《法律与金融》课程教学资源（阅读文献）A Political Theory of Corporate Finance

A POLITICAL THEORY OF AMERICAN CORPORATE FINANCE* Mark I.Roe** INTRODUCTION Why is the public corporation-with its fragmented shareholders on the stock excha the d omin ant form of ente Since Berie and Means,the conventional corporate law story begins with technology dictating large enterprises with capital needs so great that even a few wealthy individuals cannot provide enough.These enterprises consequently must draw capital from many dispersed shareholders.Shareholders diversify their own holdings,further fragm nting ownership. This ation of a huge enterprise ,concentrated management,and dispersed,diversified stock holders shifts corporate control from shareholders to managers.Man- gerscan pursue their own agenda,at times to the detriment of the survived because it best bala needs.In a Darwinian evolution,the large public firm mitigated the managerial agency problems with a board of directors of outsiders,with a managerial headquarters of strategic planners overseeing the operat- isions,and with ncentive Co. Hostile takeovers,proxy contess and the threat managers. Pomentedd adapted.They solved enough of the governance problems created by the large unwieldy structures needed to meet the huge capital needs of technology.In the conventional story,the large public f modern technolo ient respo onse to the economics of orga Iargue here that the public corporation is as much a political adap- tation as an economic or technological necessity.The size and technol- Tmereeented w nted ownership of the large public corporation;the most prominent alternative concen- t©l99l.Mark I.Roe Professor of Law,Columbia Law School.I benefited from presentations at Lucketer.Chicngo Columbia.Harvard:McCill.and OcI stein, Coffee, Andy Rutten,Susan Tobias,and John Wiley. 1.A.Berle G.Means,The Modern Corporation and Private Property (rev.ed. 1967)(original edition published in 1932). 10

A POLITICAL THEORY OF AMERICAN CORPORATE FINANCE* MarkJ. Roe** INTRODUCTION Why is the public corporation-with its fragmented shareholders buying and selling on the stock exchange-the dominant form of enter￾prise in the United States? Since Berle and Means, the conventional corporate law story begins with technology dictating large enterprises with capital needs so great that even a few wealthy individuals cannot provide enough. These enterprises consequently must draw capital from many dispersed shareholders. Shareholders diversify their own holdings, further fragmenting ownership. This combination of a huge enterprise, concentrated management, and dispersed, diversified stock￾holders shifts corporate control from shareholders to managers. Man￾agers can pursue their own agenda, at times to the detriment of the enterprise.' In the classic story, the large public firm survived because it best balanced the problems of managerial control, risk sharing, and capital needs. In a Darwinian evolution, the large public firm mitigated the managerial agency problems with a board of directors of outsiders, with a managerial headquarters of strategic planners overseeing the operat￾ing divisions, and with managerial incentive compensation. Hostile takeovers, proxy contests, and the threat of each further disciplined managers. Fragmented ownership survived because public firms adapted. They solved enough of the governance problems created by the large unwieldy structures needed to meet the huge capital needs of modern technology. In the conventional story, the large public firm evolved as the efficient response to the economics of organization. I argue here that the public corporation is as much a political adap￾tation as an economic or technological necessity. The size and technol￾ogy story fails to completely explain the corporate patterns we observe. There are organizational alternatives to the fragmented ownership of the large public corporation; the most prominent alternative is concen- * © 1991, MarkJ. Roe. ** Professor of Law, Columbia Law School. I benefited from presentations at Berkeley, Chicago, Columbia, Harvard, McGill, and UCLA, and from comments from Lucian Bebchuk, Bernie Black, Victor Brudney, Marvin Chirelstein, Jack Coffee, Alfred Conard, Jeffrey Gordon, Joe Grundfest, Cliff Holderness, Howell Jackson, Michael Jensen, Lou Lowenstein, Henry Manne, Robert Mundheim, Roberta Romano, Andy Rutten, Susan Tobias, and John Wiley. 1. A. Berle & G. Means, The Modern Corporation and Private Property (rev. ed. 1967) (original edition published in 1932)

1991] A POLITICAL THEORY OF THE CORPORATION trated institutional ownership,a result prevalent in other countrie But American law and politics deliberately diminished the power of fi- nancial institutions to hold the large equity blocks that would foster serious oversight of managers,making the modern American corpora- tion adapt to the political terrain.The modern corporation's origin lies in technology,economics,and politics Shareholder control of managers arises when the owner holds a large block of stock.Individuals rarely have enough money to buy big blocks.Institutional investors do.But law creates barriers to the insti- tutions'taking big blocks.Banks,the institution with the most money can own stock. Mutual funds generally can ot own cor ntrol blo cks c stock.Insurance companies can put only a fragment of their invest- ment portfolio into the stock of any one company.Pension funds own stock,but they also face restrictions.More importantly,corporate man- agers control private pension funds,not the other way around. And we have just exhausted the major financial institutions in America;none can readily and without legal restraint control an indus- trial company.That is the first step of my argument:law prohibits or raises the cost of institutional influence in industrial companies. The second step is to examine the politics of corporate financial structure.Many legal restraints had public-spirited backers;some rules would be those that wise regulators,unburdened by politics,would reach.But many important rules do not fit into this public-spirited mold.Examining financial regulation through the lens of the new icchoice literature reve als a complex and new repeatedly foreclosing alternatives to the Berle-Means corporation. Opinion polls show Americans mistrust large financial institutions with ulated d have aly h d of Wall Street con- trolling industry. Politicians responded to that distrust by enacting rules restricting private accumulations of power by financial institu- tions.Various interest groups also benefited from fragmentation;Con- gress and the administrative agencies also responded to them. During the SEC's formative years,its chairman said Ishould and will bel restricted to under Insofar as manag ent [and]for ustrial policies the banker will be superseded.The financial n er which he has exercised in the past over such processes will pass into other hands.? An inquiry into the interplay of political ideology and financial in stitutions follows.We shall examine the ideas of opinion leaders and ing us to speculate on a political expl nation for corporat e str cture 2.W.O.Douglas,Democracy and Fi rly every important Wall Street vestment banker speec n193%

1991] A POLITICAL THEORY OF THE CORPORATION 11 trated institutional ownership, a result prevalent in other countries. But American law and politics deliberately diminished the power of fi￾nancial institutions to hold the large equity blocks that would foster serious oversight of managers, making the modem American corpora￾tion adapt to the political terrain. The modern corporation's origin lies in technology, economics, and politics. Shareholder control of managers arises when the owner holds a large block of stock. Individuals rarely have enough money to buy big blocks. Institutional investors do. But law creates barriers to the insti￾tutions' taking big blocks. Banks, the institution with the most money, cannot own stock. Mutual funds generally cannot own control blocks of stock. Insurance companies can put only a fragment of their invest￾ment portfolio into the stock of any one company. Pension funds own stock, but they also face restrictions. More importantly, corporate man￾agers control private pension funds, not the other way around. And we have just exhausted the major financial institutions in America; none can readily and without legal restraint control an indus￾trial company. That is the first step of my argument: law prohibits or raises the cost of institutional influence in industrial companies. The second step is to examine the politics of corporate financial structure. Many legal restraints had public-spirited backers; some rules would be those that wise regulators, unburdened by politics, would reach. But many important rules do not fit into this public-spirited mold. Examining financial regulation through the lens of the new pub￾lic choice literature reveals a complex and new political story, of law repeatedly foreclosing alternatives to the Berle-Means corporation. Opinion polls show Americans mistrust large financial institutions with accumulated power and have always been wary of Wall Street con￾trolling industry. Politicians responded to that distrust by enacting rules restricting private accumulations of power by financial institu￾tions. Various interest groups also benefited from fragmentation; Con￾gress and the administrative agencies also responded to them. During the SEC's formative years, its chairman said: [T]he banker... [should and will be] restricted to ... under￾writing or selling. Insofar as management [and] formulation of industrial policies . . . the banker will be superseded. The financial power which he has exercised in the past over such processes will pass into other hands.2 An inquiry into the interplay of political ideology and financial in￾stitutions follows. We shall examine the ideas of opinion leaders and political actors, and the content of major political investigations, lead￾ing us to speculate on a political explanation for corporate structure: 2. W.O. Douglas, Democracy and Finance 32, 40-41 (1940) (Douglas stunned his audience of nearly every important Wall Street investment banker when he gave this speech in 1937)

COLUMBIA LAW REVIEW [Vol.91:10 Main Street America did not want a powerful Wall Street.Laws dis- couraging and prohibiting control resulted. I.BERLE AND MEANS A.The Classic Story Berle and Means'vision is central to corporate law scholarship. Their story is straightforward:"[T]he central mass of the twentieth- century American economic revolution [is a]. massive collectiviza- tion of cline of Pa oted to pro oduction with [an]accom pa nying de- d ecision-making and and a]mass dissociation of wealth from active management.This restructuring turns corporate law on its head:stockholders,the owners,become powerless.The stockholder's vote"is of diminishing importance as the number of shareholders in each corporation increases. diminishing in fact to ne gible 0 ance as the orpora ome giants.As the om rmely me Aoehela number of stockhol shareholders as a "passive"investment while managers control the corporation. The problem is not solely the separation of shareholders from managers or,as Berle and Means put it,the "massive dissociation of wealth from active management."The problem is atomization.Most public companies are held by thousands of shareholders,each with only a small stake.As a result,an active shareholder cannot capture all of the ng nagers. The costs of monitoring are ecomes ed,studies th te prise,or sits on the board of directors and thereby takes the risk of enhanced liability.But since monitoring gains would be divided among all shareholders,most fragmented shareholders rationally forego involvement. This disincentive to monitor has costs enterprises are run imper fectly as managers pursue their own agenda.Managers want high sala- ries,nice offices,and,if the firm is large enough,corporate jets. Occasionally they take corporate opportunities for themselves.Much ial ursue operating policies thati ealth. T ney want to grow ond an effi cient size for the prestige,power,and salary tha t comes with running a larger organization.Too large,the enterprise slows down;it runs less efficiently.5 25时o a shareholder with ldveto empire-building acquisiti ons 3.A.Berle G.Means,supra note 1,at xxv;see id.at 4-7. 4.Id.at xix. 5.See id.at 112-14;O.Williamso

COLUMBIA LAW REVIEW Main Street America did not want a powerful Wall Street. Laws dis￾couraging and prohibiting control resulted. I. BERLE AND MEANS A. The Classic Story Berle and Means' vision is central to corporate law scholarship. Their story is straightforward: "[T]he central mass of the twentieth￾century American economic revolution [is a] ... massive collectiviza￾tion of property devoted to production, with [an] accompanying de￾cline of individual decision-making and control[, and a] massive dissociation of wealth from active management."'3 This restructuring turns corporate law on its head: stockholders, the owners, become powerless. The stockholder's vote "is of diminishing importance as the number of shareholders in each corporation increases-diminishing in fact to negligible importance as the corporations become giants. As the number of stockholders increases, the capacity of each to express opin￾ions is extremely limited." 4 As a result, corporate wealth is held by shareholders as a "passive" investment while managers control the corporation. The problem is not solely the separation of shareholders from managers or, as Berle and Means put it, the "massive dissociation of wealth from active management." The problem is atomization. Most public companies are held by thousands of shareholders, each with only a small stake. As a result, an active shareholder cannot capture all of the gains from monitoring managers. The costs of monitoring are borne by the shareholder who becomes involved, studies the enter￾prise, or sits on the board of directors and thereby takes the risk of enhanced liability. But since monitoring gains would be divided among all shareholders, most fragmented shareholders rationally forego involvement. This disincentive to monitor has costs: enterprises are run imper￾fectly as managers pursue their own agenda. Managers want high sala￾ries, nice offices, and, if the firm is large enough, corporate jets. Occasionally they take corporate opportunities for themselves. Much more perniciously, many managers pursue operating policies that di￾minish social wealth. They want the enterprise to grow beyond an effi￾cient size for the prestige, power, and salary that comes with running a larger organization. Too large, the enterprise slows down; it runs less efficiently.5 A large shareholder might make a difference: a shareholder with 25% of the company's stock could veto empire-building acquisitions, 3. A. Berle & G. Means, supra note 1, at xxv; see id. at 4-7. 4. Id. at xix. 5. See id. at 112-14; 0. Williamson, The Economics of Discretionary Behavior: Managerial Objectives in a Theory of the Firm 34-35, 79 (1964). [Vol. 91:10

19911 A POLITICAL THEORY OF THE CORPORATION 13 question managerial performance,and in the extreme instance replace the managers.Since it could capture a quarter of the gains,the large shareholder would often have the incentive to act,an incentive frag- mented shareholders lack. B.Modern Complaints About the Berle-Means Corporation odewitersto sharchoders, who they say va sh ly,to the deriment of nation. They claim that managers would take the long-view but are stymied by Wall Street's short-run goals;companies shun long-term in- vestment,and industry underinvests in research and development.6 The lon ng/short co ntroversy posits a market failure.After all,insti- tutions should know how to d long-term value to present value While no one has demonstrated that the long/short phenomenon exists, consider the effect of fragmentation.Fragmentation diminishes the value to a single shareholder of assessing long-run soft information not reflected in the hard numhers of current financial statements.To as- sess long-term research nd devel s often equ res st consultants with specialized expertis f there are sca economies in evaluation,then a fragmented shareholder may rationally decline to in- cur the cost.?Theoretically,the investor would invest in research and buy up undervalued stocks.That is,the size of shareholding would in- crease to reflect any scale economies in information.But.as I shall document in Part I,institutions have ceilings on their stock positions. Consider the difficulty in conveying soft long-term information to a fragmented marketplace;dispersed investors cannot cheaply distin- Wr g With Wall St ,5-6.9,56-63,76 1881 e,e.gAb What's Ha 1yAug.1980,at67,68-70,Lp in the of Fina Corporatism,136 U.Pa.L.Rev.1,7-9,23-25(1987);Dobrzynski,More Than Ever,It's Ma gement fo the Short Term,E Wk. 4.1986,at 82;Drucker,A Crisis of Wall S ept.5 986 colRid at32 6, of the de of managers [who push]c orate ma agement to focus on short-term results."). 5ed byTenology AreLot onaly Wall analyst ng 0nge 8.Furthermore,managers may feel constrained to follow average shareholder opin ion,for fear that the average will sell out and prompt a change in control.An isolated institution with a har of the enterprise will ac ingly be una protect managers fom gation of the go priect.SceT.Hoshi,A.Kashy p&D.Scharfstein Co orate Structure,Liquidity,and Investment:Evidence from Japanese Panel Dat 9-15,19-250M firm af Working Paper No..Sep (da liation with banks in Japan mitigates some markets

1991] A POLITICAL THEORY OF THE CORPORATION 13 question managerial performance, and in the extreme instance replace the managers. Since it could capture a quarter of the gains, the large shareholder would often have the incentive to act, an incentive frag￾mented shareholders lack. B. Modern Complaints About the Berle-Means Corporation Modem writers blame corporate mismanagement on shareholders, who they say value short-run profits excessively, to the detriment of the nation. They claim that managers would take the long-view but are stymied by Wall Street's short-run goals; companies shun long-term in￾vestment, and industry underinvests in research and development. 6 The long/short controversy posits a market failure. After all, insti￾tutions should know how to discount long-term value to present value. While no one has demonstrated that the long/short phenomenon exists, consider the effect of fragmentation. Fragmentation diminishes the value to a single shareholder of assessing long-run soft information not reflected in the hard numbers of current financial statements. To as￾sess long-term research and development plans often requires staff or consultants with specialized expertise. If there are scale economies in evaluation, then a fragmented shareholder may rationally decline to in￾cur the cost. 7 Theoretically, the investor would invest in research and buy up undervalued stocks. That is, the size of shareholding would in￾crease to reflect any scale economies in information. But, as I shall document in Part II, institutions have ceilings on their stock positions. 8 Consider the difficulty in conveying soft long-term information to a fragmented marketplace; dispersed investors cannot cheaply distin- 6. See, e.g., L. Lowenstein, What's Wrong With Wall Street 1, 5-6, 9, 56-63, 76 (1988); Hayes & Abernathy, Managing Our Way to Economic Decline, Harv. Bus. Rev., July-Aug. 1980, at 67, 68-70; Lipton, Corporate Governance in the Age of Finance Corporatism, 136 U. Pa. L. Rev. 1, 7-9, 23-25 (1987); Dobrzynski, More Than Ever, It's Management for the Short Term, Bus. Wk., Nov. 24, 1986, at 82; Drucker, A Crisis of Capitalism, Wall St. J., Sept. 30, 1986, at 32, col. 3; Altman & Brown, A Competitive Liability, Ridding Wall Street of a Short-Term Bias, N.Y. Times, June 1, 1986, § 3, at 3, col. 1 (former Assistant Secretary of the Treasury decries "a new cadre of professional money managers . . . [who push] corporate management to focus on short-term results."). 7. Cf. Wilke, Among Those Baffled by Technology Are Lots of Stock Analysts, Wall St. J., Sept. 28, 1989, at Al, col. 6 (stock analysts have trouble evaluating long-term research). 8. Furthermore, managers may feel constrained to follow average shareholder opin￾ion, for fear that the average will sell out and prompt a change in control. An isolated institution with a small share of the enterprise will accordingly be unable to "protect" managers from other shareholders; both managers and the fragmented institution see￾ing an undervalued long-term opportunity will fear that other shareholders will force termination of the good long-term project. See T. Hoshi, A. Kashyap & D. Scharfstein, Corporate Structure, Liquidity, and Investment: Evidence from Japanese Panel Data 9-15, 19-25 (MIT Working Paper No. 2071-88, Sept. 1988) (data suggests industrial firm affiliation with banks in Japan mitigates some informational defects of securities markets)

14 COLUMBIA LAW REVIEW [Vol.91:10 guish egoistic empire-building from a high net present value project. And managers are wary of revealing proprietary information to scat- tered shareholders:9 without good information,even highly paid,tech- nically com petent analysts c nnot evaluate long-term research and opment In contra cial analysts with gene ric skills can eas ily evaluate short-term financial data. Complaints also are heard that shareholders do not monitor man- agers.Managers build empires and pursue bad strategies without reholder in lenc e of theh tervention until matters are so out-of-hand that the vio- or the of the leve raged buyout results.Persistent shareholder involvement could lead to intervention before bloodshed. the Bne perniclous monitoring and intormnation stores depend on oration.Imploring an owner of $10 million of the stock。 a $10 billi be sha reholder is us less. The sharehol lder can capture only 1/1,000 of the corporat ' gain.The shareholder should rationally decline to invest $100,000 of his or her time and wealth,even if that $100,000 would yield a $100 million gain for the corporation But a 25%shareholder could invest millic ons of dollars in monitor ing and in costly evaluation of soft research and development informa- tion.Beneficial monitoring does not even depend on the monitors being better than managers at most tasks,as I discuss in Part IV.The 25%shareholder could in fact generally be worse,but could still help if it were art en ough to resist tion until corporate results w poor,and had some skill in assessing wheth the poor re were due to poor management. Moreover.management would more willingly reveal proprietary information to the large long-term shareholder,who has the incentive to maintain secrecy. The large sha reholder would protect secrets and protect managers from outsi ders who would guess truly pro fita ble long-run investments.If an owner could take 25%stock positions in a few firms,it might find it worthwhile to assemble a staff with the expertise to monitor effectively.Finally,managerial motivation to pur- wealth maxim managers knew tha change 95 was already if the owner was inactive day-to-day;managers would realize tha deviation from long-run profitability could activate the large-block holder,or ac tivate an outsider who would find it easy to buy the control block.Fi- aeconomcague that large block sharcholding improves corporate operai Markets and Hierarchies:Analysis and Antitrust Implica 10.See Holderness &Sheehan,The Role of Majority Shareholders in Publicly Held 24(1989).But see I emsetz

COLUMBIA LAW REVIEW guish egoistic empire-building from a high net present value project. And managers are wary of revealing proprietary information to scat￾tered shareholders; 9 without good information, even highly paid, tech￾nically competent analysts cannot evaluate long-term research and development. In contrast, financial analysts with generic skills can eas￾ily evaluate short-term financial data. Complaints also are heard that shareholders do not monitor man￾agers. Managers build empires and pursue bad strategies without shareholder intervention until matters are so out-of-hand that the vio￾lence of the hostile takeover or the instability of the leveraged buyout results. Persistent shareholder involvement could lead to intervention before bloodshed. These pernicious monitoring and information stories depend on the Berle-Means corporation. Imploring an owner of $10 million of the stock of a $10 billion industrial firm to be an active shareholder is use￾less. The shareholder can capture only 1/1,000 of the corporation's gain. The shareholder should rationally decline to invest $100,000 of his or her time and wealth, even if that $100,000 would yield a $100 million gainfor the corporation. But a 25% shareholder could invest millions of dollars in monitor￾ing and in costly evaluation of soft research and development informa￾tion. Beneficial monitoring does not even depend on the monitors being better than managers at most tasks, as I discuss in Part IV. The 25% shareholder could in fact generally be worse, but could still help if it were smart enough to resist intervention until corporate results were poor, and had some skill in assessing whether the poor results were due to poor management. Moreover, management would more willingly reveal proprietary information to the large long-term shareholder, who has the incentive to maintain secrecy. The large shareholder would protect secrets and protect managers from outsiders who would second guess truly profita￾ble long-run investments. If an owner could take 25% stock positions in a few firms, it might find it worthwhile to assemble a staff with the expertise to monitor effectively. Finally, managerial motivation to pur￾sue wealth-maximizing operating policies could change for the better if managers knew that a 25% block was already assembled, even if the owner was inactive day-to-day; managers would realize that deviation from long-run profitability could activate the large-block holder, or ac￾tivate an outsider who would find it easy to buy the control block. Fi￾nancial economists argue that large block shareholding improves corporate operations. 10 9. See 0. Williamson, Markets and Hierarchies: Analysis and Antitrust Implica￾tions 35-37, 97-98 (1975). 10. See Holderess & Sheehan, The Role of Majority Shareholders in Publicly Held Corporations, 20J. Fin. Econ. 317, 333-45 (1988); Wruck, Equity Ownership Concen￾tration and Firm Value, 23 J. Fin. Econ. 3, 14-16, 23-24 (1989). But see Demsetz & [Vol. 9 1: 10