Faculty of law blogs / UNIVERSITY OF OXFORD

Eclipse of the Public Corporation Revisited: Concentrated Equity Ownership Theory

The era of the US public corporation is in decline. Tectonic shifts in seemingly disparate regions of the corporate landscape are underway. Through the lens of a new theory of the firm, these phenomena are eerily consistent with Harvard Professor Michael Jensen’s bold prediction in Eclipse of the Public Corporation (1989). Yet, much debate in securities law and corporate governance continues to be premised upon the 1932 Berle-Means corporation, marked by a separation between share ownership and managerial control. Eighty-five years later, that ownership structure is being displaced by a more robust organizational form that is particularly suitable to exponential innovation and growth in highly competitive markets – conceptualized as the founder-centric firm.

Concentrated Equity Ownership Theory of the Firm

Concentrated equity ownership (CEO) theory explains the rapid rise of founder-run companies over the last decade. My work, “Eclipse of the Public Corporation Revisited: Concentrated Equity Ownership Theory”, also reveals theoretical continuity in the seemingly disparate investment styles of Jorge Paulo Lemann with 3G Capital, William Ackman with Pershing Square Capital Management, and Warren Buffett with Berkshire Hathaway. CEO theory unifies, among other things, the economic principles sustaining the performance of: (1) an accumulating number of global scale founder-run companies; (2) high performing private equity in public markets; and (3) activism focused on business fundamentals. In identifying hidden economic efficiencies powering the world’s largest corporations from Apple to Facebook, Google, and Amazon, while paralleling that discovery alongside other economic phenomena under a new theory of the firm, this work displaces the fulcrum of the dominant paradigms in corporate governance theory. 

Ownership Structure of the Corporation

Generally, two broad forms of ownership structure exist in US capital markets – (1) traditional US corporations with a dispersed shareholder base and relatively minimal or passive engagement with management; and (2) concentrated equity ownership, that is, corporations with controlling, dominant or influential shareholders engaged in direct monitoring or active management. Within the first structure, management will tend to adopt shorter-term time horizons and are subject to greater pressure to show consistent quarterly results, which can inadvertently incentivize suboptimal long-term decision making. Conversely, within the second structure, significant shareholders are often active within the board of directors and/or senior management, and an individual or group of shareholders actively monitors business operations. Founder-run companies, private equity in public markets, and hedge fund activists all fall within this inclusive model of concentrated equity ownership. CEO structures, specifically those with founder-centric qualities as discussed below, favourably insulate management from short-term pressures during volatile periods, while preserving accountability and lowering agency costs. CEO theory concerns itself with the discriminatory costs problem – essentially, private benefits accruing to concentrated equity holders at the expense of other shareholders (Rojas, 2014). Discriminatory costs are the central economic problem in concentrated equity ownership structures, as distinct from managerial agency costs in traditional US public corporations (Jensen & Meckling, 1976).

Founder Centrism and Long-Term Leadership

Founder-run companies, such as Facebook, Netflix and Google are at the forefront of a new wave of organizational structure better suited to long-term value creation. Founder centrism, an inclusive concept within CEO theory, integrates the capacity of founder and non-founder senior leadership to adopt an owner’s mindset in traditionally structured corporations, such as Thomas J. Watson Sr. and Thomas Watson Jr. with IBM, Steve Jobs and Tim Cook with Apple, Jamie Dimon with JPMorgan Chase, Lloyd Blankfein with Goldman Sachs, Rick George with Suncor Energy, and many others. In substance, all fall within the ambit of founder centrism – leaders with a founder’s mindset, an ethical disposition towards the shareholder collective, and an intense focus on exponential value creation without enslavement to a quarter-by-quarter upward growth trajectory. In traditionally structured firms, high performing executives gain deference, become highly influential, and take on the qualities of concentrated equity owners. To the extent these leaders embrace founder centrism, their companies will experience efficiency advantages relative to competitors operating within traditional parameters.

Private Equity in Public Markets: Berkshire Hathaway and 3G Capital

From the perspective of founder centrism, 3G Capital’s private equity control position in publicly traded companies is conceptually akin to Berkshire Hathaway’s management-friendly disposition. Both acquire concentrated positions with a focus on long-term business fundamentals, a disinclination towards discriminatory costs, and an ethical disposition towards fellow shareholders. Although Berkshire Hathaway is deferential to management, while 3G Capital engages as an operator, both leverage the enhanced economic efficiencies inherent within the concentrated equity ownership structure. In brief, founder centrism is the conceptual bridge between the wildly successful investment styles of Warren Buffett and Jorge Paulo Lemann. This novel approach to private equity has generated significant value for fellow shareholders.

Activism on Business Fundamentals: Bill Ackman’s Pershing Square

A common misconception, that all shareholder activists are focused on short-term returns, is rooted in an antiquated phase in US capital markets history – particularly, the highly opportunistic transactions of 1980’s ‘corporate raiders’. In recent years, however, shareholder activism has noticeably shifted towards longer-term value creation. For example, Armour & Cheffins, (2009) distinguish between (1) offensive and (2) defensive shareholder activism, essentially defining the first as falling within traditional views on hedge fund activism, and the second as embracing institutional investor engagement. Inspired by that research, this work deconstructs the broad category of hedge fund activism into two sub-categories of participant – (1) financial activists and (2) engaged activists.

  • Financial activists are shorter-term, speculative traders involved in technical analysis of stock price charts and financial engineering, with an inclination to capture value in a manner consistent with traditional views on shareholder activism. Financial activism involves primarily an active focus on value transfer rooted in financial reconfigurations, as distinct from business building. Generally, this form of activity contributes to expansion in financial apparatus, including liquidity, financial transparency, and informational efficiency – important attributes of a market economy. Nonetheless, short-term pressures on management run the risk of incentivizing suboptimal decision making.
  • Engaged activists are longer-term, fundamental investors aspiring to capture value through business-level decision making. Engaged activism is the active focus on value creation rooted in business fundamentals, as distinct from financial engineering. Generally, this form of activity contributes meaningfully to expansion in the real economy, including building or acquiring new technologies, factories, and lines of business, or hiring new management. For example, Pershing Square actively engaged with Canadian Pacific Railway as a long-term shareholder in proposing a slate of directors, occupying board positions, and bringing in a new chief executive officer. Relative to financial activism, engaged activism has greater correlation with the long-term interests of the shareholder collective. This approach to activism falls within CEO theory as an efficiency proxy, particularly in the absence of a pre-existing founder-centric structure.

In sum, CEO theory is at the epicentre of seismic change in the US corporate landscape. In an era of rapidly disseminated information and high frequency trading, short term pressures on senior leadership in traditional structures can result in suboptimal value creation. In contrast, when the inherent advantages of concentrated equity ownership converge with robust business fundamentals, competitive agility amplifies, productive output surges, and exponential value accrues. As predicted by Jensen in 1989, new organizational structures have indeed emerged as more efficient alternatives to the traditional US public corporation – with enhanced economic efficiencies that are better suited to non-linear growth patterns. Increasingly, shareholders wield sufficient power to alter or significantly influence corporate policy. In focusing upon this evolution in ownership structure – specifically, narrowing within the separation between ownership and control – a distinct economic theory for the enhanced efficiency of public corporations has emerged. 

Eclipse of the Public Corporation Revisited: Concentrated Equity Ownership Theory builds upon the theoretical foundations in An Indeterminate Theory of Canadian Corporate Law.

Claudio R Rojas is Director at Hurt Capital Inc. and is a founding member of the Institute for Founder Centric Studies.


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