A mystery about corporate control is why anyone would want it, let alone fight for it. Decision making in a corporation is a necessary but burdensome task that involves considerable investment in gathering and processing information. In the standard economic analysis of corporate governance, decision makers, who are many and varied in a large business firm, provide the critical input of decision-making services—for which some, namely CEOs, are compensated, handsomely. But what is the value of control for shareholders? Shareholders, too, are paid by a firm, not only for providing some decision-making services but, more importantly, for supplying the essential input of equity capital. Their pay for both of these inputs is a claim on residual revenues or profits. Since profits, unlike the return to other input providers, can vary with the fortunes of a firm, control has value for shareholders mainly as a means for securing a rightful return for their input of equity capital.
If control is of value to shareholders mainly as a means for securing a return on the equity capital they provide to a firm, then they should be satisfied to leave most decisions to boards of directors and the management team of a firm. Having a decision-making role should be valuable to them mainly when a firm is significantly underperforming or otherwise facing a crucial change in direction. At other times, what is the benefit in making the effort and taking on the expense to become involved in difficult, costly decision making? Thus, the economic analysis of corporate governance correctly predicts that diversified shareholders would, most of the time, be “rationally disinterested” in matters of corporate decision making.
If this rational disinterestedness of shareholders prevailed all the time, then there would be no subject matter for the book under review. In The Firm Divided, Graeme Guthrie suggests that conflict between shareholders and managers is a prominent and ubiquitous feature of the modern corporation, that the corporate world is a veritable battlefield of fights over control. Most chapters begin with and examine, in detail, a recent example of a high-profile, hard-fought conflict between shareholders and managers. These vivid accounts involve epic battles at such iconic American corporations as AOL, Disney, Home Depot, and Anheuser-Busch, as well as equally intense struggles for control at lesser known companies. Along the way, readers are introduced to a colorful cast of characters: company founders, dominating CEOs, activist and gadfly investors, and corporate raiders.
The book provides a modicum of academic analysis. The source of the manager-shareholder conflict is the familiar separation of ownership and control in the modern corporation, along with the resulting principal-agent problem. The conflict arises from the combination of weak shareholder-agents, who are the putative, de jure owners of a firm, and strong manager-principals, who exercise effective, de facto control. Guthrie identifies four main mechanisms or strategies for addressing the manager-shareholder conflict: monitoring of managers by shareholders and the boards of directors they elect; motivating managers, mainly by means of well-designed compensation packages; delegating the tasks of monitoring and motivating managers to outside forces, such as capital markets, rating agencies, analysts, and large shareholders; and selling, which utilizes the power of the market for corporate control to restrain or, ultimately, replace a management team.
The concluding chapter recognizes that the “rules of the game” matter and that the manager-shareholder conflict occurs not only within a set of rules designed largely by government but also within the rule-setting process itself, in legislatures, regulatory agencies, and the courts. In addition to rules about such matters as shareholder voice (for example, “say on pay,” proxy access, board elections, and takeover tactics and defenses), a powerful weapon for shareholders involves access to the information that firms provide in complying with extensive disclosure requirements.
Although The Firm Divided makes a convincing case that conflict between shareholders and managers exists in the modern American corporation and that fights for corporate control do occur, questions can be raised about the seriousness of the problem. Virtually all the conflicts surveyed in this book were eventually settled, with reasonably acceptable outcomes. One can ask, though, whether these conflicts were settled in the right way. Were the outcomes ethically justified, and if so, why? Do the conflicts themselves involve some ethical wrongdoing that should be avoided, and if so, how?
The strengths of the book lie in the journalistic richness of the detail about the illustrative examples, the analysis of the sources of the conflicts, and the means currently employed for their resolution. These are all descriptive matters that would be of interest and value to readers seeking to understand certain aspects of the current state of corporate governance. However, for readers with normative concerns about the rightful roles of shareholders, managers, and other participants in the governance of the modern firm, the book, unfortunately, has little to offer.
In particular, Guthrie expresses no clear views about the proper role of shareholders in matters of corporate governance. Some passages suggest that he believes that shareholders, as the owners of a firm, ought to have more control than they, in fact, do. That is, with the separation of ownership and control, which created a principal-agent relationship, shareholders became weak principals, who lost some of their rightful power to stronger manager-agents. In the useful discussion of the importance of bargaining power, Guthrie also suggests that managers have a strong, possibly unfair, advantage over their weaker adversary.
Guthrie notes, for example, that individual shareholders lack an incentive to sponsor resolutions at annual meetings since they would bear all the costs but reap only a proportionate share of the benefits. Many conflicts involve cases in which shareholders believe that management breached a fiduciary duty to act in their interest and to fulfil a required corporate objective of maximizing shareholder value. Furthermore, if managers really are agents of shareholder-principals, then shareholder voices ought to be heard, loud and clear. Guthrie cites, without comment, a remark by the president of the Business Roundtable: “Corporations were never designed to be democracies” (239). The extensive focus of the book on the dismissive treatment of shareholders at annual meetings suggests that more democracy would be in order.
The lack of a substantial discussion in the book of normative concerns about the rightful roles of shareholders, managers, and other participants in the governance firms is of little consequence, except insofar as readers might assume an incorrect view of these roles and hold, in particular, that shareholders are being badly mistreated. The extensive literature on the theory of corporate governance dismisses the naïve view that shareholders are owners of a corporation in any meaningful sense with a right to almost complete control. On the standard economic analysis of corporate governance, shareholders have some right of control as a condition of their provision of equity capital, but this right is limited largely to matters that affect their claim on profits; further, control rights are typically those offered by firms in bargaining over the input of equity capital, and these rights can vary from one firm to another. The ideas that managers have a legal fiduciary duty to operate the firm with the objective of maximizing shareholder wealth and that managers are agents of shareholder principals in a legal sense have also been qualified in the literature so as to sharply limit shareholder rights.
The theoretical literature on corporate governance has given us more nuanced views of the roles not only of shareholders and managers but also of boards of directors. Although boards receive a substantial amount of attention in The Firm Divided, they are viewed mostly as agents, beholden, like managers, to direction from their shareholder-principals. In manager-shareholder conflicts, the book pictures boards as either grouped with managers, as targets of shareholder wrath, or else as innocent bystanders, caught in the middle of the turmoil. Some recent academic studies suggest that modern corporate America has moved beyond management-focused corporations to an emerging board-centered system of governance. Perhaps the firm should be described in the book as divided three ways, instead of just two.
Even the relevance of principal-agent theory for an analysis of corporate governance has been questioned in the recent literature. If weak principals and strong agents are major impediments to organizing production in a modern corporation, then the focus of corporate governance should be, as it has been, on reducing costs in the principal-agent relationship between shareholders and managers. However, another impediment in organizing production is the hold-up problem, which occurs when other input providers besides investors are reluctant to cooperate, partly from fear that overly strong shareholders will not permit them a fair return. The resulting team production theory provides an alternative to principal-agent theory in creating a role for boards of directors. Instead of being agents for shareholders, boards in the team production theory are “mediating hierarchs,” who induce all input providers to cooperate by ensuring that returns are distributed fairly.
To return to the mystery about corporate control, why anyone would want it, let alone fight for it, economic theory provides one answer: It is valuable to shareholders to secure their claim on profits, which is the return on their input of equity capital. And their role in corporate governance is limited largely to the rights necessary to protect this claim. Other parties—directors, managers, and other groups to whom control is delegated—receive compensation for their decision-making services. Decision-making services are merely one input needed by a firm, and as long as every input provider for all the inputs required for production is fairly compensated, no conflict need arise. In theory, the firm should be a harmonious wealth creator for everyone. Also, in theory, if any group—dissident shareholders, activist investors, or corporate raiders—think a firm under their management would create more value, they are free to compete for control, and if they succeed, everyone is even better served.
In practice, however, control confers some power to allocate the wealth created by a firm. Shareholders, managers, activist investors, corporate raiders, even workers and the public have opportunities to seek more than their fair share—at the expense of other groups. Seizing these opportunities is, in economic terms, rent seeking. Firms are divided in many ways, not just between managers and shareholders, and the fight for corporate control takes many forms, including the current concerns about wage stagnation and wealth inequality. Distinguishing between fair distributions and rent seeking in a market economy is an extremely difficult task. The Firm Divided makes a valuable contribution to this task by describing one specific conflict, between managers and shareholders, but the book offers little guidance for answering important normative questions about the justified roles of these two groups and for evaluating outcomes in the fights for corporate control.
