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Shareholder Activism as a Corrective Mechanism in Corporate Governance

39 Pages Posted: 12 Sep 2013 Last revised: 29 Aug 2015

Paul Rose

Ohio State University - Moritz College of Law; Bocconi University - BAFFI Center on International Markets, Money, and Regulation; Tufts University - The Fletcher School of Law and Diplomacy; Fundación Instituto de Empresa, S.L. - IE Business School

Bernard S. Sharfman

R Street Institute

Date Written: August 28, 2015

Abstract

Under an Arrowian framework, centralized authority and management provides for optimal decision making in large organizations. However, Kenneth Arrow also recognized that other elements within the organization, beyond the central authority, occasionally may have superior information or decision-making skills. In such cases, such elements may act as a corrective mechanism within the organization. In the context of public companies, this article finds that such a corrective mechanism comes in the form of hedge fund activism, or, more accurately, offensive shareholder activism.

Offensive shareholder activism operates in the market for corporate influence, not control. Consistent with a theoretical framework that protects the value of centralized authority and a legal framework that rests fiduciary responsibility with the board, authority is not shifted to influential, yet unaccountable, shareholders. Governance entrepreneurs in the market for corporate influence must first identify those instances in which authority-sharing may result in value-enhancing policy decisions, and then persuade the board and/or other shareholders of the wisdom of their policies, before they will be permitted to share the authority necessary to implement the policy. Thus, boards often reward offensive shareholder activists that prove to have superior information and/or strategies by at least temporarily sharing authority with the activists by either providing them seats in the board or simply allowing them to directly influence corporate policy. This article thus reframes the ongoing debate on shareholder activism by showing how offensive shareholder activism can co-exist with — and indeed, is supported by — Kenneth Arrow’s theory of management centralization, which undergirds the traditional authority model of corporate governance.

This article also provides a much-needed bridge between the traditional authority model of corporate law and governance as utilized by Professors Steven Bainbridge and Michael Dooley and those who have done empirical studies on hedge fund activism, including Lucian Bebchuk. The bridge helps to identify when shareholder activism may be a positive influence on corporate governance.

Keywords: corporate governance, shareholder activism, hedge funds, governance entrepreneurs

JEL Classification: K2, K20, K22

Suggested Citation

Rose, Paul and Sharfman, Bernard S., Shareholder Activism as a Corrective Mechanism in Corporate Governance (August 28, 2015). Brigham Young University Law Review, Vol. 2014, No. 5, 2014; Ohio State Public Law Working Paper No. 225. Available at SSRN: https://ssrn.com/abstract=2324151 or http://dx.doi.org/10.2139/ssrn.2324151

Paul Rose (Contact Author)

Ohio State University - Moritz College of Law ( email )

55 West 12th Avenue
Columbus, OH 43210
United States

Bocconi University - BAFFI Center on International Markets, Money, and Regulation ( email )

Milano, 20136
Italy

Tufts University - The Fletcher School of Law and Diplomacy ( email )

Medford, MA 02155
United States

Fundación Instituto de Empresa, S.L. - IE Business School ( email )

Calle Maria de Molina 12, Bajo
Madrid, Madrid 28006
Spain

Bernard S. Sharfman

R Street Institute ( email )

1050 17th Street Northwest
#1150
Washington, DC 20036
United States
(202) 525-5717 (Phone)

HOME PAGE: http://www.rstreet.org/

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