The firm divided : manager-shareholder conflict and the fight for control of the modern corporation

353 Pages·2017·2.448 MB·English

by  Guthrie, Graeme Alexander

the firm divided

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The Firm Divided
MANAGER–SHAREHOLDER CONFLICT AND THE FIGHT
FOR CONTROL OF THE MODERN CORPORATION
Graeme Guthrie
1
1
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Contents
Preface vii
part one monitor
1. Agadflyintheointment:Theconsequencesofseparatingownershipandcontrol 3
2.Whosesideareyouon?Theroleoftheboardofdirectors 14
3.Overseeingtheunseeable:Theconflictbetweenmanagersandshareholders 28
part two motivate
4.Narrowingthegap:Theincentivesgeneratedbymanagerialownership 43
5. Aprimeronpay:Executivecompensationandefficientcontracting 58
6.Hidinghighpay:Executivecompensationandmanagerialpower 80
7. Separatingthewheatfromthechaff:Incentivesgeneratedbyexecutives’
careerconcerns 99
part three delegate
8.Withonehandtiedbehindtheirback:Delegatingmonitoringtoexternal
capitalmarkets 121
9.Noskininthegame:Delegatingmonitoringtofinancialanalysts 139
10. Crashingtheparty:Delegatingmonitoringtolargeshareholders 159
part four sell
11. Anewbroom:Themarketforcorporatecontrol 181
12.Bypassingtheboard:Offensivetacticsinhostiletakeovers 198
13.Fightingback:Defensivetacticsinhostiletakeovers 218
v
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part five the rules of the game matter as well
14.Caughtinthemiddle:Reformingthelegalandregulatoryenvironment 241
epilogue 250
acknowledgments 252
notes 253
bibliography 291
index 331
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Preface
shareholders at america’sbest-knownfirmsarerevolting.In2015,shareholders
atMacy’swantedthedepartmentstore’srealestateassetssoldandtheproceedspaidout
asadividend.1AtYahoo,theywantedacashstockpilepaidouttoshareholderstostopit
beingspentonmorewastefulacquisitions.2DoleFoods’formershareholdersweresaying,
“Wetoldyouso.”ADelawarejudgehadjustruledthatthefirm’schiefexecutiveofficer
(CEO)haddeliberatelydrivendownthesharepricesothathecouldbuythecompany
back from shareholders more cheaply.3 Shareholders at eBay and FedEx demanded a
greater say in their firms’ affairs.4 At Ford and Google, they just wanted their shares
tohavethesamevotingrightsasthoseownedbythefirms’founders.5 Shareholdersat
StarbucksandTargettriedtostriptheCEOofsomeofhispower.6 Atmattressmaker
TempurSealy,theyjustwantedhimfired.7
ThesurveysofCEOpaythatappearinthebusinesspresseachyearaddfueltothefire.
IntheWallStreetJournal’s2015survey,thehighestpaidCEOreceived$112m;according
to the New York Times, a different CEO was paid more, $156m; Bloomberg gave top
prizetosomeoneelse,with$285m.8 Eachoutlethasitsownranking,whichjustserves
tosowconfusioninthemindsofshareholders.However,theunderlyingmessagesent
toshareholdersisconsistent:CEOpayishigh,probablytoohigh,gettinghigher,and
not closely linked to firm performance. At some firms, shareholders appear powerless
to do anything about it. The tech firm Oracle is a good example. Every year for four
years,morethanhalfofthevotescastatOracle’sannualshareholdermeetingrejectedthe
firm’sexecutivecompensationpolicies.9 ThevoteswerenotbindingonOracle’sboard,
vii
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soexecutivesgottheirpay.However,thevotesrevealshareholderoppositiontothefirm’s
paypracticesandtheirinabilitytodoanythingaboutit.
Shareholders get angry when executives do not seem to have their best interests at
heart.Theygetangrierwhentheybelieveexecutivesarebeingpaidexcessivelyandangrier
still when they feel powerless to do anything about it. Shareholders’ power is limited
because they do not appoint the CEO directly. Instead they elect the firm’s board of
directors, which does have the power to fire the CEO. However, even board power is
limited. It does not help that boards are chaired by the firm’s CEO at 84% of large
corporations.10 Making matters worse, shareholders are offered the same number of
candidates as there are vacancies at most annual board elections—and the candidates
arechosenbytheboarditself!Unsurprisingly,theyarereelectedalmosteverytime.11To
manyshareholders,CEOsseemuntouchable.
Ifthereisonethingthatmakesshareholdersevenangrieritisthefactthatmostofthe
behaviortheydislikeislegal.Infact,allofthebehaviordescribedinthisbookisentirely
legal.Therearenoaccountingscandalsinthepagesthatfollow;thereisnoinsidertrading.
Instead,thereisacollectionofindividualsoperatingwithintherulesandstructuresthat
directors,politicians,regulators,andshareholdershaveputinplace.
Theultimatesourceofshareholderangerisaconflictwithinthemoderncorporation.
Manager–shareholder conflict has been around for as long as there have been public
corporations.Scholarshavestudieditsconsequencessincetheearly1930s,whenAdolf
BerleandGardinerMeanspublishedTheModernCorporationandPrivateProperty.12
Berle and Means showed how control of the largest U.S. corporations had become
separatedfromtheirownershipandraisedtheawkwardquestionofwhethercorporations
werebeingrunforthebenefitofownersormanagers.Thisquestionisatleastasrelevant
nowasitwasintheearly1930s.Indeed,withcorporationsgrowingeverlargerandcontrol
seemingtobeheldinfewerhands,thequestionisevenmorerelevantnow.13
FinancialandlegalscholarshavespentthedecadessinceBerleandMeanspublished
theirbookinvestigatingcorporategovernance,whichisthetermtheyusetodescribethe
arrangementsthataresupposedtobetteraligntheinterestsofmanagersandshareholders.
In this book I describe the causes and consequences of manager–shareholder conflict,
andthegovernancearrangementsthathaveevolvedinresponsetothisconflict.Idoitby
tellingthestoriesofsomeofthefirmsthatmakeupcorporateAmericaandofsomeofthe
individualsthatmakethosefirmsoperateinthewaytheydo.Alongthewaywewillfollow
theanticsofaseptuagenarianshareholderwhotraveledthecountrytormentingCEOs,
learnhowanactivisthedgefundwasabletodislodgeoneCEOinjustafewweeksafter
buyingonly1.3%ofafirm’sshares,andseehowaself-mademanoncedescribedbyaU.S.
federaljudgeasa“snakeinsheep’sclothing”managedtoseizecontroloftheworld’smost
valuablesportsteam.
Therearemanypartialsolutionstomanager–shareholderconflict,butnoneofthem
workperfectly.Infact,evenwhentheyareallcombined,theoutcomeisfarfromperfect.
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However,theyallmakeacontributiontoreducingtheconflictbetweenafirm’sexecutives
anditsshareholders.Thisbookworksitswaythroughthesesolutions,onebyone.In
some solutions, shareholders and directors play a hands-on role, taking responsibility
themselvesforkeepingmanagersinline.Inshort,theymonitor.Shareholdersdosome
monitoringthemselves;theresttheyleavetoaboardofdirectors,whichtheyelect—but
everyoneisinvolvedinmanagingthemanagers.Directorsplaymoreofahands-offrolein
thenextsetofsolutions.Theysetafewgroundrulesthatexecutivesmustfollow,create
afewincentives,andthenstepbackandalloweventstounfold.Thatis,theymotivate.
However,directorscannotdoeverythingthemselves,sointhethirdsetofsolutionsthey
enlistoutsidepartiestodosomeofthemonitoringandmotivatingontheirbehalf.They
delegate. These outsiders have their own selfish reasons for getting involved, but their
presencecanstillbenefitshareholders.Asalastresort,andthelasttimethatshareholders
areevenindirectlyinvolvedinthegame,shareholderscansell,orthreatentosell,their
sharestoanotherfirm.Sellingistheultimatehands-offpolicy.Alloftheseapproaches
to corporate governance occur in a world of rules and regulations. That is why there
is a final solution to manager–shareholder conflict, of which shareholders are entirely
passivebeneficiaries:thefighttochangetherulesofthegame.Thesearethekeystepsto
effectivecorporategovernance:monitor,motivate,delegate,sell.Therulesofthegame
matteraswell.
We start our journey at the epicenter of manager–shareholder conflict, the annual
shareholders’ meeting where executives and shareholders eyeball each other. Each
new solution to manager–shareholder conflict takes us slightly further afield, first
to the boardroom, where directors are supposed to work on shareholders’ behalf,
doing some eyeballing of their own, and then to the executive labor markets, where
executives are matched with firms. Our next steps take us further away still, to the
capital markets where those firms try to raise the funds they need to survive and
prosper, and then to the market for corporate control that puts fear into executives’
hearts. We will finish our journey in Washington, DC, in congressional committee
roomsandathearingsoftheSecuritiesandExchangeCommission(SEC).Itisabout
as far away from the annual shareholders’ meeting as possible, but decisions made in
Washington profoundly influence what happens at shareholder meetings across the
country.
Beforewebegin,anoteabouttheroleofeconomics.Thisisabookaboutcorporations
and what economists think about how they are run. Economists look at individuals
operatingwithinasetofrulesandtrytounderstand thebehaviortheyobserve.They
trytounderstandwhatdrivesthatbehaviorandtopredictthebehavioralchangesthat
wouldoccuriftheruleswerechanged.Mainstreameconomistsdothisbyassumingthat,
ateveryturn,individualsactinwaysthatadvancetheirownbestinterests.Thatisthe
economicframeworkadoptedinthisbook.Wetrytounderstandindividuals’decisions
byimaginingwhattheywoulddoiftheywereinterestedonlyinlookingafternumber