Rethinking Corporate Governance for a Bondholder Financed, Systemically Risky World

Abstract

This article rethinks the shareholder-primacy model of corporate governance, arguing that bondholders, who are more risk averse than shareholders, should be included in the governance of systemically important firms. The inclusion of bondholders not only could help to reduce systemic risk but also is merited by two crucial changes in the bond markets. In contrast to the past century, bond issuances have dwarfed equity issuances as the source of corporate financing for more than a decade. Bondholders therefore often have more invested in firms than shareholders. Moreover, bondholders — like shareholders — now typically trade their securities instead of holding them to maturity. That ties bond prices to the firm’s performance. Therefore bondholders, like shareholders, also have a vested interest in that performance.

It therefore is logical to include bondholders in corporate governance if that could be done without impairing legitimate corporate profit-making. The article examines two ways to accomplish that: by enabling bondholders and shareholders to directly share governance, with shareholder representatives having voting control except as needed to protect bondholders from significant harm; and by requiring a firm’s managers to balance a dual duty to both bondholders and shareholders. Of these approaches, the former (sharing governance) would be simpler, involving less managerial discretion. Both of these approaches, however, should not only have lower costs but also more effectively reduce systemic risk than post-crisis regulatory experiments to try to harness bondholder risk-aversion through the forced issuance of contingent capital.