Monday, August 23, 2004

Not a Dichotomous Choice

As is the case with a good deal of his writings (at least on his blog) ProfessorBainbridge oversimplifies complex matters. (ed: isn't that what all conservatives do?) To read this piece one would be led to believe that the question facing corporate governance is a simple dichotomous choice between shareholder rule or board rule. The problem, of course, is that there are some of us who believe that there is a third way, somewhere in the middle.

The dangers of an all powerful board have been made apparent over the past few years. The centralization of power between the board and the officers of the corporation have allowed inefficient, and illegal, practices to continue. To people like Bainbridge who support the current regime, the answer is for shareholders to vote with their feet and sell their shares. However, this is a poor solution in that there is an enormous potential for the investor to lose value in that transaction. It also fails to consider the inefficiency of transaction costs of shareholders being forced to sell as their only remedy.

On the other side, it is equally inefficient for shareholders to have any say over day to day operations of a corporation. It might be questionable to even give them a voice in somewhat larger decisions. Yet, allowing shareholders some control over broad corporate goals makes sense. After all, they are in FACT the owners of the corporation. Take a look back and Berle and Means seminal work The Modern Corporation and Private Property, written in the 1930's, to see the warnings they made about the concentration of power away from the actual owners of public corporations. What they said seventy years ago is equally applicable today.

And today's boards and officers have even nore power represented by their use of poison pills and other devices to prevent takeovers. By exercising these powers, board and officers have locked shareholders (owners) out of selling the corporation. This may not sound too bad, but think of what it represents. Why would a corporation wish to purchase another- often because the pursuer believes it can run the business more profitably. So by blocking the transaction the board and officers have in effect protected inefficient management.

By reforming governance such that shareholders have a vote in the mergers and acquisitions context, we allow the actual owners the power to sell their assets. But we also eliminate an inefficient management's source of protection. It is a reform that would be relatively simple to implement and one that would maximize economic efficiency. Plus, it simply makes sense that the owners of a set of assets be allowed to sell those assets, if they so decide. Management and the board have ample opportunity to persuade shareholders why a sale would not be in their best interests. And shareholders would be free to disagree.

The current system of governance protects, if not encourages, poor management and the only solution it contemplates for unhappy shareholders is one that potentially costs them value. We should hope to treat owners with a little bit more esteem and respect. However, I think many (like Bainbridge) who oppose governance reform are more worried about institutional activism that might be politically motivated by a politics they do not share.


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