Controlling Shareholders in the Twenty-First Century: Complicating Corporate Governance Beyond Agency Costs

By the end of the twentieth century, the then-dominant literature on “law and finance” assumed that concentrated ownership was a product of deficient legal systems that did not sufficiently protect outside investors. At the same time, commentators posited that the competitive pressures of economic globalization would push countries around the world to adopt an efficient regime of strong investor protection, which was thought to facilitate ownership dispersion. Nevertheless, at the dawn of the 2020s, ownership concentration not only persists, but appears to be on the rise among the world’s largest companies. As of 2015, there was only one controlled company under a single-class structure (Walmart) among the world’s ten largest firms by market capitalization. By 2019, four of the top ten first in the globe are controlled companies with dual-class shares (Alphabet, Facebook, Alibaba, and Berkshire Hathaway). Moreover, Amazon is a borderline case, with founder Jeff Bezos holding a sizable equity stake and outsize influence in the company.

In this symposium essay in honor of Professor Ron Gilson, I explore what went wrong with the earlier predictions of a decline in concentrated ownership and the resulting lessons for corporate governance analysis. First, as suggested by Gilson, non-pecuniary private benefits of control, such as psychic benefits and socio-political prestige associated with corporate control, help explain the relative prevalence of controlling shareholders in different jurisdictions and industries. The large tech companies employing dual-class shares, such as Facebook and Alphabet (Google), can influence global culture and politics in ways that are coming to dwarf the role of traditional media.

Second, the world economy followed an unforeseen direction. Scholars expected globalization to increase product market competition, which, they thought, would put pressure on controlling shareholder systems. Product market competition substitutes for monitoring, thereby lessening the role of controlling shareholders in mitigating managerial agency costs. Greater competition in product markets would also require more efficient firm management and access to external capital markets, thereby undermining inefficient controlling shareholder systems. Surprisingly, however, the promise of increased competition due to globalization can no longer be taken for granted, with several studies pointing to a decrease in product market competition in the last decades.

Third, and perhaps more importantly, the forecasts about the decline of controlling shareholders suffered due to the prevailing uncomplicated, but also unsatisfactory, understanding of corporate governance developments exclusively in terms of agency costs. I show how the focus on agency costs that dominated the earlier literature overlooked the fact that corporate governance structures are both (i) influenced by factors beyond tradeoffs in agency costs, and (ii) affect social welfare in ways other than through their effects on investor protection.

I illustrate this argument by relying on my previous work on nationalism, which is a powerful, but often neglected, force in the evolution of corporate law and governance. While the literature has focused on the interaction between corporate governance and competition among firms, it has mostly ignored the role of corporate governance in the competition among nations. In effect, nationalism has significantly shaped recent developments in ownership structures and control rights based on the premise that domestic control has important welfare effects for a given jurisdiction and may confer on it economic and geopolitical advantages. Conversely, various corporate law initiatives (most conspicuously at the E.U. level) have been premised on the countervailing economic and geopolitical benefits of economic integration. Beyond the conflict between nationalism and economic openness, this further development to consider the external effects of ownership structures and corporate governance arrangements is essential to make sense of other emerging challenges of the twenty-first century, such as competition and stability.

The essay then reflects on the emerging challenges to what I call the “modularity approach” to corporate law scholarship, and contemporary law-and-economic analysis more generally, which stipulates that each area of law should serve one key efficiency objective. The purpose of corporate law is to reduce agency costs; the purpose of antitrust law is to maximize consumer welfare; the purpose of bankruptcy rights is to maximize firm value for the benefit of creditors; and the list goes on. Distributional objectives should be handled exclusively by the tax-and-transfer system. While—remarkably—such modular specialization came to dominate policy discourse at least since the 1980s, it is increasingly coming under attack. There is, for instance, growing skepticism about the use of consumer welfare as the sole normative objective of antitrust law and about the exclusive reliance on the tax-and-transfer system to achieve distributional objectives. The near-consensus about normative specialization and purity in corporate law is also faltering.

The modularity embodied in traditional law-and-economics analysis, in the form of “one function per field,” certainly has the advantage of reducing complexity. Administering complexity is, after all, a key purpose of modularity. Yet, such simplification through modularity can also come at a cost. A key problem of modular thinking in law and economics is that different areas of law or legal rules are not fully separable or nearly decomposable.

Efficient corporate governance practices from an agency cost perspective can nevertheless have detrimental consequences for national economic development or economic integration—and this is but one example. It can be hard to revert any negative effects of control arrangements through mechanisms situated in other areas of law. This new form of complication to account for the broader effects of corporate governance arrangements is critical for us to better understand and influence corporate governance developments.

The complete paper is available for download here.