The Case for Increasing Shareholder Power

Abstract

This paper reconsiders the basic allocation of power between boards and shareholders in publicly traded companies with dispersed ownership. U.S. corporate law has long precluded shareholders from initiating any changes in the company's basic governance arrangements. I show, and support with empirical evidence, that shareholders' existing power to replace directors is insufficient to secure the adoption of value-increasing governance arrangements that management disfavors. I put forward an alternative regime that would allow shareholders to initiate and adopt rules-of-the-game decisions to change the company's charter or state of incorporation. Providing shareholders with such power would improve over time to improve all corporate governance arrangements, largely by inducing management to initiate value-increasing changes and without shareholders' having to exercise their power to intervene.

Furthermore, I argue that, as part of their power to amend governance arrangements, shareholders should be able to adopt provisions that give them additional power to intervene, down the road, in specific business decisions. Power to intervene in game-ending decisions (to merge, sell all assets, or dissolve) could address management's bias in favor of the company's continued existence. Power to intervene in scaling-down decisions (to make cash or in-kind distributions) could address management's tendency to retain excessive funds and engage in empire-building. Shareholders' ability to adopt, when necessary, provisions that give themselves additional power to intervene could thus produce benefits in many companies.

A regime with shareholder power to intervene, I show, would address governance problems that have long troubled legal scholars and financial economists. These benefits would result mainly from inducing management to act in ways that better serve shareholder interests and without shareholders' having to exercise their power to intervene. I also discus how such a regime could best be designed to address concerns that supporters of management insulation could raise; for example, to allay such concerns, shareholder-initiated changes in governance arrangements could be adopted only if they enjoy shareholder support in two consecutive annual meetings.

Finally, examining a wide range of possible objections, I conclude that they do not provide a good basis for opposing the proposed increase in shareholder power.

Note: Previously titled "The Case for Empowering Shareholders"

Keywords: corporate governance, shareholders, managers, directors, boards, stakeholders, agency costs, mergers, takeovers, acquisitions, proxy contests, corporate charters, charter amendments, state competition, dividends, distributions, free cash-flow, empire-building, myopia, short-termism, corporate reform

JEL Classification: D70, G30, G32, G34, G38, K22