Shareholder Empowerment

Recent trends in shareholder empowerment have spurred a heated debate about whether empowered shareholders will ultimately cure corporate ills or adversely affect corporate fortunes. Publicly traded corporations are uniquely positioned to facilitate financial risk bearing, due to their dispersed ownership and liquidity and shareholders’ ability to diversify their financial risk (Easterbrook & Fischel, 1985). They have not only served as “the main engine of economic progress” in the twentieth century (Jensen, 1989: 61), but have also driven social progress by facilitating professionalism, upward mobility, and meritocracy, as well as by providing job stability, and retirement and health care benefits (Davis, 2011, 2013; Demsetz, 1983). The United States “owed everything to the corporation,” writes Beatty (2001), tracing the very development of democracy in the United States to the morphing of early settler companies into a commonwealth. Yet views on corporations have polarized from “the basis of the prosperity of the West and the best hope for the future of the rest of the world” (Micklethwait & Wooldridge, 2003) to the critical query, “are corporations evil?” (Litowitz, 2003).

Since the work of Berle and Means (1932), organizational scholars have recognized that the interests of “owners” of a firm may differ from those of management. Agency theory research has a long tradition of focusing on these potentially different interests (e.g., Eisenhardt, 1989; Fama & Jensen, 1983; Jensen & Meckling, 1976). Scholars also recognize that “owners” can be a diverse mix of different types of investors and have provided typologies of these different “types” (e.g., Brickley, Lease, & Smith, 1988; Bushee, 1998; Connelly, Hoskisson, Tihanyi, & Certo, 2010; David, O’Brien, Yoshikawa, & Delios, 2010). However, most of these typologies still remain mired in agency theory assumptions of economic rationality and purely financial motivation.

From an agency theory perspective (Fama, 1980; Fama & Jensen, 1983; see Lan & Heracleous, 2010, for a recent review), shareholder empowerment can be seen as a means of enhancing the balance of power between owners and managers, controlling managerial power, reducing the effects of information asymmetries, and keeping agency costs in check (Bebchuk, 2005). Critics of this view argue that changing regulatory arrangements (including shareholders’ voting rights and decision influence) would have unanticipated negative effects. Concerns include the introduction of inefficiencies in corporate governance and uncertainty as to how shareholders would be held accountable for their decision influence (Bainbridge, 2006; Bratton & Wachter, 2009; Sharfman, 2012). The equivocal outcomes of shareholder activism on both firm performance and shareholder returns (Goranova & Ryan, 2014) make an evaluation of the desirability of shareholder empowerment even more complex.

The subject of corporate governance—defined by Ryan, Buchholtz, and Kolb as “the roles, responsibilities, and balance of power among executives, directors, and shareholders” (2010: 673)—presents management scholars with a number of vexing problems. These problems have included such issues as executive compensation, the adoption of poison pills, the payment of greenmail, the establishment of golden parachutes, and resistance to many shareholder proposals on annual proxy ballots. While many of these issues are of concern mainly to scholars and shareholder activists, executive compensation, because of the ever-increasing multiple of executive pay to average worker pay (Economic Policy Institute, 2013), also resonates with many members of the general public.

Today’s corporate environment, and the interactions among its participants, are increasingly complex and dynamic. The market has responded with expansive regulations, listing rules, and bylaws aimed at empowering shareholders. With this empowerment, shareholders can now voice their discontent and demand necessary corrections. Notably, corporate constituents have not only more information, but also more ways to access it (e.g., formal reporting, public filings, Twitter, blogs, e-mails, listservs, etc.), creating both greater transparency and greater scrutiny of organizational behaviors.

For investment institutions that fully exploit their private status, hedge funds command a surprisingly large public profile. For example, the media gave significant coverage to SAC, the hedge fund started by Steven A. Cohen, with eight employees convicted of insider trading (Stevenson & Goldstein, 2014). Recent cases of successful hedge fund activism include Daniel Loeb’s Third Point Fund pressuring of auction house Sotheby’s—the oldest company traded on the NYSE—to separate its businesses, engage in stock buybacks, and increase its dividend (Stevenson & de la Merced, 2014). A case of activism that has met with opposition from other investors concerns leveraged-buyout-turned-hedge-fund-activist Carl C. Icahn pressing Apple for a stock buyback (de la Merced, 2014). Another visible case is the battle between William A. Ackman of Pershing Square Capital Management and Herbalife, in which he has “pulled the levers of power” in pressing regulators and politicians against the company (Schmidt, Lipton, & Stevenson, 2014). Rooted in collective memory is Long-Term Capital Management, which in 1998 created turmoil in currency markets, causing 14 central banks to facilitate efforts to avoid global contagion of the downturn (Dungey, Frey, Gonzalez-Hermosillo, & Martin, 2007; Furfine, 2006; Halstead, Hedge, & Klein, 2005) and leading to popular use of the phrases “too big to fail” and “moral hazard.” Yet, despite the publicity surrounding them and despite their global importance, information about hedge funds remains incomplete and insufficient (McCahery & Vermeulen, 2008).

Angel investors are often the first outside investors in a firm (Wetzel, 1983). Given the history of the firm prior to their financing—that is, virtually new and unknown—their decision to provide funding for the entrepreneurial venture poses quite an investment risk (Mason & Harrison, 2002). Ventures perceived to be less risky while still offering an acceptable return on investment are more likely to receive financing (Ganzach, 2000; Lange, Leleux, & Surlemont, 2003; Tyebjee & Bruno, 1984). Certain firm and angel characteristics influence the angel’s perception of the investment and decision to participate (Galbraith, De Noble, & Ehrlich, 2009). Once involved as part-owners, the angels themselves can have a strong influence on the firm and its functioning (Prowse, 1998). Provided that the firm survives and moves more closely to an investor exit (e.g., initial public offering [IPO] or buyout), the angels also play a role with regard to the next-stage owners.

The corporate governance literature identifies two major governance models. The first is based on equity finance, controlled by capital markets, and mostly seen in common law system countries such as the United Kingdom and the United States. The second is based on debt finance, controlled by financial institutions, and mostly seen in continental European countries (such as Germany) and Japan. Because both equity and debt markets were underdeveloped, transition economies (also some South American and Asian countries) have introduced a third model characterized by concentrated ownership (Estrin, Hanousek, Kočenda, & Svejnar, 2009; Pistor, 2006). Transition economies are formerly socialist countries and are distinguished by a number of institutional and organizational features that introduce peculiar problems and may dictate differences in corporate governance mechanisms. In fact, “no other place in the world offers such ample and creative corporate governance pathologies” (Fox & Heller, 2006: 391). In particular, principal-principal (PP) conflicts, which refer to the potential expropriation of minority shareholders by controlling owners, are among the most well known corporate governance problems in transition economies (Young et al., 2008).

Dominant legal (La Porta, Lopez-de-Silanes, Shleifer, & Vishny, 1997, 1998, 2000) and political (Roe, 2003) views of corporate governance systems suggest that such institutional changes as regulatory reforms and privatization processes can break down the institutions of stable shareholding. So the partial stability of ownership patterns in Italy during the last two decades, despite a large increase in investors’ rights and the privatization of a number of state-owned firms, seems to be an “unambiguous disconfirmation of existing theories” (Culpepper, 2007: 799).

Agency theory’s principal-agent corporate governance model has taken the fields of financial economics and management studies by storm since it was first introduced by Jensen and Meckling (1976). Its employment by scholars of both denominations has since then largely shaped the language that we employ to describe the modern corporation (Lubatkin, Lane, Collin, & Very, 2005). In fact, the large industrial corporation is primarily discussed, both in the business press and by security analysts, using such financial terms as “debts,” “assets,” and “cash flow” (Fligstein & Freeland, 1995). In turn, managers and owners of firms have largely begun to see their firms in exactly the same way (Useem, 1993). Firms in the United States and the United Kingdom are particularly evaluated according to a financial economics framework, and governed in light of a financially inspired view of the modern corporation (Fama, 1980; Fama & Jensen, 1983; Roe, 1994).