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Corporate Law and the Longterm Shareholder Model of Corporate Governance

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Corporate Law and the Longterm Shareholder Model of Corporate Governance Scholarship Repository University of Minnesota Law School Articles Faculty Scholarship 1992 Corporate Law and the Longterm Shareholder Model of Corporate Governance John H. Matheson University of Minnesota Law School, [email protected] Brent A. Olson Follow this and additional works at: https://scholarship.law.umn.edu/faculty_articles Part of the Law Commons Recommended Citation John H. Matheson and Brent A. Olson, Corporate Law and the Longterm Shareholder Model of Corporate Governance, 76 MINN. L. REV. 1313 (1992), available at https://scholarship.law.umn.edu/faculty_articles/ 400. This Article is brought to you for free and open access by the University of Minnesota Law School. It has been accepted for inclusion in the Faculty Scholarship collection by an authorized administrator of the Scholarship Repository. For more information, please contact [email protected]. Corporate Law and the Longterm Shareholder Model of Corporate Governance John H. Matheson* and Brent A. Olson** TABLE OF CONTENTS Introduction ................................................ 1315 I. The Dialectical Development of Corporate Governance ........................................... 1323 A. The Shareholder Primacy Norm ................. 1326 B. Managerial Capitalism and Longterm Corporate Welfare ........................................... 1330 C. Monitoring Management ......................... 1333 D. Insulated Managerialism ......................... 1337 1. Legislation Minimizing Market Monitoring and Shareholder Input ........................ 1338 a. Bypassing Shareholder Input Regarding "Business Combinations" .................. 1341 b. Minimizing Shareholder Input Regarding Voting Rights For "Control Shares"..... 1342 c. Bypassing Shareholder Input by Empowering Directors to Consider Nonshareholder Interests ................. 1344 2. Legislation Limiting Director Accountability 1346 3. Judicial Decisions Insulating Management ... 1347 a. Employment of Defensive Measures ...... 1347 b. Consideration of "Corporate Welfare" .... 1351 II. Escalating Tensions and the Pathway to Reform .... 1354 A. The Ascendancy of the Institutional Investor ... 1354 1. The Phenomenal Rise of the Institutional Shareholder ................................... 1354 * Professor of Law, University of Minnesota Law School. Of Counsel, Kaplan, Strangis & Kaplan, PA. ** J.D., University of Minnesota, 1991; M.B.A., University of Minnesota, expected 1992. 1313 1314 MINNESOTA LAW REVIEW [Vol. 76:1313 2. Current Governance Initiatives by Major Shareholders .................................. 1356 B. Reforming Governance by Improving the Board of Directors ....................................... 1358 C. Reforming Governance by Improving the Proxy System ............................................ 1361 D. The ALI Project ................................. 1363 E. Shareholder Advisory Committees and the Seeds of the Longterm Shareholder ............. 1365 III. Transcending the Dialectic: The Longterm Shareholder Model of Corporate Governance ........ 1368 A. A Process Approach to Governance Reform .... 1372 B. A Procedural Governance Framework ........... 1375 IV. Issues in the Application of the Longterm Shareholder Model .................................... 1381 A. The Respective Roles of the Corporate Actors .. 1381 1. The Board's New Role ........................ 1382 2. The Nature and Role of the Longterm Shareholder ................................... 1383 3. Longterm Shareholders' Time has Come .... 1384 B. Benefits of the Longterm Shareholder Model ... 1386 1. Enhanced Monitoring and Accountability .... 1386 2. Enhanced Board Decision Making ............ 1386 3. Enhanced Economic Efficiency ............... 1387 4. Bridging Ownership and Control ............. 1389 C. Responding to Possible Criticism ................ 1389 1. Shareholders Make Poor Monitors ........... 1389 2. Managerial Discretion is Compromised ...... 1390 Conclusion .................................................. 1391 1992] CORPORATE GOVERNANCE 1315 INTRODUCTION The key to effective [corporate] accountability today appears to be the existence of a class of "permanent" owners, holding approximately one-quarter of the outstanding equity, who have an incentive to moni- tor the operations of the corporation. This is essentially the system in Germany, Britain, and Japan.... In the United States, encouraging a pattern of domestic institutional ownership will be a way of ensuring the continuance of effective governance. The challenge, then, for the United States is to identify its "permanent" shareholder institutions and to ensure that they have the incentive and ability to 1 perform the monitoring function. As recently as a few years ago, the ability and desire of cor- porate shareholders to mount a challenge over corporate gov- ernance2 seemed suspect. After all, shareholders were considered to be passive, impotent, and unconcerned. A share- holder revolution, however, is occurring, highlighted by the as- cendancy of the institutional investor.3 This development, combined with the current anti-shareholder corporate govern- ance trend, renders obsolete much of contemporary corporate 1. ROBERT A.G. MONKS & NELL MINow, POWER AND AccoUNTABnxrY 243-44 (1991) (emphasis added). Monks and Minow believe that pension funds supply the necessary core of "permanent" shareholders. Id at 262. 2. As used herein, "corporate governance" defines the process by which the balance of power between a corporation's shareholders and nonsharehold- ers is allocated. Nonshareholders include the corporation's board of directors, officers, creditors, suppliers, and customers. The current framework of corpo- rate governance is defined through state-enacted corporate codes, case law, and customized corporation-specific provisions such as articles of incorporation and bylaws. 3. Monks and Minow, acknowledging this new regime, explain: [W]e are now witnessing the reagglomeration of ownership of the largest corporations, so that long-term shareholders are well on the way to majority ownership of America's companies. They are, of course, the institutional shareholders, who invest collections of indi- viduals' assets through pension funds, trusts, insurance companies, and other entities. MONKS & MINOW, supra note 1, at 18. "Notwithstanding major differences among them, institutional investors as a group, have vastly expanded their economic sphere of influence in a number of important ways. Moreover, while they may be diverse, a high con- centration of economic power resides among a relatively small and extraordi- narily stable group of institutions." Carolyn K. Brancato, The Pivotal Role of Institutional Investors in Capital Markets: A Summary of Research at the Co- lumbia Institutional Investor Project, Presented at The Conference on the Fi- duciary Responsibilities of Institutional Investors, Leonard J. Stern School of Business, New York University (June 14, 1990), in INSTITUTIONAL INVESTORS: PAsSIVE FIDuCIAuES TO ACTVIST OwNERs 406, 406-07 (PLI Corp. Law & Prac- tice Course Handbook Series No. 704, 1990) [hereinafter INSTITUTIONAL INVESTORS]. 1316 MINNESOTA LAW REVIEW [Vol. 76:1313 law doctrine and practice. As a result, corporate law is in flux and turmoil. "[A]n extraordinary ferment of activity in the field of cor- porate governance"4 has resulted, including the proliferation of state-adopted and corporation-imposed antitakeover mecha- nisms such as the poison pill,5 increased involvement by the Se- curities and Exchange Commission (SEC), and intense criticism by institutional investors of current corporate governance structures and mechanisms. Such intense controversy sur- rounding corporate governance issues appears inevitable given the far-reaching economic and social impact of the modern cor- 7 poration.6 The stakes are enormous. 4. Roswell B. Perkins, The President's Letter, 4 A.L.I. REP. 1 (1982), quoted in Melvin A. Eisenberg, An Introduction to the American Law Insti- tute's Corporate Governance Project,52 GEO. WASH. L. REV. 495, 496 (1984). 5. Poison pills or shareholder rights plans typically are stock warrants or rights which allow the holder to buy a suitor's stock at low prices ("flip- overs") or to sell target stock to the target itself ("flip-ins"). See, e.g., P. John Kozyris, Corporate Takeovers at the Jurisdictional Crossroads: Preserving State Authority Over Internal Affairs While Protecting the Transferabilityof Interstate Stock Through Federal Law, 36 UCLA L. REV. 1109, 1156 (1989). The Investor Responsibility Research Center, an independent non-profit re- search group, found that 51% of large American companies were armored with poison pills as of August, 1990. Majority of Large U.S. Corporations Have Adopted Poison Pills,IRRC Finds, [July-Dec.] Sec. Reg. & L. Rep. (BNA) No. 47, at 1659 (Nov. 30, 1990); see also Kozyris, supra, at 1125 n.59 ("If the recent trends continue, virtually all major corporations will be transformed into for- tresses in the near future."). 6. "Today ... the corporation is the dominant form of business organiza- tion[,J ... account[ing] for about 89 percent of business receipts.... [O]verall, the business corporation is the principal form for carrying out business activi- ties in this country." ROBERT C. CLARK, CORPORATE LAw § 1.1, at 1-2 (1986). Few governance issues affect society as broadly and intensely as corporate takeovers. Thus, "[n]o current corporate issue has attracted more attention from legal and economic scholars than takeover defensive moves by corporate managers." Larry E.
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