Balance of power politics and corporate governance.

• Author: Briggs, Thomas W.
• Position: Corporate Governance and the New Hedge Fund Activism: An Empirical Analysis

Plainly, hedge-fund activists have a role to play in corporate governance. This Article has shown that, when they choose to get involved, hedge funds can be a real force with which to be reckoned. The question then becomes how they fit into current corporate governance theories and, more practically, whether they improve governance or worsen it. The answer requires a look at hedge funds both as shareholders without more and (assuming proxy contest or settlement success) as shareholders with direct board representation.

1. Hedge-Fund Activism Matters

   Given how infrequently this Article has found that hedge funds do get directly involved, does hedge-fund activism matter?

   Whatever else might be uncertain in our post-Enron world, there would appear to be little room for doubt on this point: We should care about hedge fund activism because the people who run and advise U.S. public companies care. In other words, those most directly affected by takeovers and proxy fights tell us we should care. (181) According to Martin Lipton's recent advice to his clients, for example, "[t]he current high level of hedge fund activism warrants the same kind of preparation as for a hostile takeover bid." (182) The press reports reviewed in the Introduction tell the same story, albeit in somewhat over-wrought terms. (183) Delaware Vice Chancellor Leo Strine has similarly noted "the power of a good example" and predicted that "[r]eplacing a few poorly performing boards will have substantial, beneficial ripple effects on the performance of other boards." (184) Evidently the increasing frequency of publicly reported instances of direct hedge-fund activism is having a still broader, more important, in terrorem effect on an indeterminately wider universe of public companies.

   Many successful hedge fund activism negotiations and settlements also happen behind the scenes with little or no publicity. (185) It is still true, as Michael Useem wrote a decade ago, that "[o]pen struggles for control draw attention but also mislead ... [because] most of the traffic between managers and investors transpir[es] out of sight." (186) This kind of quiet activism can be thought of as a kind of Napoleonic military campaign. It is not only the actual battles you fight that count. (187) Real battles cost casualties and money. Battles that the other side can be made to think you are ready to fight matter just as much. Since unfought battles are much cheaper than real ones, you can fight more of them, but with the same expenditure of scarce manpower, time, and money. And quiet, unpublicized shareholder settlement victories are victories nonetheless. (188)

   Empirical and other academic studies that review only "proxy fights" while excluding pressure campaigns and most contest settlements miss this considerably larger universe of shareholder activism entirely, and consequently unintentionally understate its significance. (189) In 2005, for example, only 10 of the situations in this Article's survey counted as tracked "proxy fights" in the widely-used Georgeson Shareholder Annual Corporate Governance Review data. (190) Acquiring a better understanding of hedge fund activism means probing deeper into publicly reported hedge fund campaigns--something this Article has taken a first step towards doing--though even then quiet settlements, private negotiations, and some less-reported situations are inevitably missed. (191) It only remains certain that hedge fund activism plays a far more important role in corporate governance than a simple look at the raw numbers would first suggest.

2. Activist Hedge Funds As Shareholders

   Taking the reality of all this hedge fund activism and trying to fit it into the various corporate governance theories that have been worked out over the years makes for an interesting exercise. Nothing quite fits.

   1. Ownership and Control

      As with almost all exercises such as this one, the starting point is the 1932 classic by Adolf Berle and Gardner Means, The Modern Corporation and Private Property, (192) which first clearly articulated and popularized the notion that widely dispersed shareholdings had effectively separated ownership from control in public corporations. "Under such conditions," Berle and Means wrote, "control may be held by the directors or titular managers who can employ the proxy machinery to become a self-perpetuating body, even though as a group they own but a small fraction of the stock outstanding." (193) By the mid 1970s, the principal concern had become how shareholders (the owners) could control and monitor their agents (the directors and managers) while minimizing the "monitoring costs designed to limit the aberrant activities of the agent[s]." (194) Such activities might include almost any imaginable unremunerative sin, including shirking, chasing after perquisites, empire building, and a host of other "rent seeking" crimes. An influential group of scholars writing in this tradition came to see the corporation as a "nexus" or "set of explicit and implicit contracts" among employees, managers and other constituencies, with the shareholders getting "votes rather than explicit promises." (195) According to the theory, "[v]otes make it possible for the investors to replace the managers." (196)

      This is where the problems begin. What does it mean to "vote" and "monitor" when, by hypothesis, shareholders are too dispersed and beset by the collective action problems discussed earlier really to do either? (197) If they were somehow to overcome these problems enough to monitor closely, at what point do they start usurping the management role? And what qualifies them to manage better than the managers themselves anyway? Are board members really mere agents?

   2. Shareholder Primacy

      The predominant theoretical response to these and other related questions has come to be called "shareholder primacy," and means basically what the name implies: shareholders should have the ultimate control over the corporation. (198) Since this demonstrably happens only rarely in the actual everyday world of uncontrolled public companies, two of the main academic inquiries have been into why shareholders do not have this...