SEC Commissioner Troy Paredes on Shareholder Access and Business Judgment Rule

New SEC Commissioner Troy Paredes has mentioned shareholder access to directly nominating directors in the context of exploring whether CEO overconfidence is the product of corporate governance. In a 2004 paper, he noted that, whatever its other merits or demerits, the SEC’s shareholder access rule, if adopted, will make it easier for shareholders to nominate directors and it is reasonable to expect that shareholder-nominees, if elected, will be more responsive to shareholders than to management or other directors.

In seeking other antidotes to CEO overconfidence, the future commissioner said that a lead director could be a counterweight to the CEO. He posits that governance can cause CEO overconfidence in two ways: large executive compensation packages and deference to managerial decisions largely dictated by the business judgment rule. He examines the possibility of extending the law of fiduciary duty to cover mismanagement rooted in overconfidence, even while acknowledging that this could undermine the business judgment rule.

Courts could also decide to assert greater say over the size and structure of executive pay by revitalizing the waste doctrine. He also noted that a controversial accounting change, the expensing of stock options, may also curb excessive compensation since companies may limit the number of options granted to mitigate the earnings hit of the expense.

In an interesting theory, the commissioner suggests that courts could adjust what it means to be reasonably informed under the business judgment rule to better ensure that corporate decision makers account for the cognizable risk of CEO overconfidence and the risk that directors and subordinate officers will too easily go along with the chief executive. Under a business judgment rule more sensitive to CEO overconfidence, inquiry and deliberation would become a central component of the duty of care.