A Blueprint for Corporate Governance

Fred Kaen

• Verlag: AMACOM
• Jahr: 2003
• ISBN:
  9780814426982
• Thema: Business
• Thema: Human Resource Management

Recent events have turned the spotlight on the issue of corporate accountability -- especially when it comes to protecting shareholder value. In the modern corporation, non-owners commonly manage day-to-day operations, and their decisions have a direct impact on the company's overall value. But what can management do to positively impact share price and protect shareholder investment? A Blueprint for Corporate Governance is unique in that it addresses shareholder value from a managerial perspective. This important book covers all essential corporate governance issues from this angle, providing detailed information and insights on: * Contemporary asset pricing models, and how they can help managers determine optimal returns on shareholder funds * Financial structures and dividend policies designed to advance shareholder interests * Methods for executives, managers and boards of directors to work as one to enhance and increase shareholder value.

CHAPTER 1

CORPORATE GOVERNANCE: AN OVERVIEW

INTRODUCTION

Corporate governance is about who controls corporations and why. In the United States, the legal ‘‘who’’ is the owners of the corporation’s common stock—the shareholders. However, the reality—even the legal reality—is much more complicated, and the ‘‘why’’ is to be found in historic American concerns about the connections between ownership, social responsibility, economic progress, and the role of markets in fostering a stable pluralistic democracy.

Initially, these concerns were focused on the role and responsibilities of the owners of business firms because the owners managed the firms themselves. However, with the emergence of large corporations, perhaps symbolized by the Standard Oil Trust in the late nineteenth century, Americans focused their attention on a new group of individuals: professional managers. Prior to the emergence of these corporations, managers and owners had been the same people, but now things were changing. Now wealthy and often absentee owners were hiring managers to run large, powerful companies, leading to a new set of questions. Among them were: Who were the managers to represent and why? What were the managers’ connections to the owners, and what, if any, were the social responsibilities of the managers and owners? Could the managers be trusted to carry out whatever economic and social objectives were entrusted to them? How could they be held accountable for their actions? And, how could they be controlled? In short, what was this beast that came to be called the modern corporation, who should control it, and how should it be controlled?

THE MODERN CORPORATION

The modern corporation, a term coined by Adolf Berle and Gardiner Means, is a limited liability company (limited liability means that the owners are not personally liable for the debts or any other legal obligations of the firm) in which management is separated from ownership and corporate control falls into the hands of the managers.¹ This separation of ownership from management and the resulting loss of direct owner involvement in the firm forced many people to rethink the conventional wisdom about the role of markets and the need for private ownership of capital in shaping the citizens’ sense of civic responsibility, preserving liberty, and ensuring economic progress. To explain why this occurred, we need to consider briefly two dominant historical theories about the importance of property ownership and markets for ensuring that Americans would live in a free society that promised equality and fairness for all: civic republicanism and nineteenth-century liberalism.²

CIVIC REPUBLICANISM

The term civic republicans describes those who believed that a strong link existed between property ownership and socially responsible civic behavior. As American thought and mythology evolved in the eighteenth and nineteenth centuries, many individuals regarded the ownership of property (land, tools of production, machinery, and so forth) as essential for motivating individuals to participate in the political process so as to protect their property from the opportunistic behavior of others. Essentially, widespread property ownership was seen as a means of promoting social and political stability by providing a defense against demagogic attempts to gain control of the political apparatus. Property ownership was deemed necessary for changing human behavior by giving people a stake in society.

Because of this important link between property ownership and responsible civic behavior, property ownership became the basis for the political franchise. Furthermore, citizens’ rights and obligations, including commitments to the community and relationships to neighbors, were defined in terms of property ownership. Finally, participation in politics at the local level was considered to be training for eventual civic participation at higher levels—county, state, and federal.

Civic republicans also saw widespread property ownership as a means for achieving liberty and equality. Liberty meant freedom from tyrants and oligarchs. It meant substituting the rule of law and the freedom of self-determination—especially economic self-determination—for dependence on a ruling class and its benevolent largess. Economic self-determination, in particular, meant no longer having to rely on an aristocracy for one’s living or being forced to ‘‘sell’’ one’s labor or services to a landed gentry. Instead, one could get the highest price for one’s labor and production in the ‘‘market.’’ In other words, it was the market that made possible the escape from dependency, and so the market was as essential as property ownership for enabling individuals to enjoy the benefits of ‘‘life, liberty, and the pursuit of happiness.’’

Markets facilitated economic freedom by making it possible for people to secure the just rewards of their labor—rewards that, in turn, enabled them to become economically self-sufficient. Markets also enhanced economic efficiency by allocating resources through an arms-length process in which social status and class were not particularly important in determining who had claims on economic wealth, thereby supporting the ideals of equity and fairness. Markets, in fact, were class levelers that made the objective of economic equality attainable. So, property ownership and markets were inexorably tied to each other as the means for supporting democracy, liberty, freedom, and socially responsible behavior.

But for all this to happen, property ownership had to become and remain widespread. And, equally important, the markets themselves had to operate efficiently and not be subject to manipulation—the need for transparency in market transactions was recognized quite early.

LIBERALISM

Those who held contrasting views to those of civic republicans were called liberals. These nineteenth-century liberals, although they also wanted to foster democracy, freedom, and liberty, were more cynical about human nature than the civic republicans. The liberals, unlike the civic republicans, did not believe that you could change human nature through the marketplace and widespread ownership of property. Individuals would be opportunistic and self-seeking regardless of whether they owned property, and property ownership in and of itself would not motivate individuals to become virtuous, socially responsible citizens. Instead, the liberals emphasized the creation of institutional structures, procedures, and governance systems that would fragment or at least discourage the concentration of economic and political power and that would prevent a particular interest group from dominating and taking advantage of other groups. In other words, in sharp contrast to the civic republicans, the liberals did not want to eliminate self-seeking opportunistic behavior—they saw that as an impossible dream. Instead, they wanted to harness it and use it to control peoples’ behavior.

But, if the market and property ownership were not needed for changing human behavior (as the civic republicans believed them to be), why were they needed? Well, the market was needed to facilitate economic transactions; barter was not an efficient alternative. And, property was to be used to create economic wealth and generate economic growth. Economic growth was important because if everyone experienced substantial improvements in their economic situations, the problems associated with the unequal distribution of wealth would largely disappear—the old notion of a rising tide lifting all boats.

For the liberals, then, an efficient market and property ownership remained very important. But, for them, markets and property ownership were the means to an end rather than the end in itself, as they were for the civic republicans. For the liberals, the end was economic growth, not a change in human nature.

THE CORPORATION COMPLICATES THE WORLD

The emergence of the corporation in the latter half of the nineteenth century and the rapid growth of corporations near the end of the century created dilemmas for both the civic republicans and the liberals. For the civic republicans, the goal of widespread ownership of property increasingly seemed unattainable as these ‘‘monster’’ firms grew and wealth became increasingly concentrated in the hands of the few. And without widespread property ownership, human nature could not be changed and people would not develop into responsible citizens.

It is critical to remember that for the civic republicans, economic efficiency was not the ultimate measure by which the corporation—or, for that matter, any other organizational form—was judged. The ultimate measure was whether the corporation supported the development of democratic ideals, freedom, and liberty—not whether it maximized the economic wealth of its owners or any other stakeholders. Concentration of property ownership hindered or precluded individuals’ civic development and the maintenance of a democratic society and could lead to a class-dominated society like those in Europe.

The liberals found themselves in an equally precarious position. To justify their political positions, they had to demonstrate that a concentration of corporate power would not lead to class warfare and would not destroy competition in the market and, consequently, the efficiency of markets for allocating resources and supporting economic growth.

In fact, class warfare was already happening. Political coalitions of farmers, small businessmen, and workers had formed and were demanding various reforms. Some of these groups called for a redistribution of property and power. This redistribution was to be brought about by limiting firms’ size through such means as antitrust legislation. (Again, note that the focus of attack was on size, not on any question of whether size compromised economic efficiency.) Others made a direct attack on private property itself. This attack sought to enhance the state’s direct power over industrial production and appealed to progressive reformers ranging from businessmen who sought to rationalize competition through public or quasi-public agencies to socialists like the early Walter Lippman.³ Lippman and others like him thought the ‘‘science of management’’ could just as well be entrusted to publicly controlled managers as to private officials. This second attack effectively dismissed the need for private ownership of firms and, hence, private ownership of property. Private ownership, in this scheme of things, played no positive role in supporting economic efficiency.

But who was to control the ‘‘scientific’’ managers? The answer was a democratic political process. The public would limit corporate power through the electoral process, and the whole process would be overseen by a professional civil service. Unfortunately, evidence began accumulating that the political process might have been making things worse, not better. There were never-ending stories of official corruption and of elected officials being bought off by corporate interests. For example, around the turn of the century, Rockefeller interests were effectively in control of a number of state legislatures, and the notion that the political process and public officials could be used as a check on the concentration of wealth and as a protection for the ordinary citizen was fast losing adherents. So, once again, questions about how to control (read govern) the corporation came to the forefront. Now, though, attention centered on whether and how managers and insider control groups could serve society’s needs for economic growth rather than simply their own self-interest.

THE SEPARATION OF MANAGEMENT AND OWNERSHIP

During the first decades of the twentieth century, people began to become concerned about two seemingly contradictory developments. The first was what appeared to be a transformation of American business from family-controlled firms to firms controlled by a financial plutocracy (financial capitalism), perhaps best characterized by the House of Morgan. These concerns were exemplified by the Pujo committee hearings in 1912, set up to investigate whether a wealthy few had gained control of financial markets. The second was an increased dispersion of public ownership and the decline of financial capitalism. What both developments had in common was the separation of ownership and management—a development that boded ill for the notion that property ownership and management had to reside in the same people (family-owned businesses, for example) in order to produce socially responsible behavior.

In reality, financial capitalism (bank control of firms) was on the wane by the 1920s, so the development of dispersed ownership eventually began to receive most of the attention. What was happening was that corporations were obtaining capital from a dispersed investor base. In other words, many investors owned small amounts of stock, leaving the individual public shareholder in a very weak position with respect to influencing managerial decisions. As a result, managers and insider control groups (holders of large blocks) could run the company in their own interests and not those of the public shareholders or the public itself. This dispersion of ownership also meant that any connection between property ownership and the development of the citizens’ (shareholders’) civic and social responsibilities had been severed. So, the public policy question became: How could management be held accountable to the public interest, where that interest was defined in terms of fostering economic growth while preserving democratic ideals of equality and freedom?⁴

Two strategies emerged. One cast the managers as trustees for society at large. The other sought to use self-interest and self-seeking behavior to control stakeholders in general and managers in particular. Both approaches required corporate governance structures that could be relied upon to make managers accountable for their ‘‘social responsibility’’ to enhance economic growth and the general economic welfare.

The Trustee Approach

The essence of the trustee approach was that economic efficiency would be ensured by defining managers as legal trustees for the stockholders’ property. In this way, managers could be held legally accountable for any dilution, waste, or misuse of the stockholders’ property. In the trustee model, the courts would be the arbiters of conflicts of interest among the stakeholders, especially between management and the public shareholders.

By the end of the 1920s, the trustee approach was well established as the dominant paradigm. Managers were recognized as the trustees of the corporate assets and were seen as being legally liable to shareholders with respect to the use of those assets. This trustee approach received reinforcement from—or perhaps spurred—the development of management as a ‘‘scientific’’ profession dedicated to running the company in a technically sound manner while protecting the other stakeholders from the shareholders (owners). An often-identified spokesman for this notion of the manager as paternalistic trustee for society at large is Owen Young, a public utilities attorney and subsequent chairman of General Electric.

The notion went as follows: The managers were, indeed, trustees. But they were trustees for the public, not the owners, and they had a fiduciary responsibility to the public. Therefore, managers had to and would be expected to balance the public’s interests with those of the shareholders, creditors, employees, and so on. Explicitly, this view meant that the rights of the shareholders were limited; they were not at the apex of any organizational or governance chart of the corporation. Young, in a speech dedicating the Baker facilities at the Harvard Business School—a school devoted to training professional managers—advocated that business schools emphasize the public trustee role of corporate managers. Managerial opportunism was to be overcome by wellmeaning and right-thinking professionals—and by science.

The trustee approach continued to gain adherents as the country and the world moved into the Great Depression. Now, it came to be coupled with plans to administer the economy through industrial trade groups, cartels, and other such devices in order to deal with what many thought were the causes of the Depression: a mature economy, overproduction, and excess capacity in product and labor markets. Professional managers would join forces with professional government administrators to plan and coordinate economic activity. These ideas manifested themselves in Roosevelt’s National Recovery Administration (NRA), which oversaw the development of industry codes and plans but was eventually ruled unconstitutional.

With the legal demise of the NRA, Roosevelt set about establishing regulatory commissions and agencies that targeted specific industries and markets. Investment banking was separated from commercial banking through the Glass-Steagall Act, and a system of bank deposit insurance (the Federal Deposit Insurance Cor...

Inhaltsverzeichnis

• Cover
• Title
• Copyright
• Contents
• Chapter 1: Corporate Governance: An Overview
• Chapter 2: The Governance Structure of American Corporations
• Chapter 3: Markets: Can You Trust Them?
• Chapter 4: Valuation
• Chapter 5: Corporate Governance Issues in Investment Decisions
• Chapter 6: Corporate Governance Issues and the Financing Decision
• Chapter 7: Corporate Governance Dividend Issues
• Chapter 8: Corporate Governance and Managerial Compensation
• Chapter 9: The Corporate Control Market
• Chapter 10: The Board of Directors and Shareholders Rights
• Chapter 11: Alternative Governance Systems: Germany and Japan
• Notes
• Index
• About the Author