The primary function of corporate governance in the United States has been to address the managerial agency cost problem that afflicts publicly traded companies with dispersed share ownership. Berle and Means threw the spotlight on this type of agency cost problem—using different nomenclature—in their famous 1932 book The Modern Corporation and Private Property. Nevertheless, it was only in the 1970s that the now ubiquitous corporate governance movement began. Why did the corporate governance movement gain momentum in the U.S. when it did? And given its belated arrival, why did it flourish during ensuing decades?
Posts Tagged ‘Brian Cheffins’
“Leximetrics,” which involves quantitative measurement of law, has become a prominent feature in empirical work done on comparative corporate governance, with particular emphasis being placed on the contribution that robust shareholder protection can make to a nation’s financial and economic development. Using this literature as our departure point, we are currently engaging in a leximetric analysis of the historical development of U.S. corporate law. Our paper, Law and History by Numbers: Use, But With Care, prepared for a University of Illinois College of Law symposium honoring Prof. Larry Ribstein, is part of this project. We identify in this paper various reasons for undertaking a quantitative, historically-oriented analysis of U.S. corporate law. The paper focuses primarily, however, on the logistical challenges associated with such an inquiry.
The standard historical narrative is that the market for corporate control took on its modern form in the mid-1950s with the emergence of the cash tender offer. Our paper, The Origins of the Market for Corporate Control, which was prepared for a University of Illinois College of Law symposium honoring Prof. Larry Ribstein, pushes the story back to the beginning of the 20th century. Drawing primarily upon hand-collected data from newspaper reports, we show that were numerous instances during the opening half of the 20th century where a bidder sought to obtain voting control of targeted companies when the incumbent managers were opposed to change. Having documented that the most popular hostile bid technique initially was the purchasing of shares on the stock market we explain why cash tender offers came to dominate the market for control after World War II.
The general consensus is that the market for corporate control, a term coined by Henry Manne in the mid-1960s, only began to emerge as a meaningful corporate governance mechanism in the United States in the mid-1950s when the cash tender offer was initially deployed. Various observers have acknowledged the existence of a highly rudimentary pre-1950 market for corporate control but empirical analysis was lacking until a 2011 study of ours in which we used the ProQuest Historical Newspapers database to search major daily newspapers over the period 1900-1949 to identify “open market bids” (OMBs), these being instances where an attempt was made, without consent from a target company’s board, to buy sufficient shares on the stock market to acquire control of a public company. We revisit our findings in this paper, confirming there were 82 hostile bids for control launched by way of open market purchases of shares over the fifty year period.
Hedge funds first began engaging in the assertive form of shareholder activism for which they are renowned in the United States, and the United States is where hedge fund activism has become most firmly entrenched as part of the corporate governance landscape. Nevertheless, hedge fund activism is a global phenomenon, with companies in numerous countries being targeted. The United Kingdom, Japan and Canada are the three countries other than the U.S. where hedge fund activism has been most prevalent. The efforts of hedge fund activists in Britain and Japan have begun to capture the attention of academics (e.g. Iris Chiu, The Foundations and Anatomy of Shareholder Activism (2010) and John Buchanan, Dominic Chai and Simon Deakin, Hedge Fund Activism in Japan: The Limits of Shareholder Primacy (2012)). In the case of Canada, however, little has been said about hedge fund activism in the academic literature. Correspondingly in “Hedge Fund Activism Canadian Style,” recently published on SSRN, I describe the emergence of hedge fund activism in Canada, identify the legal and economic variables that account for its rise to prominence and offer predictions on whether the trend will be sustained.
Since the late 1990s, a “law and finance” literature emphasizing quantitative comparative research on the relationship between national legal institutions on the one hand and corporate governance and financial systems on the other has achieved academic prominence. An important tenet of the law and finance literature is that corporate law “matters” in the sense it does much to explain how durable and robust equities markets develop. While “law and finance” has an important forward-looking normative message, namely that countries must enact suitable laws to reach their full economic potential, the thesis that corporate law influences stock market development seems to be well-suited to offer insights into if, when and how a country develops a corporate economy widely held companies dominate. Law and finance thinking implies that this should not occur in the absence of corporate law providing significant stockholder protection. In Questioning “Law and Finance”: U.S. Stock Market Development, 1930-70, recently published on SSRN, we draw upon events occurring in the United States to cast doubt on this logic.
The role that regulation should play in the development of securities markets is much debated and a persistent lull in initial public offerings helped to prompt some deregulation through the enactment of the 2012 Jumpstart Our Business Startups (JOBS) Act. While the appropriate scope of public regulation of securities markets is a contentious issue and while the market for newly listed firms can be a bellwether for the development of public equity markets, the empirical literature on regulation of IPOs is small and generally inconclusive. In our paper, Regulating IPOs: Evidence from going public in London and Berlin published on SSRN, we use history to offer insights concerning regulation of IPOs and the development of public equity markets. In particular, we draw upon hand-collected Initial Public Offering (IPO) datasets to undertake a comparative study of the London and Berlin stock markets between 1900 and 1913, a period that coincides with the apogee of an era of global financial development unmatched until the end of the 20th century.
In contrast to most other countries, in both Britain and the United States, a hallmark of corporate governance is a separation of ownership and control in major business enterprises. Various theories that have been advanced to account for why patterns of ownership and control differ across borders, with the most influential being that the “law matters” in the sense that ownership dispersion is unlikely to become commonplace in public companies unless company law provides substantial protection to outside investors. As one of us has argued elsewhere, these theories do not explain effectively why a separation of ownership and control became the norm in the UK. In our paper “Ownership Dispersion and the London Stock Exchange’s ‘Two-Thirds Rule’: An Empirical Test”, recently published on SSRN we analyze a different law-related hypothesis concerning the evolution of ownership patterns and show that it similarly lacks substantial explanatory power.
In the paper Delaware’s Balancing Act, which was recently made publicly available on SSRN, we examine the decline in Delaware’s popularity as a venue for corporate litigation. The Delaware court system has functioned to a significant degree as a de facto “national” court for U.S. corporate law. Corporate disputes arising in Delaware courts frequently generate extensive press coverage. Delaware law is a central part of the business law curriculum in U.S. law schools and law students learning corporate law are exposed to a steady diet of Delaware case law. Official comments accompanying the Model Business Corporations Act (M.B.C.A.), a model set of laws prepared by the Committee on Corporate Laws of the Section of Business Law of the American Bar Association followed by 24 states, frequently refer to Delaware cases to provide examples or as a source of further explanation. Courts in M.B.C.A. states often rely on Delaware case law to clarify gaps in the M.B.C.A. and sometimes even cite Delaware jurisprudence in preference to M.B.C.A. court decisions.
In our paper, The Corporate Pyramid Fable, which was recently published on SSRN, we investigate the impact intercorporate taxation of dividends had on corporate pyramids. Intercorporate taxation of dividends became a permanent feature of the U.S. tax landscape in 1935. Correspondingly, to assess the impact of this change, we rely on a pioneering hand-collected dataset based on filings made between 1936 and 1938 with the Securities and Exchange Commission by investors owning 10% or more of shares of corporations registered with the Commission. To the extent that the received wisdom concerning tax and corporate pyramids is correct, the introduction of taxation on intercorporate dividends in 1935 should have prompted the rapid unwinding of corporate-held ownership blocks in public companies, thus causing the simplification of complex group structures, including pyramidal arrangements.
Our results indicate matters worked out much differently. Although politicians may have supported the intercorporate dividends tax because they believed that it would induce corporations to unwind stakes held in other publicly traded corporations, tax reform apparently did not have that effect. Corporations that owned large stakes in publicly traded firms rarely sought to exit in the years immediately following the introduction of intercorporate taxation of dividends, and many corporations even increased their ownership stakes in other corporations. A key reason the introduction of intercorporate taxation of dividends did not have the anticipated impact was that the tax burden was so modest. Although dividends by one corporation to another corporation were no longer completely tax-free, they remained largely exempt.
In my paper Did Corporate Governance “Fail” During the 2008 Stock Market Meltdown? The Case of the S&P 500, a draft of which is currently available here, I provide the first detailed empirical analysis of the operation of U.S. corporate governance during the stock market turmoil of 2008. The study focuses on a sample of companies at “ground zero” of the stock market meltdown, namely the 37 firms removed from the iconic S&P 500 index. The results indicate that, despite U.S. stock markets experiencing their worst year since the 1930s, corporate governance performed tolerably well. This in turn implies it would be premature for policymakers to overhaul existing arrangements.
As the paper describes, over the past few decades U.S. corporate governance has been re-oriented towards the promotion of shareholder value. The sharp decline in share prices that occurred in 2008 implies this shareholder-focused corporate governance model “failed” and that reform is correspondingly justified. However, corporate governance is not the primary determinant of share prices, as reflected by the fact academic testing of the hypothesis that good corporate governance improves corporate financial performance has yielded inconclusive results. It therefore is possible that in 2008 corporate governance in public companies generally functioned satisfactorily amidst general market trends that inexorably drove share prices downwards. The paper examines whether this in fact might have been the case by examining corporate governance in companies removed from the S&P 500 index.
Over the next while there likely will be numerous studies of how corporate governance functioned during the recent financial crisis. However, the 37 companies removed from the S&P 500 in 2008 provide an apt starting point. One reason is that big public companies are markedly more important from an economic and investment perspective than their smaller counterparts — the S&P 500 index covers approximately 75% of the total value of the U.S. equities market. Another is that among any sample of publicly traded firms “troubled” companies will likely be the center of the action with respect to corporate governance controversies (e.g. Enron), and companies dropped from the S&P 500 index are apt to fall into this category. Among the 37 companies removed in 2008 20 can be categorized as “at risk”, with 13 of the companies having been dropped due to a dramatic fall in their market value, six due to “rescue mergers” (i.e. mergers where the company would have likely otherwise ended up bankrupt) and one due to Chapter 11 bankruptcy. Of the 10 industrial sectors represented in the S&P 500, firms from the “financials” sector dominated both the overall sample (15 out of 37 firms) and the “at risk” cohort (12 out of 20).
The primary search strategy I used to assess the operation of corporate governance in the 37 companies removed from the S&P 500 during 2008 was a thorough analysis of press and newswire coverage. A wide-ranging set of searches was conducted for each of the sample companies using Factiva, which offers extensive coverage of newspapers, business magazines and trade journals. The searches were structured to find out what corporate governance mechanisms were activated in the six months before and six months after a company’s removal from the S&P index, with the objective being to assess how responsive and effective corporate governance was during the stock market turmoil.
Due to the prominence of companies that are part of the S&P 500, the Factiva searches should have brought to light most material corporate governance developments concerning the sample companies. Nevertheless, the Factiva searches were supplemented by analysis of Georgeson’s 2008 Annual Corporate Governance Review, the Stanford Law School Securities Class Action Clearinghouse database and an AFL-CIO website offering data on CEO pay for 2007.
The key findings of the study are as follows:
• Only a minority of the sample companies experienced overt criticism of the board or publicized boardroom turnover, with the firms involved almost exclusively being in the “at risk” category
• A sizeable minority of “at risk” companies experienced publicized turnover of senior management
• The executive pay policies of a sizeable minority of the sample companies were criticized, with the controversies being restricted to at risk companies and companies that paid their CEOs more than the S&P 500 average
• Private equity went AWOL in a difficult climate for public-to-private buyouts
• Institutional investors (i.e. mutual funds and pension funds) were largely silent
• Hedge fund activism affected only a small minority of the sample companies, though the interventions produced results when they occurred
To the extent that corporate governance did “fail” among the companies removed the S&P 500, the difficulties were restricted largely to the financials sector. Boards of a number of banks and thrifts were subjected to intense criticism and bonus-driven executive pay may well have provided senior managers of major financial companies with incentives to take risks that were ill-advised due to the hit their firms would take if things went wrong. The corporate governance challenges financial companies pose, however, are likely to diminish over the next while, with the entire sector retrenching due to a combination of market trends and regulatory factors.
Once the financials are removed from the equation, the case in favor of a regulatory overhaul of corporate governance is weakened considerably. Based on what happened with the companies removed from the S&P 500 during 2008, corporate governance performed tolerably well. Moreover, while the U.K. already has in place a number of the features of corporate governance popular among those who advocate reform in the U.S., the stock market meltdown was worse in Britain than in America. Future studies perhaps will uncover damning evidence of corporate governance breakdowns during the stock market meltdown of 2008. However, at this point the case for radical reform has not been made out.
The paper is available here.