Political Determinants of Corporate Governance
Mark J. Roe
Harvard Law School
Harvard Law and Economics Discussion Paper No. 451
The claim I advance is that the large firm's ownership structure is too often analyzed as one arising solely from organizational imperatives and technical foundations. The political and social predicates that make the large firm possible and that shape its form can deeply affect which firms, which ownership structures, and which governance arrangements survive and prosper, and which do not.
To be concrete, much political analysis can be made to fit a principal-agent model. For ownership to separate from control, managers must be sufficiently aligned with shareholders. But the ways in which some polities settle conflict - or the ways in which the corporate players team up to work together - can affect the degree to which managers ally with shareholders and, concomitantly, how easy it is for ownership and control to separate.
Managers' agendas can differ from shareholders'; tying managers tightly to shareholders has been central to American corporate governance. But in other economically advanced nations, ownership is not diffuse but concentrated. It is concentrated in no small measure because the delicate threads that tie managers to shareholders in the public firm fray easily in common political environments, such as those in common in continental European in the late 20th century. Politics can press managers to stabilize employment, to forego some profit-maximizing risks with the firm, and to use up capital in place rather than to downsize when markets no longer are aligned with the firm's production capabilities; these political tendencies correspond closely to managers' historical tendencies, even in the United States. Since managers must have discretion in the public firm, how they use that discretion is crucial to stockholders, and common political pressures induce managers to stray farther than otherwise from their shareholders' profit-maximizing goals. Owners may be reluctant to turn the firm over to independent managers if managers would more willingly expand and make hard-to-reverse investments. The polity may refuse to give distant shareholders the tools that roughly align managers with shareholders, and it may denigrate the private means that align the two. And some of these political results are easily to implement in weakly competitive product markets, the kind of markets that give managers yet more discretion. Hence, public firms in such polities, all else equal, have higher managerial agency costs, and large-block shareholding has persisted as shareholders' best remaining way to control those costs. Indeed, when we line up the world's richest nations on a left-right political continuum and then line them up on a close-to-diffuse ownership continuum, the two correlate powerfully. True, the effects on total social welfare are ambiguous; such polities may enhance total social welfare, but if they do, they do so with fewer public firms than less socially responsive nations. These results strongly suggest that the corporate governance and ownership characteristics are linked, directly or indirectly, to basic political configurations in the wealthy West. European structures, for example, may link more tightly to Europe's late 20th-century politics than to technical institutions, and the technical institutions may derive from late 20th-century politics as much as anything else. We thus uncover not only a political explanation for ownership concentration in Europe, but also a crucial political prerequisite to the rise of the public firm in the United States, namely the weakness of social democratic pressures on the American business firm.
Number of Pages in PDF File: 19
Keywords: corporate governance, ownership separation, securities markets, agency costs
JEL Classification: A13,P16,P12,O16,N82,N83,N84,N80,K22,J50,G38,G34
Date posted: January 14, 2004