shareholder’s shares.) Top executives of U.S. corporations can use corporate
funds to solicit proxies. By contrast, insurgent shareholders (those seeking to
change management) receive compensation for their proxy solicitation only if
they are successful in the proxy battle.
The second obstacle stems from the difficulties of collective shareholder
actions. Large institutional investors excepted, the typical shareholder owns
a very small fraction of the outstanding voting shares of a large corporation.
This shareholder recognizes that his or her vote will have a negligible effect
on the outcome of any voting contest. Consequently, few shareholders will
take the considerable time, effort, and cost of understanding the competing
solicitations in a proxy battle. (This phenomenon is sometimes called rational
apathy.) Most shareholders cast their votes for current management.
Therefore, the chance is small that a challenge, no matter how meritorious,
will succeed.
For example, suppose a small group of shareholders is convinced (and
rightly so) that a change in top management would increase the value of the
firm by $10 million. However, the group of challengers collectively holds only
1 percent of the voting shares. Thus, their gain from the change would be
$100,000. Suppose that a reasonable estimate of the challengers’ cost of wag-
ing a proxy fight is $150,000. Given the difficulties in educating and subse-
quently enlisting hundreds of poorly informed small shareholders, the chances
of winning the fight might be 30 percent at best. In this case, the group’s
expected gain from waging the battle is (.3)(100,000) (.7)(150,000)
$75,000. (Note that if the proponents win, they are reimbursed for their solic-
itation costs.) Thus, the challenger group has absolutely no financial incentive
to launch this proxy fight, despite the $10 million collective benefit from a
management change. As a result, proxy challenges are rare (most elections fea-
ture only the incumbents) and, of the few that happen, most fail.610 Chapter 14 Asymmetric Information and Organizational DesignCHECK
STATION 5Frequently, an inventor-entrepreneur who launches a new firm occupies the role of chief
officer and owns between 50 and 100 percent of the firm. Ten years later, the same inven-
tor-entrepreneur might have reduced his or her ownership share to well below 50 percent
and have transferred decision-making responsibilities to a cadre of other top managers.
Explain why.LIMITING THE POWER OF TOP MANAGEMENT Because shareholders pos-
sess limited control over the selection and performance of top management,
one would expect significant principal-agent problems. Top-level managers
have the necessary information and presumably the expertise to make optimal
decisions. However, managers often pursue their own agendas and undertake
plans that conflict with the interests of shareholders. For instance, executives
might engage in “empire building,” thereby, incurring unnecessary costs
(inflated management salaries, executive jets, and the like). Alternatively, in
pursuit of the prestige of being market-share leaders, executives might bec14AsymmetricInformationandOrganizationalDesign.qxd 9/26/11 11:03 AM Page 610