Institutions as Relational Investors: A New Look at Cumulative Voting

Abstract

The hostile takeover may have become a receding memory, but the problem that the market in corporate control purported to address nevertheless remains. In a world of imperfect competition, the product, capital, and managerial markets may temporarily indulge suboptimal performance by a firm's managers. As cases such as GM, Sears, American Express, and IBM illustrate, a firm with a substantial franchise and substantial financial reserves can sustain deteriorating economic performance over a significant period, resulting in a long slow slide of economic values. Shareholders and society generally will benefit from a mechanism that replaces the firm's incumbent managers well before the firm succumbs to competitive forces. The shareholder interest is obvious: as the firm heads to oblivion, share values head to zero. The social interest is no less compelling, since wasteful use of real economic resources reduces society's wealth and since the consequences of poor management are eventually shared by workers, suppliers, customers, and communities.\nThe hostile takeover became important in the 1970s and 1980s at least in part because of the legal, practical and cultural barriers to internal shareholder mobilization at a time of accelerating economic change. The low rate of internal shareholder intervention to replace managers who followed suboptimal strategies opened up opportunities for takeover entrepreneurs. As events in the late 1980s demonstrated, however, hostile takeovers were not an ideal intervention mechanism. The transaction costs were high; the associated financial market structure became overextended; the legal rules promoted "last dollar" auctions that, among other factors, led to bidder overpayment and fragile financial structures; the magnitude of the transactions led to speculation and illegality; and the eventual political reaction produced deal-breaking legal rules that were perversely more protective of managers than ever before.

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