Corporate governance politics display a peculiar feature: while the rhetoric is often heated, the material stakes are often low. Consider, for example, shareholder resolutions requesting boards to redeem poison pills. Anti-pill resolutions were the most common type of shareholder proposal from 1987–2004, received significant shareholder support, and led many companies to dismantle their pills. Yet, because pills can be reinstated at any time, dismantling a pill has no impact on a company’s ability to resist a hostile bid. Although shareholder activists may claim that these proposals vindicate shareholder power against entrenched managers, we are struck by the fact that these same activists have not made any serious efforts to impose effective constraints on boards, for example, by pushing for restrictions on the use of pills in the certificate of incorporation. Other contested governance issues, such as proxy access and majority voting, exhibit a similar pattern: much ado about largely symbolic change.
Posts Tagged ‘Governance reform’
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?
“Prosecutors in the boardroom” is a slogan reflecting an unintended early 21st century overlap of corporate governance and corporate criminal liability. Although exaggerated, the phrase reflects how prosecutors increasingly demand corporate governance reforms when settling criminal cases using deferred prosecution agreements (DPAs). While a growing body of scholarship seeks to put governance beyond the purview of prosecutors, ousting prosecutors from the boardroom, I explain why prosecutors should consider governance carefully in determining how to proceed ex ante and state rationales for governance changes in DPAs ex post.
Prosecutorial failure to consider governance ex ante can have adverse consequences, including activating governance mechanisms not designed to the purpose and imposing on corporate actors to hastily adopt changes they would ordinarily evaluate dispassionately. Subsequent prosecutorial prescriptions of governance changes are rarely the product of articulated rationales and can seem like ransoms or trophies created on the fly by prosecutors seeking victory. Irreconcilable criticisms result: some say DPAs are coerced extractions of overzealous prosecutors, others that they are mere whitewash that let corporate crooks off the hook.
Prosecutors should publicly articulate the rationales for the governance changes they propose ex post and that articulation should be based on their assessment of the target’s governance profile ex ante. Creating such an ex ante profile would involve modest incremental costs while improving the quality of prosecutorial decisions on how to proceed with a case. Subsequent articulation of rationales would add systemic benefits by increasing rationality, building credibility, deflecting criticism and creating a catalogue of useful. I thus part with critics of prosecutors in the boardroom by explaining the value of prosecutorial investment in corporate governance.
Is there a competition for corporate charters in Europe? Corporate and comparative scholars have been discussing the similarities between the Delaware-led competition in the United States with the slowly emerging market for corporate legal forms in the European Union.
In my recent paper, Corporate Mobility in the European Union – a Flash in the Pan? An empirical study on the success of lawmaking and regulatory competition, recently made available on SSRN, I provide new empirical evidence on the development of the market for incorporations in Europe, and on the impact of national law reforms.
Since the seminal Centros case in 1999, European entrepreneurs have been allowed to select foreign legal forms to govern their affairs. While much academic effort has been spent to evaluate the early market reactions to this case-law, effectively opening up the European market, relatively little attention has been devoted to subsequent developments. This is surprising, since the various national lawmakers’ responses to the wave of entrepreneurial migration offer a rare glimpse on the effects of regulatory competition and subsequent business’ reaction, as well as on the relevance and effects of lawmaking and regulatory responses to market pressure.
My newest book, Citizens DisUnited: Passive Investors, Drone CEOs and the Corporate Capture of the American Dream, has been in the works for the last year, and is really the culmination of thirty years of work in corporate governance, activism and government. It was prompted by frustrations and failures, in many ways. But it was through those frustrations that I gained clarity on the problems facing our nation. Not just problems in the boardroom but the larger issues of power that tie corporations to the power structure in Washington and how it affects our society. The specific thoughts that led to this book began almost two years ago with a speech I gave at ICGN in Paris and are further illuminated in some new research done for the book by GMIRatings’ Ric Marshall.
In the course of planning the book, I had begun to think of some corporations as “drones” – in the sense that they are untethered from reality and responsibility. We define them as corporations, “in which no single shareholder retains a principal position, defined by the SEC as 10 percent or more.” The owners aren’t at the helm — but manager-kings are. And there are no limits to prevent these CEOs from enriching themselves at the shareholder expense or from shifting the burden of externalities onto society.
Ric, in the meantime, had begun to find empirical data that showed that,
In the paper, The Sensitivity of Corporate Cash Holdings to Corporate Governance, forthcoming in the Review of Financial Studies, my co-authors (Qi Chen, Xiao Chen, Yongxin Xu, and Jian Xue) and I analyze the change in cash holdings of a large sample of Chinese-listed firms associated with the split share structure reform that required nontradable shares held by controlling shareholders to be converted to tradable shares, subject to shareholder approval and adequate compensation to tradable shareholders. The reform removed a substantial market friction and gave controlling shareholders a clear incentive to care about share prices, because they could benefit from share value increases by selling some of their shares for cash.
We predict and find that this governance improvement led to reduced cash holdings of affected firms, and that the effect is more pronounced for private firms than for state-owned enterprises (SOEs), for firms with more agency conflicts, and for firms for which financial constraints are most binding. We interpret these results as consistent with both a direct free cash flow channel and an indirect financial constraint channel. These results are robust to several alternative specifications that address concerns about endogeneity and concomitant effects. They provide strong evidence that governance arrangements affect firms’ cash holdings and cash management behaviors. To the extent that cash management is a key operational decision that affects firm value, our findings suggest an important mechanism for corporate governance to affect firm value.
In the paper, Corporate Law and the Team Production Problem, which was recently made publicly available on SSRN, I discuss an alternative framework to the principal-agent model for understanding corporate law. For much of the last three decades, the dominant perspective in corporate law scholarship and policy debates about corporate governance has adopted the view that the sole purpose of the corporation is maximizing share value for corporate shareholders. But the corporate scandals of 2001 and 2002, followed by the disastrous performance of financial markets in 2007-2009, have left many observers uneasy about this prescription. Prominent advocates of shareholder primacy such as Michael Jensen, Jack Welch, and Harvard’s Lucian Bebchuk have backed away from the idea that maximizing share value always and everywhere has the effect of maximizing the total social value of the firm. Shareholders, they concede, may often have incentives to take on too much risk, thereby increasing the share of firm value they capture by imposing costs on creditors, employees, taxpayers, and the economy as a whole.
In response to the problems with shareholder primacy revealed by corporate and financial market crises in recent years, some scholars and practitioners have considered the “team production” framework for understanding the social and economic role of corporations and corporate law (Blair and Stout, 1999) as a viable alternative. Whereas the principal-agent framework provided a strong justification for the focus on share value, the team production framework can be seen as a generalization of the principal-agent problem that is symmetric: all of the participants in a common enterprise have reasons to want all of the other participants to cooperate fully. A team production analysis thus starts with a broader assumption that all of the participants hope to benefit from their involvement in the corporate enterprise, and that all have an interest in finding a governance arrangement that is effective at eliciting support and cooperation from all of the participants whose contributions are important to the success of the joint enterprise. A team production-based analysis of corporate law then points to a number of features of corporate law and the corporate form that do not seem consistent with shareholder primacy but that may provide a workable solution to the team production problem.
In our paper, Corporate Governance Reforms and Cross-Border Acquisitions, which was recently made publicly available on SSRN, we investigate how investor protection affects the allocation of foreign capital inflows at the firm level. A simple model provides an explanation for a well-documented but little understood phenomenon on international capital flows—the tendency of foreign investors to target better-performing firms in emerging markets.
When a foreign acquirer‘s country has stronger IP than a target country, the acquirer‘s controlling shareholder values control premiums less than controlling shareholders of local firms because stronger IP imposes greater constraints on diversion for private benefits. Within the target country, controlling shareholders of firms with more profitable investments take fewer private benefits and, hence, demand lower control premiums. Foreign acquirers, which value control premiums less, will target firms with more profitable investments. This cherry picking tendency will intensify (moderate) as the IP gap between the acquirer and target countries increases (decreases).
In my paper, The Plight of the Individual Investor in Securities Class Actions, forthcoming in the Northwestern University Law Review, I offer a reassessment of both federal and Delaware law favoring the selection of institutional investors as lead plaintiffs in securities or transactional class actions. While it is clear that institutional investor lead plaintiffs have brought numerous benefits to class members, their influence has also marginalized the interests of individual investors. I identify four persistent sources of conflict between institutional and individual investors. These include derivatives trading, corporate governance reform, conflicts between selling and holding plaintiffs, and, in the transactional context, conflicts created when institutional investors own a stake in both target and bidder companies. I argue that in many instances, these conflicts render institutional lead plaintiffs atypical and inadequate class representatives, in contravention of the requirements of Fed. R. Civ. P. 23 and its state equivalents. To allay these concerns, I suggest that the optimal solution is for courts to appoint representative individuals as co-lead plaintiffs with the presumptive institutional lead plaintiffs.
In our paper Does Governance Travel Around the World? Evidence from Institutional Investors, forthcoming in the Journal of Financial Economics, we examine whether institutional investors affect corporate governance by analyzing portfolio holdings of institutions in companies from 23 countries during the period 2003-2008.
We find that international institutional investors export good corporate governance practices around the world. In particular, foreign institutional investors and institutions from countries with strong shareholder protection are the main promoters of good governance outside of the U.S. Our results are stronger for firms located in civil-law countries. Thus, international institutional investment is especially effective in improving governance when the investor protection in the institution’s home country is stronger than the one in the portfolio firm’s country.