The basics of corporate governance contests was discussed in our article, “Corporate Struggles-Who Has Power When Push comes to Shove?” This article shall concentrate on a single tool in the arsenal of corporate power struggles-the right for cumulative voting.
Essentially, this allows a minority shareholder to maintain a position of power in a corporation greater than would be available if pure majority voting by number of shares was imposed. It is an ancient tool to protect minority rights and California (and many other states) provide that cumulative voting shall be required if and when a shareholder so insists, with varying notice requirements imposed upon that shareholder. Legal advice and careful planning is required before this tool is to be used but this article shall give the basic outlines of its methodology.
Basic Cumulative Voting Rights:
In its most basic form, this rule allows a person to vote for a director by multiplying the number of shares the person has by the number of directors…and being able to allocate all those shares to a single director. Simple arithmetic should indicate that this allows a minority shareholder to elect a single director if the total board is three or more if a minimum number of shares are owned by the shareholder and that minimum number is far less than fifty percent. When coupled with restrictions on the minimum number of directors a corporation can have, this acts to assure a minority shareholder at least a minority position on the board of directors.
The workings of cumulative voting are quite simple and are best explained in the context of "straight voting," which is what most companies use. Assume a company, XYZ Company, in which the majority owner owns 750 shares of 1250 total shares and the minority shareholder owns 500 shares. Assume five people on the board of directors.
Straight Non Cumulative Voting: Assume the company has 1,250 shares outstanding. If the company has a contested election for board of directors and there are essentially two slates of candidates, the Majority Slate and the Minority Slate, each with five people on them, Minority Shareholder (MS) can vote its 500 shares for each of the five candidates on the Minority Slate. If it only likes three candidates on the Minority Slate but does not like anyone on the Majority Slate, it can simply withhold its votes on the others. Of course, Majority Shareholder (MSH) owns 750 shares in the company, and as a result, will win every election. There is no set of circumstances short of MSH not voting where the Minority Slate can win any seats.
Cumulative Voting: With cumulative voting, MS gets 2,500 votes total and MSH gets 3,750, for a total of 6,250 votes. That is, MS can vote the number of shares it owns times the number of seats up for election. What is more, MS can spread the votes around however it wishes and even spend them all on one candidate. With five seats up for election and 6,250 votes, it takes 1,250 votes to get on the board. Let's say, MS split its votes between two candidates, giving each 1,250. MSH would then split its shares to ensure it would elect a majority, which means it has to spend at least 1,250 votes on three candidates. That guarantees that MS will be able to elect two board members.
And that is the basic workings of cumulative voting, although there are caveats. For instance, many companies have "classified boards," meaning all the directors don't come up for election every year. When that is the case, the calculus of the cumulative voting can change. You need more votes to get your directors elected. In fact, in the share distribution painted above, MS would not be able to elect any directors.
Pluses And Minuses
The overall purpose of the purported benefits of cumulative voting is protection of minority rights. It is all about minority representation and making sure the board is somewhat responsive to minority views. As to the reasons companies oppose shareholder proposals to implement cumulative voting, some argue that it permits the election of narrowly focused directors who do not represent the interests of all shareholders. Sometimes boards that have such members are not peaceful places to conduct business—the board can become "cliquish," for lack of a better word.
In terms of larger companies, many argue that large companies now have ample governance protections in place (majority of independent directors, declassified board, etc.) that protect minority shareholders just as well, if not better than, the simple ability to elect a board member of their choice.
The simple fact is that if a shareholder wishes to guaranty a place on the board and has less than fifty percent of the shares, cumulative voting is by far the best method to insist upon.
One often hears that some states are “friendly” to corporations and most people assume this means tax benefits. While tax benefits are often a factor, just as often the “friendliness” usually translates into not have various minority protections for minority shareholders…such as cumulative voting rights. Thus such states as New York and California have them…while certain other states do not. Again, legal advice can advise the person starting a company whether it makes sense to seek to incorporate in a state “friendly” to majority rights.