Stockholders’ Ownership And Control Research Paper

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Theory and research on the relations among top managers, company directors, stockholders, and external contenders for corporate control experienced a remarkable flowering during the 1990s. Early work addressed the central puzzle raised by the widespread separation of ownership and control among large American corporations, namely, why would any sensible person—much less thousands of them—invest their savings in businesses run by unaccountable professional managers? As Berle and Means (1932) framed the problem, those who ran such corporations would pursue ‘prestige, power, or the gratification of professional zeal’ in lieu of maximizing profits. Shareholders weakened by their fractionation could do little to stop them. Yet generations of individuals and financial institutions continued to invest in these firms. Why?

1. Resolving The Separation Of Stock Ownership From Company Control

Answering this question led to the creation of a new theory of the firm that portrayed the public corporation as a ‘nexus of contracts.’ In this model, the managers of the corporation were disciplined to optimize shareholder value by an array of mechanisms, from incentive compensation and vigilant directors to an unforgiving ‘market for corporate control.’ Taken together, these devices worked to vouchsafe shareholder interests even when ownership was widely dispersed. Research in this tradition flourished in the 1980s, as takeovers of under-performing firms in the US became common and restive institutional investors made their influence known. Studies focused on assessing the effectiveness of such contrivances as governing boards dominated by outsiders, executive pay tied to stock performance, and susceptibility to hostile acquisition (Walsh and Seward 1990).

Three developments, however, expanded research on ownership and control beyond these mechanisms and beyond American business. The first was for investigators to view the governance structure of the firm—the set of devices that evolve within the firm to monitor managerial decision making—as an ensemble. Rather than regarding any particular aspect of the firm’s structure as essential, researchers came to study them as complements or substitutes. Remuneration highly leveraged around share price, for instance, could act as a substitute for a vigilant board, and together they could really tighten the leash.

The second development was a growth of comparative and historical research that highlighted the idiosyncrasy of the American obsession with ownership and control. American-style corporate governance, aimed at ‘solving’ the problems created by the separation of ownership and control, came to be seen as only one of several feasible systems. Indeed, among some advanced economies with well-developed business enterprise, the problem needed no solving at all since the separation of ownership from control remained much the exception (Roe 1994).

The third development was the articulation of a reflexive stance on the theory of ownership and control. While agency theory can be viewed as an empirical theory of the corporation, it also came to be considered a prescriptive theory, an explanation of not only what is but also a vision of what could or should be. Its influence on public policy debates during the 1980s and 1990s is evident in the widespread rise of the rhetoric of shareholder value in the business press and executive suite (Useem 1996).

2. Shareholder Influence On Top Management And The Corporation

When ownership is dispersed widely, shareholders possess few direct devices to ensure their control—or at least their influence—on the company’s direction and performance. This is the essence of the ‘agency problem’ identified by Berle and Means (1932), and it remains potentially potent among many US firms. Three-quarters of the 100 largest US corporations in 1999 lacked even a single ownership block of 10 percent or more and, of the top 25, the biggest single holder averaged a scant four percent (Brancato 1999).

Scattered shareholders in effect relinquish their control to directors whom they elect to serve as their agents in selecting and supervising top management. Dispersed holders can influence the firm only through trading shares and voting directors. They have no real voice in the selection of executives, or even who serves on the board. By one argument, shareholder in- attention is in fact the only rational course for small shareholders since the cost of learning about the governance of the firm and mobilizing change is sure to be far overshadowed by the marginal and non-selective benefits of any resulting performance improvement. This problem of collective action could result in management unaccountability in some capital markets, but investors nonetheless rest easy in the US because of a well-developed set of mechanisms that have arisen to ensure share price maximization with- out overt investor control (Easterbrook and Fischel 1991).

The most forceful instrument for riveting attention on share price is the ‘market for corporate control.’ By hypothesis, a poorly-run corporation suffers a depressed market valuation, and this opens an opportunity for outsiders with better management skills to acquire the firm at an implicit discount, oust top management, and rehabilitate the firm, thus restoring value to its long-suffering stockholders. Unwanted takeovers and their threats provide a potent mechanism to shock top managers who under-serve share-holder interests; they know that executives generally find themselves on the street after an unfriendly take- over. The market for corporate control is thus the most visible hand of Darwinian discipline, weeding out poorly run firms and protecting shareholders from bad management (Manne 1965).

Hostile takeovers are a blunt instrument for corporate control, and as a result, some US institutional investors have moved toward more fine-grained methods of influence. Large pension funds, for example, often field shareholder proxy proposals for better governance. Though little evidence yet confirms that this mode of shareholder activism has immediate impact on the share price of target firms, it does push targeted firms to improve their governance and thereby further open them further to investor influence (Karpoff 1998).

If hostile takeovers are often too blunt an instrument and shareholder activism too diffuse, stock analysts provide an intermediate form of shareholder influence on company behavior. Analysts investigate companies in order to render judgments on their prospects for future earnings and thus to estimate their appropriate valuation. Analysts are often allowed privileged access to corporate executives and are in a position to give strategic and governance advice directly to senior managers, something rarely afforded to the firm’s small shareholders. In principle, the rewards go to the most accurate analysts, giving them incentives to act as corporate watchdogs. In practice, however, some analysts are not entirely dispassionate observers: those who work for firms doing business with a corporation give systematically more favorable evaluations than do others. While analysts may serve as a more refined channel for shareholder influence, this avenue of control remains problematic as well (Useem 1996).

3. Between Ownership And Control: Top Management

A handful of company executives make the defining decisions, whether to launch a new product, enter a promising region, or resist a tender offer. It is they who most directly control the fate of the firm. It is they who stand between corporate owners and company results.

Firms often define their ‘top’ as no more than the seven or eight most senior officers. To much of the world beyond the company walls, however, top management is personified almost solely by the chief executive. Academic researchers had long been drawn to the same pinnacle of the pyramid, partly on the conceptual premise that the chief executive is the manager who really matters, and partly on the pragmatic ground that little is publicly available on anybody except the CEO. We have, thus, benefited from a long accumulation of work on their family histories, educational pedigrees, and political identities, and we know as a result that their origins are diverse, credentials splendid, and instincts conservative. More contemporarily, we have learned much about their tangled relations with directors and investors as well. To know the CEO’s personal rise and board ties is to anticipate much of the firm’s strategic intent and performance promise. They are also a good predictor of the CEO’s own fortunes. An elite MBA degree accelerates movement to the top, a wealthy background attracts outside directorships, and a hand-picked board enhances pay and perquisites (Useem and Karabel 1986).

The conceptual and pragmatic underpinnings for shining the light solely on the CEO as the fulcrum for ownership and control, however, have eroded in recent years, as companies redefined their operations and researchers reconceived their methods. A central thrust of company restructuring during the 1980s and 1990s has been to transform the chief executive’s office into the office of the executive. At many companies, CEOs have fashioned teams among their top officers that meet frequently and resolve jointly, their vertical control giving way to lateral leadership. As a result, researchers expanded their field of view from the chief executive to the entire upper echelon. They applied fresh strategies, ranging from personal interviews to direct observation and internet surveys, to acquire data on top managers other than the chief executive who now matter far more to company performance and stock analysts. A host of studies subsequently confirmed what many executives already appreciated. A better predictor of a company’s performance than the chief executive’s capability is the quality of the team that now runs the show (Finkelstein and Hambrick 1996).

Yet even this widening of research attention beyond the chief executive has not broadened enough. Many companies have expanded the concept of top management to include one, two, or even three hundred senior managers whose decisions have decisive bearing on firm performance. The concept of top management, then, has expanded in the minds of company managers and, to a lesser extent, academic researchers, from just the boss to the boss’s team and now to the boss’s court. If shareholders are increasingly insistent that company directors require top managers to deliver steadily rising returns on their investments, their action is premised on a critical assumption that these top management teams do make the difference. While the premise may seem intuitively obvious to those inhabiting this world, it is far from self-evident to those who study it. Observers diverge from the assumption of influential executives in two opposing directions, one viewing top managers as all powerful, others seeing them as all but powerless.

Vilfredo Pareto and kindred ‘elite’ theorists early articulated the all-powerful view, but C. Wright Mills captured it best for the US in his classic work, The Power Elite (1956). Company executives, in his acid account, had joined with government officials and military commanders in an unholy alliance to exercise a commanding control over companies and the country. To the extent that top management is indeed all powerful, shareholders possess a silver bullet for righting whatever has gone wrong in a company: install new management.

For the community of management scholars, Pfeffer (1981) well articulated the opposite, all-powerless view with the contention that market and organizational constraints so tied top management’s hands that it was much the captive, not a maker, of its own history. Production technologies and competitive frays in this view are far more determining of company results than the faceless executives who sit in their suites. It counts little who serves in top management, and, by ex- tension, on the board. If top management is as powerless as the imagery suggests, investors seeking new management in response to poor performance are surely wasting their time.

Company executives do complain of a seeming helplessness at times, but almost anybody in working, consulting, or research contact with top managers reports just the opposite. Direct witnesses typically describe instead a commanding presence of top management, and they characterize its capabilities as making the difference between a company’s success or failure. Investors themselves think otherwise as well. When companies announce executive succession, money managers and stock analysts are quick to place a price on the head of the newly arrived, and, depending on the personality, billions can be added to or subtracted from the company’s capitalization.

The importance that investors and directors attribute to top management for growing their fortunes can also be seen in the ultimate punishment for failure to do so: dismissal. Whether the US, Japan, or Germany, the likelihood of a CEO’s exit in the wake of a stock free fall is increased by as much as half. And investors are often the engine behind the turnover. Study of Japanese companies stunned by a sharp reversal of fortune, for example, reveals that those whose top ten shareholders control a major fraction of the firm’s stock are more often than others to dismiss the president and replace directors (Kaplan 1997, Kang and Shivdasani 1997).

Similarly, company boards are observed to reward successful executives far more generously than in the past. For each additional $1,000 added to a company’s value in 1980, directors on average provided their chief executive an extra $2.51. By 1990, the difference in their payments had risen to $3.64, and by 1994 to $5.29. Put differently, in 1980 the boards of companies ranked at the 90th percentile in performance gave their CEOs $1.4 million more than did boards whose firms ranked at the 10th percentile (in 1994 dollars). But by 1990, the boards had expanded that gap to $5.3 million and by 1994 to $9.2 million (Hall and Liebman 1998).

4. Between Stockholders And Top Management: The Governing Board

If companies make semiconductors and concrete much the same way the world around, they organize their directors in almost as many ways as there are national economies. American boards tend to include only two or three insiders, while Japanese boards rarely include even two outsiders. German and Dutch governance is built around a two-tier governance structure, employees holding half of the upper tier seats; British and Swiss governance is designed around a single-tier, management-dominated structure. Some systems give formal voice to labor, others none: German law requires that labor representatives serve on the board, while French law places labor observers in the boardroom. American law mandates nothing, but some boards have added a labor leader on their own (Charkham 1994).

Yet such varieties in national practices may well diminish for two reasons. First, as equity markets internationalize, with companies seeking capital from all corners of the globe, investors predictably prefer relatively consistent director models that they believe will optimize shareholder value and performance transparency regardless of country. Their mental models of what’s right may not always be right, but that is beside the point. Consider the preference expressed by some institutional investors in the US for a board chair who is not a sitting executive, believing that separation improves monitoring. Whatever the separatist penchant and however well it may have served some companies, research reveals that such a division creates no clear advantage for company performance (Baliga et al. 1996).

The diversity in directorship practices is likely to diminish, however, for a second, more factual reason. Certain practices do engender better performance, regardless of the setting, and as companies increasingly compete worldwide for customers and investors, they are likely to adopt what indeed does prove best. A case in point here is the number of directors on the board. Research on teams’ success suggests that bigger is not better when boards exceed 15 or 20 members. When the number of directors climbs far above middle range, the engagement of each diminishes, and so too does their capacity to work in unison. Studies of American and European firms reveals that smaller boards displayed stronger incentives for their chief executive, greater likelihood of dismissing an under-performing CEO, and larger market share and superior financial performance (Conyon and Peck 1998).

It is not surprising, then, to see companies migrating worldwide toward smaller boards in search of improved performance. Directors in principle protect owner interests, direct company strategy, and select top management. In practice, they had concentrated more on strategy and selection and less on owner interests. But the rising power of investors has made for greater director focus on creating value and less coziness with top management. American and British directors, following the ‘Anglo-Saxon’ model, are already more focused on value than most. But directors in other economies can be expected to gravitate slowly toward the mantra of shareholder supremacy as well.

5. Shareholders, Directors, And Executives At The Table

With the rise of professional investors and their subjugation of national boundaries, those who occupy the executive suite and those who put them there are drawing far more research and policy attention, and justifiably so. In a by-gone era when markets were more steady and predictable, when airline and telephone executives confidently knew what to expect next year, the identity of top management mattered little. When shareholders were far smaller and decidedly quieter, when airline and telephone directors comfortably enjoyed inconsequential board meetings, the composition of the governing body mattered little either. During the 1990s, however, all of this has changed in the US and UK, with other economies close behind. As shareholders have sought to reclaim authority over what they owned, they have brought top management and company directors back in. Company strategy and financial results can no longer be understood without understanding the capabilities and organization of those most responsible for delivering them.

The market is no longer viewed as so impersonal, the company no longer so isolated. Ownership and financial decisions are embedded in a complex network of working relations among money managers, stock analysts, company directors, senior executives, and state regulators. Given the right combination of features, that lattice can yield high investment returns and robust national growth. Given the wrong amalgam, it can lead instead to self-dealing, frozen form, and economic stagnation. The road ahead thus depends on how well researchers understand what control mechanisms and leadership styles work well both within national settings and across cultural divides, and on the extent that top managers, company directors, and stockholders learn and apply what is best.


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