The rise of agency capitalism is the first article in our Winter 2019 issue.The past 50 years have seen a fundamental change in the ownership of U.S. public companies, one in which the relatively small holdings of many individual shareholders have been supplanted by the large holdings of institutional investors, such as pension funds, mutual funds, and bank trust departments. Such large institutional investors are now said to own over 70% of the stock of the largest 1,000 U.S. public corporations; and in many of these companies, as the authors go on to note, “as few as two dozen institutional investors” own enough shares “to exert substantial influence, if not effective control.”
As few as two dozen institutional investors own enough shares to exert substantial influence, if not effective control.
But this reconcentration of ownership does not represent a complete solution to the “agency” problems arising from the “separation of ownership and control” that troubled Berle and Means, the relative powerlessness of shareholders in the face of a class of “professional” corporate managers who owned little if any stock. As the authors note, this shift from an era of “managerial capitalism” to one they identify as “agency capitalism” has come with a somewhat new and different set of “agency conflicts” and associated costs.
The fact that most institutional investors hold highly diversified portfolios and compete (and are compensated) on the basis of “relative performance” provides them with little incentive to engage in the vigorous monitoring of corporate performance and investor activism that could address shortfalls in such performance. As a consequence, such large institutional investors—not to mention the large and growing body of indexers like Vanguard and BlackRock—are likely to appear “rationally apathetic” about corporate governance.
Authored by Ronald J. Gilson and Jeffrey N. Gordon.
How Have Green Companies Fared in Transactions with Banks?
In the last article of our Fall issue, the authors’ recent study investigates whether and to what extent a company’s environmental practices and record affect the terms of its bank loans. The study reports evidence of a clear association between environment-friendly corporate practices and both lower borrowing costs and less use of restrictive financial covenants. And consistent with the above findings, the authors also report that companies with better environmental practices have more stable income streams, lower leverage ratios, and higher future valuations. The authors also find that relationship (as opposed to first-time) lenders respond to improvements in companies’ environmental records by offering more favorable borrowing terms over time.
Moreover, the authors find that the association between more effective environmental management and lower loan costs is more pronounced for corporate borrowers that operate in industries facing greater industry competition and stricter environmental regulation.
In addition, borrowers with better records for green management are less likely to violate covenants, default on loans, or file for bankruptcy—a conclusion that should shed light on the current green finance policy debate among central banks and regulators as to whether they should reduce capital requirements or offer other policy inducements for bank financing of green assets.
Authored by Dawei Jin, Liuling Liu, Jun Ma, Haizhi Wang, and Desheng Yin
Do Staggered Boards Matter for Firm Value?
In the fifth article of our Fall issue, the authors address, and attempt to settle, the heated debate over the effect of staggered boards on corporate performance. Critics of staggered boards claim they enable the entrenchment of inefficient managements and boards; and by working in tandem with poison pills to discourage hostile takeovers of underperforming companies, such boards end up generally reducing corporate values.
Consistent with this theory, some institutional investors and shareholder rights advocates have urged companies to eliminate their staggered boards, while the most extreme critics have gone so far as to call for a regulatory ban. By contrast, supporters of staggered boards argue that they help increase corporate values by allowing managements and boards to focus on long-term goals, and by providing board members a degree of independence from corporate executives who might want them replaced. The most extreme proponents of staggered boards have proposed that such boards be not only permitted, but indeed mandated.
Both sides of the debate claim to be backed by empirical studies whose findings provide sharply conflicting pictures of the consequences of staggered boards. Whereas the earlier studies found that companies with staggered boards have significantly lower values, more recent studies have concluded that staggered boards lead to higher corporate values.
The authors show that neither side of the debate has convincing empirical support. The earlier studies failed to account or control for important variables and corporate characteristics that explain corporate decisions to stagger their boards, or for changes in the companies’ characteristics over time. For example, to the extent that a company’s poor performance drives its decision to adopt or retain a staggered board provision—presumably to give it more freedom to restructure and improve its operations—the association of staggered boards with poor performance ends up confusing cause and effect.
When the authors control for variables that affect both corporate values and the choice of staggered boards in a sample of close to 3,000 U.S. companies from 1990 to 2013, they find that the effect of a staggered board on firm value becomes generally insignificant. As the authors put it, “The effect of a staggered board is idiosyncratic; for some firms it increases value, while for other firms it is value destroying.” On the basis of such findings, the authors caution against legal solutions advocating either wholesale adoption or repeal of staggered boards, urging managements and boards to determine the value-maximizing approach that reflects their own companies’ opportunities and circumstances.
Authored by Yakov Amihud, Markus Schmid, and Steven Davidoff Solomon