Bainbridge on shareholder activism: do we really need shareholders?

Steve Bainbridge has a new paper, Investor Activism: Reshaping the Playing Field? In this paper he announces that directors should have less power and that we should have more shareholder activism.  Just kidding.  Really, here's the abstract:

Shareholders of U.S. corporations historically tended towards rational apathy. Holding small blocks that were unable to affect the outcome of the vote and faced with the considerable costs associated with gathering sufficient information to make an informed decision, they adopted the so-called Wall Street Rule (it was easier to switch than fight). In the last 15 years or so, a growing number of commentators and investor activists have claimed that the rising importance of institutional investors has the potential to reshape the field by empowering shareholders to become active players in corporate governance. This paper situates investor activism in the so-called director primacy theory of corporate governance. In so doing, it demonstrates that the separation of ownership and control typical of U.S. public corporations has significant efficiency benefits. It then argues that shareholder activism threatens to undermine the advantages of director primacy without offering significant countervailing gains. Accordingly, the paper concludes that pending regulatory proposals to expand shareholder governance rights should be viewed with suspicion.

As Steve points out, "institutional investor activism does not solve the principal-agent problem but rather merely relocates its locus." He makes theoretical sense. Moreover, his theory his supported by the fact that we actually observe little effective shareholder activism. The exception is union and pension funds, which proves the rule.  As Steve points out, "these are precisely the institutions most likely to use their position to self-deal—i.e., to take a non-pro rata share of the firms assets and earnings—or to otherwise reap private benefits not shared with other investors."

But if we can’t rely on the owners to keep managers honest, how can we make them accountable? Well, I have another idea – the “uncorporation,” including private equity and publicly held partnerships. See my Rise of the Uncorporation. These firms go Steve one better by effectively eliminating outside shareholders.

Of course there’s still a market for control, the conventional way to empower shareholders. But aside from strategic combinations engineered by incumbents, the disciplinary role of the control market is largely due to uncorporations -- private equity restructuring and activist hedge fund intervention.

I'll have more to say about all this, and a new version of my paper, at a conference at the University of Chicago next month.

Comments

[Michael F. Martin]

I guess it's gotten harder and harder for me to understand from whence the opposition between directors and shareholders should arise. If directors have a big stake in the company, then they're shareholders and have the same incentives as shareholders. If not, then they're probably more in the pocket of management. So then the opposition is between management and shareholders.

This seems to be one of the major normative suggestions of the "uncorporation" paper -- i.e., that managers will behave more like shareholders when their incentives are hard-wired to be aligned with the shareholders', like in a low-management fee GP/LP structured hedge fund.

The wisdom of that suggestion seems clearly right in view of the successes of founder-managed firms and limited-partnership structured conglomerates such as Berkshire-Hathaway.