, though, is when a majority of them vote against or withhold votes from a director at a company that has adopted a form of majority voting that forces them to submit their resignations—a method known as plurality-plus—and the rest of the board just refuses to accept it. Yep, that can happen. It's like if the American people voted for a president and the U.S. Supreme Court just said, “no we're going to decide this one.” (That could never happen, right?)

Boards willfully disregard the votes of their own shareholders more often than you would guess. According to a study by the Investor Responsibility Research Center Institute and governance ratings firm GMI, from July 1, 2009, and June 30, 2012, 175 director nominees at Russell 3000 companies failed to win a majority of votes, meaning more than half of the votes cast for them were either against or withheld. Of those, only 5 percent led directly to the director's removal.  

For example, in March of 2011, HSN (that's Home Shopping Network to you and me) should have given director Gregory Blatt a cheap watch and sent him on his way after getting just 43 percent of the votes cast. Instead, they just said no. In 2009, three directors of Pulte Homes received majority opposition and again, the board said, “sorry, they're staying.”

In a country that loves democracy and will demonstrate that early next month, it's time for some board election reforms. Majority voting is a good first step, but there are other practices that need to change, including making it easier for opposition candidates to get on the ballot and enforcing the idea that if more than half of the shareholder votes say you should go, you should go.