04.bebchuk.case empowering shareholders

8/18/2019 04.Bebchuk.case Empowering Shareholders

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Abstract

This paper reconsiders the basic allocation of power betweenmanagement and shareholders in publicly traded companies. U.S.corporate law has long precluded shareholders in such companies

from directly intervening in any major corporate decisions. I arguethat the case for such insulation is weak, and I put forward a regimein which shareholders have the power to initiate, and approve byvote, major corporate decisions.roviding shareholders with the power to intervene can signi!cantlyaddress important governance problems that have long occupiedthe attention of corporate law scholars and !nancial economists. Inparticular, shareholder power to make "rules#of#the#game$ decisions% to amend the corporate charter or change the state ofincorporation%would ensure that corporate governancearrangements change over time in ways that serve shareholderinterests. Shareholder power to make "game#ending$ decisions% tomerge, sell all assets, or dissolve%would address managers&e'cessive tendency to retain their independence. (inally,Shareholder power to make "scaling#down$ decisions%to contractthe company&s si)e by ordering a cash or in#kind distribution%wouldaddress problems of empire building and free cash *ow. A regimewith shareholder power to intervene could greatly improvecorporate governance.

+eywords corporate law, corporate governance, investors,

shareholders, managers, directors, boards, stakeholders, agencycosts, mergers, takeovers, ac-uisitions, pro'y contests, corporatecharters, charter amendments, regulatory competition, elaware,state competition, dividends, distributions, free cash *ow, empire#building, myopia, short#termism, corporate reform. /01 classi!cation 23, 453, 456, 457, 458, +66. 9 1ucian :ebchuk6337. All rights reserved.


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U.S. 1aw

Rules-of-the-Game Decisions

Game-Ending Decisions

Scaling-Down Decisions

The iCerent Approach of ;ther S& 0BISTI=4 ;@0>S

reliminary >emarks on the olicy Duestion

The ower to >eplace irectors

Elections and Decisions

The Problem of BundlingThe Chrysler Examle

!mediments to Relacing Directors

Shareholders& Eeto ower ;ver (undamental 0?;10> ;@0> T; I=T0>E0=0

Rules-of-the-Game Decisions


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!ssues Co'ered

!mro'ing Cororate (rrangements

Cororate Charters

Fb) Reincororation Decisions and State $aw Rules

4ame#0nding ecisions

!ssues Co'ered


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(ddressing the "anagerial Bias Toward Retaining Control

Ex Post E*ects

Ex (nte Bene+ts

Scaling#own ecisions

!ssues Co'ered

(ddressing Emire-Building and ,ree-Cash-,low Problems

Emire-Building and ,ree-Cash-,low Problems

Sueriority to the se of Debt

Sueriority to Stricter .udicial Re'iew

0Cectiveness and esign

/ill Proosals be !nitiated0

/ill Shareholders &ote (gainst "anagement0

!t1s the !ndirect Bene+ts2 Stuid

3uisance Proosals

4ortunistic Proosals

"anagement Counter-Proosals

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Imperfect Information

The


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The u))ling Scope of the Stakeholder Interests


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"irectors are thus supreme during their time. . . . Hirectors, whilein oJce, have almost complete discretion in managementK and

most of the general corporation acts in terms so provide.$L

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This paper -uestions the basic allocation of power betweenmanagement and shareholders under U.S. corporate law. I arguethat the considerable weakness of shareholders in companies withdispersed ownership is not all due to the dispersion of ownershipK itis at partly due to the legal rules insulating management fromshareholder intervention. I also present the case for grantingshareholders the power to initiate, and approve by vote, majorcorporate decisions. 4ranting such power would address importantagency problems that have long aMicted publicly traded companies,considerably improving corporate governance.


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The major corporate decisions for which I will consider shareholderintervention power can be usefully grouped into three categories FiP"rules#of#the#game$ decisions to amend the corporate charter orchange the company&s state of incorporationK FiiP "game#ending$decisions to merge, sell all assets, or dissolveK and FiiiP "scaling#

down$ decisions to contract the si)e of the company&s assets byordering a cash or in#kind distribution. These three types ofdecisions are those for which shareholder power to intervene isworth e'amining.

art II describes the absence of intervention power under e'istingand long#standing corporate law principles. 1ong#standing principlesof U.S. corporate law grant management a decisive say with respect

to all three categories of major corporate decisions.7 Although rules#of#the#game decisions and game#ending decisions generally re-uire

a vote of shareholder approval, only the board can initiate suchvotes. As for scaling#down decisions — and the decisions withrespect to the corporate distributions they involve — these aresolely the prerogative of the board.

To be sure, shareholders in the American public corporation are notpowerless. Their power lies in their right to vote on the election ofdirectors. The U.S. corporation can be regarded as a completely"representative democracy$ in which the members of the polity can

act only through their representatives and never directly. Theunderlying view is that, as long as shareholders have the power to

replace the directors, corporate decisions can be e'pected to beattentive to shareholders& wishes and not to stray far from them.

art III e'plains, however, why the power to elect directors and thepower to veto fundamental corporate changes are insuJcient toensure that shareholders generally have their way. To begin with,shareholders might be pleased with management&s generalperformance but still want to make a particular decision inopposition to management&s wishes. Suppose that shareholderswould like both to have management continue running the

7 (or an account of the current division of power, see owe, "ills, olls and rofessors A reply torofessor 4ilson,$ Delaware .ournal of Cororate $aw F6336P.


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company and have the charter amended, but management does notwish to make the desired amendment. If a competing managementteam were to run a pro'y contest promising to initiate the charteramendment, shareholders& power to replace directors would providethem with a choice between FiP having the current, preferred

management team without the desired charter amendment, and FiiPhaving the desired amendment but with a diCerent managementteam. The power to replace directors would not enable shareholdersto have their most preferred outcome, which is FiiiP having both thecurrent preferred management team and the desired charteramendment.(urthermore, using the power to replace directors in order to get thedesired charter amendment would itself be hindered by the factthat, in most publicly traded companies, the board is classi!ed, withonly a third of its members changing each annual election.


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It should be stressed that, while I believe intervention power isdesirable in each of these three categories, the choice is not limitedto having intervention power in all of them or none of themK readersmay conclude that they support intervention power for some ofthese decisions but not for others. Indeed, judging from reactions in

presentations of an earlier version of this paper, the proposedintervention power wins support most easily when applied to rule#of#the game decisions and meets most resistance when applied toscaling#down decisions.

@hat the three categories have in common is that they all involvedecisions that are suJciently important so that shareholders mightrealistically wish to use their intervention power. (urthermore,granting shareholders the power to intervene in the decisions ineach of these categories is likely to address substantial distortionsand ineJciencies. The category of "rules#of#the game$ decisions consists of decisionsto amend the corporate charter or to reincorporate in another jurisdiction. These are "constitutional$ decisions that aCect thecorporate governance arrangements to which the company will besubject. @ithout shareholder intervention power, management&smonopoly over initiating such changes might well lead to ineJcientcorporate governance arrangements. 4iving shareholders the powerto intervene in this area can produce, in one bold stroke, asubstantial improvement in the -uality of corporate governancearrangements over time.

Thus, shareholder power to make rules#of#the#game decisions wouldby itself ensure that the arrangements governing any othercorporate law issue do not considerably depart from the onesdesired by shareholders. A main reason for why corporategovernance failures need to be addressed by corporate law reform,as recent legislation has done, is that shareholders in large, publiclytraded companies lack the power to intervene and change e'istingarrangements. @ith shareholder power to intervene, desiredchanges

did not attempt to provide an analytic framework for assessing shareholderpower to intervene in a broad set of corporate decisions. These early worksinclude /ohn


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can be e'pected to occur commonly without such outside legalintervention. (or e'ample, shareholders concerned about recentgovernance failures would be able to eCect, should they wish to doso, charter amendments that improve the process by whiche'ecutive pay is set, re-uire separation between the


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from nuisance and opportunistic proposals and that would facilitatecounter#proposals to ensure that the best outcome is generallyattained.

art E and art EI turn to e'amining potential objections to granting

shareholders the power to intervene. I attempt to e'amine the fullrange of possible arguments that can be made against shareholderintervention. After reviewing all the arguments that have beenmade in the literature as well as others that could be made, Iconclude that these arguments, either individually or incombination, are hardly compelling.

art E e'amines claims that having the power to intervene would infact hurt shareholders rather than bene!t them. The e'istence ofsuch power, the argument goes, would produce substantial coststhat would make it overall undesirable. ;n this view, shareholders

would be better oC if their hands were tied. To begin, it can be argued that, because management has superiorinformation, shareholders would be better oC if management alwaysmakes corporate decisions. roviding shareholders with the powerto intervene, however, hardly implies that management&sinformation would be unused. anagement could still communicateits information, or at least its recommendation, to the shareholders.Shareholders would intervene only in those occasions in which theyconclude that it would be desirable to do so notwithstandingdirectors& superior information. enying shareholders the power to

intervene implies that, instead of letting shareholders decidewhether to defer to management, deference is mandated. In today&scapital markets, such paternalistic "hand#tying$ is unlikely to bene!tshareholders. andated deference should not be e'pected toproduce for shareholders better results overall than lettingshareholders decide for themselves whether to defer. It thereforemay well be undesirable to compel them to defer to management.Second, it can be argued that consistency in decision#makingre-uires that shareholders leave decisions to management forreasons similar to those that counsel against back#seat driving. Thisargument, however, is inapplicable to game#ending decisions. Such

decisions should be analogi)ed not to back#seat driving but rather todecisions to sell the car, terminating the driver&s hold on the wheel.(urthermore, decisions in the rules#of#the#game and scaling#downcategories are often separable from those concerning managementof e'isting operating assets. As a result, considerations ofconsistency in decision#making have limited force with respect tothese two categories of corporate decisions as well. In any event,giving shareholders

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the power to intervene just implies that these considerations wouldget whatever weight shareholders would !nd appropriate.

Addressing claims that intervention power would produce disruptivesocial choice cycling, I show that such cycles are unlikely to present

a signi!cant problem and can in any event be addressed within aregime of intervention. As for objections that companies wouldprivately adopt such a regime if it were value#enhancing, I point outthat adopting such a regime is largely precluded by the laws of moststate corporate law codes. (urthermore, I; !rms can hardly bee'pected to adopt arrangements that are unconventional andradically diCerent from those in use. I conclude that none of theobjections considered provides a basis for denying shareholders thepower to intervene.

(inally, art EI e'amines arguments based on the protection of non#

shareholder constituencies. 0ven assuming that stakeholders shouldget some protection beyond what is accorded by their contracts,support for board control does not follow. Insulating the board fromshareholder intervention would not be a good way to protectstakeholders. The overlap between the interests of managementand those of stakeholders is hardly such that management can berelied upon to use its powers to protect stakeholders. anagementis unlikely to use its power to protect stakeholders. Therefore, thoseinterested in stakeholder protection should seek arrangementstailored speci!cally to address this concern. Stakeholder concerns

thus do not provide a good basis for e'panding the discretionarypower of management in the hope that this would somehow work tothe bene!t of stakeholders.

The analysis of the paper indicates that the current weakness ofshareholders in U.S. companies with dispersed ownership is not anecessary product of the dispersion of ownership. The current powerof management and weakness of shareholders is at least in part dueto the legal rules in place that insulate management and precludeshareholders from intervening. 0ven given the e'isting patterns ofownership, providing shareholders wit the power to intervene would

substantially strengthen their power vis##vis management.

This understanding of the sources of shareholder weaknesscomplements an in*uential view that views legal rules as partlyresponsible for the dispersed ownership in publicly traded

companies.2 According to this view, this dispersion of ownership,which weakened shareholders, was at

2 See ark >oe, Strong "anagers2 /ea% 4wners FLOO7P.


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least partly due to U.S. legal rules that prevented or discouragedthe holdings of large blocks by !nancial institutions. As I show in thispaper, even given dispersed ownership, shareholder interests couldhave substantially more in*uence than at present. Thus, in additionto the rules that produce dispersed ownership, another set of rules

plays a key role in making U.S. shareholders weak % the rulesdenying shareholders the power to intervene. 0ven with the e'istingpatterns of ownership, introducing shareholder power to intervenewould considerably change the balance of power betweenmanagement and shareholders and thereby have profound andlargely bene!cial impact on corporate governance.:efore proceeding, I should stress that my aim in this paper is not toprovide a complete and precise blueprint for a regime ofshareholders power to intervene. >ather, I seek only to put forwardthe general case for such a regime. To this end, I aim todemonstrate the main problems with management insulation fromshareholder intervention, to outline an alternative regime, and toidentify the potential bene!ts and design choices of such analternative regime. This analysis, I hope, will provide a frameworkfor subse-uent discussion of a possible reallocation of power inpublicly traded companies.

II. T?0 0BISTI=4 A11;

This art discusses the e'isting allocation of power betweenmanagement and shareholders. Section A describes the managerial

principles underlying U.S. corporate law. To highlight the e'tent towhich this principle is not a corollary of the nature of the moderncorporation, Section : describes how the legal rules of the U.+. andsome other common law countries, which also have a large numberof publicly traded companies with dispersed shareholders, take adiCerent approach.

(6 6S6 $ (/

The corporate laws of both the U.S. and the U.+. start with the samebasic principle 0ven though they are the ones supplying the funds,shareholders do not necessarily have the power to order thedirectors to follow any particular course of action. >ather, thepowers of shareholders are

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determined by the corporate code and the company&s constitution.8 ?owever, the U.S. and the U.+. diCer in the regimes supplied bytheir codes.

1et us start with the U.S., whose approach can be viewed as

managerialist. @hile the U.S. has diCerent codes for diCerent states,there are in fact many similarities among the diCerent statutes, both

in general and with respect to our subject in particular.O (orconcreteness, I shall focus below on the


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:usiness


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76 Rules-of-the-Game Decisions

">ules#of#the#game$ decisions are decisions concerning the rules bywhich corporate players play. The corporate governancearrangements of a company come from two sources the corporate

charter and the laws of the company&s state of incorporation. :oththe charter and the state of incorporation can be changed, but suchchanges generally re-uire initiation by management. The rules governing charter amendments are similar to thosegoverning termination decisions. Such amendments re-uireshareholder approval by a majority of the outstanding stocks, butvoting can take place only on proposals brought by the board ofdirectors. Shareholders cannot initiate charter amendment

proposals and bring them to a vote.LL

As for the state of incorporation, no state statute e'plicitly sets forth

a procedure for reincorporating in other states. >eincorporation isgenerally accomplished by merging the corporation into a shellcorporation incorporated in the desired new state of incorporation.Since state statutes allow for merger with a corporationincorporated in another state, it is possible to create a companythat is identical in every respect but is simply incorporatedelsewhere. As reincorporating takes procedurally the form of amerger, the rules governing merger decisions apply. Thus, underelaware law, reincorporation re-uires a shareholder vote of

approval, but only the board can initiate such a vote.L6

(inally, it is worth noting that, under current rules, shareholdershave the concurrent authority with the board to amend the

company&s by#laws.L5 The by#laws, however, are subordinate to thecharter and cannot alter any of the arrangements set in the charter. Thus, surprisingly, while shareholders have power to intervene insecond#order rules, they are denied the power to intervene in high#

level rules.L7

See, e.g., elaware 4eneral evised odel:usiness


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6. Game-Ending Decisions

:y "4ame#ending$ decisions I will refer throughout to terminationdecisions that will bring to an end the e'istence of the company

andWor its business. This category thus includes merger andconsolidation decisions, as well as dissolution decisions anddecisions to sell all assets.

Shareholders generally have a say in termination transactions,which usually re-uire a vote of approval by a majority of theoutstanding shares. :ut the power granted to shareholders is only aveto power. Shareholders lack the power to initiate terminationdecisions. =o matter how much they want it, shareholders cannotforce management to consider a termination decision. Shareholders&role is a passive one they can block a termination decision initiatedby management, but they cannot compel management to proceedwith a termination or even to consider a termination.

Under elaware law, the !rst step in a merger or consolidationtransaction must be the approval of a merger agreement by theboard. After such approval, the merger agreement is brought to avote of the stockholders at an annual or special meeting and must

receive approval by a majority of the outstanding stock.L elawarelaw does not permit shareholders to initiate merger transactions bysubmitting them for approval by the board or even by a shareholder

meeting. elaware law applies similar arrangements to bothli-uidation decisions and decisions to sell all corporate assets.LQ Indeed, the elaware code speci!cally authori)es the board toabandon a merger or a proposed sale of assets that received prior

approval from the shareholders.L2

See elaware 4eneral


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stockholders.

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86 Scaling-Down Decisions

A third important category includes decisions to distribute value toshareholders, thus scaling down the scope of the company.istributions can be made in cash or in kind Ffor e'ample, in the

stock of a subsidiary in the case of a spin#oCP. Under elaware lawand the law of other states, the power to declare dividends isgranted e'clusively to the board, and no shareholder approval is

re-uired.L8 @ith respect to dividend decisions, shareholders lack notonly initiative power concerning dividends but also the veto powerthey have over termination decisions. ividend decisions are viewedas matters fully reserved for management&s business judgment, andcourts are not willing to subject dividend decisions to judicial

scrutiny.LO

The view underlying this approach is that decisions on dividendpolicy do not represent the kind of fundamental change that callsfor shareholder veto. >ather, such decisions are viewed as part ofthe ordinary conduct of business delegated to the sole prerogativeof management.


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See +amin vs. American 0'pressK Eictor A. :rudney, "ividends, iscretion,and isclosure,$ QQ &irginia $aw Re'iew FLO83P.

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large number of publicly#traded companies with dispersed

ownership,6L and these are the companies for which the subjectunder consideration is important.

As in the U.S., shareholders in the U.+. do not have unlimited power,

but only the powers granted to them by law and the corporatecharter.66 Still, U.+. law provides shareholders with greater powerthan U.S. law and, in particular, provides them with some power ofintervention. To be sure, U.+. companies are also run in the ordinary course ofevents by their boards. The default arrangement, which is providedby model provisions of the article of association supplied by the


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Article 23, Table A, The ule 66QA and Section L5F6P to the


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management of the corporation.62 (urthermore, shareholdersalways have the inalienable right to make any corporate decisionsby adopting a special resolution with the re-uired 2X majority.

;ther common law countries follow a similar approach.68

To be sure, these common law countries still have some preferencefor shareholder action through replacing the board. U.+. specialresolutions, for e'ample, re-uire a majority of 2X of the vote,whereas replacing the board re-uires only a simple majority. :ut allof these countries provide some power of intervention despite thefact that, unlike the case in most U.S. companies, shareholders intheir companies can -uickly replace all the directors. The diCerentapproach of these common law countries clearly indicates thatmoving away from strong board control is not inconceivable. @iththis in mind, I now turn to evaluating the policy arguments.

T?0 1IITS ;( S?A>0?;10>S& 0BISTI=4 ;@0>S

(6 Preliminary Remar%s on the Policy #uestion

:efore proceeding to e'amine the arguments for and againstshareholder power of intervention, several preliminary observationsare worth making. To begin, the starting point of my analysis is that,in publicly traded companies with dispersed ownership,management&s interests do not fully overlap with those of

shareholders and, as a result, agency costs might arise.6O There are,of course, factors that lead management to care about shareholderinterests, from e'ecutive compensation schemes to the inherent

trustworthiness and integrity of directors.53 And one who believesthat these

=ote that Section L5QF5P authori)es the corporate constitution to specifyadditional re-uirements, beyond the re-uirement of a special shareholderresolution, for its own amendment. This makes the Australian regime fullyenabling.

:oth


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factors lead to perfect aligning of interests between managementand shareholders should, of course, have no interest in shareholderpower of intervention or any other measure seeking to improvecorporate governance.

The assumption underlying this work, as well as much of the work inthe corporate governance area, is that these factors are notsuJcient to eliminate all agency problems. 4iven the e'istence ofagency problems, it is desirable to have rules in place that wouldaim at reducing agency costs as much as possible. (rom thisperspective, the case against shareholder intervention should notbe based on ignoring agency problems. >ather, it should be madeby showing that such problems are best addressed by a regimewithout shareholder intervention.

Second, it is worth keeping in mind that, in certain conte'ts, those

who own assets that are managed by someone else generally havethe power to intervene. If the owner of, say, a building in Seattlewere to hire a manager#agent to run the property, the owner wouldhave, under the established principles of agency law, the power tointervene from time to time, instructing the manager to take a

certain course of action For inactionP.5L To be sure, the building&sowner might often elect not to intervene, believing that the Seattlemanager is better informed. There is no -uestion, however, that inthose instances in which the owner elects to intervene and instructthe manager how to act, the manager will not be able to ignore the

owner&s instructions. Although the owner might make decisions thatwill prove regrettable, the owner has the full legal power todetermine what its interests are and what course of action wouldfurther them.

>ock, QO 6 Chi6 $6 Re' . 82L F6336P. (or discussion that take the view orassume that directors can be trusted to do what is good for shareholders, see

Stepehen . :ainbridge, irector rimacy The eans and 0nds of


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his principal&s wishes.$ ?. >euschlein R @. 4regory, Agency and artnershipLL#L6 FLO2OP.

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In the case of corporate managers, however, the law has chosen to

take a diCerent approach.56 Unlike the owner of the Seattle building,shareholders cannot instruct managers to sell the assets Fthey canonly veto an initiative of management to sell the assetsP ordistribute the cash produced by the assets rather than reinvest it.

The -uestion, then, is whether taking such a diCerent approach inthe case of corporate managers is warranted. Thus, in e'aminingbelow the arguments for management control, it will be helpful toconsider whether they have greater force in the corporate conte'tthan in other conte'ts in which assets are managed by someoneother than their owner.

Third, it is worth noting at the outset that shareholdernonintervention is not re-uired in order to obtain the bene!ts ofcentrali)ed management. As ean obert


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See


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such matters that shareholders can plausibly be e'pected to havesuJcient incentive to initiate and vote over management&sopposition.

The subse-uent Sections of this art consider arguments that, at

least with respect to such key decisions, shareholder power tointervene is not necessary to ensure that they are made inaccordance with shareholder preferences. @henever shareholdershave a clear preference for a certain important corporate decision,the argument goes, the e'isting powers of shareholders aresuJcient to ensure that management will make the decisionfavored by shareholders. ;n this view, management cannot bee'pected to stray from shareholders& wishes because such strayingwould be prevented by shareholders& powers to replace directorsand veto fundamental corporate changes. :elow, I consider each ofthese two basic powers in turn, and I e'plain why they areinsuJcient Fseparately as well as in combinationP to ensure thatshareholders generally have their way on issues of importance tothem.

The Power to Relace Directors

Elections and Decisions

The strongest and most important mechanism that arguably couldensure that shareholder interests are served is the shareholder

franchise%the power of shareholders to elect the directors. Thispower is one that corporate statutes provide57 and that courts view

as fundamental element of the corporate structure.5

The power to replace directors, it might be argued, can ensure thatshareholders have their way with respect to all matters that aresigni!cant to them and on which they have clear preferences. Ifmanagement does not follow shareholder preferences with respectto such matters, the argument goes, then shareholders will replacethe management team with one that will do so. (urthermore,

shareholders& power to replace management will ensure thatmanagement generally heeds shareholders& preferences to beginwith, making replacement unnecessary. Thus, on this view, even ifactual replacement of the current directors happens infre-uently,the power of

See, e.g., elaware 4eneral


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push management to take action A. anagement will refrain fromtaking action A, because management will know it will be able toremain in oJce even without taking this action.

Suppose ne't that the bene!t from action A is viewed by

shareholders as larger than the advantage of current managementremaining in charge. In such a case, if the e'isting managementdoes not recogni)e the intensity of shareholder preferences, a pro'ycontest will be able to succeed and the challenger team promisingto take action A will gain control. In this case, the shareholders willagain not secure their most preferred outcome%they will get actionA but without their preferred management team.

There remains the case in which action A is suJciently important toinduce voting for a challenger and in which management recogni)esthe danger. In this case, the threat of ouster might lead

management to change it ways. =onetheless, even in this case, theoutcome most preferred to shareholders might well not be attained.Suppose that the action A is "divisible$ in that a more "moderate$version of it can be undertaken. In this case, management will beinduced to go in the direction of A up to a point that would besuJcient to make shareholders prefer to stay with currentmanagement. :ecause shareholders prefer to have the assetsmanaged by the current management rather than by the challengerteam, management would not need to fully match the challenger&spromise to adopt A%going part way might be suJcient to win the

contest. Thus, even in this case, shareholders& power to replacemanagement, although inducing management to move in thedirection desired by shareholders, would not be suJcient to securethe outcome most preferred by shareholders.

86 The Chrysler Examle

To emphasi)e the potential problems produced by the bundling ofdecisions and management teams, it might be useful to illustratethem with a concrete e'ample. To this end, let us consider +irk+erkorian&s well#known campaign to get


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LOO, +erkorian held Fthrough a company named TracindaPappro'imately L7X of


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there.$ See Nork ay Try a ro'y (ight for


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proposal regarding the single issue of distributing cash to

shareholders. 73 Such shareholders would have been happy to votefor distributing funds, if they could do so without supporting+erkorian&s management of the remaining operations. :ut this wasnot an option that the pro'y !ght provided.

Indeed, even though +erkorian had a signi!cant amount of stockhimself, and even though he championed a course of action thatwas seemingly favored by many shareholders, his chances of

winning a pro'y contest were viewed by observers as "slim.$7L 0ventually, after a protracted process, and facing an uphill battle inthe pro'y !ght, +erkorian reached a compromise with


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repurchases of [6 billion for the foreseeable future.

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hardly suJcient to secure fully the corporate decisions that are

most favored by shareholders. 75

:6 !mediments to Relacing Directors

In the corporate conte't there is an additional limitation, absent inthe ordinary case of assets not managed by their owners, on theability to use the power to replace management to induce it to takethe decisions desired by shareholders. In the Seattle buildinge'ample, the default arrangement would permit the owner toreplace the manager at will. To be sure, the owner might becontractually obligated to compensate the !red manager. Still,should the manager refuse to carry out some action desired by theowner, the owner would be able to -uickly replace the manager withsomeone who would do so. In publicly#traded companies, however,

the arrangement governing board elections often precludesshareholders from replacing management without much delay.

Indeed, in the corporate conte't, shareholders very often cannotvote to replace directors immediately. This would be possible only inthose companies in which shareholders have the power to call aspecial meeting or act by written consent and in which the board isnot staggered. @hen shareholders do not have the power to call aspecial meeting or to act by written consent, they will have to waitat least until the ne't meeting and, if the board is staggered, atleast until the annual meeting after ne't, which might be two years

down the road. Indeed, most U.S. companies have

75 Another e'ample of bundling, also with respect to "scaling#down$decisions, is that involving


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charters that would force shareholders to wait a signi!cant period of

time before they can vote management out. 77

@hether it is desirable to limit substantially the power to replacemanagers is a -uestion beyond the scope of this paper, and I leave

it for another occasion. (or our purposes, what is important is that,as long as this remains true for a large fraction of U.S. companies, itwill substantially limit the e'tent to which shareholders& power toelect directors will enable them to have their preferences followed.

Suppose again that decision A is desired by shareholders but wouldnot serve management&s private interests. And, to put aside theproblem of bundling, suppose that current management is viewedby shareholders as only marginally superior to a rival team. @ouldthe power of shareholders to vote on the election of directors ensure

that management is induced to adopt decision A right awayG If thecompany has a staggered board, management would not be muchthreatened by a pro'y !ght by a challenger promising to adopt A. Tobegin with, shareholders might be discouraged from voting for thechallenger by the knowledge that a victory by the challenger wouldinvolve some disharmony on the board for two years.(urthermore, the challenger might not persevere for two elections.In any event, why would management capitulate to the challenger&sdemand now instead of waiting a whileG 4iven that the issue mightbecome moot or otherwise goes away in the meantime, waitingmight well be management&s preferred strategy. And the

anticipation that a challenger might not win in the end if the issuebecomes moot or goes way, and that at the minimum it would haveto persevere for a long period, might discourage the initiation of apro'y contest to begin with.

C6 Shareholders1 &eto Power 4'er ,undamental Changes

Another power that shareholders have is to veto fundamentalcorporate changes. (undamental corporate changes%mergers,sales of all assets, charter amendments, and dissolutions%re-uire ashareholder vote of approval. This veto power, it might be argued,can ensure that at least all

77 See >obert aines and ichael +lausner, "o I;


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decisions regarding fundamental corporate changes will be made inthe interest of shareholders. As discussed below, however, this isnot the case.

76 Cases in which "anagement Prefers the Status #uo

Shareholders have the power to 'eto fundamental changes ratherthan the power to direct that they be made. There is considerablediCerence between these two powers. Eeto power ensures thatthere will be no fundamental changes that would make shareholdersworse oC compared with the status -uo. This is a "negative$ powerto prevent any worsening of the shareholders& situation. :ut thispower cannot ensure that fundamental changes that would besuperior to the status -uo for shareholders would indeed take place.In particular, when such a change is desired by the shareholders butmanagement prefers the status -uo, shareholders& veto power will

not enable them to obtain their desired fundamental change.ather, from the set of possible improvements over the status -uo, the selected choice will

be very much in*uenced by the preferences of management.Indeed, if there is a set of possible changes that would be preferableto the status -uo for both shareholders and managers, there isreason to e'pect that the one that will be selected will be the onemost preferred by managers and not the one most preferred byshareholders.

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surplus division, management and shareholders are not e-ualpartners in the adoption of fundamental corporate changes.anagement&s control over the agenda makes it the much strongerpartner and enables it to select which outcome would be chosenamong the constraint of the set of outcomes that improve upon the

status -uo.An e'ample can illustrate the potential signi!cance for corporategovernance of management&s agenda#setting power. Suppose that acompany is incorporated in its home state ? and that two states, Aand :, are trying to attract incorporations from ?#state companies.And suppose that, compared with the rules of ?, both A and : oCera set of rules that are better for both shareholders andmanagement. Suppose also that, compared with the rules of A, :&srules are favored by management and disfavored by shareholdersbecause : oCers certain "managerial$ rules that enable someineJcient e'traction of private bene!ts by management. In thiscase, the company can be e'pected to move to : rather than A. Ifmanagement brings a proposal to move to : to a shareholder vote,the shareholders%recogni)ing that a move to : is still better thanthe status -uo and that a move to A is not on the table %willapprove the move. (urthermore, because management is able tosecure reincorporation to the state oCering the managerial rule,states interested in attracting reincorporations have an incentive toadopt this rule.

86 Cases in which Shareholders $ac% &eto Power

(or completeness, it should be noted that, while shareholders haveveto power over game#ending decisions and rules#of#the#gamedecisions, U.S. corporate law does not grant them veto power overscaling#down decisions. The decision whether to make distributionsin cash or in#kind are solely the prerogative of the board, which isfree to make them without any need for shareholder approval. This absence of veto power, however, is not a source of concern forshareholders in practice. 4iven that incumbents have an incentiveto keep assets inside the company and not reduce the si)e of theempire, it seems plausible to assume that in cases in which even

incumbents would choose to distribute assets, shareholders wouldnot wish to oppose the distribution. This management tilt againstdistributions indicates that the problem for shareholders is not inthe distributions that management elects to do but in those that itavoids. Thus, while this tilt suggests that shareholder veto powerover distributions would not be of practical signi!cance forshareholders, it

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replacing the board is generally an uphill battle, it is conceivablethat shareholders might be suJciently interested in a termination ora scaling down that they would be willing to replace incumbentmanagement with a new team in order to achieve such a result.?owever, while changes in rules of the game may be signi!cant, in

light of the bundling phenomenon they are unlikely to be ofsuJcient weight to enable a challenger to win a pro'y contest onthat basis alone. @hen shareholders view the incumbent team asgenerally doing a good job, it is unlikely that they would vote for achallenger team solely because of its promise to initiate some givencharter amendment or reincorporation. (or this reason, shareholderpower to intervene in rules#of#the#game decisions can signi!cantlyimprove corporate arrangements.


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impose mandatory corporate law rules.7Q Second, short of adoptingmandatory rules, it has been suggested that, as new circumstancesarise, default corporate law should err on the side of arrangementsless favorable to management because of the diJculty of opting outof arrangements favored by management. @ith management

having control over charter amendments, if shareholders would liketo reverse a default chosen by public oJcials, such reversal can bee'pected if management disfavors the default but not if

management favors it.72

Taking as given the e'isting distortion in the charter amendmentprocess, it is desirable for corporate law to follow the aboveapproaches. :ut it might be better yet for corporate law to addressthe underlying problem by eliminating the underlying distortion infavor of management. roviding shareholders the power to

intervene in rules#of#the#game decisions would do this. @henshareholders are able to initiate charter amendments, they will beable to eCect value#increasing changes that management does notfavor for its own, private reasons. They will no longer !ndthemselves stuck with arrangements that they view as inferior butwhich they are powerless to change without management initiation.lus, against this background, management will be more likely toinitiate value#increasing amendments itself.


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incentives to states seeking to attract incorporations.78 :ecausemanagement plays such a key role in reincorporation decisions,states have an incentive to provide rules that management prefers.

In some -uestions of corporate law, where the interests of

shareholders and management suJciently overlap, this incentive ofstates does not adversely aCect shareholders. ?owever, withrespect to rules that have a substantial eCect on management&sprivate bene!ts of control, the incentive might lead states to oCerrules that are e'cessively favorable to management. (or e'ample,the incentive might lead states to oCer incumbents more protectionfrom hostile takeovers than is optimal for shareholders. Indeed,recent evidence shows that adopting antitakeover statutes enables

states to be more successful in the market for incorporations.7O States therefore have an incentive to adopt such statutes.

4ranting shareholders the power to intervene in rules#of#the#gamedecisions thus will not only improve reincorporation decisions but,perhaps more importantly, it will work to improve the corporate lawrules of the states among which a state of incorporation is chosen.@ith shareholders having the power to make reincorporationdecisions, the best strategy for a state seeking to attractincorporations will be to oCer the rules that best serve shareholders.As a result, states will have incentives to focus on shareholders&interests. The resulting improvement in the -uality of statecorporate law rules will considerably improve the arrangements

governing publicly traded companies.

B6 Game-Ending Decisions

76 !ssues Co'ered

There are several decisions that could terminate the e'istence of acompany&s business. A regime of shareholder intervention couldpermit shareholders to initiate and bring to a shareholder vote aproposal to FiP have a merger or consolidation with another

company, FiiP sell all of the assets to aSee 1ucian :ebchuk, \(ederalism and the


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certain buyer, or FiiiP dissolve the company. The initiative for ashareholder vote would not have to come from the board as isre-uired by e'isting rules. ;nce a proposal is brought to ashareholder vote and is approved by the re-uired majority, it wouldhave the same force and would be binding in the same way as

proposals that are approved under current rules.@ithout intervention power, shareholders are only able to get anac-uisition oCer accepted over the objection of management byaccepting a tender oCer. anagement has long sought to blockunsolicited tender oCers, and courts and lawmakers have permittedthem to engage in defensive tactics and, in particular, to maintain apoison pill. Under a view to which I subscribe, however, defensivetactics are acceptable only as an instrument of protectingshareholders from being pressured into tendering. ;n this view, inthe face of a tender oCer, it would be desirable to re-uiremanagement to redeem the poison pill in the event that the oCer

gains suJcient support in a shareholder vote. 3

0stablishing shareholder power to initiate a vote to approve anac-uisition oCer would be a simple and clean way to accomplish aresult that is substantively e-uivalent. The initiated vote woulde'press shareholders& undistorted choice on whether acceptance ofthe oCer is in their collective interest. Thus, providing shareholderswith the power to initiate proposals to accept ac-uisition oCerswould be a good way to resolve the long#standing debate ondefensive tactics.

=ote that the ability to vote on an ac-uisition proposal would oCersome *e'ibility that tender oCers do not currently oCer. Inparticular, the unsolicited tender oCers that now provide the onlyway to accomplish a transaction without management support donot always allow full reali)ation of the potential savings toshareholders from having the transaction structured as a ta'#freereorgani)ation. ermitting shareholders to bring ac-uisition oCers toa shareholder vote would enable the full reali)ation of ta' bene!tsthat are now possible only with merger agreements supported by

management.

3 See 1ucian :ebchuk, /ohn


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;ne -uestion worth considering is whether shareholders shouldhave not only the power to sell the company to a particular buyer,but also the possibility to direct that the company be sold through aspeci!ed auction procedure. @hether or not a particular buyer hasalready e'pressed interest in the company, shareholders might wish

to have an auction that would sell the company to the highestbidder. Under current rules, only management can start such aprocess. In a regime of shareholder intervention, however, it might

be worth permitting shareholders to begin such a process as well.L

(ddressing the "anagerial Bias Toward Retaining Control

Ex Post E*ects

;ne of the problems that has for long occupied legal scholars and!nancial economists concerns the bias of management in favor ofcontinuing the e'istence of their !rm. :ecause management enjoyssigni!cant private bene!ts that will be terminated if the companyceases to e'ist, termination might not serve management&sinterests. (or this reason, one must worry that management mightreject opportunities to terminate%via merger, sale, or dissolution%even if pursuing them would serve the interests of shareholders. Tobe sure, when termination would suJciently bene!t shareholders,e'ecutives& stock options might make it worthwhile for managementto facilitate termination. :ut there might be a range of cases inwhich the interests of shareholders and management diverge. To

use the language of nocal, termination decisions confront us with"the omnipresent specter that a board may be acting primarily in its

own interests.$6

The empirical evidence on ac-uisition oCers indicates thatmanagement decisions in this area produce signi!cant agencycosts. (or e'ample, studies indicate that, when directors of targetcompanies use their veto power to defeat oCers, shareholders onaverage e'perience a signi!cant

Another -uestion worth considering is who should carry out a terminationdecision that is initiated by shareholders and subse-uently approved in avote. Although the adoption of a termination decision would signal that theend of the company is in sight, it might be necessary in the meantime tohave people be in charge of carrying out the decision. ;ne possibility is toleave this to e'isting management and rely on its !duciary duties to induce itto carry out the termination in the best way possible. Another possibility is toallow shareholders to include as part of a proposed termination theappointment of a new team to carry out the termination.

Unocal, 7O5 A6d at O7.

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stock market loss. (or e'ample,


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negotiations,


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operating performance%including lower pro!t margins, return on

e-uity, and sales growth.Q3

There is also evidence that insulation from takeover threats resultsin greater consumption of private bene!ts by managers.

:orokhovich, :runarski, and arrino found that managers withstronger antitakeover defenses enjoy higher compensation levels.QL :ertrand and ullinathan obtained similar !ndings for managers

that are more protected due to antitakeover statutes.Q6 (inally,4ompers, Ishii, and etrick found that companies whose managersenjoy more protection from takeovers are more likely to engage in

empire building.Q5

C6 Scaling-Down Decisions

76 !ssues Co'ered

At present, all decisions concerning distributions are inmanagement&s hands. anagement may decide to distribute toshareholders a cash dividend or an in#kind dividend Fsay, in sharesof a subsidiaryP. Such decisions transfer assets from companycontrol into shareholder hands, in eCect reducing the si)e of theempire under management&s control.Under a regime of shareholder intervention, shareholdersthemselves would be able to initiate and approve distributions.

Shareholders, for e'ample, would be able to order the payment of a[6 billion dividend at the end of the year. Such a decision wouldspecify the amount of the dividend to be paid, the future recorddate Fto determine which shareholders have a dividendentitlementP, and the payment date. ;nce a distribution decisionpasses by vote, the company would be obligated to pay thedividend, just as if the board had made the decision. Thus, in thee'ample of


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would have enabled +erkorian to bring to a shareholder vote hisproposal to distribute the company&s cash hoard.

Under an intervention regime, shareholders would also be able toorder in#kind distributions, forcing the company to distribute, for

e'ample, its shares in a subsidiary. These decisions, too, wouldreduce the scale of the enterprise governed by management andwould remove some shareholder value from management control.

;ne -uestion worth considering is whether shareholders, in decidingto make a distribution, should be able to order a distribution ofnewly#issued securities or to mandate future dividends whoseamounts are as yet uncertain. (or e'ample, shareholders might begranted the power to order a distribution of new debt securitiesthat, once distributed, might compel management to startli-uidating assets to satisfy the claims of the new securities.

Shareholders might also be given the power to order the companyto pay in the future dividends e-ual to, say, 3X of annual earnings.

It should be clear that an intervention regime would not weaken theprotection currently accorded to creditors. obert


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Cororate $awFLO8QP.

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;ne of the agency problems that has received a great deal ofattention from !nancial economists and corporate law scholarsconcerns the tendency of managers to avoid distributing cash or

assets to shareholders.Q A company might have cash reserves

whose distribution to shareholders would be value#ma'imi)ingbecause the company currently has poor internal investmentopportunities. A company might also have assets that would bebetter managed separately, and it thus would be value#ma'imi)ingto spin oC these assets or sell them to a third party and thendistribute the cash proceeds to shareholders. In such circumstances,management might, for self#serving reasons, refrain from takingactions that would reduce the si)e of the empire under its control.

anagement might prefer not to reduce the si)e of its empire

because it derives larger private bene!ts, in both pecuniary andnon#pecuniary terms, from running a larger !rm. >etainingundistributed li-uid funds F"free cash *ow$P, or assets that can beturned into such funds, increases the autonomy of management vis##vis the capital markets and increases its freedom to pursuee'pansion plans. Indeed, some scholars have viewed theseproblems as the most signi!cant agency problems that large public

companies face.QQ


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*ow$P.

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reduces the discretion management has over the allocation of freecash *ow. Thus, having debt in a company&s capital structure servesa bene!cial bonding role, committing management to pay out someof the company&s cash *ow.

The view that bonding is an important motivation for the use of debthas gained much support among !nancial economists.Q2 Indeed,commentators have viewed the bonding bene!ts as an importantmotivation for the LO83&s wave of leveraged ac-uisitions andbuyouts. The belief that leveraged structures are desirable in orderto mitigate problems of empire building and free cash *owunderscores how seriously these problems are taken by !nancialeconomists.

There is no -uestion, however, that debt !nancing is an highly

imperfect remedy. To begin with, high leverage produces its ownineJciency distortions.Q8 (urthermore, leverage is a rather in*e'ibleand costly mechanism. @hen the level of debt is set, there isuncertainty about how much e'cess cash *ow the company willhave in the future and what the company&s investment needs willbe. Accordingly, any level set might turn out to be too low and thusinsuJcient check on ineJcient empire building, or too high and thusa costly burden on the company.

Suppose that a company is e'pected to generate future cash *owwith an e'pected value of [633 million a year, that it will not have

bene!cial investment opportunities, and that it will be eJcient toremove whatever cash *ow the company will have. aviv, "ole of ebt,$ 7

.ournal of ,inance 56L FLOO3PK >ene . Stul), "anagerial iscretion and;ptimal (inancing olicies,$ 6Q .ournal of ,inancial Economics 5 FLOO3P. See e.g., ichael


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insuJcient to remove fully the unnecessary cash *ow Fif annualpro!ts turn out to be [533 million a yearP.


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all earnings in the company. Second, and importantly, there might be cases inwhich FiP

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@e can thus conclude that shareholder intervention power wouldprovide the best and most eCective way for dealing with theproblems of empire building and free cash *ow. 0' post, when acompany has more cash than what bene!cial investmentopportunities can absorb, the shareholders would be able to

intervene to remove whatever funds would be desirable todistribute. :etter yet, the very e'istence of intervention powerwould induce management to make such a distribution itself. 0'ante, if the problems of empire building and free cash *ow aree'pected to be addressed, it will become easier and less e'pensiveto raise e-uity capital.

E*ecti'eness and Design

/ill Proosals be !nitiated0

It might be argued that shareholders would not have suJcientincentives to initiate proposals. @ithout a willingness to initiateproposals, the shareholder power to intervene would not havesubstantial impact.

The concern may be grounded in the observation that the currentincentives to run a pro'y contest over an "issue$ are much lowerthan the incentive to run a pro'y contest for control. In the lattercase, if the challenger wins the contest, the challenger will gaincontrol of the board and capture the associated private bene!ts of

control. (urthermore, the challenger will be able to authori)e its ownreimbursement for the costs of running the pro'y contest. Incontrast, when a party runs a pro'y contest over an issue Fe.g.,opposition to a management proposalP, victory will bring neitherprivate bene!ts of control nor a reimbursement of costs.Still, there are reasons to e'pect that, when changes could producesigni!cant improvement, they will be initiated in a regime ofshareholder intervention. (or e'ample, it can be e'pected that"issue$ proposals will be brought by shareholders with signi!cantholdings%or by groups of shareholders that together hold asigni!cant block%on the prospect of a signi!cant appreciation in the

value of their shares. The incentive to initiate a proposal would bestrongest in those instances in which there will be a

each shareholders would prefer that all shareholders not withdraw their fundsfrom the company, but that FiiP taking as given what others are going to do,each shareholder prefers to have its own funds withdrawn. In such a case, theindividual option would lead to withdrawal of funds by all shareholders,whereas shareholder power to intervene would lead to the outcome that is inshareholders& collective interest.

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meaningful chance of the proposal&s adoption, which is e'actlywhen it would be desirable to have the proposal brought.

=ote that in the case of some proposals there would not be muchneed for campaigning since the issues will be suJciently familiar to

shareholders. This would be the case for most rules#of#the#gameproposals, since these will focus on general governance issues. =otealso that, even though shareholder resolutions currently initiatedunder the pro'y rules of the securities laws have no binding forceand are regularly ignored if passed, many such resolutions,including ones that end up gathering substantial votes of support,are nonetheless initiated. This pattern suggests that, in a regime inwhich shareholder#initiated proposals are binding and can produce atermination, scaling#back, or rule#changing decision, a signi!cantnumber of proposals can be e'pected.

oreover, once intervention power is introduced, it would bepossible and indeed desirable to strengthen incentives to bring goodproposals with meaningful chances of adoption by installingappropriate reimbursement rules. Speci!cally, when a proposal isadopted in a vote, or perhaps even when it passes a speci!edthreshold of support Fe.g., 53X of the voteP, it would be desirable toreimburse the costs of the shareholders initiating the proposal.Indeed, if further strengthening of incentives to bring proposals withpotential signi!cant support is viewed as desirable, the proponentsof successful proposals might be granted some multiple of their

costs. Such !nancing rules would encourage the bringing of e'actlythose proposals, and only those proposals, which enjoy substantialshareholder support and thus are worth encouraging.

96 /ill Shareholders &ote against "anagement0

It might be argued that shareholder intervention power would havelittle eCect for a second reason. 0ven if proposals are initiated, theargument goes, they will not be adopted because shareholders willnot have suJcient incentives to participate in the vote or, even ifthey participate, they can be e'pected to defer to management

rather than vote against it.Shareholders have only weak incentives to participate in voting

because of a "rational apathy$ problem.26 Still, the costs of votingare rather small, and the incidence of corporate voting is rathersubstantial, even on

26 See


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non#binding shareholder resolutions.25 (or one thing, institutionalinvestors by and large vote their shares. Thus, the -uestion is onlywhether they can be e'pected to vote against management&srecommendation.

The tendency of institutional investors to vote with managementmight result from rational deference to a party that institutionsbelieve is better informed on the -uestion at hand. It might also bereinforced by the desire of institutional investors to be on goodterms with management in order to receive information and in somecases also to obtain business. (or this reason, voting can bee'pected to be somewhat tilted in favor of management&s position.:ut there is no reason to assume that shareholders will always votewith management.

There might well be instances in which, given the presence of clearagency problems on management&s part and the importance andappeal of the proposal on the table, rational shareholders will havesuJcient con!dence in their judgment to vote againstmanagement. This possibility is clearly indicated by the fact that inrecent times, many proposals for de#classifying boards haveattracted a majority among voting shareholders even though they

are merely advisory in nature.27 The incentive of institutions to votefor such proposals would only increase in a regime in which they arebinding.

Institutional investors& bias in favor of voting with management doesnot at all indicate that shareholders should be denied the power tointervene. @hen a majority of shareholders will in fact be preparedto vote for a shareholder#initiated proposal, there will be no reasonto block them from doing so. To the contrary, if shareholdersactually choose to intervene, despite their tendency not to voteagainst management, such a vote would suggest that the proposalis strongly in the shareholder interest.

86 !t1s the !ndirect Bene+ts2 Stuid

(inally, and perhaps most importantly, it should be emphasi)ed thatthe bene!ts of a regime of intervention should not be measured bythe number of times that shareholders would in fact intervene andadopt shareholder#initiated proposals. >ather, the primary bene!tswould be

See 4eorgeson R


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indirect ones. Introducing the power to intervene would inducemanagement to act diCerently in order to avoid the power tointervene. Thus, if a regime of intervention does not produce manyadoptions of proposals, this would not imply that the power is notworking as hopedK rather, it might well mean that the power is

working better than e'pected. To illustrate, consider the e'isting power of shareholders to vetofundamental changes, which is generally viewed as valuable.Shareholders almost always approve proposals for fundamentalchanges submitted by management. :ut this hardly means that thee'istence of the approval re-uirement does not serve an importantpurpose. anagement&s choice of fundamental changes is likelyin*uenced by the need for a shareholder vote of approval.anagement does not pursue those changes that could favor it butthat could not be e'pected to obtain shareholder approval. In aregime without an approval re-uirement, such changes would takeplace. The approval re-uirement prevents such changes not byactual veto when proposed but rather by discouraging managementfrom bringing them to a vote to begin with.

Shareholder power to intervene would similarly produce its bene!tsprimarily by in*uencing management&s behavior rather than byactual interventions. If the prospect of distributing


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proposals might be conditioned on their being co#sponsored byshareholders having together more than a threshold fraction Fsay,X or L3XP of the company&s shares. Such threshold re-uirementsare already used in state law rules and charter provisions that allowshareholders to call a special meeting. In addition, it would be

possible to disallow the submission of proposals when a similarproposal was voted on in the preceding year and failed to get acertain threshold of shareholder support Fsay, LXP. >e-uirementsof this sort, though perhaps not demanding enough in theirspeci!cs, are used already in connection with the initiation of voteson advisory resolutions under the pro'y rules of the securities laws.2

Second, proposals that satisfy the re-uirements for submission buthave limited support among shareholders are unlikely to cause any

signi!cant inconvenience for either shareholders or management. This can be ensured, for e'ample, by re-uiring that adoptedproposals gain support of a majority of outstanding shares Fand not just shares that are votedP. Under such a rule, abstaining fromvoting on a proposal is e-uivalent to voting against it. As a result,shareholders that do not support a proposal do not have to botherto vote against it.

(or a proposal to be adopted, it would need such strong support thatholders of a majority of outstanding shares would aJrmativelysupport it. 4iven that getting support from a majority of outstanding

shares is somewhat demanding, management would have to payattention only to proposals that appear to have support among asigni!cant fraction of the shares. Thus, management would nothave to pay costly attention to proposals other than those withsigni!cant shareholder support, which is precisely the desirable

state of aCairs. 2Q

A6 4ortunistic Proosals

See e.g.,


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other shareholder groups or by management. anagement counter#proposals, in particular, can serve an important role in a regime ofintervention power.

Suppose that, in the @;U1 ?U>T S?A>0?;10>S

This art considers claims that, even if shareholder power to

intervene would produce some bene!cial outcomes forshareholders, it would also impose on them costs that would makehaving such power overall undesirable for shareholders. :ecause ofthese costs, the argument goes, shareholders are best oC whentheir hands are tied and they cannot intervene. :elow I considerseveral claims in turn and conclude that they do not provide a goodbasis for tying shareholders& hands.

(6 !merfect !nformation

The most commonly used argument against e'pansions in

shareholder voting rights is based on the informationaldisadvantage that they are likely to have vis##vis management.28 anagement, the argument goes, is better

28 See >obert


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informed about the company and is thus in a better position toevaluate which decision would most enhance shareholder value. That management might sometimes have superior information has

been long accepted by corporate law.2O If shareholders were allowedto make decisions themselves, the argument proceeds, they would

make poorer decisions than management would. Therefore,shareholders are made better oC by being denied the power tointervene. ?aving decisions made by management or at leastinitiated by management prevents shareholders from making some

poor, erroneous decisions.83

Shareholders& possibly inferior information, however, does notwarrant denying them the power to intervene. To begin with, someof the decisions in the categories under consideration are ones withrespect to which shareholders have perfectly ade-uate information.

>ules#of#the#game decisions are especially likely to be ones forwhich shareholders commonly have perfectly ade-uate informationto make a good decision. ather, the bene!t lies in the rights& collective functionin a takeover, where a buyer purchases a controlling block to use the votingrights inherent in the shares to displace management. Id. At sec. 5.L.L.

(or e'ample, the elaware courts have viewed as plausible and legitimatedirectors& concern that shareholders might mistakenly view as ade-uate anoCer that, according to the directors& superior information, is in fact,inade-uate. See aramount


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I do agree, however, that there are some decisions for whichintervention power is proposed for which management&s privateinformation might be useful. anagement often has privateinformation, both hard and soft, that public investors do notpossess. anagement also might have devoted more time and

eCort to assessing the body of information about the company thatis publicly available. Thus, management might have the bestinformation about the company&s independent value and about thecompany&s investment and growth opportunities, which are relevantfor end#of#the#game decisions and scaling#down decisions.


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judgment. 0ven when a shareholder initiative oCers up a decisionfor shareholder vote, management&s superior information would notnecessarily be wasted. anagement would be prevented fromblocking the proposal, but management would be able to use theinformation as a basis for its communications and recommendations

to shareholders.@hen confronted with a proposal that seems to have a meaningfulchance of being accepted, management is likely to communicate toshareholders its reason for opposing it, and they might back up suchcommunication with new information and, if appropriate, aninvestment banker&s opinion. Such communications might close orsigni!cantly reduce whatever information gap e'isted betweenmanagement and public investors prior to the oCer. ;f course, insome circumstances, management might be unable tocommunicate the information underlying their position because

business considerations re-uire secrecy

86

or because theinformation is diJcult to disclose credibly.85 In such cases,management can still communicate to the shareholders itsrecommendation and the general reason for it.

In the face of such a communication from management, rationalshareholders can be e'pected to balance two considerations. ;n theone hand, they will recogni)e that management might be betterinformed. That shareholders are imperfectly informed about thecompany&s value or investment opportunities does not imply thatthey are unaware that this is the case. This consideration wouldweigh in shareholders& decision#making in favor of deferring tomanagement.

;n the other hand, shareholders will also take into accountwhatever considerations might weigh against deferring tomanagement. (irst, as discussed earlier, management might haveself#serving reasons for opposing termination, scaling#backdecisions, or rule#changing decisions. (urthermore, like otherhumans, the directors might make mistakes and might suCer from

See, for e'ample, Shamrock ?oldings, Inc v. olaroid


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a cognitive#dissonance tendency to view favorably both their own

past performance and the course of action serving their interests.87

In balancing these considerations, shareholders will consider variousfacets of the particular case facing them. Among other things,

shareholders might take into account the following factors theirown judgment concerning the bene!ts of accepting the proposalFe.g., if they view the case for it as marginal, the risk from deferringto management is smallPK how likely management is to have privateinformation of substantial import for the -uestion at hand Fwhich inturn might depend on the nature of the company&s businessPK andthe estimated magnitude of management&s divergence of interestFthe more shares the managers hold, for e'ample, the smaller the

likely divergence of management&s and shareholders& interestsP. 8

In any event, after balancing the considerations for and againstdeferring to the directors, rational shareholders might oftenconclude that deference would be best on an e'pected#value basis.;ther times, however, they might reach the opposite conclusion. ;fcourse, shareholders might not always get it right. :ut given that itis their money that is on the line, shareholders naturally would haveincentives to make the decision that would best serve their

interests.8Q

In contrast, in a regime of nonintervention, deference tomanagement is mandated as a general rule. A regime withoutintervention power and a

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situation as many parties who must decide whether to defer to an agent whohas greater e'pertise. :ecause we e'pect such parties to have incentives tobalance well the costs and bene!ts of deference, we generally believe thatsuch parties would be better oC if they were allowed to make the decisionrather than be re-uired to defer to the e'pert agent.

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regime with such power would produce diCerent outcomes only inthose cases in which shareholders would elect not to defer if thedecision were in their hands. Thus, to block any and all shareholderintervention, one would have to believe that%due to ignorance,imperfect information, irrationality, or hubris%shareholders would

be making the wrong choice in most of those cases. That is, onewould have to believe that shareholders& decision#making onwhether to defer would be so *awed that tying shareholders& handsand mandating general deference to management would makeshareholders better oC.In conclusion, let us re*ect brie*y on the Seattle building e'ample. The building manager in that e'ample might well have superiorinformation with respect to possible termination and scaling#backdecisions. =onetheless, neither law nor contracting practice in suchcases deprive the owner from the power to order that the buildingbe sold or that funds be sent back to the owner. The owner is free toseek the manager&s recommendation on such matters, and mightdefer to it as long as the owner !nds deference to be optimal.Similarly, for the reasons discussed in this Section, shareholdersshould have the freedom to decide for themselves whether to deferto the better informed management or to view a case as suJcientlye'ceptional that deference is no longer warranted.

B6 The Consistency (rgument (gainst Bac%-Seat Dri'ing

A related objection to shareholder intervention is that shareholders

would likely make bad decisions not so much for lack of particularpieces of information, but because their decisions would not cohereas well as management&s would with other corporate decisions. There is much value, the argument goes, to corporate decisionshaving suJcient internal consistency to add up to a coherent andwell#integrated whole. The -uestion of how a certain issue should bedecided, it is argued, cannot be well answered in isolation from how

other issues are e'pected to be resolved. 82

roponents of this argument can accompany it with an appeal to ourintuitions For e'perienceP cautioning us against back#seat driving or

letting82 Although this argument seems to be "in the air,$ I have not been able toidentify any paper making it e'plicitly. It has some relationship, but is notidentical to, ean obert


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two or more people prepare one dish. Shareholders should sit calmlyin their back seats, the argument goes, and not try to instruct theperson at the wheel how to driveK intervening might lead toaccidents or at least a nerve#racking trip. And, as long as they donot plan on replacing the chief chef, shareholders should stay out of

the kitchen and let management prepare its dish without directionfrom shareholders what ingredients to includeK intervention is hardlya recipe for a tasty meal.

This argument, however, is unpersuasive. To begin with, the issuesfor which intervention power is proposed are hardly ones for whichconsistency with other corporate decisions is a key element of agood decision. 4ame#ending decisions can best be analogi)ed not toback#seat driving but rather to decisions to sell the car. Scaling#down decisions can be best analogi)ed not to adding ingredients toa chef&s dish but rather to asking the chef for the remainder of thefunds you gave her to buy ingredients for the meal when you do notwish the chef to invest remaining funds in preparing another mealwhich you are not interested in having.

(urthermore, the argument against back#seat driving suCers fromthe same problems as the argument about imperfect informationwhy not let the shareholders themselves decide how much weightto give to the consistency considerationG 4ranting shareholders thepower to intervene does not imply that they will constantly use it. They might commonly defer to management, guided by their

recognition that management might have superior information orthat consistency in decision#making is sometimes valuable. It seemsa safe bet that money managers taking cabs to the airport do notengage in much back#seat driving. They might intervene only inthose rare occasions when they see that the driver is heading to=ewark whereas their *ight leaves from 1a4uardia, and in suchcases the intervention will be in their interest.

Similarly, shareholders will use their power to intervene only inthose cases in which they see strong signs that call for suchintervention and that outweigh the considerations of consistency

and deference to management. ere recognition that back#seatdriving might sometimes have costs is hardly suJcient to mandategeneral deference to management. Such mandated deferencewould follow only if shareholders were assumed to be suJcientlyirrational or undisciplined that they could not be trusted to make thedeference decision themselves. Again, in today&s capital markets,where institutional investors have a dominant presence, suchpaternalistic hands#tying is hardly warranted.

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C6 Disruti'e Cycles

In an interesting article, /eC 4ordon argued that giving shareholdersthe power to intervene in any given corporate decision would

produce "social choice$ problems.88 In particular, he argued thatshareholder power to initiate proposals would lead to "cycles$ thatwould disrupt or even paraly)e corporate decision#making.

To illustrate the potential problem, consider a hypothetical scenarioin which a potential charter provision ( is favored by a majority ofthe shareholders over another potential provision B, that B isfavored by FanotherP majority of shareholders over potentialprovision


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Collecti'e (ction and Social /elfare FLO23P.

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shareholder interest in ma'imi)ing share value, than thepreferences of populations in which cycling might be an important

phenomenon. O3

Second, the important problem for corporate governance is not the

possibility that the set of top choices will lend itself to cycling, butrather the more realistic possibility that there will e'ist choices thatare inferior to all the choices in the top set. Suppose that potentialprovision is viewed by all shareholders as worse than any of theprovisions (, B, and C. @ithout shareholder power to intervene, if is for some reason preferred by management to the other possibleprovisions, shareholders might be "stuck$ with an arrangement thatis inferior to all of the top choices. The power to intervene ensuresthat the company will not end up with any arrangement outside theset of top choices.

Third, assuming that a cycle of top choices arises, addressing thisproblem does not make it necessary to eliminate the power tointervene, which is needed to rule out and other inferiorarrangements. The problem could be addressed by merelypermitting management to accompany any shareholder initiativewith management counter#proposals. Suppose that we are in thehypothetical case with A, :, and < forming a cycle. Suppose furtherthat management prefers A, and that the status -uo is A. If someshareholders initiate a vote on


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power to initiate votes. This power is necessary to ensure thatchoices made by companies are always within the set of top choices

for shareholders.91

D6 Panglossian Claims

=o discussion of corporate law reform can conclude withoutaddressing what might be referred to as the "anglossianargument.$ According to this argument, we live in the best of all

possible worlds because the market ensures that this is so.O6 According to the anglossian view, if a given arrangement werebene!cial to shareholders, it would have emerged already becausefounders taking companies public would have an incentive to adoptthis arrangement in the company&s I; charter. Although there are

some general problems with this type of argument,O5 the

anglossian argument, however, is especially weak in the case ofthe reforms under consideration.

To start with, U.S. corporate law does not enable companies to optinto a regime with shareholder intervention. evised odel :usiness ::


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O5 (or discussion of the problems

04.bebchuk.case empowering shareholders

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