Copyright © 1996, LENS Inc. All Rights Reserved
Comments to webmaster@lens-inc.com
Robert A.G. Monks and Nell Minow
Just as the system for representational democracy was established to provide a legitimate basis for public power, the system of corporate governance was established to provide a legitimate basis for private power. Both are attempts to grapple with the problems that arise when increasingly complicated issues require the full-time attention of professional experts exercising delegated authority on behalf of the community, whether the community consists of citizens or shareholders. Economists call these problems agency costs and lawyers call them conflicts of interest. Both terms are used to express concern about the exercise of delegated authority, and the incentives it provides for self-dealing. To the extent that authority is delegated, it may be abused. To the extent that the potential for abuse requires oversight, it imposes costs. That is what makes the relationship between ownership and control so important to the vitality of the corporation.
Tradition and custom in America have relied on various bases for corporate legitimacythe discipline of the marketplace, governmentally imposed constraints, and management accountability to ownership, among them. Other countries balance public and private interests through structures appropriate to their society. Germany does so through its banks; England through the institutional investors and banks; Japan through interlocking corporate ownerships and government bureaucracy; France and Italy through nationalization. The vast increase in size and impact of corporate activity, the internalization both of business and ownership and the expanding power of new techniques of communication over electorate and government, emphasizes the need for a durable basis to assure the alignment of corporate interests and the public good.
In his recent essay, Peter Rona argues that the notion of managing a company for the benefit of shareholders is wrong: "A sane corporate law would require the board and management to operate the enterprise without regard to the stock market. It would prohibit boards from having anything to do with, let along participate in, the public auctioning of corporations. It would permit shareholders to remove directors, but not to sue them except for moral turpitude...And it would provide for a voice on takeovers--hostile or friendly--to all who have an economic stake in the outcome."
We agree with Rona's assertion that the advantage of the corporate structure is that it permits differentiation of roles. What we disagree with is his mischaracterization of the shareholders' role and his failure to recognize it as the essential element of accountability. Rona's suggestion that managers and directors should be trusted to make decisions without any meaningful accountability to shareholders, through the law or through the market, ignores the incentives that his structure would create for managers to make decisions that benefit themselves to the exclusion of employees, customers, suppliers, and the community as well as shareholders.
The foundation of our concept of corporations is our belief that because shareholders can be counted on to require that their own long-term interests be accommodated, corporations will be directed along lines most beneficial to society. All discussions of corporate governance begin with the inveterate and unchanging conviction that corporate stakeholders and constituents benefit most when management devotes its loyalty, energy, and competence to maximizing the value of the enterprise. This accountability permits us to give corporations enormous power to make decisions that affect every aspect of our lives, influencing what we will eat, wear, read, and drive, what diseases we will cure, where we will live, what our working conditions will be, and what our income will be after we retire. When we decide who will make these decisions, the choice is not, as Rona suggests, between shareholders and management; it is between shareholders and the government. As F.A. Hayek noted, "So long as the management has the one overriding duty of administering the resources under its control as trustees for the shareholders and for their benefit, its hands are tied; and it will have no arbitrary power to benefit this or that particular interest. But once the management of a big enterprise is regarded as not only entitled but even obliged to consider in its decisions whatever is regarded as the public or social interest or to support good causes and generally to act for the public benefit, it gains indeed an uncontrollable power--a power which could not long be left in the hands of private managers but would inevitably be made the subject of increasing public control."
Professor Roberta Romano said, "we focus on enhancing shareholder value because when looking at a corporation, it is difficult to conceive of who else's interests would be appropriate for determining the efficient allocation of resources in the economy." Certainly, it should not be the interests of managers and directors, who in protecting their jobs and increasing their compensation. The lower court's decision in the recent Time-Warner case noted that the one real deal-breaker in the two-year negotiation was the compensation for the head of Time-Warner. The entire merger was on hold for five months until that was resolved. In the words of the court, "Other aspects of the agreement came easily." This does not provide much assurance that the people negotiating the deal really believed that the long-term development of the two companies was the central issue. It is even more troubling to note that the deal actually carried out was thrown together in days, was quite different from the one developed over the two-year period given such deference by the judge, and resulted in a heavily debt-laden company, far worse from the shareholder's perspective than either the original proposal or the offer from Paramount.
Both owners and managers have, on occasion, acted in outrageous disregard of each other's rights. This has resulted in notorious failures in the system during the recent decade of hostile takeovers. Coercive bustup takeovers on the one hand and greenmail, golden parachutes, and entrenchment tactics on the other, have all demonstrated the absence of an effective and constructive relationship between owner and manager.
But we are now witnessing the reagglomeration of ownership of the largest corporations so that longterm shareholders are well on the way to majority ownership of America's companies. They are, of course the institutional shareholders, who invest collections of individuals' assets through pension funds, trusts, insurance companies, and other entities. As the great historian James Willard Hurst put it, "some prophets said that these investors, moved by their stakes and informed by their expertise, would begin to play in earnest the supervisory roles of the legendary stockholders." Their size makes it possible for them to do so and their obligation as fiduciaries requires them to do so. More important, involvement in governance is an investment with long-term returns that are impossible to ignore, and institutional shareholders are, before anything else, investors.
The evolution of the market has produced, in institutional investors, a small group of easily identifiable owners who have the capacity to understand and act. They also have two indisputable motives for paying close attention to ownership: avoiding liability for breach of fiduciary duty and enhancing portfolio values by promoting management accountability. There seems every reason to reestablish the accountability of management to ownership that has been the historical underpinning of capitalism.