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E-MailRonald J. Gilson is Charles J. Meyers Professor of Law and Business, Emeritus, and Curtis J. Milhaupt is Professor of Law at Stanford Law School. This post is based on their recent paper.
Corporate governance scholarship is typically portrayed as driven by single factor models, for example, shareholder value maximization, director primacy or team production. These governance models are Copernican; one factor is or should be the center of the corporate governance solar system. In this essay, we argue that, as with binary stars, the shape of the governance system is at any time the result of the interaction of two central influences, which we refer to as capital market completeness and policy channeling. In contrast to single factor models, which reflect a stable normative statement of what should drive corporate governance, in our account the relation between these two governance influences is dynamic.
Motivated by Albert Hirschman’s evocative book, Shifting Involvements: Private Interest and Public Action, we posit that all corporate governance systems undergo repeated shifts in the relative weights of the two influences on the system. Capital market completeness determines the corporate ownership structure and privileges shareholder governance and value maximization by increasing the capacity to slice risk, return, and control into different equity instruments. The capability to specify shareholder control rights makes the capital market more complete, tailoring the character of influence associated with holding particular equity securities and its reciprocal, the exposure of management to capital market oversight. Policy channeling, the instrumental use of the corporation for distributional or social ends, pushes the corporate governance gravitational center toward purposes other than maximizing shareholder value. We argue that disappointment with corporate performance—whether the result of unrealistic expectations, the choice of mechanisms incapable of delivering the desired results, or rising dissatisfaction with the prevailing balance of the two influences—is an endogenous driver of the repeated shifts in the relative weights of capital market completeness and policy channeling. The actors who experience disappointment with corporate performance and the methods chosen to shift the weights of the two influences will differ over time and across different governance systems. But the pattern is not unique to a particular corporate governance system or time period.
We illustrate our argument by tracing the cyclical reframing of Berle and Means’ thesis in the U.S. (an illustration of how intellectual currents can contribute to shifting influences), Japan’s sluggish movement from policy channeling in its postwar heyday toward capital market completeness under the Abenomics reforms (an example of government policy explicitly designed to engineer a shift), and in China, where the pattern is found even in its short history of market-oriented reforms, and its recent shift back toward policy channeling via state-owned enterprises and party influence on private firms is a product of political will. China is distinctive in that capital market completeness—accomplished through the massive growth of its stock markets, initially to fund SOE reform and then growth of the private sector, has itself been used as a policy channeling instrument under the pervasive influence of the Chinese Communist Party, creating the world’s most stakeholder-oriented system of corporate governance. The consistency of the pattern of shifting influences across countries with very different business and corporate systems, and across different periods of time, provides support for the dynamic pattern we describe.
We close by examining the means through which the current shift toward policy channeling in U.S. and U.K. corporate governance is taking place—the “stewardship” movement and the debate over “corporate purpose.” The stewardship movement seeks to harness the influence of institutional investors to promote long-term, sustainable growth of portfolio companies. Corporate purpose proponents urge corporations to have a publicly stated purpose to serve a broad group of stakeholders beyond shareholders. We view both of these mechanisms to increase the influence of policy channeling as a reaction to the reduced managerial discretion caused by the reconcentration of ownership in the hands of institutional investors. Our analysis suggests that stewardship and corporate purpose are likely to lead to disappoint on the part of their proponents, because their expectations are unreasonably high and the mechanism chosen to accomplish the shift toward policy channeling (the monitoring and votes of institutional investors) is not well suited to the task.
The pattern of repeated oscillations in the relative weights of the two influences in corporate governance appears to be driven in significant measure by overreach in both directions: excessive confidence in market mechanisms to provide the optimal mix of incentives and monitoring technologies for corporate managers to maximize shareholder returns, on the one hand, and overconfidence in the ability of regulation to mandate or facilitate corporate solutions to economic and social problems that, at bottom, require direct action by the government on the other. Failure to meet unrealistic expectations in either realm of corporate governance generates momentum moving the corporate governance system back in the direction from whence it came. This lesson should generate a measure of humility and historical perspective in proponents of corporate governance reform of all stripes.
The complete paper is available for download here.
