Carl Icahn got rich out of ruining companies by extorting greenmail from spineless targets and running companies like TWA into the ground. But these days he's trying to remake himself into some sort of good corporate governance, aided and abetted by academic allies who ought to know better. In today's WSJ, Icahn pulls out the tired old shareholder democracy canard:
I'm no political scientist, but it doesn't take a genius to understand that voting is crucial to democracy. When things aren't going well, citizens can vote the leaders out. A lot of blood has been shed for these rights, and while democracy isn't perfect, to paraphrase Winston Churchill, it's far better than any other system of government.
What baffles me is that voting rights really don't apply to public corporations. Shareholders can vote, but boards can just ignore them under the "business judgment rule" backed by state laws and courts. In the middle ages, feudal lords asserted the "divine right" of royalty to justify their lordly positions while plundering the peasants. Today's boards act like they are vested with similar powers: the divine right of boards!
How did this board-centric system ever come about? Years of lobbying by pro-management groups in state legislatures produced a thicket of laws that protect the impregnability of boards and CEOs. Shareholders have been relegated to a "take it or leave it" status.
First, the business judgment rule does not protect directors who plunder the company, So that's one lie.
Second, board-centric corporate governance is not the product of recent legislative action, but has been a central feature of corporations since corporations first came into existence. So that's a second lie.
But the big lie is the premise that democracy has anything to do with corporate governance.
As Delaware’s Chancellor William Allen has observed, our “corporation law does not operate on the theory that directors, in exercising their powers to manage the firm, are obligated to follow the wishes of a majority of shares. In fact, directors, not shareholders, are charged with the duty to manage the firm.”[1] Allen further recognized that the fact that many, “presumably most, shareholders” would have preferred the board to make a different decision “done does not . . . afford a basis to interfere with the effectuation of the board’s business judgment.” In short, corporations are not New England town meetings.
And that's a god thing, because the people who are really likely to plunder a corporation are not its directors but rather activist shareholders like Icahn. (Indeed, give Icahn's track record, it is the height of chutzpah for him to complain about corporations being plundered. Compared to the average director, Icahn is Captain Blackbeard.)
Activist investors with substantial decisionmaking influence will be tempted to use their position to self-deal; i.e., to take a nonpro rata share of the firms assets and earnings. Let us make the heroic assumption, however, that institutional investors are entirely selfless. Institutional investor activism would still be undesirable if the separation of ownership and control mandated by U.S. law has substantial efficiency benefits.
The root economic argument against shareholder activism thus becomes apparent. Large-scale institutional involvement in corporate decisionmaking seems likely to disrupt the very mechanism that makes the Berle-Means corporation practicable; namely, the centralization of essentially nonreviewable decisionmaking authority in the board of directors. The chief economic virtue of the Berle-Means corporation is not that it permits the aggregation of large capital pools, as some have suggested, but rather that it provides a hierarchical decisionmaking structure well-suited to the problem of operating a large business enterprise with numerous employees, managers, shareholders, creditors, and other inputs. In such a firm, someone must be in charge: “Under conditions of widely dispersed information and the need for speed in decisions, authoritative control at the tactical level is essential for success.” Shareholder activism necessarily contemplates that institutions will review management decisions, step in when management performance falters, and exercise voting control to effect a change in policy or personnel. In a very real sense, giving institutions this power of review differs little from giving them the power to make management decisions in the first place. As economist Kenneth Arrow observed, “If every decision of A is to be reviewed by B, then all we have really is a shift in the locus of authority from A to B and hence no solution to the original problem” of allocating control under conditions of divergent interests and differing levels of information. Even though institutional investors probably would not micromanage portfolio corporations, vesting them with the power to review major decisions inevitably shifts some portion of the board’s authority to them. Given the significant virtues of discretion, preservation of board discretion should always be the null hypothesis. The separation of ownership and control mandated by U.S. corporate law has precisely that effect.
[1] Paramount Communications Inc. v. Time Inc., 1989 WL 79880 at *30 (Del. Ch. 1989), aff’d, 571 A.2d 1140 (Del. 1990).
