Ronald J. Gilson

Jeffrey N. Gordon

Columbia Law School

Stanford Law School

 

The Agency Costs of Agency Capitalism : Activist Investors and the Revaluation of Governance Rights

11/12/2019

Equity ownership in the United States no longer reflects the dispersed share ownership of the canonical Berle-Means firm. Instead, we observe the reconcentration of ownership in the hands of institutional investment intermediaries, which gives rise to “the agency costs of agency capitalism.” This ownership change has occurred because of (i) political decisions to privatize the provision of retirement savings and to require funding of such provision and (ii) capital market developments that favor investment intermediaries offering low-cost diversified investment vehicles. A new set of agency costs arises because in addition to divergence between the interests of record owners and the firm’s managers, divergence exists between the interests of record owners—the institutional investors—and the beneficial owners of those institutional stakes. The business model of key investment intermediaries like mutual funds, which focus on increasing assets under management through superior relative performance, undermines their incentive and competence to engage in active monitoring of portfolio company performance. Such investors will be “rationally reticent”—willing to respond to governance proposals but not to propose them.

 

We posit that shareholder activists should be seen as playing a specialized capital market role of setting up intervention proposals for resolution by institutional investors. The effect is to potentiate institutional investor voice, to increase the value of the vote, and thereby to reduce the agency costs we have identified. We therefore argue against recent proposed regulatory changes that would undercut shareholder activists’ economic incentives by making it harder to assemble a meaningful toehold position in a potential target.

I. INTRODUCTION

The canonical account of U.S. corporate governance, which stresses the tension between dispersed shareholders and company managers in large public firms, has become factually obsolete and now provides a misleading framework for contemporary corporate governance theorizing.

In this account, framed eighty years ago by Adolf Berle and Gardiner Means, shareholders individually own too few shares to monitor management’s performance and confront coordination costs that make collective monitoring difficult. But as we shall see, the Berle-Means premise of dispersed share ownership is now wrong. In 2011, for example, institutional investors owned over 70% of the outstanding stock of the thousand largest U.S. public corporations.

In this Article, we address the impact on corporate governance of the ownership reconcentration of U.S. public corporations. Beneficial owners now typically hold their equity interests through a set of intermediary institutions like pension funds and mutual funds, which are the actual record owners and hold equity as fiduciaries for their beneficiaries. This shift from the Berle-Means archetype of widely distributed ownership to concentrated institutional ownership gives rise to what we call “agency capitalism,” an ownership structure in which agents hold shares for beneficial owners. The consequence is a double set of agency relationships: between shareholders and managers and between beneficial owners and record holders.

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