Shareholder Activism, Institutions of Corporate Governance and Re-reading Roe

More than ten years ago, Mark Roe summarised core problems and key institutions of corporate governance. He identified three core problems: managerial agency costs, dominant shareholders and corporate legitimacy. The key institutions were more numerous. Roe discussed, among other things, the role of markets, the board of directors, coalescing shareholders and capital structure. Lately, activist shareholders have been hailed as a novel key player to achieve better corporate governance. In my paper, I review Roe’s core problems of corporate governance and his shareholder-related institutions aiming at an understanding of the role activist shareholders could fill.

Roe framed corporate governance as ‘the relationship among the triumvirate at the top’. His focus on aligning the interests of management with those of shareholders and on ‘running the firm well’ continues to apply in today’s European context. However, agreement over what it means to run a firm ‘well’ is increasingly hard to reach. This is not only the case if, in a European spirit, we broaden the horizon to stakeholders such as employees, creditors, or, more lately, taxpayers. Even if we focus on shareholder value exclusively, we may find very different opinions on running a corporation ‘well’.

Roe addresses some of these concerns when he contrasts the ‘vertical’ and the ‘horizontal’ dimension of corporate governance. He locates the vertical dimension ‘between senior managers and distant shareholders’. Institutions of vertical corporate governance are geared towards keeping incentives of controlling managers and owners aligned. Rationally apathetic, dispersed shareholders have neither the time nor the interest to engage with management. They usually have a no-strings-attached attitude. Save for behavioural biases, they will be happy to get rid of an investment if it does not meet their expectations. However, this does not necessarily tell us when managers work in shareholders’ interest. Some shareholders will hope for a low-risk investment. Others will have invested because the corporation promised interesting short-term gains. Yet others will hold shares as part of a portfolio strategy, possibly linked to an index. Different investment plans usually account for different shareholder interests. The management’s strategy will work well for some and less for others.

Roe’s ‘horizontal dimension’ moves away from the relationship between shareholders and management and looks in more detail at the group of shareholders. Dropping the assumption of dispersed share ownership, he focuses on conflicts between dominant and minority shareholders. Why do dominant shareholders often suffer less from problems of the ‘vertical’ dimension? First, they have ‘skin in the game’: the larger the block they hold, the more prominent the incentive to overcome rational apathy and to engage with management. Second, they have better access to management: good access to management brings influence and information.

Roe identified ten institutions of corporate governance. My interest lying with activist shareholders, the paper is limited to institutions which involve shareholder action. It looks in some detail at distant shareholders and at institutional investor voice. For the latter I focus on the extent to which horizontal corporate governance problems can be minimised and on the promises of stewardship. I then move on to consider the extent to which activist shareholders are likely to make more of the existing institutions of corporate governance when compared with dispersed and institutional shareholders.The hope that activists will deliver a one-size-fits-all solution to corporate governance problems is not shared in the paper. The reason for this is straightforward: horizontal corporate governance poses far more problems than blockholders ‘stealing’ from other shareholders, to use Roe’s term. Shareholders’ interests vary greatly. We find shareholders betting on a corporation’s stock price going down. We find others prepared to support measures which will lead to stock prices going up for the short-term only. We find shareholders uninterested in the corporation, holding shares only due to an index tracker or investment advice. We find yet others heavily invested in keeping a low-risk investment over a very long time span. Out of the broad spectrum of possible management strategies which every corporation faces, each option will cater more to the taste of some than of others. Working out institutions to disclose shareholders’ interests and, possibly, ways to align them, is one of the challenges corporate governance faces today.

Katja Langenbucher is a Professor of Private Law, Corporate and Financial Law in Goethe-University's House of Finance and is an affiliated professor at Science Po, Paris.