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Most cited: Shareholder governance as accepted wisdom

by Robert Teitelman | Published June 8, 2012 at 11:15 AM

Hollywood has its Academy Awards, legal academia has The Most Cited Law-Review Articles of All Time. The latter ranking, the third ever (pioneered by Fred Shapiro, a legal librarian at Yale Law School, who was helped this time by Harvard Law School librarian Michelle Pearse) is not televised, but it does get the law professors, a notoriously competitive bunch, excited, particularly if they find their names there (see Stephen Bainbridge's reaction). Just a few days ago, The Harvard Law School Forum on Corporate Governance and Financial Regulation, rocketed off an e-mail touting five corporate law articles from current Harvard law professors on the list: Lucian Bebchuk (2), Mark Roe (1) and Reinier Kraakman (2). One of Kraakman's papers, with NYU Law School's Henry Hansmann, caught my eye: a 2000 article with the catchy title "The End of History for Corporate Law."

Why that one? Well, obviously, there's the allusion in the title to Francis Fukuyama's book, "The End of History and the Last Man," which posited that liberal democracy and free markets had attained such a stage of optimality that debates and discord over political structures could now end. The years since Fukuyama's original essay and book have not been kind to that thesis. Since the book was published in 1992, there has been a lot of history in the literal sense and a lot of debate over liberal democracy in Fukuyama's particular Hegelian sense. Even Fukuyama himself has conceded some flaws in his convergence thesis. Hansmann and Kraakman's article pivots off Fukuyama and argues for convergence in corporate governance to what they call the "standard" or shareholder governance model. In fact, their very notion that this is the standard model suggests a kind of inevitability to shareholder governance in which all debate must cease and acceptance of the shareholder-centered "ideology" (their term) must take place.

But like Fukuyama, convergence in governance looks a lot less inevitable and powerful from the perspective of 2012. It's not that there are any truly competitive models to shareholder governance in the U.S. -- although attempts are regularly made to bring back some variant of stakeholder governance -- but what is manifestly true is that the model has been beaten and battered by, well, history. Reading their paper today brings back an era where the Washington Consensus was still going strong, Fukuyama's thesis still seemed viable, and American hegemony in the world (and all that that implied) was still taken for granted. In 2000, the dot-com and telecom bull market was peaking; the Clinton administration was basking in surpluses; growth and productivity was high, unemployment low. The dot-com bust was a year ahead. Enron, WorldCom and Tyco were still admired corporations. China was not a huge American creditor, real estate was not a bubble, and credit default swaps and collateralized debt obligations were as arcane and unregulated as Osama bin Laden. Europe had recently adopted the euro and was flush with success.

Shareholder governance was a part of that consensus triumphalism. "Although there remained a considerable room for variation in governance practices ... the pressures for further convergence are now rapidly growing. Chief among these pressures is the recent dominance of a shareholder-centered ideology of corporate law among the business, government and legal elites in key commercial jurisdictions. There is no longer any serious competition for the view that corporate law should principally strive to increase long-term shareholder value (my italics)." Other governance models -- managerial, labor-oriented, state-oriented and a combination of them all: stakeholder governance -- had been felled by the appeal and the success of the shareholder model. They each had their day but they lost out as a "normative ideal." What is this normative ideal? This is the notion of elite consensus. The shareholder model has triumphed because it has achieved the greatest acceptance -- it has become the conventional or received wisdom. Shareholder-centered governance wins because it has, well, won. And in winning, it has stepped out of history, becoming a kind of Platonic ideal, or a final Hegelian stage of progress. All this despite the fact that Hansmann and Kraakman admit that other normative ideals have been adopted in other eras. "In the U.S., there existed an important strain of normative thought from the 1930s through the 1960s that extolled the virtues of granting substantial discretion to the managers of large business corporations." But that normative ideal fell with the failure of the conglomerates in the '70s, to be replaced by another normative ideal. "It is now the conventional wisdom that when managers are given great discretion over corporate investment policies, they mostly end up serving themselves, however well-intentioned they may be."

Other examples of this kind of circular argument abound. Shareholder governance has won because it is more efficient. But because measuring corporate efficiency, particularly in a comparative way, is difficult, Hansmann and Kraakman lean on the accepted identity of shareholder governance with performance. This appears in a lot of governance research. The complex world of the corporation is reduced to a series of governance practices, which researchers then attempt to show has some connection, or correlation, with efficiency and growth. The "proof" is always circumstantial. Accepted governance practices become synonymous with "value-enhancing practices." Other factors -- managerial skill, culture, innovation -- submerge; only governance structures matter. Other models are viewed as de facto old, obsolete and inefficient. "Viewed through the lens of the new ideology, the old practices are not only inefficient but unjust, since they deprive ordinary citizens, including pensioners and small investors, a fair return on their investments." What is a fair return? What is unjust in terms of investments? (Is it unjust to charge pensioners high fees?) Their use of ideology in hindsight is revealing. Nowhere in this paper do they offer a shred of evidence as to the efficiency, performance or "fair return" of the shareholder governance. It's normative, which may also speak to why it has been cited enough to make the cut.

In one case they argue that "proof" here involves "a simple comparison across countries adhering to different models -- at least in very recent years (again, my italics)." In short, the U.S. has outperformed East Asia and Europe, "which are less in alignment with the standard model." Hansmann and Kraakman compare American performance to German, Japanese and French economies. There is no mention of China, India, Brazil South Korea, Singapore or any of the emerging economies, most of which don't adhere tightly to the standard model. "One might, to be sure, object that the success of the shareholder-oriented model will perhaps prove to be ephemeral, and that the apparently normative consensus based on success will be ephemeral as well." They dismiss such doubts. "But this is probably a mistaken interpretation of the nature of economic competition in recent decades and is surely at odds with today's prevailing opinion." And, of course, the prevailing opinion is always right.

What's interesting here, of course, is not whether governance practices determine corporate performance or whether the shareholder model is better than the state or managerial model; those debates remain open. Rather, it's their twinned notions that the "best" model is determined by normative acceptance, and that acceptance, at least in this case, is, like Fukuyama's liberal democracy and free markets, beyond dispute -- if not perfect, at least optimal, that is better than competitive models. End of discussion. At the core of this is the belief that shareholders constitute, as they say, a "coherent interest group" which not only should benefit from rights of ownership, particularly since shareholding has grown so broad, but that whatever shareholders desire in terms of performance is, de facto, the best and most efficient use of resources. Let us quibble. Shareholders do not constitute a coherent group; their interests diverge radically, from short-term hedge funds and high-frequency traders to indexers to long-term holders. Measuring shareholder interest by stock price is a form of necromancy. Most shareholders also do not act like owners, leaving the power to those that do. Many shareholders do not care about issues that agitate governance groups, like executive pay or, in terms of financial firms, excessive risk. Ownership requires accountability. And shareholders are rarely held even partially accountable for the disasters that occurred since this paper was published: the bubbles, the crashes, the corruption, the broader economic failures. The very fact that more and more shares are traded more and more frequently should raise questions -- as the state-oriented Asians have -- about the underlying model.

It's true; we're not going back to a stakeholder model any time soon. But it's false that in this highly diverse world of ours variants on the shareholder-centered model have not prospered. That's not to say that these other models won't evolve and fade as conditions change. There is no perfect, eternal governance model for corporations. Indeed, to declare that, which seems now so very legalistic, so very American and so very lost in time is to seal its fate. Rigid eternal mechanisms -- shareholder governance, the gold standard, the current version of the euro zone, legal doctrine itself -- will eventually collapse of their own weight. That's not a normative opinion, but an historical one. - Robert Teitelman

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