The Mythical Benefits of Shareholder Control

Abstract

In "The Myth of the Shareholder Franchise," Professor Lucian Bebchuk elegantly argues that the notion that shareholders in public corporations have the power to remove directors is a myth. Although a director facing a proxy contest might find this to be a bit of an overstatement, the core idea is sound. In a public company with widely dispersed share ownership, it is difficult and expensive for shareholders to overcome obstacles to collective action and wage a proxy battle to oust an incumbent board. Nor is success likely when directors can use corporate funds to solicit proxies to stay in place. The end result, as Adolf Berle and Gardiner Means famously observed in 1932, is that shareholders in American public corporations are "subservient" to directors "who can employ the proxy machinery to become a self-perpetuating body." In other words, not only is Bebchuk correct to suggest that shareholder control is largely a myth in public companies today, it has been recognized to be largely a myth for at least three-quarters of a century. What should we conclude from this? Bebchuk concludes the time has come to breathe life into the idea of the shareholder-controlled public firm. But as a matter of logic, this conclusion does not follow from the observation that shareholder power to vote out directors is largely mythical. There are many myths—vampires, zombies, giant alligators in the sewers of New York City—we would not want to make real. Why make shareholder power to oust directors a reality? In this Response to Bebchuk's essay, I will address this vital question. The lack of director "accountability" typically seen in public corporations has an obvious downside. While directors have some interest in ensuring the firm's survival, they do not have a strong financial interest in optimal corporate performance. As a result, board control contributes to the "agency cost" problem in firms. Nevertheless, as Part I will describe, board governance offers important upsides as well. An extensive literature on the theory of the corporation (a literature largely glossed over by Bebchuk in his essay) suggests that shareholders enjoy net benefits from board governance. This is because board governance, while increasing agency costs, also promotes efficient and informed decisionmaking, discourages intershareholder opportunism, and encourages valuable specific investment in corporate team production. Because board control has both costs and benefits, the wisdom of Bebchuk's proposal to make it easier for shareholders to oust directors cannot be determined by theorizing. It must be based on evidence. Part II will look at the empirical evidence and conclude that the evidence does not support Bebchuk's proposal. To the contrary, studies of charter provisions in IPOs strongly support the claim that shareholders themselves often prefer firms with strong board control. Why, then, do so many observers, including but not limited to Bebchuk, believe shareholders should be given greater influence over boards? Why is the idea of shareholder control so appealing when there is so little evidence that it works? Part III will argue that calls for greater "shareholder democracy" appeal to laymen, the business media, and even many business experts not because they are based on evidence, but because they have a strong emotional allure. In particular, the emotional appeal of shareholder control can be traced to three sources: a common but misleading metaphor that describes shareholders as the "owners" of corporations, the opportunistic calls of activist shareholders seeking leverage over boards for self-interested reasons, and a strong but unfocused sense that something (anything!) should be done in the wake of recent corporate scandals. The result has been a widespread, and unfortunate, acceptance of yet another myth—the myth that shareholder control in public companies actually benefits shareholders. This Response will conclude by reminding readers of the dangers of policymaking based on myth rather than evidence, using the cautionary case of stock options.

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