Contests for Corporate Control: Corporate Governance and Economic Performance in the United States and Germany

347 Pages·2000·22.5 MB·English

by  Mary O'Sullivan

CONTESTS FOR CORPORATE CONTROL
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Contests for Corporate Control
Corporate Governance and Economic Performance
in the United States and Germany
MARY O'SULLIVAN
OXPORD
UNIVERSITY PRESS
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ISBN 0-19-829346-1
Acknowledgements
My interest in the subject of corporate control dates back more than a decade.
Growing up in Ireland, a country that was heavily dependent on foreign direct invest-
ment for jobs, exports, and growth, I found myself wondering about the process
through which major corporations made decisions that had repercussions for the eco-
nomic and social development of regions and nations. The relationship between busi-
ness organization and the process of economic development in Ireland still interests
me, and indeed has become an integral part of my research agenda as an academic,
but in the process of intellectual development that led to the writing of this book I
became convinced of the importance of understanding the evolution of corporate
control in the leading advanced industrial economies.
The Dublin of the late 1980s, with unemployment running into the high teens,
had little in common with what has become in the late 1990s, with the emergence
of the Celtic Tiger, Europe's party capital. Like so many Irish people before me my
first job took me abroad, in my case to London in 1988 to pursue a career with
McKinsey and Company. It was there that I developed a fascination with all aspects
of financial economics, an interest that I was to pursue in a more academic setting
when McKinsey sponsored me to undertake a Master of Business Administration
(MBA) at Harvard Business School.
I arrived at HBS in 1990. The great wave of financial restructuring that became
known as the Deal Decade had collapsed. Serious questions were being raised about
its impact on the productive capabilities of the American corporate economy. The
Japanese system of corporate governance was the toast of the international commu-
nity. If ever there was a time to go to HBS, it was then, because there was scope for
debate about the merits and shortcomings of different economic systems for deliver-
ing growth, employment, and, at least in some classes, equity.
Three professors at HBS stand out for their influence on my intellectual develop-
ment during my MBA studies and, in particular, for encouraging me to pursue a
Ph.D. in Economics. One was Richard Vietor, whose encouragement of classroom
debate and refusal to tolerate nonsense, no matter how eloquently delivered, made
his classes among the most stimulating and thought-provoking that I have enjoyed.
William Sahlman, an expert in entrepreneurial finance, ran one of the most chal-
lenging analytical courses at the school, and constantly reminded us how much we
did not know about the techniques of financial analysis and their application, as well
as some of their limits. Finally, but undoubtedly most important in persuading me
of the value of a Ph.D., was Michael Jensen.
Jensen's course at HBS was one of the most popular electives in the school. His
course was essentially a sustained argument for the merits of shareholder value as a
principle of corporate governance. As a teacher and a writer he was highly persua-
sive, and he convinced many MBA students of the merits of leveraged buyouts and
vi ACKNOWLEDGEMENTS
hostile raids for enhancing economic performance. I greatly enjoyed Jensen's course
although there were central elements of his thesis that I found troubling. As will be
evident from the arguments contained in this book, that discomfort has burgeoned
into outright disagreement with proponents of shareholder value. Yet the journey
from there to here has been a long one, and Michael Jensen played an important role
in my embarking on it by encouraging my questions, by suggesting that I pursue
further studies in economics to develop my understanding of corporate control and
economic development, and by recommending me for the Ph.D. programme in
Business Economics at the Harvard Economics Department.
The transition from one school to another, although they were both part of the
same university, was a shock to the system. From the initial 'math camp' it was clear
that what mattered to the economists was analysis, not debate, and general princi-
ples rather than anecdotes. To someone who had spent two years on an MBA pro-
gramme, reading more cases than I care to remember and listening to classroom
discussions that were often higher in confidence than in content, the shock was ini-
tially a refreshing one. Finally, I had an opportunity to develop my capabilities to
analyse the principles underlying the operation and evolution of economic systems
in a rigorous, scientific way.
The gloss took some time to wear off because the intensity of the programme was
such that there was little time to stand back from what we were learning to consider
its value. One incident does stand out in my mind, however, as sowing the first seeds
of doubt about the relevance of what I was being taught. At the end of three months
of an intensive Microeconomics course, the professor paused after a fifteen-line equa-
tion and asked what economic intuition it supported. The class was silent. He asked
again, this time giving us a hint. 'When prices go up . . .', he said, waiting for us to
finish the sentence, but no one responded. Apparently, our training was too advanced
to grasp the inverse relationship between price and quantity that every introductory
class on economics teaches!
It was not, however, until we had the final few weeks of instruction in Micro-
economics by Steve Marglin that I began to see the systematic biases in the course
material for what they were. At the time Marglin was allotted approximately four
weeks to teach everything that did not fall under the umbrella of neoclassical eco-
nomics. Thus we got our first taste, and for most students their last, of Schumpeter,
Marx, and Keynes, and anyone else who had the temerity to throw off the traces of
mainstream economic thought.
I remember leaving Harvard for the summer, having completed my general exams,
in a state of great confusion. I spent the ensuing few months reading like a maniac-
trying to understand where the course material fitted in with the evolution of eco-
nomic thought. That challenge continues to preoccupy me to this day but what I
could quickly see even then was that what I was getting at the Harvard Economics
Department as the cutting edge of scientific endeavour in economics was only the
tip of the iceberg of what economic thinkers have learned. I focused in particular on
the economics of the corporate economy and found that although I was enrolled in
ACKNOWLEDGEMENTS vii
an institution that had been home to some of the most otiginal thinkers in the field,
their legacy had been systematically erased.
When I returned to Harvard, I began working with Steve, and he was to become
my thesis adviser as well as my most important mentor for the duration of my doc-
toral studies. It is to him, and especially his interest in savings and investment, that
I owe my recognition of the importance of corporate resource allocation to economic
outcomes. With his guidance and support I felt ambitious enough to attempt to chal-
lenge on economic grounds the dominant paradigm in the corporate governance
debates.
Other members of the Harvard Economics Department also provided me with
important intellectual support at various stages of my work. Oliver Hart stands out
among them for his guidance. A number of fellow-students in the department also
made a major difference to my intellectual development and social life as a graduate
student, especially Sanjay Reddy and Jeff Bernstein.
As a student in Business Economics, I was permitted to rope in non-economists
on my committee, and I exploited that opportunity to gain access to my other two
advisers, Joe Bower of HBS and Roberto Unger at Harvard Law School. I had known
Joe since my MBA years, and I had often talked with him about my work. His own
earlier research in corporate resource allocation meant that he was a great source of
advice for me in my work on corporate governance and was a natural choice of adviser
for me. I became acquainted with Roberto Unger's work through a course on 'Firms,
Workers, and Governments' that he taught at Harvard Law School with another law
professor, David Charny. Coming from economics, at a time when neoliberal think-
ing was in the ascendant, and many of my fellow graduate students were trotting off
to Moscow to bring, as they saw it, the good news of the market economy to the
Russian masses, I found Unger's approach to be a breath of fresh air. I was already
committed to being a critical economist, but Unger's contentious and original argu-
ments constantly alerted me to the dangers of economic determinism that are
common to many schools of economic thought. In both Harvard Business School and
Harvard Law School I also found kindred spirits among the student population.
Jonathan West and Kerry Rittich deserve special mention as colleagues and friends.
Indeed, the great benefit of doing a Ph.D. at Harvard was precisely the opportu-
nity that it gave me to engage in cross-disciplinary research. It was certainly a chal-
lenge, often a headache, and I sometimes wondered whether it would lead anywhere,
but I was never in any doubt that to understand the issues with which I was con-
cerned disciplinary boundaries had to be traversed. I was encouraged in my efforts
by the time that I spent at the Center for European Studies (CES) at Harvard. I am
very grateful to Charlie Maier and Abby Collins for their support and also to the
other scholars with whom I came into contact while I was there, first as a graduate
student and later as a Faculty Affiliate. A constant reminder of the complexity of the
corporate economy, but also of the possibilities of cross-disciplinary discussion, was
the Business History seminar at Harvard Business School. There I had the pleasure
of getting to know scholars in the field of business history like Alfred Chandler,
viii ACKNOWLEDGEMENTS
Thomas McCraw, and Takashi Hikino, who were based at HBS, as well as other dis-
tinguished scholars who came to give seminars there.
It was through the Business History seminar that I came into contact with Bill
Lazonick, an economist, who had once been a colleague of Steve Marglin in the
Harvard Economics Department. He had since moved first to Barnard College at
Columbia University and subsequently to the University of Massachusetts Lowell to
contribute to the building of that university's capabilities in the study of regional
economic and social development. I was planning to write a term paper on the history
of the cotton industry in Lancashire, and I was told that I should contact Bill, who
had long attended the Business History seminar and was a well-known expert in the
history of the textile industry.
Bill had also made a name for himself as a critical economist and was less than
thrilled to get a call from someone who, as a graduate student in economics, was
likely to be enamoured with what he had described as 'the myth of the market
economy'. Our inauspicious first contact was, however, to evolve into a long-term
collaboration in the study of business organization and comparative economic devel-
opment that is still going on. Many of the ideas developed in this book owe an
immeasurable debt to my work with Bill and to our discussions together.
Through Bill I also came into contact with a number of scholars who regularly
attended a Friday afternoon seminar at UMass Lowell including Beth Almeida, Mike
Best, Bob Forrant, Erin Flynn, Ann Frost, Qiwen Lu, William Mass, Phil Moss, and
Chris Tilly as well as the Vice-Chancellor of the university, Fred Sperounis, and the
Chancellor, William Hogan. The number of students that attended this seminar from
Harvard and MIT was testament to the quality of the discussions that one could find
there as well as the dearth of similar debates in Cambridge. Many of the people I
met through these seminars continue to play important roles in my intellectual life.
It is only as one writes an acknowledgements section that one realizes just how
many people have had an identifiable influence on one's thinking in the years that
go into the development of a book. Keith Smith played a crucial role in supporting,
both intellectually and financially, the early stages of my research on corporate gov-
ernance. In particular, he provided funding through the STEP (Studies in Technol-
ogy, Innovation, and Economic Policy) Group for me to spend a summer in Oslo
working on my thesis. I benefited greatly from my time there and especially from
my interaction with other researchers at STEP. In a variety of other academic venues,
comments on my work by Franco Amatori, Alice Amsden, Ron Blackwell, Kristine
Bruland, Youssef Cassis, Zhiyuan Cui, Andrea Colli, Ronald Dore, Lou Ferleger,
Martin Fransman, Patrick Fridenson, Lou Galambos, Les Hannah, Philippe Haspes-
lagh, Gary Herrigel, Ulrich Jiirgens, Henry Mintzberg, Jonathan Story, Kazuo Wada,
Christian Weller, and Jonathan Zeitlin all deserve special mention.
Fellowships from Harvard Business School, the Harvard Graduate School of Arts
and Sciences, and the Center for European Studies at Harvard have permitted time
for research and writing. My work on corporate governance was funded for a number
of years by the Levy Institute, where I am a Research Fellow. The European Com-
mission has also provided me with financial support, first through TSER project No.
ACKNOWLEDGEMENTS ix
SOE1-CT95-1004 on 'Innovation Systems and European Integration', directed by
Charles Edquist from Linkoping University in Sweden, and more recently through
TSER project No. SOE1-CT98-1L14 on 'Corporate Governance, Innovation, and
Economic Performance in the EU', co-directed by Bill Lazonick and me from the
European Institute of Business Administration (INSEAD).
Three years ago I was appointed an assistant professor at INSEAD. I initially had
serious reservations about taking a faculty position there given that most business
schools do not consider it their responsibility to engage in critical discussions of cor-
porate control. In this respect INSEAD is no different, even if some individuals there
recognize the importance of educating students to think critically about the eco-
nomic and social roles that their business careers accord them. What does distinguish
INSEAD, however, is its commitment to admitting a truly international student
body. Given the diversity of the students that attend the school, it is hard to stifle
debate about the strengths and weaknesses of different systems of corporate gover-
nance even if one wanted to (as indeed many do). For someone who places a high
value on intellectual debate, perhaps due to the cantankerous Irishwoman in me but
also because I have seen what happens without a serious commitment to it in many
economics departments, a wide variety of students is a constant joy. I would like to
acknowledge the crucial role that my MBA students have played in pushing me to
refine my ideas on corporate governance when I thought that I had lost the energy
to go any further. They have persuaded me that serious debates about economic effi-
ciency and equity can happen at business schools.
I would also like to extend a special thanks to Valerie Bouland and Michele Plu,
who have worked with me since my arrival at INSEAD and who have helped me
more times than I can remember in the process of getting this book to press. David
Musson from Oxford University Press was largely responsible for my deciding to
write this book and, throughout its development, he struck the perfect balance
between patience and persistence. T. W. Bartel did an excellent job of copy-editing
the manuscript and Sarah Dobson was a great help in getting the book through to
publication.
My family have by now had just about enough of this book but it certainly would
not have been finished without their encouragement and support. They also made
sure that when I took the manuscript and myself too seriously for my own good they
were around to make sure I laughed myself out of whatever dilemma I had created
for myself. Special gratitude is due to my parents not only for all of the help that
they gave me while I wrote the book but for what they've put up with for a lot longer
than that. To them I dedicate this book in the year that they both turned sixty. There
was a point at which they thought they might be seventy before it finally appeared
on their bookshelf, and I am more than happy to have proven them wrong.
On a more sombre note, however, I would like to pay tribute to my great friend,
Qiwen Lu, for the great conversations and wonderful times that we had together over
the last six years. Qiwen was a Ph.D. student in Sociology at Harvard when I was
there but we actually met at UMass Lowell. Since then we have moved along similar
paths, finishing our doctorates around the same time and getting our first jobs in the