Jon Macey, Deputy Dean and Sam Harris Professor, of Corporate Law, Corporate Finance, and Securities Law at Yale, has recently published a book titled Corporate Governance, Promises Kept, Promises Broken.
According to Macey, the board of directors cannot be counted on to keep the promises made to shareholders because of the problem of capture. Instead, the best method of ensuring that promises are kept is a robust market for corporate control.
In an era when financial markets are in turmoil and reliance on the markets has fallen out of favor as a solution, this is a tough argument. Essentially, he is contending that it should be left to the markets to protect shareholders.
There can be no argument that a market for corporate control is an important component for any system of governance. But Macey's argument goes further. He more or less sees it as the only significant source of discipline on corporate management.
There are many problems with that approach. First, he must assume that there are no alternatives to ensuring proper governance. As we will discuss in the next post, he discounts derivative suits and dissident directors as a source of improved governance, but his arguments are not very convincing.
Second, he views hostile acquisitions as inherently beneficial, noting that target shareholders receive abnormal returns. The analysis in this area, however, requires greater nuance. It is true that target shareholders earn a premium in hostile acquisitions. But that ignores what happens once the acquisition occurs. It is quite common, in fact, probably the majority rule, for bidders to poorly manage acquisitions. This is an actual, not a theoretical, cost to the economy. Disney was the subject of takeover efforts in the 1980s, mostly to break up the company and sell off the land around the theme parks. Disney fended off the overtures and brought in Michael Eisner as CEO. It is highly unlikely that the acquisition of Disney would have produced a more efficient use of Disney assets. In the Hobbsian universe of a robust market for corporate control, the inefficient bidder will eventually be acquired, but not before substantial damage has been done.
Third, no matter how much one improves the robust nature of the market for corporate control, there are substantial costs associated with finding targets and completing an acquisition, not the least of which is the need to pay a large premium (50% in case of hostile takeovers, as Macey notes). That means that companies must obtain a certain degree of inefficiency before they will become a target. The market for corporate control cannot, therefore, police most self serving decisions by management. This is particularly true with respect to executive compensation. Managers can significantly overpay themselves and, as long as the amount isn't so great that it would trigger a takeover, can do so without concern about the consequences.
We will do one more post that examines the alternatives to hostile takeovers as a means of effectuating a system of corporate governance that protects the interests of shareholders.