Stockholders and stakeholders: the battle for control of the corporation.

• Author: Charron, Donna Card

The American corporation is in trouble not only because of various immoral executives, but also because it is a target of sustained attacks. For several decades, corporate revisionists have toiled to transform the corporation from private to public property. Were they to succeed, the tragedy of the commons would slowly sap the corporation of its vitality. My objective in exposing the battle for corporate control is to urge and encourage those committed to the preservation of this highly performing institution to place the issue more prominently on their agenda. To this end, I detail the evolution of the battle and assess the present state of affairs. In so doing, I describe and critique "stakeholder theory," the revisionist's chosen weapon for gaining control of the corporation. Stakeholder theory currently dominates textbooks and syllabi of courses in business management, human resource management, marketing, and public policy. It colors the decisions of many corporate executives. And it controls the thinking in the majority of business ethics centers. Aware of its reach, I adumbrate a strategy for reversing the destructive inroads of stakeholder theory.

The Threatened Corporation

The corporations most endangered in this momentous property dispute are the private, publicly traded ones in which stockholders are owners (principals) and hired corporate officers are managers (agents). Board directors have the duty to oversee the agents. Agents and directors have a fiduciary duty of care to protect and increase the investment of owners. Directors have the added duty of loyalty to stockholders. Corporate law gives no detailed discussion of the obligations of directors to employees who are not officers in the company. However, corporate law does emphasize that every employee of the firm has the same fiduciary obligation to the corporation as do the officers.

In the other direction, law grants that corporations may spend corporate earnings on nonbusiness related projects for the benefit of employees, the community or society at large, provided that such expenditures can be expected to advance the corporation's primary goal of making profits for stockholders.

These traditional agreements on the nature of corporate relationships constituting the firm are in serious dispute. Inside and outside the corporation, corporate revisionists are seeking to disestablish the corporation as a privately owned, publicly traded entity. In its place, they seek to ensconce an institution publicly owned and controlled by political decision rather than by the market.

Battle Inside the Corporation

In many of today's corporations, managers are the revisionists. Throughout the cultural revolution of the 1960 and 1970s, managers and stockholders stood together rejecting stakeholder theory. Few corporate observers, other than Adam Smith (1776), would have thought that this solidarity would crumble or that managers would support actions to disenfranchise the stockholder and ultimately weaken the corporate institution itself.

As control of the corporation separated from ownership, the controlling managers found themselves conflicted. As legal agents, they were to maximize profits for their stockholder principals; but, as individually rational agents, many tended to maximize benefits to themselves. In time, they began to divert stockholder wealth to stakeholders through higher compensation packages, more expensive perquisites, comfortable surroundings, and generous charitable contributions.

Market for Corporate Control

It is argued that if managers deviate too far from acting in the interests of stockholders, the market for corporate control will intervene and oust them. The market for corporate control, as explained by law professor Henry Manne in his 1965 article "Mergers and the Market for Corporate Control," recognizes stockholders' power to replace underperforming managers with a team expected to gain greater wealth for the company. Subscribing to the efficient market theory, Manne assumes that the average stock market price is the best gauge of the value of a company. Inefficient management is revealed in earnings and stock prices lower than those of competitors in the industry. When companies consistently underperform, they risk becoming targets for takeover, through tender offers, proxy fights, or mergers. The stockholders will replace old nonentrepreneurial management with a new entrepreneurial team.

For market players, underperforming companies represent an opportunity for gain.

The lower the stock price, relative to what it could be with more efficient management, the more attractive the takeover becomes to those who believe that they can be entrepreneurially more creative and manage the company more efficiently. And the potential return from the successful takeover and revitalization of a poorly run company can be enormous [Manne 1965: 113]. If the return can be so enormous, why have takeovers been relatively rare? Stockholders may be losing wealth under nonentrepreneurial managers, but the high cost of entering the market for corporate control sometimes protects managers. The cost of organizing and communicating is greater than the lost wealth. However, if managers go beyond a given threshold in their wealth diversion such that gains would exceed the cost of entry, they are likely to trigger takeover action.

Control by Mergers and Acquisitions

Since the 1980s, academic rhetoric resounded in the marketplace as reality mirrored Manne's theory. Activating the market for corporate control, T. Boone Pickens, Sir James Goldsmith, Carl Ichan, and others painted themselves as saviors of corporate America, banishing nonentrepreneurial managers. Thus, there emerged the internal battle for the American corporation, the battle between stockholders and wealth-diverting managers.

The wealth opportunities enticed short-term arbitrage investors and occasioned the establishment of merger and acquisition departments of investment banking and brokerage firms. Corporate America came under the scrutiny of financial brains. Dissecting financial performance of corporations through meticulous study of annual reports, financial statements, and corporate actions, analysts looked for corporations with nonproductive spending, including overly generous employee benefits, large community contributions, and many personal prerequisites together with low funding of productive goods and services, including R&D, advertising, and capital equipment. If a liquid capital stash exists, it is all the better. Corporations fitting this description became targets for a corporate takeover. The market for corporate control made a difference in boardrooms. With every takeover, onlooking managers became increasingly aware that they too could be removed if the board judged that new management could make greater profits for the firm.

Subversion of the Market for Corporate Control

One could hardly expect managers to welcome hostile takeovers. They reacted defensively, charging that enemies of the public corporation were perpetrating a "financial rape" of the corporation's assets and an attack on professional managers. They argued that the takeover activists were short-term investors interested only in quick profits and not in the long-term health of the target corporation. They called the activists "raiders" and accused them of acting in their own interest, not in the interest of stockholders. Managers coalesced to portray themselves as the real saviors.

In late 1980s, the Business Roundtable, with the power of 200 chief executive officers of the largest United States corporations, took a leadership role to protect managers from stockholders (see Charron 1985b). Corporate managers formed The Coalition to Stop the Raid on Corporate America, organized in Washington, D.C., to lobby against corporate takeovers. In 1996, Silicon Valley managers formed TechNet, their owl self-defense lobby. The word around corporate headquarters was "Vote with management!"

Many boards adopted poison pills, golden parachutes, and two-tiered stock arrangements. They participated in lobbying campaigns that succeeded in passing anti-takeover laws in a number of states. More than 35 states enacted such statutes as profit disgorgement, cash out, fair price, and freeze out: most of which are still on the books. Then, cutting to the quick, Pennsylvania enacted a statute that redefined the fiduciary duty of directors. It permitted directors to base business decisions on the interests of all the stakeholders, not primarily on the interests of stockholding owners. This permission reduced stockholder rights.

Pennsylvania's landmark move began a legal reconsideration of the nature of the firm throughout the land. By these acts, state legislatures empowered stakeholders and disempowered stockholders. Stockholder-rights proponents challenged the revisions in courts.

But, state supreme courts upheld the legality of the anti-stockholder measures: among them was the court of Delaware, home of 300,000 U.S. corporations. In the 1980s, managers subverted the market for corporate control and entrenched themselves.

Attempts at Reassertion of the Market for Corporate Control

To counteract the subversion, T. Boone Pickens, as chairman, and Ralph M. Whitworth, as president, formed the United Shareholders Association (USA), a nonprofit 501(c)4 organization. Its purpose was to organize advocacy for stockholder rights, "to give shareholders a united voice at the public policy table backed up by a nationwide grassroots network ... to stir a national debate of shareholder rights and corporate governance ... to reform the proxy voting rules, giving shareholders a better opportunity to elect accountable boards and to influence major corporate policies" (Whitworth 1993: 2).

USA sought to establish for public corporations a one-stock one-vote standard, confidential corporate elections, independent tabulation of voting, and...