It is well known that the original owners of a company sell their shares to the public in order to diversify their assets so as to reduce risk and the necessity for company’s to seek more capital. Both motives lead to the selling of shares, and thus to share dispersion. This creates a problem of managerial agency costs. As mentioned above owners step away from active management and this brings the necessity to hire agents to run the firm. This may, however, make the shareholders have second thoughts since the managers may exploit their positions at the expense of shareholders.
Accordingly, potential investors realize this risk. Without protection against insider abuses, the founding family will have trouble selling shares, and the company will have trouble raising capital through the sale of equity17. As a result we have reached a condition in which the individual interest of the shareholder is definitely made compliant to the will of a controlling group of managers. Shareholders want the company to maximize its profits, but the managers dislike hard work and prefer other things, like prestige, paid vacations, and similar rewards.
Consequently, if mismanagement does, at some point, become a serious concern, an investor who is aware of the liquidity of the stock market offers, may sell his shares which is a much quicker and less costly solution than trying to turn the company around by taking absolute control18. Therefore, since investors know that shares in a company offer this feature the most they can lose is what they have paid19. While they are not fully accountable for corporate financial obligations their personal wealth is not at risk.
There is also the view that the separation of ownership from control might enable controlling managers to increase their own wealth at the shareholders expense. Indeed, Berle and Means suggested that by broadening the responsibility of a company’s board of directors to a kind of trusteeship to address the need for such a countervailing power20. To a large extent, Berle and Means attributed this condition to the appearance of widely dispersed company ownership that accompanied the development of the large corporation.
The capital markets agency structure incorporates a shareholder, and a manager who is hired by the shareholder and to whom the manager reports21. It is important to recognize that the Berle and Means thesis is supposed to be applicable only to large firms with some market power. More diffused ownership not only implied greater transaction costs including greater costs of collecting information regarding the efficiency of the managers decisions, but also a small return to each shareholder from seeking to monitor inefficiencies.
More dispersed ownership however, also permits greater specialization among shareholders Thus, inefficient decisions by managers induce the better informed owners to reach sooner and more accurately, selling some or all of their shares and thereby lowering the shares market price and the cost of taking over the company22. Separation of ownership from management and effective securities markets reinforce each other. The underlying theory is straightforward: If bosses can steal, distant owners will not buy shares.
The civil law systems that prevail in continental Europe supposedly provide inadequate protection, so ownership remains concentrated. Moreover, fiduciary duties23 only aspire to prevent insiders from stealing. They do not control the main costs that shareholders face when they do not manage the company themselves, such as unprofitable expansion, shirking, retention of free cash flow, and empire building. Unless there is a conflict of interest between a company’s management and its board, owners in common law countries have no legal recourse when managers operational or strategic decisions are bad, stupid, or otherwise harmful to shareholders.
In reassessing some of the conclusions of Berle and Means Herman Edward examine the control and accountability of the large corporations. He states that management control has steadily eclipsed the influence of shareholders and financial institutions. He finds that today controlling groups seem to be as devoted as ever to profitable growth. Although control by financial institutions has declined Herman says they still sometimes exercise an important influence on decision making24.
He argued that corporations have in fact remained faithful to their basic profit maximization objectives, continuing to be somewhat solid to demands for responsibility for the public welfare25. The basic Berle and Means thesis focuses on a managerial revolution in which corporate control came to be transferred from owners to managers. Currently, it is arguable that control of corporate policy has shifted back to owners in what has come to be called investor capitalism. Stock market manipulators, as owners, have currently come to assert increased levels of control over CEO autonomy26.
For decades, the corporate world behaved, at least in part, the way Berle and Means said it would. While paying the best interests of shareholders, many major corporations acted, in fact, in the best interests of the people who ran the company. This led to some rotten diversification aimed in the basic business, but these moves often turned out to be bad investments. It led to often irrational expansion where a company’s executives have used money that might better have been returned to shareholders27. In a nation like the United States and the United Kingdom, where employees can be fired easily, shareholders have less to fear.
But in a labor strong society, dominate shareholders those with the most to lose if development goes wrong have reason to keep managers on a restriction. When managers are forced to cut employment, they are more likely to think that they are destroying lives rather than raising economic efficiency and increasing wealth. Such societies should have fewer public firms, and narrower or no ownership separation. Accordingly, in Korea, Indonesia, Thailand, and indeed most developing economies there is no separation of ownership and control; owners control their companies even when they are listed.
Accordingly, it is not surprising that such ownership leads to the formation of family owned business groups. A complete understanding of the corporate ownership and control issues discussed by Berle and Means requires some notion of what a company is. This literature, unlike the theory of the company, recognizes that at least one actor in the company, the chief executive officer (CEO), is the agent of shareholders. But it ignores the other agents in the company, and, as a result, delivers little in the way of a theory of organizations.
It might be assumed that we can better understand the conflict between shareholders and management, if we recognize that there is more to management than the CEO28. In fact, however, separation of ownership and control is a highly efficient solution to the decision making problems faced by large corporations. Because joint decision makes it almost impossible in such situations, authority based structures are characterized by the existence of a central agency29 to which all relevant information is transmitted and which is empowered to make decisions binding on the whole30.
As firms grow in size, however, consensus based decision making systems become less practical. By the time we reach the Berle Means Corporation, their use becomes basically impractical. Consider the problems faced by shareholders, who are usually assumed to be the corporate constituency with the best claim on control of the decision making machinery. The absolute mechanics of achieving consensus amongst thousands of decision makers preclude an active role for shareholders.
Even if those mechanical difficulties could be overcome, active shareholder participation in corporate decision making still would be precluded by the shareholders’ usually different interests and different levels of information. True, most shareholders presumably come to the corporation with profit making as their principal goal. However, are likely to vary from short term speculation to long term buy and hold strategies, which in turn is likely to result in disagreements about corporate strategy. A more important factor is the shareholders lack of motivation to actively participate in decision making.
A rational shareholder will disburse the effort necessary to make informed decisions only if the expected benefits of doing so outweigh its costs. Given the length and complexity of corporate disclosure documents, the opportunity cost entailed in making informed decisions is both high and apparent. In contrast, as discussed above, the expected benefits of becoming informed are quite low, as most shareholders holdings are too small to have significant effect on the vote’s outcome. Shareholders of Berle and Means corporations thus are rationally apathetic.
Since corporate governance arrangements influence the efficient use of society’s resources and the ability of the companies to create new wealth, the theory of management control, as put forward by Adolf Berle and Gardiner Means, still seems to be full of promise for management researchers and practitioners.
Robert A. G. Monks and Nell Minow, Corporate Governance, 3rd Edition, 2004, Blackwell Publishing. Company law: Theory Structure and Operation, by Brian R. Cheffins, Faculty of Law University of British Columbia, Clarendon Press Oxford 2003.