The Rise and Fall (?) of the Berle-Means Corporation

Brian Cheffins is S J Berwin Professor of Corporate Law at the University of Cambridge. This post is based on a recent paper by Professor Cheffins. Related research from the Program on Corporate Governance includes The Agency Problems of Institutional Investors by Lucian Bebchuk, Alma Cohen, and Scott Hirst (discussed on the Forum here).

A description of a separation of ownership and control in America’s largest companies was the best-known feature of Adolf Berle and Gardiner Means’ renowned 1932 book The Modern Corporation and Private Property. Diffuse share ownership and the managerial autonomy which tends to follow on from it would become hallmarks of American corporate governance. Explaining why ownership becomes divorced from control in large firms has been the topic of lively debate. There has also been speculation lately that it is no longer appropriate to think of the typical American public company in terms of a separation of ownership and control. The Rise and Fall (?) of the Berle-Means Corporation, which formed part of the proceedings in a symposium which focused on Adolf Berle and the world he influenced, explores these related topics.

Berle and Means became sufficiently closely associated with the separation of ownership and control in American public companies that law professor Mark Roe coined in the early 1990s the term “Berle-Means corporation” to refer to a large public firm with fragmented share ownership. This shorthand has been adopted with some regularity since. One might infer from the notoriety of Berle and Means’ separation of ownership and control thesis that dominant shareholders were passé in large U.S. companies by 1932. In fact, as Berle and Means’ own data indicate, the diffusion of share ownership with which they are so closely associated still had some distance to go. By the beginning of the 1960s, though, a separation of ownership and control indeed was the norm in large American public companies.

What accounted for the rise of the Berle-Means corporation? As awareness grew in the early 1990s that a divorce between ownership and control was not the norm globally and that many highly successful businesses around the world had dominant shareholders, a spirited and still unresolved debate about the determinants of ownership and control in large firms began. This paper seeks in the American context to move that debate forward in two ways. First, attention is drawn to points Adolf Berle made from the 1930s through to the 1960s that offer clues as to why the Berle-Means corporation moved to the forefront of American corporate governance. Second, an analytical framework oriented around three questions is deployed to get a better handle on the process by which ownership separates from control: 1) Why might those owning large blocks of shares want to exit or accept dilution of their stake? 2) Will there be demand for shares available for sale? 3) Will the new investors be inclined to exercise control themselves? Addressing these questions with American developments in mind provides insights regarding leading ownership and control theories relating to financial services regulation, political ideology and the protection afforded to investors by corporate and securities law.

Once the Berle-Means corporation moved fully into the ascendancy, it appeared to be a durable construct, given that Mark Roe only developed the nomenclature in the early 1990s. Speculation has been rife, however, that the Berle-Means corporation era will end soon, if it has not ended already. In fact, writing off the separation of ownership and control as a core feature of U.S. corporate governance is premature.

The Berle-Means corporation moved to the forefront of the American corporate economy when shareholders with sufficiently large ownership stakes to dictate outcomes when stockholders voted became the exception to the rule in large companies. One might logically expect that the Berle-Means corporation’s supposed demise is due to a revival of shareholders of this sort. There has been no such trend. According to a 2016 study of ownership patterns among companies in the S&P 1500 stock market index only 105, or 7 percent, of firms had a shareholder with a voting stake large enough to exercise de facto control.

A more plausible threat to the Berle-Means corporation’s dominance is that the collective stake of the largest institutional shareholders has now become so sizeable the concept’s fate must be sealed. Bebchuk, Cohen and Hirst (discussed on the Forum here), for example, make this point with data indicating that as of 2016 the largest 50 institutional shareholders in America’s biggest companies owned, on average, 44 percent of the shares. It cannot be taken for granted, however, that collective institutional stakes of the sort currently prevailing translate automatically into substantial compromising of managerial discretion. Institutional shareholders have for decades been biased against intervening in the affairs of the companies in which they own shares and at present there is little evidence to suggest they are forsaking past practice.

Two other trends could jeopardize the predominance of the Berle-Means corporation. First, there is hedge fund activism, which has grown considerably in prominence over the past 15 or so years. As minority shareholders hedge funds can only execute successful campaigns against management with substantial support from “mainstream” institutional investors (e.g. pension funds and mutual funds). Conceivably, then, the surge in hedge fund activism has introduced effective shareholder-related governance unknown to the Berle-Means corporation. Aside from a few headline-grabbing instances, however, hedge funds rarely target large public companies. Also, the seemingly inexorable growth of hedge fund activism appears to have stalled. Hedge fund activists correspondingly have not dealt a fatal blow to the Berle-Means corporation and are unlikely to do so in the foreseeable future.

Second, there is the popularity of “passive” funds that track the performance of well-known stock market indices. Robust investor demand has resulted in the proportion of public company shares owned by index trackers increasing substantially since the mid-2000s. Operators of major index funds have in turn been emphasizing their commitment to shareholder engagement. Index tracker funds have, however, very weak incentives to step forward. Those running passive funds do not compete over the performance of the index they are set up to mimic, which is taken as a given, and instead focus on keeping costs as low as possible and on eliminating tracking errors. Correspondingly, if those running an index fund expend resources to identify and correct underperformance in particular companies, any gains will be shared with the market at large, fees will increase and market share could well be lost rapidly to cheaper, fully passive rivals in an industry where price competition has a significant effect on investor inflows. Continued growth in the popularity of index trackers thus will likely reinforce the institutional bias against activism rather than pose any sort of existential threat to the Berle-Means corporation.

Concrete, sustained evidence of institutional shareholders taking meaningful, proactive steps to keep management in check would mean that it would no longer be appropriate to refer to the paradigmatic American public company as the Berle-Means corporation. That evidence is currently lacking and likely will be for some time yet. Hence, despite the Berle-Means corporation having suffered institutional shareholder-related wear and tear in recent decades, it has yet to fall by the wayside and seems unlikely to do so for the foreseeable future.

The complete paper is available for download here.

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