Director-adopted bylaws that affect shareholders’ litigation rights have attracted both praise and controversy. Recent bylaws specify an exclusive judicial forum for litigation of corporate-governance claims, require that shareholder claims be arbitrated, and (most controversially) impose a one-way regime of fee shifting on shareholder litigants. To one degree or another, courts have legitimated each development, while commentators differ in their assessments. My paper, Forum-Selection Bylaws Refracted Through an Agency Lens, brings into clear focus issues so far blurred in the debate surrounding these types of bylaws.
Posts Tagged ‘Shareholder power’
In our paper, Liquidity and Shareholder Activism, forthcoming in the Review of Financial Studies, we provide new insights on how stock liquidity influences shareholder activism. Blockholders’ incentives to intervene in corporate governance are weakened by free-rider problems and high costs of activism. Theory suggests activists may recoup expenses through informed trading of target firms’ stock when stocks are liquid. We show that stock liquidity increases the probability of activism—but, does less so for potentially overvalued firms for which privately informed blockholders may have greater incentives to sell their stake than to intervene. We also document that activists accumulate more stocks in targets when stock is more liquid. We conclude that liquidity helps overcome the free-rider problem and induces activism via pre activism accumulation of target firms’ shares.
Most existing theories of blockholder governance consider a single firm. However, in reality, many institutional investors hold blocks in multiple firms. In our paper, Governance and Comovement Under Common Ownership, which was recently made publicly available on SSRN, we study the implications of common ownership for corporate governance and asset pricing. In particular, we address two broad questions. First, does holding multiple blocks weaken governance by spreading a blockholder too thinly, as commonly believed? If not, under what conditions can multi-firm ownership improve governance? Second, can common ownership lead to correlation between stocks with independent fundamentals, and if so, in which direction?
My article, Radical Shareholder Primacy, written for a symposium on the history of corporate social responsibility, seeks to make sense of the surprising disagreement within the corporate law academy on the foundational legal question of corporate purpose: does the law require shareholder primacy or not? I argue that disagreement on this question is due to an unappreciated ambiguity in the shareholder primacy idea. I identify two models of shareholder primacy, the “radical” and the “traditional.” Radical shareholder primacy makes strong claims about both shareholder governance rights, conceiving of management as the shareholders’ agent, and also about corporate purpose, insisting that corporate law mandates shareholder wealth maximization. Because there is no legal basis for either of these claims, those who deny that shareholder primacy is the law are correct at least as to this model. However, the traditional version of shareholder primacy accords to shareholders a special place in the corporation’s governance structure vis-à-vis the corporation’s nonshareholder stakeholders, for example, with respect to voting rights and the right to bring derivative suits. Beyond this privileged position in the horizontal dimension, there is no maximization mandate and corporate law does very little to provide shareholders with the tools necessary to exercise governance powers; there is no primacy in the vertical dimension or on the question of corporate purpose. Nevertheless, this conception of shareholder primacy—modest as it is—is enshrined in corporate law. Those who deny that shareholder primacy is the law need to acknowledge this fact, but once it is understood that traditional shareholder primacy has little in common with the radical version there is no reason to be reluctant to do so.
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.
The much-maligned 1980s tactic of “greenmail”  appears to have made a comeback in 2013. “Greenmail” has generally been defined as the practice of purchasing enough shares in a company to threaten a takeover, and then using that leverage to pressure the target company to buy those shares back at a premium in order to abandon the takeover. Today’s variety of greenmail does not always involve the threat of a takeover, but instead typically involves the actual or implied threat of a proxy contest that would effect major corporate change.
In just the last few months, several noted activist investors have profited handsomely by selling shares back to their target companies, including, among others, Icahn Associates with respect to its stake in WebMD and Corvex Management with respect to its stake in ADT.
In the paper, Blockholders and Corporate Governance, forthcoming in the Annual Review of Financial Economics, I review the theoretical and empirical literature on the different channels through which blockholders (large shareholders) engage in corporate governance. Berle and Means’s (1932) seminal article highlighted the agency problems that arise from the separation of ownership and control. When a firm’s managers are distinct from its ultimate owners, they have inadequate incentives to maximize its value. For example, they may exert insufficient effort, engage in wasteful investment, or extract excessive salaries and perks. The potential for such value erosion leads to a first-order role for corporate governance—mechanisms to ensure that managers act in shareholders’ interest. The importance of firm-level governance for the economy as a whole has been highlighted by the recent financial crisis, which had substantial effects above and beyond the individual firms involved.
Traditional theories of blockholder governance have focused primarily on blockholder intervention in management decisions. However, recent theories posit that blockholders can govern firms even when they have no intervention power. These theories view blockholders as informed traders who control management through “exit,” i.e., selling a firm’s stock based on private information (Admati and Pfleiderer 2009, Edmans 2009, Edmans and Manso 2011). Blockholder exit in these models exerts downward pressure on the stock price, which hurts management through its equity interest in the firm. Management therefore wants to make sure its actions are such that blockholders are willing to stay with the firm.
When blockholders are informed traders, management undertakes productive effort and investment in order to improve firm value and dissuade blockholders from exiting. The true governance force therefore comes from the threat of blockholder exit, not actual exit. Even if no exit is observed, blockholders could be governing effectively because their exit threat is sufficient to discipline management.
In our paper, Exit as Governance: An Empirical Analysis, forthcoming in the Journal of Finance, we empirically test the governance impact of blockholder exit threats. Since threats cannot be directly observed, this study focuses instead on a key mechanism that facilitates exit threats, namely stock liquidity. The exit threat models suggest that stock liquidity enhances the power of exit threats and improves firm value. For example, in Edmans (2009), the manager is compensated on the stock price and can take fundamental actions to improve firm value. Stock liquidity encourages strategic traders to acquire more information on firm fundamentals and trade on it in larger volumes (or blocks). The manager is sensitive to the resulting stock price, and therefore takes actions to increase firm value and induce (informed) blockholders to stay. Liquidity thus enhances the power of blockholder exit threats and improves firm value. This theoretical prediction forms the basis of our empirical tests.
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,
The power of short-term shareholders in widely-held public firms is widely blamed for “short-termism”: directors and executives feel pressured to boost the short-term stock price at the expense of creating long-term economic value. The recent financial crisis, which many attribute to the influence of short-term shareholders, has renewed and intensified these concerns.
To reduce short-termism, reformers have sought to strengthen the number and power of long-term shareholders in public corporations. For example, the Aspen Institute has recommended imposing a fee on securities transactions and making favorable long-term capital gains rates available only to investors that own shares for much longer than a year. Underlying these proposals is a long-standing and largely uncontested belief: that long-term shareholders, unlike short-term shareholders, will want managers to maximize the economic pie created by the firm.
I recently posted a paper on SSRN explaining why this rosy view of long-term shareholders is wrong. In my paper, The Uneasy Case for Favoring Long-term Shareholders, I demonstrate that long-term shareholder interests do not align with maximizing the economic pie created by the firm – even when shareholders are the only residual claimants on the firm’s value. In fact, long-term shareholder interests might be less well aligned with maximizing the economic pie than short-term shareholder interests. In short, we can’t count on long-term shareholders to be better stewards of the firm simply because they hold their shares for a longer period of time.