Top Management, Company Directors and Corporate Control, Lecture notes of Corporate Finance

Download Top Management, Company Directors and Corporate Control and more Lecture notes Corporate Finance in PDF only on Docsity! Theory and research on the relations among top managers, company directors, investors, and external contenders for corporate control – broadly, the field of corporate governance – experienced a remarkable flowering during the 1990s. Early work addressed the central puzzle raised by the widespread separation of ownership and control among large American corporations, namely, why would any sensible person – much less thousands or millions of them – invest their savings in businesses run by unaccountable professional managers? As Berle and Means (1932) framed the problem, those who ran such ‘managerialist’ corpora- tions would pursue ‘prestige, power, or the gratification of professional zeal’ (1932: 122) in lieu of maximizing profits. Weak share- holders could do little to stop them. Yet gener- ations of individuals and financial institutions continued to invest in these firms. Why? Answering this question led to the creation of a new theory of the firm that portrayed the public corporation as a ‘nexus of contracts.’ In the contractarian model, the managers of the corporation were disciplined in their pursuit of shareholder value by a phalanx of mecha- nisms, from the way they were compensated, to the composition of the board of directors, to the external ‘market for corporate control.’ Taken together, these mechanisms worked to vouchsafe shareholder interests even when ownership was widely dispersed. Research in this tradition flourished in the 1980s, as takeovers of under-performing firms became common and restive institutional investors made their influence known. Studies focused on assessing the effectiveness of devices such as having boards numerically dominated by outsiders, tying compensation to share price, or ensuring susceptibility to outside takeover (Walsh and Seward, 1990, provide a review). Following the dictates of financial economics, ‘effectiveness’ was commonly measured via stock market reactions to various actions by top management and/or the board. The results of these studies provided proof of which actions and structures promoted shareholder value, and which promoted ‘managerial entrenchment’ of the sort feared by Berle and Means. Corporate governance research during the 1990s expanded from a narrow focus on large corporations to a broader concern with issues of political economy. The transition of state socialist societies to market economies, and the spread of financial markets to emerging economies around the globe, infused the puzzle of managerialism with enormous policy relevance. What mechanisms could be put in place to inspire the confidence of investors in businesses housed in distant and often unfa- miliar cultures? The place of financial markets 11 Top Management, Company Directors and Corporate Control G E R A L D F . D A V I S and M I C H A E L U S E E M Spetch11.qxd 5/18/2001 4:14 PM Page 233 in the project of globalization, as a means to channel investment funds from wealthy nations to emerging markets with limited local capital, assured that corporate governance would be a topic of intense interest for years to come. The decade of the 1990s saw three develop- ments that moved the governance literature beyond the simple assessment of mechanisms in US firms. The first development was the examination of the governance structure of the firm – the set of devices that evolve within the organization to guide managerial decision- making – as an ensemble. Rather than regard- ing any particular aspect of the firm’s structure as essential, researchers began to study them as complements or substitutes. Compensation strongly tied to share price may act as a sub- stitute for a vigilant board, for instance, while a vigilant board is not sufficient to make up for a poorly integrated top management team. Governance structures, in short, were configu- rations of interdependent elements (Beatty and Zajac, 1994; Anderson et al., 1998). The second development was the growth of comparative and historical governance research, which highlighted the idiosyncrasy of the American system. American-style cor- porate governance, aimed at ‘solving’ the problems created by the separation of owner- ship and control, is only one of several possi- ble governance systems and reflected a path-dependent developmental trajectory. A range of alternatives is consistent with eco- nomic vibrancy, and the American system is not the crown of creation (Roe, 1994). Indeed, even among wealthy economies with well- developed corporate sectors, corporations with separated ownership and control were quite rare as late as the mid-1990s (LaPorta et al., 1999). Moreover, empirical findings on the dynamics of the American system often held only for specific times; for instance, the takeover market of the 1980s, when hostile ‘bust-ups’ were common, was much different from takeovers of the 1990s, when friendly deals were the norm (Davis and Robbins, 1999). The nexus of contracts approach seemed increasingly like a theory of US cor- porate governance in the 1980s rather than a general theory of the firm. The third development was the articulation of a reflexive stance on the theory of gover- nance. While agency theory can be viewed as an empirical theory of the corporation, it can equally be considered a prescriptive theory, that is, not an explanation of what is but a vision of what could or should be. Its influence on public policy debates during the 1980s is evident in documents of the time (Davis and Stout, 1992) and in the subsequent spread of the rhetoric of shareholder value. But it is important to recognize that corporate man- agers are quite skillful in their use of this rhetoric (Useem, 1996). Declarations of share buy-backs are met with share price spikes, whether or not they are subsequently imple- mented (Zajac and Westphal, 1999). The announcement of a new compensation plan is met by more positive reactions from the stock market when described as means of aligning management with shareholder interests than when the identical plan is described as a human resources tool; naturally, managers gravitate toward the sanctioned rhetoric (Westphal and Zajac, 1998). And even earnest attempts to meet the demands of shareholders for transparency and accountability, as pre- scribed by the agency theory of governance, often have unintended consequences. Firms that improve the quality of their disclosure attract more transient institutional investors, which in turn increases the volatility of their share prices – exactly the opposite of what was anticipated (Bushee and Noe, 1999). In short, the dominance of the American system described by the agency theory of governance may take the form more of rhetoric than real- ity, a point worth bearing in mind in the ongo- ing debates about the convergence of national systems of corporate governance. If the prototypical research question in the corporate governance literature of the 1980s was ‘Is it better for shareholders for a corpora- tion’s board to have more “outside” direc- tors?’, the characteristic question of the early 21st century is ‘What ensemble of institutions best situates a nation for economic growth in a global, post-industrial, information-based eco- nomy?’ Put another way, the vital questions going forward are not about why some stalks of corn in a field grow taller than others, but about the characteristics of soil and farming techniques that make corn in some fields grow taller than in others. Thus, research has come to span levels of analysis from within the organization to the nation-state and beyond. Behind this development is a recognition that HANDBOOK OF STRATEGY AND MANAGEMENT234 Spetch11.qxd 5/18/2001 4:14 PM Page 234 A nation’s system of corporate governance can be seen as an institutional matrix (North, 1990) that structures the relations among own- ers, boards, and top managers, and determines the goals pursued by the corporation. The nature of this institutional matrix is one of the principal determinants of the economic vital- ity of a society. By hypothesis, getting the institutions of corporate governance right means ensuring that those who run corpora- tions make decisions that lead to superior national economic performance. This means making sure that top managers and their super- visory board are appropriately responsive to signals from the product markets and the capi- tal markets (Gordon, 1997). Thus, corporate governance can be seen as the institutional matrix that links market signals to the deci- sions of corporate managers. According to Douglass North (1990: 6), ‘The central puzzle of human history is to account for the widely divergent paths of his- torical change. How have societies diverged? What accounts for their widely disparate [eco- nomic] performance characteristics?’ Accepted theory in economics predicts that through trade, national economies would converge in institutions and thus performance, as inferior institutions were weeded out and politicians in weaker economies adopted the policies of stronger ones. Yet economies are immensely diverse in their institutional structures and per- formance, leading to an enormous gap between rich and poor nations (see Firebaugh, 1999 for a recent assessment). Two questions arise from this observation. First, given that large corporations are disproportionately responsible for the economic wellbeing of a society, is there a best model of corporate gov- ernance? That is, is there an institutional matrix that reliably encourages corporate managers to make choices leading to eco- nomic growth for a society? Second, can an institutional matrix be emulated? The struc- tures of particular organizations may be copied with more or less fidelity, but the insti- tutions of corporate governance, such as a system of corporate and securities law, operate largely at a national level and thus entail politi- cal choices. Is it possible for a nation to move from one system of corporate governance to another? The first question – what is the right model? – is deceptively simple. It should be a straightforward matter to rank economies by their economic vitality, select the top per- former, and abstract the crucial elements of its institutional matrix. The experience of the 1990s suggested to many commentators that the American model of investor capitalism was the obvious winner (see, Soros’s [1998] critical account and Friedman’s [1999] affir- mative account of free market triumphalism). The American economy experienced the longest expansion in its history, generating millions of new jobs, countless new business starts, and a long stock market boom. This contrasted sharply with its rich-country rivals, particularly Japan, as well as with the emerg- ing markets that entered deep slumps in the late 1990s. Moreover, the American model appeared especially amenable to a world of borderless capital, in which geography was of little concern in the process of matching investment flows to business opportunities. In principle, even a nation with little indigenous savings could achieve prosperity by adopting a system of American-style investor capitalism and opening itself to foreign investment. In the words of Treasury secretary Larry Summers, ‘Financial markets don’t just oil the wheels of economic growth – they are the wheels’ (Wall Street Journal, 8 December 1997). The institutional matrix that makes up the American system of corporate governance is codified in the contractarian approach to the firm, also known as agency theory. Agency theory was developed primarily within finan- cial economics to describe the various mecha- nisms that ‘solve’ the agency problems created by the separation of ownership and control, by ensuring managerial devotion to increasing the company’s share price: Managers’ wealth is tied to share price through numerous devices, including outright owner- ship, stock options, and compensation keyed to stock performance that align executive and shareholder interests. Because share price does not necessarily reflect detailed inside information about how well the firm is being managed, firms have adopted other devices to monitor managers, including shareholder- elected boards of directors that ratify important decisions (Fama and Jensen, 1983), concen- trated and thus powerful ownership blocks for firms whose performance is difficult to monitor (Demsetz and Lehn, 1985), efficient managerial CORPORATE CONTROL 237 Spetch11.qxd 5/18/2001 4:14 PM Page 237 labor markets that ensure that managers are paid over the long run according to their con- tribution (Fama, 1980), and high debt that com- pels managers to meet regular payment hurdles and optimal returns to capital markets (Jensen, 1986). If all these mechanisms fail and bad management drives the firm’s share price down far enough, superior managers will acquire control of the firm, fire incumbent managers, and run the firm better themselves; they are rewarded for their trouble by their personal gain from the recovery of firm value, while shareholders are compensated by the premium paid. Thus, capital markets ensure that the structure of the nexus of contracts that survives is the one that minimizes agency costs and maximizes shareholder wealth. Managers who sought to sell company shares that, say, made it too difficult for shareholders to remove them if they did a poor job or paid themselves too much would find few buyers. Thus, managers have built-in incentives to propose organiza- tional structures that limit their own discretion (Davis and Thompson, 1994: 144–5). Each element of the theory – from manage- ment compensation and board composition to the structure of ownership and dynamics of takeovers – has received extensive research attention as it applies to large US corporations, particularly during the 1980s (see virtually any issue of the Journal of Financial Economics published during this period). If a cross- national adoption of American corporate gov- ernance institutions proved desirable, agency theory provides the blueprint: in the words of one recent review, ‘the Anglo-American gov- ernance system, born of the contractarian par- adigm, is the most flexible and effective system available. Indeed, notwithstanding its idiosyncratic historical origins and its limita- tions, it is clearly emerging as the world’s standard’ (Bradley et al., 1999: 8). But questions of institutional transfer are premature. Those with long memories recall that at the beginning of the 1990s, it was the Japanese and German systems that served as the world’s models, and pundits advocated a system of bank-centered relationship capital- ism to cure the social disruption caused by America’s myopic shareholder orientation. The virtues of ‘Toyotaism’ and the remarkable success of East Asian economies emulating Japanese business organization led the business press to herald the emergence of American-style keiretsu. ‘Unfettered Anglo-Saxon capital- ism is finding it difficult to cope with the present’ and thus American corporations should be encouraged to form keiretsu-like groups, which ‘insulate management from short-term stock-market pressures without cre- ating incompetent managers’ (Thurow, 1992: 19, 281). In short, the most productive economies got that way because their systems of corporate governance, sometimes called communitarian or relationship capitalism, muffled the signals from impatient financial markets and encouraged cooperation among firms and their suppliers – exactly the opposite of the American system of investor capitalism. Determining the best system of governance – investor capitalism, ‘crony capitalism,’ or something else – thus turns out to be far from trivial. Indeed, choosing which measure of per- formance to use and which time period to focus on yields rather divergent results – while the US economy expanded continuously from 1992 through 1998, expanding the time horizon to a full decade creates a rather different picture. From 1989 to 1998, both Germany and Japan experienced substantially higher productivity growth than the US, Germany displayed a higher per capita growth in GDP, and Japan recorded lower average unemployment (The Economist, 10 April 1999). Locating the effec- tive ingredient in a national economy’s institu- tional matrix may be a hopeless endeavor and the safest course may be to call it a draw among the three major contenders (cf. Roe, 1994). Even the pleasing simplicity of an abstract ‘governance model’ may imply more coher- ence than is warranted. The American system is often referred to as the Anglo-American system because key elements are held to be common between the US and the United Kingdom. Yet even these two are rather diver- gent on several dimensions, which suggests strong limits on the extent to which institutions can be adopted across cultures. In the UK, for instance, the positions of chairman of the board and the chief executive officer are held by different persons on more than four out of five boards among the largest 500 firms; the shared understanding is that ‘the CEO runs the company and the Chair runs the board’ (Pettigrew and McNulty, 1998). In contrast, three quarters of Fortune 500 firms in 1999 were led by CEOs who also held the chair’s job, HANDBOOK OF STRATEGY AND MANAGEMENT238 Spetch11.qxd 5/18/2001 4:14 PM Page 238 and seasoned directors are virtually unanimous in viewing the forced separation of the two jobs as undesirable because of the ambiguity it creates about ‘who’s in charge’ (Neiva, 1995). On another contrasting front, 22% of the typical Fortune 1000 firm’s directors are ‘insiders’ (executives of the firm), while the comparable figure in the UK is roughly 50% These facts are attributed to cultural differences in the boardrooms of the two nations, and neither nation shows much sign of budging in the other direction (Davis, 1998). Thus, even between the two named practitioners of Anglo-American corporate governance, there are sharp divergences on such basic matters as the organization and composition of the board. There are also, notably, sharp differences in economic perfor- mance, favoring the US. Adopting Anglo- American governance practices is evidently not sufficient to ensure superior economic per- formance for an economy, even supposing one could determine what these practices were. These cultural differences notwithstanding, the attractions are undeniable in emulating American corporate governance for firms seek- ing outside investment. The number of non-US firms listed on the New York Stock Exchange increased from 96 in 1990 to 379 in 1998, while the value of US equity investment abroad increase more than six-fold during the same period (Useem, 1998; New York Stock Exchange, 1999; Federal Reserve, 1999). Effectively borderless financial markets are per- haps the strongest force in encouraging the adoption of American corporate governance and its valorization of ‘transparency’ and ‘account- ability.’ But while a particular firm may come to adopt an American model of governance – just as many manufacturers sought to adopt the Toyota model of production in the 1980s and 1990s – a system of governance, as an institu- tional matrix embedded in a particular culture, is far less prone to such wholesale change (cf. Coffee, 1998). Species may adapt, but it is far more difficult for an entire ecosystem to do so. WHO ARE TOP MANAGERS AND COMPANY DIRECTORS? Though market capitalism can epitomize imper- sonality – and some company headquarters seem as remote as Kafka’s castle – they are nonetheless intensely personal at the top. A handful of individuals make the defining decisions, whether to launch a new product, enter a promising region, or resist a tender offer. It is they who set the rules and fix the procedures that come to constitute the imper- sonal bureaucracy. Top management is the catch phrase for those who work at the apex, and companies often define their ‘top’ as no more than the seven or eight most senior officers. Their color photos adorn the annual report’s early pages. They speak for the company to inquisitive journalists and skeptical analysts. They are the ‘they’ when employees grumble about nasty work or shareholders gripe of shortchanged expectations. To much of the world beyond the company walls and capital markets, however, top man- agement is personified almost solely by the chief executive. Readers of the American business press know that Jack Welch ‘runs’ General Electric, Michael Eisner rules Walt Disney Company, and Warren Buffett is Berkshire Hathaway. Attentive Japanese recog- nize that Fujio Cho drives Toyota and Germans that Jurgen Schrempp steers DaimlerChrysler. It is enough to know the commanding general, it seems, to anticipate the strategy of attack. The upper apex of top management is what really counts. Academic researchers had long been drawn to the same pinnacle of the pyramid, partly on the conceptual premise that the chief executive is the manager who matters, and partly on the pragmatic ground that little is publicly known about anybody except the CEO. We have thus benefited from a long accumulation of work on their family histories, educational pedigrees, and political identities, and we know as a result that their origins are diverse, credentials splen- did, and instincts Republican. More contem- porarily, we have learned much about their tangled relations with directors and investors as well. To know the CEO’s personal rise and board ties is to anticipate much of the firm’s strategic intent and performance promise. They are also a good predictor of the CEO’s own fortunes – an elite MBA degree accelerates movement to the top, a prestigious background attracts outside directorships, and a handpicked board enhances pay and perquisites (Belliveau et al., 1996; Useem and Karabel, 1986). CORPORATE CONTROL 239 Spetch11.qxd 5/18/2001 4:14 PM Page 239 for their chief executive, greater likelihood of dismissing an under-performing CEO, and larger market share and superior financial per- formance. In parallel study, the same is found to prevail among large companies in Denmark, France, Italy, Netherlands, and UK (Yermack, 1996; Conyon and Peck, 1998). It is not surprising, then, to see companies worldwide migrating toward smaller boards in a search of improved performance. In their 1999 report to the stockholders, Sony’s chief executive Norio Ohga and co-CEO Nobuyuki Idei, wrote that they had launched a new ‘cor- porate reorganization’ to ‘maximize shareholder value.’ A central feature of their reorganiza- tion is to improve their directors’ ‘monitoring ability,’ and, to that end, Sony reduced its ros- ter of 35 directors to just 9. Japan Airlines moved parallel fashion. The company had reported losses during three of its past five years, and its largest investor, Eitaro Itoyama (holding 3.4% of its shares), had announced a campaign to oust top management to ‘save JAL.’ To improve its directors’ effectiveness and, hopefully, company performance, the air- line shrank its board from 28 directors to 15 and required that they stand for election yearly rather than bi-annually (Institutional Share- holder Services, 1999; Sony, 1999). Directors in principle protect owner inter- ests, direct company strategy, and select top management. In practice, they had concen- trated more on strategy and selection and less on owner interests. But the rising power of investors has made for greater director focus on creating value and less coziness with top management. American and British directors, following the ‘Anglo-Saxon’ model, are already more focused on value than most. But directors in other economies can be expected to slowly gravitate toward the mantra of share- holder supremacy as well. HOW DO SHAREHOLDERS AND OTHER STAKEHOLDERS INFLUENCE THE CORPORATION? The Uncommon Problem of the Separation of Ownership and Control Imagine that the owners of a public corpora- tion had a simple goal: to maximize the value of their investment at minimum risk. The most straightforward measure of the achievement of this goal is growth in the price of the firm’s shares, and effective managers are those that successfully endeavor to maximize share price. Governance systems vary widely in the means by which owners can influence managers – owners might have a direct say in corporate strategy and in selecting members of the top management team, they might delegate these functions to a board but ensure that com- pensation and other incentives are aligned with share price maximization, or they might rely on mechanisms such as takeovers to ensure managerial devotion to share price. Corpora- tions where management was not held account- able for achieving the corporation’s goals would attract little outside support: as Gilson (1996: 333) puts it, ‘any successful [gover- nance] system must have the means to replace poorly performing managers.’ This is the essence of the ‘agency problem’ identified by Berle and Means (1932) in managerialist cor- porations with dispersed ownership. The problem of managerialism, however, turns out to be of surprisingly little relevance outside the US and the UK. In virtually every other economy, even the largest businesses are typically owned by controlling shareholders. A study of the largest 20 corporations in 27 of the world’s richest economies found that ‘con- trolling shareholders – usually the State or families – are present in most large companies’ (La Porta et al., 1999: 473), while another survey found that ‘a large majority of listed companies from Continental European coun- tries have a dominating outside shareholder or investment group’ (Goergen and Renneboog, 1998: 2). While minority shareholders may have little direct influence on the management of such firms, controlling shareholders pre- sumably act to ensure the pursuit of share- holder value since it is their own. Outside the wealthiest tier of nations, stock markets are of relatively less significance, and thus manageri- alist corporations are unimportant. The influ- ences of owners on managers are direct and unproblematic. The general idiosyncrasy of the American system received surprisingly little attention from corporate governance scholars before the publication of Mark Roe’s book Strong Managers, Weak Owners in 1994. Prior to this, ‘the corporate governance systems of other HANDBOOK OF STRATEGY AND MANAGEMENT242 Spetch11.qxd 5/18/2001 4:14 PM Page 242 nations were largely ignored because the American system was though to represent the evolutionary pinnacle of corporate gover- nance. Other systems, with different institu- tional characteristics, were either further behind the Darwinian path, or at evolutionary dead-ends; neither laggards nor Neanderthals compelled significant academic attention’ (Gilson, 1996: 331). In the late 1990s, however, a flourishing research interest focused on documenting and explaining the diversity of systems of gover- nance. New systems of corporate and securi- ties laws were installed in transitional East European economies to facilitate the process of privatization (with varied success – see Spicer and Kogut, 1999), and enthusiasm for financial markets as a tool for development in emerging markets created a practical need for understanding of cross-national variation in institutional structure (see the World Bank’s corporate governance agenda at www.world- b a n k . o r g / h t m l / f p d / p r i v a t e s e c t o r / c g / index.htm). Nations vary in the extent of legal protection for shareholders and the quality of enforcement, and the strength of legal protec- tion for shareholders is positively related to the degree of ownership dispersion. In other words, managerialist corporations are most common in countries with strong investor pro- tections, while concentrated ownership is most common when investor protection is weak (La Porta et al., 1998). Stock markets are larger, and there are more public corporations per person, when investor protections are stronger (La Portaet al., 1997). The single biggest factor distinguishing nations with strong legal protections for investors, and thus large capital markets and more dispersed ownership, was the origin of the legal system. Countries whose commercial law derived from a common law tradition, which includes most English-speaking countries as well as former British colonies, have stronger shareholder protections than countries with civil or ‘code’ law (La Porta and Lopez-de- Silanes, 1998). Absent strong legal protections against the types of self-aggrandizing managers contemplated by Berle and Means, and sensible people would avoid investing in companies with dispersed ownership because they would fear the loss of their investment. Concentrated ownership allows control of management with- out relying on uncertain legal enforcement. The pole for market-centered (as opposed to relationship-based) capitalism is clearly the United States. In contrast to corporations throughout the rest of the world, large American corporations have relatively dispersed owner- ship. Roughly three-fourths of the 100 largest US corporations lack even a single ownership block of 10% or more. Of the 25 largest com- panies in 1999, the largest single shareholder averaged only 4% of the holdings, while the comparable percentages are 11 in Japan, 18 in Germany, and 19 in France (Brancato, 1999). The dispersion of ownership in the US effectively rules out the direct control avail- able in firms where a single family or bank owns most of the shares. Dispersed sharehold- ers therefore delegate control to a board of directors that they elect to act as their agents in choosing and supervising the top management team. Control by minority shareholders gener- ally extends only as far as buying and selling shares, and voting for directors and other mat- ters on the annual proxy. Minority sharehold- ers almost never have a say in the selection of top managers, or even in who ends up on the board. Indeed, by some accounts inattention is the only sensible course of action for dispersed shareholders (‘rational ignorance’), as the cost of being well informed about the governance of the firm is not outweighed by the marginal benefit of improved corporate performance that might result from informed voting or activism (Fama, 1980). But while in other contexts this collective action problem would result in management unaccountable to share- holders, investors in US corporations can rest easy because of the well-developed set of institutions that have arisen to ensure share price maximization without their active partici- pation (see Easterbrook and Fischel, 1991). Takeovers The most essential mechanism for enforcing attention to share price is the takeover market or ‘market for corporate control.’ By hypothesis, a poorly-run corporation will suffer a low stock market valuation, which creates an opportu- nity for outsiders with better management skills to buy the firm at a premium from share- holders, oust the top management team, and rehabilitate the firm themselves, thus increas- ing its value (Manne, 1965). This provides an CORPORATE CONTROL 243 Spetch11.qxd 5/18/2001 4:14 PM Page 243 economic safety net for shareholders and an opportunity for outsiders who detect underval- ued firms. Moreover, it provides a mechanism to discipline top managers that fail to serve shareholder interests, as they generally end up unemployed following a takeover. In the con- tractarian model, the market for corporate con- trol is the visible hand of Darwinian selection, weeding out badly run firms and protecting shareholders from bad management. Internal control mechanisms may fail, as boards are compromised by ‘cronyism,’ and thus the hos- tile takeover – as an objective, market-based mechanism – is an essential weapon in the armory of the contractarian system (Jensen, 1993). US public policy in the 1980s made it considerably easier for outsiders to mount hos- tile takeover bids, and the result was a massive wave of takeovers in which nearly one-third of the largest publicly-traded manufacturers faced takeover bids (Davis and Stout, 1992). Reams have been written about the US takeover wave of the 1980s (see Blair, 1993) but the high points are easily summarized. The typical target had a low stock market valuation relative to its accounting or book value, as one would predict based on the contractarian model (Manne, 1965; Marris, 1964), and the source of this low valuation was often exces- sive diversification by conglomerate firms (Davis et al., 1994). Conglomerates were typi- cally purchased with the intention of busting them up into more focused components, which were sold to buyers in related industries (Bhagat et al., 1990), while non-targets restruc- tured to achieve industrial focus and avoid unwanted takeover (Davis et al., 1994). In the US, takeovers are regulated both at the federal and state level, and by the early 1990s most states had passed legislation to make takeovers attempted without the consent of the target’s board of directors extremely difficult. Thus, hostile takeovers virtually disappeared in the US after 1989. Two results of the 1980s hostile takeover wave stand out. The first is that the manufac- turing sector overall ended the decade much more focused than when it began, and the trend toward within-firm focus continued unabated through the mid-1990s (Davis and Robbins, 1999). With a few notable excep- tions, such as General Electric, the industrial conglomerate would appear to be a thing of the past in the US, in spite of its prevalence elsewhere in the world. The second result is a decisive shift in the rhetoric of management toward ‘shareholder value,’ to the virtual exclu- sion of other conceptions of corporate purpose. This is realized in efforts at managing investor relations (Useem, 1996), in the kind of spin that management puts on practices such as compensation plans (Westphal and Zajac, 1998), and in more tangible actions such as acquisition and divestiture strategies. US manu- facturers in the 1990s eschewed diversifica- tion in favor of ‘strategic’ (horizontal) mergers and acquisitions, resulting in behemoths in oil, defense, autos, and other sectors that would have been unthinkable in previous decades. Notably, this shift toward a monomaniacal focus on shareholder value occurred in spite of the fact that – in stark contrast to the 1980s – hostile takeovers had virtually disappeared in the 1990s, and takeover targets were no longer ‘underperforming’ firms but rather those that were strategically attractive to acquirers (Davis and Robbins, 1999). Evidently, the hostile takeover is less essential to investor capitalism than had previously been thought. Shareholder Activism Hostile takeovers are a rather blunt instrument for transferring corporate control, and the message they send is not especially fine- grained. But short of takeover, the channels of shareholder influence are surprisingly limited in the US (see Davis and Thompson, 1994). The formal means of shareholder voice is through proxy voting at the annual meeting. Shareholders vote on who serves on the board of directors, which accounting firm audits the firm’s books, whether to approve certain types of executive compensation plans, and other significant matters such as mergers, changes in the corporate charter, or changes in the state of incorporation. Almost without exception, these votes consist of approving (or not) pro- posals put forth by the current board of directors–competing director candidates, or competing proposals, are extremely rare. The primary means of direct shareholder voice is through shareholder proposals. Any share- holder owning a non-trivial stake in the corpo- ration can submit a proposal relevant to the corporation’s business to be included in the proxy statement and voted on by shareholders. HANDBOOK OF STRATEGY AND MANAGEMENT244 Spetch11.qxd 5/18/2001 4:14 PM Page 244 Telecom staff) to increase their mutual heft in issues of international corporate governance (CalPERS document can be found at www. calpers-governance.org/principles/interna- tional/). Given the vast growth of US institu- tional investment in equities outside the US, American-style investor activism is poised to go global. Already, investor pressures are cred- ited with forcing the ousters of Cie. De Suez’s chair in 1995 and Olivetti’s chair in 1996 (Useem, 1998). In South Korea, Jang Ha Sung formed the People’s Solidarity for Participatory Democracy to press for corporate governance reform, and while he met with little success prior to the Asian financial crisis of 1997, he has subsequently become ‘the darling of the international crowd’ and has formed successful alliances with foreign institutional investors to press for governance changes (Economist, 27 March 1999). In France, Colette Neuville formed the Association for the Defense of Minority Shareholders to push for corporate governance reform and to strengthen investor protections in takeovers (Business Week, 18 September 1995). Both non-local and indige- nous investors can draw on the principles and tactics of shareholder activism in the US. Given the relatively weak minority shareholder pro- tections outside common law countries, how- ever, it is likely that any such activism will have modest impact at best (La Porta et al., 1998). DO TOP MANAGERS REALLY MAKE A DIFFERENCE? If shareholders are increasingly insistent that board directors require top managers to deliver steadily rising returns on their investments, investor activism is premised on a critical assumption that top managers can make the difference. While the premise may seem intu- itively obvious to those inhabiting this world, it is far from self-evident to those who study it. Observers diverge from the assumption of influ- ential executives in two opposing directions, one viewing top managers as all-powerful, others seeing them as all but powerless. Jay Lorsch had examined company boards with both views in mind, and his book title well captures the bi-polar thinking about the clout of company executives as well: Pawns or Potentates (1989). Gaetano Mosca, Vilfredo Pareto, and kindred ‘elite’ theorists early articulated the all-powerful view, but C. Wright Mills cap- tured it best in his classic work, The Power Elite (1956). Company executives, in his acid account, had joined with government officials and military commanders in an unholy alliance that later observers, including US president Dwight D. Eisenhower, would later dub the ‘military–industrial complex’. Seen from this parapet, top management and their allies exer- cise commanding control over the company and the country. In E. Digby Baltzell’s cri- tique, The Protestant Establishment (1987) and G. William Domhoff’s rendering, Who Rules America (1967), they have even come to constitute a self-conscious class, favoring descent over deed. Others discern comparable customs in British business and elsewhere (Bottomore, 1993; Scott, 1990, 1997). To the extent that top management is indeed all- powerful, shareholders and directors possess a silver bullet for righting whatever has gone wrong: install new management. For the community of management schol- ars, Jeffrey Pfeffer (1978, 1981) well articu- lated the opposite, all-powerless view with the contention that market and organizational con- straints so tied top management’s hands that it was much the captive, not a maker, of its own history. Production technologies and competi- tive frays in this view are far more determin- ing of company results than the faceless executives who sit in their suites. Structures matter, personalities don’t. It counts little who serves in top management, and, by extension, on the board. Managers and directors are con- trolling and caste-conscious in Mills’ and Domhoff ’s critique, while they are both powerless and classless in Pfeffer’s hands. If top management is quite as powerless as the latter imagery suggest, investors seeking new management are surely wasting their time. Though probably less often than university deans, company executives do complain of a seeming helplessness at times. Yet almost anybody in personal contact with top managers reports just the opposite. Direct witnesses typically describe instead a commanding pres- ence of their top management, an organiza- tional dominance. It is the senior executives who shape the vision and mobilize the ranks, and it is they who make the difference between success and failure (Tichy, 1997; CORPORATE CONTROL 247 Spetch11.qxd 5/18/2001 4:14 PM Page 247 Charan and Tichy, 1998). Also consistent with the concept of the prevailing executive is evi- dence from the flourishing executive search industry, where companies pay hundreds of headhunting firms millions of dollars to find the right men and women for the executive suite. They are engaged, in the phrasing of a widely circulated assessment by McKinsey & Co. (1998), in a ‘war for talent.’ It would hardly be deemed warfare or worth millions if senior managers made so little difference when they arrived in office. Investors themselves think otherwise as well. When companies announce executive succession, money managers and stock ana- lysts are quick to place a price on the head of the newly arrived, and, depending on the per- sonality, billions can be added to or subtracted from the company’s capitalization. On the addition side, consider the appointment of Christopher Steffen as the new chief financial officer of Eastman Kodak in 1993. Steffen had been hired to help turn around a company whose earnings and stock price had been lan- guishing. He was characterized as the ‘white- knight chief financial officer who could save stodgy Eastman Kodak.’ Investors applauded his hiring. The company’s stockprice soared in the days that followed, adding more than $3 billion to the company’s value. In an immedi- ate clash with chief executive Kay Whitmore, however, Steffen resigned just 90 days later. Investors dumped Kodak shares with vigor, driving the company’s value down the next day by $1.7 billion, further affirming his worth in the eyes of discerning investors. It would seem that just a single individual with the right talent could augment a company’s value by billions in days (Useem, 1996). On the subtraction side, consider the selec- tion of John Walter as the new chief operating officer and CEO-apparent of AT&T in 1996. In the five trading days that followed, in a period when little else was transpiring in the market, AT&T’s value dropped by $6 billion. One business writer had hailed Christopher Steffen as the ‘three-billion-dollar man.’ John Walter might comparably be dubbed the ‘six- billion-dollar disappointment’ (Rigdon, 1993). The importance that investors and directors attribute to top management for growing their fortunes can also be seen in the ultimate pun- ishment for failure to do so: dismissal. Whether the US, Japan, or Germany, the likelihood of a CEO’s exit in the wake of a stock free fall is increased by as much as half. And investors are often the engines behind the turnover. Study of Japanese companies stunned by a sharp reversal of fortune, for example, reveals that those whose top ten shareholders control a major fraction of the firm’s stock are more often than others dismiss the president and even bring in new directors (Kaplan, 1994a, 1997; Kang and Shivdasani, 1997). To obtain a metric for the longer-term value that a chief executive brings to a company, we turn to several studies that have examined company results several years after a chief executive has left office, not just several days. The successor brings a distinctive blend of tal- ents to the office, and if those talents make a difference, the firm’s performance should be different as well. Net of confounding factors such as the company’s sector and economy’s momentum, investigators do find that com- pany performance does vary with executive personality. Yet compared to the firm’s struc- ture and identify, the chief executive’s contri- bution can seem modest. After all, if Bill Gates retired as chief executive at Microsoft or Jack Welch at General Electric, these companies are such product juggernauts that their succes- sors are sure to look good for some years to come. But in absolute terms, the studies report, performance can rise or fall by as much as 10 to 15% over several years after the CEO’s departure depending upon the specific succes- sor. To put that in perspective, think of a new manager of a professional baseball team that had won 80 games and lost 80 games during the past season. If the new manager’s limited talents lead the team to win 15% fewer games next season, the team’s win-loss record would drop from .500 to .425, and the coach will become the heel. If instead the new manager’s excellent talents would yield 15% more wins, the team’s record rises to .575, and coach will be the hero (Lieberson and O’Connor, 1972; Thomas, 1988). As strong as they are, these results may still underestimate the difference that top manage- ment makes now compared to the past. In a study of 48 large manufacturing firms among the Fortune 500, the researchers asked two immediate subordinates of the chief execu- tives of the extent to which their boss, the CEO: was a visionary: showed strong confi- dence in self and others, : communicated high HANDBOOK OF STRATEGY AND MANAGEMENT248 Spetch11.qxd 5/18/2001 4:14 PM Page 248 performance expectations and standards, personally exemplified the firm’s vision, values, and standards, and demonstrated per- sonal sacrifice, determination, persistence, and courage. The investigators also assessed the extent to which the firms faced environments that were dynamic, risky, and uncertain. Taking into account a company’s size, sector, and other factors, they found that these execu- tive capabilities made a significant difference in the firm’s net profit margins among compa- nies that faced highly uncertain environments. When the firms were not so challenged, how- ever, the chief executive’s qualities had far less of an impact on performance (Waldman et al., 1999). Top management matters more, it seems, when it is less clear what path the company should pursue. Given the intensification of global competition and technological change in many markets, leadership is thus likely to make more of a difference in the future than in it has in the past. We remember wartime prime ministers and presidents better than peacetime leaders, and the same is likely to be true for company executives. Thus, it not surprising that directors are observed to replace failing executives more quickly now than in years past (Ocasio, 1994). Similarly, directors are observed to more generously reward success- ful executives than in the past. For each addi- tional $1,000 added to a company’s value in 1980, directors on average provided their chief executive an extra $2.51. By 1990, the differ- ence in their payments had risen to $3.64, and by 1994 to $5.29. Put differently, in 1980 the boards of companies ranked at the 90th per- centile in performance gave their CEOs $1.4 million more than did boards whose firms ranked at the 10th percentile (in 1994 dollars). But by 1990, the boards had expanded that gap to $5.3 million, and by 1994 to $9.2 million (Hall and Liebman, 1998). The specific leadership or teamwork capa- bilities that do account for the varying perfor- mance among top managers is beyond the scope of this chapter. But broadly speaking, leadership within the company is a critical component. Unless the troops are mobilized and their mission understood, they are unlikely to deliver the value top management wants. But so too is leadership out and up, building confidence and understanding among the money managers and stock analysts who can turn against a poorly appreciated or understood company as quixotically as they did against the Asian nations when Thailand devalued its currency in July 1997. Skillful top management work with profes- sional investors is thus becoming more of a virtue since money managers and stock ana- lysts have become less tolerant of languishing results and are better able to demand stellar performance. Moreover, globally minded investors are now comparing opportunities worldwide, and top managements and their performance are judged less against their domestic neighbors and more against the best anywhere. To assure investor favor and assuage doubt, companies and directors are therefore increasingly likely to stress execu- tive ability to deliver the strategy story to the stock analysts and, ultimately, share value to the money managers. Research confirms that when chief executives present their strategies to groups of stock analysts, institutional inter- est and stockholding does indeed rise (Byrd et al., 1993). While some top managements will be tempted to create defenses against shareholder pressures, more are likely to be drawn to affirmative measures, including improved disclosure of information and stronger governing boards (Useem, 1998). HOW DO CORPORATIONS SHAPE SOCIETY? At stake in discussions of corporate gover- nance and top management are questions of corporate power and accountability, and ulti- mately of the welfare of society. Corporations are legal fictions, created by systems of law to serve social ends for consumers, workers, and investors. Systems of corporate governance are, in essence, genres – styles of thinking about the corporation, its purposes, to whom it is accountable. There is a long-standing antin- omy between the social entity model of the corporation and the property or contractarian conception (Allen, 1992). The entity concep- tion, central to organization theory, sees cor- porations as ‘containing’ members, for whom the corporations provide various goods (for example, income security, social identity) as part of a social contract. In the most expansive version of this view, corporations directly CORPORATE CONTROL 249 Spetch11.qxd 5/18/2001 4:14 PM Page 249 relationship capitalism because it renders firms too lethargic in the face of change (see Gordon, 1997). Without the prospect of out- side takeover or other mechanisms that focus decision making on shareholder value, corpo- rations are too slow to exit low-growth indus- tries by closing plants and laying off employees (Jensen, 1993). When Krupp-Hoesch Group made a hostile takeover bid for steel rival Thyssen in March 1997, Thyssen workers fearful of the inevitable job losses mounted a demonstration at Krupp headquarters, pelting Krupp’s CEO with eggs and tomatoes. Krupp was convinced by local political leaders to sus- pend the bid and enter into friendly negotia- tions. As the two firms sought to hammer out a joint venture agreement, 25,000 workers massed at Deutsche Bank headquarters in Frankfurt to protest the bank’s role in the takeover – Deutsche Bank was helping to finance Krupp’s bid, but it also had a repre- sentative on the Thyssen board – and the final, friendly agreement resulted in considerably fewer lost jobs at Thyssen. One person’s ‘industrial lethargy’ is another person’s job security. In the US, by contrast, layoffs are so com- mon as to arouse little comment, and it is dif- ficult to imagine mass protests in response to takeovers. (The US Department of Labor esti- mates that 40% of the American labor force changes jobs in any given year.) It is hard to imagine mass protests against dispersed share- holders, and public debate over the social obligations of the corporation has virtually disappeared. Indeed, those corporations that try to serve the ends of stakeholders other than shareholders find it difficult to do so. In the 1919 case of Dodge vs Ford Motor Co., the Michigan Supreme Court laid down a founda- tional view of the purpose of the corporation in a contractarian world: There should be no confusion of the duties which Mr. Ford conceives that he and the stockholders owe to the general public and the duties that he and his co-directors owe to pro- tecting minority shareholders [i.e., the Dodge brothers]. A business corporation is organized and carried on primarily for the profit of the stockholders. The powers of the directors are to be employed for that end. The discretion of directors is to be exercised in the choice of means to attain that end, and does not extend to a change in the end itself, to the reduction of profits, or to the nondistribution of profits among stockholders in order to devote them to other purposes. Indeed, as we have seen from our discussion of the Cracker Barrel case, the board of an American corporation would not necessarily be required to attend to other constituencies even if their own shareholders wanted it! (Blair and Stout [1999: 251] make a com- pelling case that the discretion of the board of directors over the use of corporate resources is ‘virtually absolute’ under American corporate law, and this discretion can be used to imple- ment something like a social entity model. They recognize, however, that custom among law and economics scholars – if not the law itself – treats the shareholders as the sole own- ers and legitimate ‘stakeholders’ of the corpo- ration, and this notion has achieved the status of doxology among American corporate man- agers in the 1990s [Davis and Robbins, 1999].) The beneficial effects of the shareholder- oriented corporation on society thus rest on the stylized argument at the beginning of this section – that corporations serve consumers, workers, and shareholders best when they focus exclusively on maximizing share price. IS A WORLDWIDE MODEL FOR TOP MANAGEMENT AND CORPORATE GOVERNANCE EMERGING? We have described corporate governance as an institutional matrix that structures the relations among owners, boards, and top managers and determines the goals pursued by the corpora- tion. The corporation is a legal fiction, and dif- ferent systems of governance represent different genres, with relationship capitalism (in which the corporation is treated as a social entity) and investor capitalism (in which the corporation is a nexus-of-contracts) as the two major distinct sub-types. Can both types sur- vive, or will global trade and investment flows prompt a Darwinian struggle in which one system drives out the other, leading to global convergence? The question of societal convergence – is it possible, likely, or desirable – has been mulled over by sociologists (Guillen, 1999) HANDBOOK OF STRATEGY AND MANAGEMENT252 Spetch11.qxd 5/18/2001 4:14 PM Page 252 and economists (North, 1990) for decades. It is fair to say that the majority opinion, if not the consensus, is that convergence has not occurred in the past and is unlikely to occur in the future. But the institutions of corporate governance, and the means of organizing top management, are considerably more circum- scribed in scope. While the flow of trade across national borders may not induce con- vergence (North, 1990), the flow of global capital dwarfs that of trade and can have far more important impacts for corporate organi- zation. The economic benefits of opening an economy to international investment, particu- larly through financial markets, are great, at least in theory – it can increase the availability and reduce the cost of capital for both new and established businesses, thereby boosting eco- nomic growth overall. But these benefits of financial markets require corporate gover- nance practices that reassure arms’ length investors that they will get a return. The US in particular is seen as having evolved a well- articulated system of institutions for ensuring that shareholders can make arms’ length investments in corporations with a reasonable degree of confidence that management will do its job as well as possible. Given the manifest benefits of the contractarian model, some commentators see movement toward this system as ‘inexorable. . . . The nature of this movement is unarguably in the Anglo- American direction rather than the other way around’ (Bradley et al., 1999: 80). Others see a global spread of American-style manage- ment as extremely unlikely, and the purported benefits as ephemeral (Guillen, 1999). In short, there is no sign of convergence in the scholarly literature on convergence. Before answering the question, it is worth asking it well. Those examining convergence often focus on very different unit of analysis. At the national level, impediments to conver- gence on American-style corporate gover- nance institutions are imposing. Common law, which is an inheritance of many former British colonies and relatively few other nations, is especially shareholder-friendly, civil law, which characterizes most nations in the world, is not (La Porta et al., 1998). The quality of legal enforcement also varies widely by nation. Entrenched and politically powerful economic interests are unlikely to abandon the basis of their economic dominance easily (Morck et al., 1998). Moreover, relationship capitalism centered around powerful financial institutions has clear advantages over financial market-based in facilitating rapid economic development; a well-trained government bureaucracy guiding investment flows through affiliated banks can create an infrastructure of basic industry quite rapidly (Evans, 1995). Thus, the most sophisticated accounts of the link between national systems of corporate governance and economic vitality do not assume that there is one best way, but that the best system is contingent on a nation’s level of economic development. In an exemplary work of this sort, Carlin and Mayer (1998) find that ‘there is a positive relation in the less devel- oped countries between activity in bank financed industries and the bank orientation of the countries and a negative relation between concentration of ownership and activity in high skill and external financed industries. In more developed countries, the relations are precisely reversed.’ Thus, forcing an American system of governance on less-developed nations could be disastrous. On the other hand, it suggests that nations that have moved from ‘emerging’ to ‘developed’ may benefit by affecting a shift from relationship capitalism to investor capitalism, however unlikely this may be in practice (Rajan and Zingales, 1999). The picture shifts when one considers not nations but firms. For the largest global corpo- rations with the greatest need for capital, such as those listing on the New York Stock Exchange, movement toward the American style appears almost inevitable, just as adop- tion of the Toyota system of manufacturing seemed inevitable for the largest manufacturers (see Useem, 1998). In his thoughtful discus- sion of the convergence debate, Coffee (1998) argues that formal convergence is unlikely but ‘functional convergence’ is plausible. His argument runs as follows. Firms with higher stock market valuations have advantages in acquiring other firms around the globe and thus are more likely to survive global industry con- solidations. As large global corporations seek the benefits of higher market valuations by list- ing on American stock exchanges, they thereby become subject to US legal standards. This moots the issues raised by La Porta et al. (1998): firms, in effect, choose their legal regime, and nations need not seek to become ‘more American’ for their indigenous firms to CORPORATE CONTROL 253 Spetch11.qxd 5/18/2001 4:14 PM Page 253 gain the benefits of American-style governance. The outcome of this process could be a world in which the largest global corporations ‘look American,’ while nations retain their distinct national institutions of governance for smaller domestic firms. In short, the most plausible scenario is for a global standard of governance to emerge for the largest global corporations, while national variation persists both in institutions of governance and in the practices of small- and medium-sized domestic corporations. The impediments for nations to move substantially toward the American system are almost cer- tainly too large to be readily overcome, even if such a transition were desirable: many national distinctions will inevitably persist. THE ROAD AHEAD Top company managers have always drawn academic and applied interest, if for no other reason than they can seem larger than life at those pivotal moments when a company’s ownership and its executive careers hang in balance. The loss of control of RJR Nabisco by chief executive F. Ross Johnson to lever- age-buyout king Henry Kravis in 1987 pro- vided ample material for a best-selling book and subsequent film (Burroughs and Helyar, 1991). The two CEOs – Gerald M. Levin and Stephen M. Case – who merged America Online and Time Warner in 2000 drew enor- mous media interest. Corporate directors have attracted less attention, partly because they avoid the limelight but also because few out- siders believed directors brought much to the table, vanquished as they were by Berle and Means’ managerial revolution. For under- standing company strategy, production tech- nologies, and market dynamics, neither senior executives nor company directors could be viewed as fertile ground for theory building. With the rise of professional investors and their subjugation of national boundaries, how- ever, those who occupy the executive suite and those who put them there are drawing far more research and policy attention, and justifiably so. In a bygone era when markets were more steady and predictable, when airline and telephone executives confidently knew what to expect next year, the identity of top management mattered little. When shareholders were far smaller and decidedly quieter, when airline and telephone directors comfortably enjoyed inconsequential board meetings, the composition of the governing body mattered little either. During the past decade, however, all of this has changed in the US and UK, with other economies close behind. As shareholders have sought to reclaim authority over what they owned, they have brought top management and company directors back in. Company strategy and financial results can no longer be understood without understanding the capabi- lities and organization of those most responsi- ble for delivering them. Research investigators have risen to the occasion. A solid flow of studies has sought to discern and dissect the dynamic relations that now characterize the world of investors, direc- tors, and managers. The market is no longer viewed as so impersonal, the company no longer so isolated. Economic and financial decisions are embedded in a complex network of working relations among money managers, stock analysts, company directors, senior executives, and state regulators. Given the right combination of features, that lattice can yield high investment returns and robust national growth. Given the wrong amalgam, it can lead instead to self-dealing, frozen form, and economic stagnation. The road ahead will thus depend on how well researchers understand what governance arrangements and leadership styles work well both within national settings and across cul- tural divides, and on the extent that top man- agers, company directors, and active investors learn and apply what is best. Five key areas deserve concerted research attention if we are to know what works and what does not, and which theories are useful and which are not: Boards and directors: What does the deci- sion process inside the boardroom look like? What are the sources of power and influence of inside and outside directors? How are the decision process and director influence contin- gent on the ‘institutional matrix’ in which a board is embedded? (Example: Pettigrew and McNulty, 1998a, b.) Comparative governance: What really accounts for the astonishing and remarkably persistent diversity in the national systems of corporate governance? 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