New research on corporate governance explores the myth of shareholder control
Many of corporate America’s biggest governance battles are fought over surprisingly small stakes, according to new research by leading corporate law experts at the University of Pennsylvania Law School and NYU Law School.
Edward B. Rock L’83, the Saul a Fox Distinguished Professor Business Law at Penn, and NYU Law School Professor Marcel Kahan maintain that the sound and fury of high-profile battles waged between shareholder activists and corporate managers signify, if not exactly nothing, then stakes that are far more symbolic than real.
The rhetoric surrounding a variety of hotly contested corporate governance controversies “cannot be justified by the material interests at stake,” Rock and Kahan write. They maintain that largely symbolic battles fought over such issues as poison pills and proxy access reinforce an idealized belief that the shareholders who collectively own a corporation actually control it.
Their analysis of one of the most common corporate controversies – shareholder proposals asking corporate boards to let “poison pills” expire – is illustrative of such symbolic governance conflicts.
A financial tactic used to defend against a hostile takeover, poison pills prevent corporate raiders from negotiating a price for sale of stock directly with shareholders, forcing them instead to negotiate with company directors.
Because they can thwart potentially beneficial takeovers and allow bad corporate managers to entrench themselves, inducing companies to let their poison pills expire is commonly viewed as a major victory for shareholder activists. But Rock and Kahan point out that, in reality, such “victories” have no impact on a company’s ability to resist a takeover bid.
“As any corporate lawyer worth her salt can tell you, it is legally and practically irrelevant whether a company has a poison pill in place when a hostile bid is made,” they write. Corporate lawyers can reinstate expired pills on a moment’s notice, they note, which gives corporations ample time to fend off hostile bids.
What’s true of battles over poison pills holds for other instances of conflict between shareholder activists and corporate managers, as well. According to Rock and Kahan, the same gap between high-octane rhetoric and low-stakes reality characterizes battles widely reported in the financial press over such issues as proxy access, majority voting in director elections, and shareholder proposals to remove supermajority voting requirements.
The authors offer several explanations for the gap between rhetoric and reality in shareholder activism. They minimize the possibility that shareholders, especially large institutional investors with access to sophisticated advisers, are simply misinformed about the direct substantive impact of their activism.
Another possibility is that battles are fought as matters of principle, to establish the notion of shareholder rights. “The ultimate objective, according to this explanation, goes beyond the explicit issue over which the battle is waged,” they write. “Rather, the battles exert pressure on directors to pay more attention to shareholder concerns more broadly. If activists can prevail on a shareholder proposal, they are more likely to be able to prevail in other battles that matter more. For larger shareholders, being taken seriously when it matters is extremely important. It assures that senior management will at least listen to you when you have doubts over the company’s business strategy.”
It’s also possible that professional activists, as well as the lawyers advising management, both have an interest in overstating the importance of some of the issues to justify the roles they play in these battles.
In the end, Rock and Kahan argue, symbolic governance victories create “the illusion of shareholder control” and thereby lend the current system of corporate governance widespread support. “Shareholder activism,” they suggest, “serves a legitimating function showing that reform for the better is possible and that shareholders have power,” even though actual control is in the hands of top managers and company directors.