My colleagues Lynn Stout and Iman Anabtawi have an op-ed in today's WSJ (subcriber link; nonsubscriber link) on shareholder democracy and the SEC's pending shareholder access rule:
American corporate law gives entrepreneurs seeking to sell stock in the companies they create the freedom to draft their corporate charters almost any way they like. This includes freedom to draft charters that either enhance shareholder voting power, or dilute it. If investors valued strong voting rights, you'd think they would pay more for the shares of companies that granted them. Corporate entrepreneurs would respond by supplying charters that give shareholders greater clout.
Yet in the real world, companies almost never "go public" with enhanced shareholder power. Instead, most IPO charters weaken shareholders' rights. Google is a case in point. Its charter gives its founders shares with multiple votes while the public gets shares with only a single vote. Such "dual class" stock is unusual, but milder forms of shareholder disenfranchisement abound. Most IPO charters these days include "staggered board" provisions making it harder for shareholders to replace incumbent directors. Far from avoiding these IPOs, investors, including sophisticated institutions, snap them up like hotcakes.
... Why, if greater power is such a boon to investors, haven't they already demanded it? Maybe because greater shareholder power isn't so wonderful for investors after all. This argument is being advanced by Google's founders, and it enjoys support from many corporate scholars as well. ...
First, even finance economists increasingly acknowledge what businesspeople have always known: stock prices don't always accurately measure value. (Remember the Internet bubble?) As a result boards can often do a far better job of picking the business strategy best for the firm in the long run than unorganized, uninvolved, and price-obsessed stockholders can.
Second, investors don't always share common interests. The SEC's proposed rule would allow only shareholders with large holdings to push their own board candidates. This invites intra-shareholder conflict, allowing large investors-including financial intermediaries, union-sponsored pension plans, and politically-motivated groups-to nominate directors who will represent only their own special interests.
Third, strong boards can mediate not only conflicts among shareholders, but also conflicts between shareholders and other important corporate constituencies. The "team production" theory of corporate governance teaches that a principal function of board governance is to encourage executives, customers, rank-and-file employees, and others to make long-term commitments to a company by assuring these groups corporate policy will not be set by an anonymous, myopic, return-hungry pack of shareholders. Shareholders go along because, by ceding control to boards, they get greater loyalty and commitment from others. Google's investors may well believe the firm's founders and employees will work harder and better with a dual-class structure that protects them against hostile takeovers or shareholder pressures to raise profits by outsourcing jobs and cutting employee benefits.
Personally, I find only their second argument persuasive. (See my TCS column Does the SEC Know When Enough Is Enough?.) As for reason # 1, I agree that boards have better information than shareholders. But the existence of such an information asymmetry is independent of whether markets accurately price stock. As to the latter question, I still believe in the efficient capital markets hypothesis as the best available theory of how markets behave. As for reason # 3, I remain unpersuaded by my friend and colleague Lynn Stout's team production model of corporation law. Unfortunately, my critique of that model is way too long for a blog post, but you can download the law review article in which I rejected the team production model.
