For the greater part of the twentieth century the role of shareholders within the public corporation has been conceptualized within the contractarian framework influenced by the neo-liberal emphasis on market efficiency. For the supporters of the contractual nature of the corporation, shareholders have in general been viewed as the main beneficiaries of corporate activity. Contractarianism goes further, dispelling the notion of shareholder ‘ownership’, and thereby relying on the efficacy of individual contracting and the constraining forces of various markets to control managerial discretion and reduce monitoring costs. Within this contractarian framework shareholders do not wish to be involved in the corporation’s management, nor do they gain any benefits from an active engagement, mainly because of the market efficacy to control managerial discretion and a series of legal and extra-legal obstacles to shareholders’ active involvement. There is, therefore, no a priori reason why shareholders should exercise control over managerial decision-making and any legally imposed reform to empower the monitoring role of shareholders is viewed as unnecessary and counterproductive. Through most of the twentieth century, this contractarian orthodoxy of the rather passive role of shareholders also coincided with practice.
My paper argues that these contractarian assertions in relation to the role of shareholders within the internal functioning of the public corporation do not hold anymore in the face of the rise in the holdings and influence of institutional investors in recent years. Most shares today are owned by institutional investors. Among them, activist hedge funds are well-positioned to monitor management because of their strong incentives to raise the stock price. Most empirical studies find that hedge fund activism is associated on average with stock price gains for shareholders, and suggest that activist hedge funds have interests coincident with the rest of shareholders, at least in the short term. Hedge fund activism also mitigates the traditional passivity of mainstream institutional investors, as the latter are not only the main source of investment capital for activist hedge funds, but they also directly or indirectly support their activist campaigns.
The positive attributes of shareholder engagement have been recognized by recent shareholder empowerment regulatory efforts to instill greater shareholder democracy into the modern corporation on both sides of the Atlantic, including the Dodd-Frank reform in the US, the introduction of binding ‘say on pay’ regulation in the UK, and the proposed amendments to the Shareholder Rights Directive in the EU which aim to increase shareholder influence on both executive remuneration and related party transactions.
In my paper I argue that the recent wave of hedge fund activism and the shareholder-centric policy reforms accompanying it prompt a re-examination of the conclusions drawn by the contractarian view of the corporation that understands shareholder franchise on the basis of residual claims or principal-agent relationships and puts faith in the institutional primacy of the market over shareholders’ intervention. Although shareholders still play a subordinate role in the governance of the modern corporation, their monitoring role is crucial.
My paper highlights, however, that power comes with responsibility. While compliance with shareholder value maximization as a proxy for aggregate social welfare is increasingly promulgated by regulatory developments and enforced by shareholder activism, the notion of shareholder ‘stewardship’, inaugurated by the UK Stewardship Code and recently espoused by the proposed Shareholder Rights Directive, harnesses shareholder power to protect the long-term interests of all the stakeholders in a company and the economy as a whole. Whilst the US has yet to track the recent developments in shareholder stewardship, concerns over the likely dysfunctionality of shareholders’ accountability are shared by the US scholarship.
These recent empirical and regulatory developments undermine the contractarian view of shareholders and arguably mark a paradigm shift for Anglo-American corporate law, from contractarianism and agency theory to what can be described as an ‘investor paradigm’ for corporate law. Within this paradigm institutional investors are expected to act in a two-fold way: as a monitoring mechanism promoting shareholder value maximization and as an accountability mechanism protecting the interests of other shareholders and the economy as a whole through the promotion of shareholder stewardship.
The last part of my paper advances the case for an approximation of the different theories of the firm and real world developments to present a more richly textured picture of the position of shareholders as active monitors and stewards within the modern public corporation.
Dionysia Katelouzou is Lecturer in Law at King's College London specialising in the areas of comparative and transnational corporate governance and corporate law.