in its corporate charter? Who should enforce the duties: private
investors (through derivative and class-action suits) or the government?
3.The Market for Corporate Control. Another limitation on executive
power comes from the market for corporate control. If the firm’s top
executives manage poorly and, therefore, depress the market price of
the shares, other firms will quickly identify a profitable acquisition
opportunity. For instance, suppose that actions taken by an inferior
management team cause the firm’s stock price to fall to $40 per share.
By removing current management and refocusing the firm’s business
strategy, a would-be acquirer could increase firm value to $65 per
share. Such an acquirer may make a tender offer (offering to buy shares
from the public) at a premium relative to market (say $50 per share),
which would be profitable for the firm’s shareholders and the acquirer
alike. If shareholders tender a majority of their shares to the acquiring
firm, then the acquiring firm has the ability (through the voting power
of these shares) to remove current management and install their own.
The ever-present threat of a takeover may provide strong incentives to
management. It forces managers to act to maximize firm value or risk a
takeover and the loss of their jobs.
In addition to these mechanisms, several proposals strive to reduce the
principal-agent problems inherent in the modern corporate form:
1. Shareholder Empowerment. These proposals seek to give public
shareholders a stronger voice in management. Some reforms aim at
altering voting rules to provide for binding shareholder resolutions.
Other measures seek to reduce the cost of shareholder challenges
(for example, by allowing shareholders to use limited corporate
resources in their challenges or allowing solicitation and voting
through the Internet). Still other proposals seek to encourage
cooperation among large institutional shareholders. Collectively,
these institutions (pension funds, insurance funds, and investment
funds) frequently hold sufficient numbers of shares to wield
significant voting power. In 2011, the SEC, under the authority
granted it by the 2010 Dodd-Frank Act, promulgated new “say on pay”
rules that require that executive compensation be subject to a
nonbinding shareholder vote at least every three years. Because
empowerment reforms seek to reduce the separation of ownership
and control, they decrease agency costs, but at the risk of unduly
restricting top management’s decision-making discretion.
2.Corporate Governance Reforms. In the United States, corporate
boards are typically composed of inside and outside directors. Inside
directors are drawn from the ranks of top management and run the
day-to-day operations of the corporation. Outside directors (other612 Chapter 14 Asymmetric Information and Organizational Designc14AsymmetricInformationandOrganizationalDesign.qxd 9/26/11 11:03 AM Page 612