A new paper in the Journal of Applied Corporate Finance looks at “agency capitalism” and its development in the United States during the past 15 to 20 years.
The term “agency capitalism” refers in general to any system in which institutional investors dominate as shareholders of record for the voting stock of publicly traded companies. The institutions in the mix include pension funds, mutual funds, and bank holding companies.
For a long time, it appeared that “agency capitalism” meant managerial capitalism—rational apathy on the part of many of these investors, allowing for a lot of discretion on the part of the managements of large publicly owned corporations. But in the last couple of decades it has appeared that certain specialized institutions, including activist hedge funds, are making the life of a corporate manager somewhat more complicated and constrained than the term “managerial capitalism” suggests.
Reticence is not Apathy
The new paper, by Robert Gilson of Stanford Law School and Jeffrey Gordon, of Columbia, says that the specialized institutions tee up questions that do concern the larger institutions, so that rational apathy has turned into mere “reticence.” The key thing about reticence is that it can be overcome.
In their own more academic prose, Gilson and Gordon argue that “the disinterest of these institutions [pension funds etc.] in serving as active monitors of portfolio companies is an endogenous response to the particular agency relationships that arise from re-concentrated record ownership in investment intermediaries,” and that in turn the rise of the pertinent hedge funds in an endogenous response to the resulting monitoring shortfall.
They acknowledge that in many jurisdictions (including the UK, Europe, and Israel) the predominant response to agency capitalism and the agency problem has been to fix the governance model by adding new corporate-governance standards, with labels such as “stewardship” or “sustainable engagement.” But, in the words of Gilson and Gordon: “We present a very different view.” They propose that “regulatory regimes must adjust” to the utility of the activism specialists, and work through the new market realities. Such regimes should not try to force the large institutional intermediaries to play a role they have neither the incentives nor the institutional expertise to play.
One example of this general line of argument involves “poison pills,” that is, tactics by which companies facing a possible takeover preserve their autonomy by making themselves unattractive. The “genius of the poison pill,” Gilson and Gordon wrote, when it was first pioneered was that “shareholder approval was not necessary; all that was necessary was board approval.”
But what is the best public policy here? If we take the agency problem seriously, we must ask: aren’t hostile takeovers cases in which the interests of the management of the target are likely to be contrary to the interests of the shareholders? Doesn’t the use of poison pills as described, and without shareholder approval, constitute already a prima facie case for self-dealing by the agents at the expense of principals?
Once introduced in the early 1980s, the use of such pills spread quickly, until as these authors remind us, there was a time quite recently when almost all publicly owned firms could be assumed to have pills.
Largely because institutional investors came to oppose pills, they are no longer so ubiquitous. More boards have been letting the pills lapse, or have not adopted them, even when a control battle seems to be in the offing.
Gilson and Gordon say that “one way to read the current campaign to compel quicker disclosure of shareholder accumulations is as an effort to persuade the SEC to impose the equivalent of a poison pill with a very low trigger at a time when institutional investors are successfully pressuring boards to turn away from poison pills.”
Relatedly, they propose, with reference to empty voting, hidden voting, etc. that “hedging [in coming years] may be effected quite differently, in a way that drastically reduces the possibility of hidden votes. The SEC should at least wait to see how that plays out before defining beneficial ownership in a fashion that is dictated only by beliefs concerning the informal operation of the derivatives market and the relationship between transacting parties.”