Alison Frankel yesterday discussed shareholder activism in an interesting blog post on Thomson Reuters. She references my concerns about the relationship between materiality and corporate political disclosure. For the interested, I’d like to expand on the concept.
What do you mean by “materiality.”
In this context, I’m referring to material facts. That is: a fact that would affect a reasonable shareholder’s financial decision to purchase, hold, or sell a particular stock. Specifically the stock of whatever company is being pressured to disclose additional activity.
Why does materiality matter?
Under long established law, any corporate expenditure or category of expenditures must be disclosed if it is material. Any expenditure means any expenditure: major investments, labor contracts, plant construction costs, distribution network expansions – and political spending.
This is already the law. So when activists demand more corporate disclosure, they’re demanding disclosure of immaterial expenditures. And that means they’re really asking for one of two things. Either (1) information about transactions that are too minor to impact the value of the company, or (2) information that would only affect the investment decisions of an unreasonable shareholder.
But surely that’s an unfair characterization. How can additional information possibly be a bad thing?
Discussions of the proper scope of corporate disclosure aren’t new. The danger of disclosing immaterial information is, to quote the Supreme Court, that too much disclosure “simply bur[ies] the shareholders in an avalanche of trivial information – a result that is hardly conducive to informed decision making.” (The quote comes from no less an icon than Justice Thurgood Marshall – the case is TSC Industries v. Northway, 426 U.S. 438 (1976)).
In other words, we should worry that investors will make their investment decisions on the basis of a $10,000 political contribution, rather than a $1 billion contract. The latter is (almost) certainly material – the wisdom of that investment will affect the economic value of the company. An expenditure of $10,000 may or may not have such an effect, but only a very foolish investor would decide to purchase a stock based on the former expenditure and not the latter.
Take another example. Corporations generally report their overall labor costs, and the market gauges the value of the company in part based on that variable (just ask any American airline). But the corporation doesn’t list the salaries of every employee, or even every executive. They don’t do this because sorting through that enormous pile of data, and making sense of it, would be a debilitating task. It’s trivial information – overall labor costs are material, but knowing that information at the individual level doesn’t really add anything.
This is true even though a particular salary could, potentially, affect a particular investor’s decisionmaking. Someone may invest based on a particular person’s name, or because they notice an old high school friend is employed there and think her salary appropriate (for good or ill). But the likelihood that this information is material – will affect whether the purchase is a good or bad investment – is very low. And it certainly doesn’t justify the costs of gathering and reporting that information or the costs to the market of sifting that additional data.
The same is true for political spending. While a $10,000 contribution probably doesn’t affect the company’s value, some shareholders may decide to purchase or sell stocks based on that contribution – for reasons of personal policy preference, emotional attachment, or the like. None of these are good reasons to buy a stock. Nor do they justify spending corporate resources to track and report expenditures that are drops in the ocean of the corporate balance sheet.
Again, I’m only talking about immaterial political activity. The moment a corporation is spending enough on political activity that a reasonable investor would make decisions based on that activity, it becomes material. And at that moment it must be disclosed under existing law.
But there’s something different about political activity. Shareholders shouldn’t be required to subsidize political speech they disagree with.
Well, if that’s true, what about all the other things corporations talk about? Why don’t we disclose immaterial spending on ads touting a corporation’s labor-friendly policies? Or discussing its charitable work? Or its contributions to the Sierra Club and the Boy Scouts? Don’t those have a political component, and don’t some shareholders – almost certainty – disagree with those positions? Once we start ignoring materiality, we have to start disclosing other things if we want to be consistent.
And what about other activity with a political element or with which some shareholders might disagree? Investments in certain countries, particular clauses in union agreements, zoning variances… if the mere potential for disagreement, on political grounds, necessitates disclosure, then corporate disclosure is going to rapidly expand. And that both costs money (the shareholders’ money) and hides the really important facts that should be driving a company’s market value.
Is that why shareholders have almost always rejected additional corporate disclosure, often by wide margins?
It’s always dangerous to speculate. But investors know that corporations must disclose material information or risk substantial legal liability. And they are aware of today’s highly-partisan political environment. They doubtless notice who is pushing these issues, and that those groups often have political missions.
Perhaps shareholders want to spend their annual meetings discussing the major opportunities and challenges facing their investment, instead of having that discussion hijacked by partisan political debates.
In any event, shareholders have decided they don’t need this information. Which is fairly good evidence that reasonable shareholders don’t consider it important to their investment decisions. Or, put differently, that investment decisions shouldn’t be yet another political preference.
So how do I invest if I’m morally opposed to political activity?
Simple: you invest only in companies that provide the information you want. They exist – as Ms. Frankel points out, several corporations have voluntarily agreed to disclose their political activities. If corporate managers, consistent with their fiduciary duties, have decided that a particular disclosure regime will maximize shareholder value, you can reward them by investing in those companies.
Management at some of their competitors have disagreed, and the investors in those enterprises have supported them.
That’s how markets work.
 To clarify an easy misunderstanding: if corporate managers fully consider their fiduciary duties and the specifics of their companies, and then choose to disclose certain political activity, they’ve done their job. Of course, in most cases that means the political spending is material for that corporation. Our disagreement is with the one-size-fits-all agreements pushed by groups like the Center for Political Accountability. Such agreements are not calibrated to a particular business and consequently ignore materiality. Adopting such an off-the-shelf approach will rarely reflect an adequate consideration of shareholder interests.