11 The Case Against Shareholder Empowerment 158 U. Penn. L. Rev. 653 ( 2010) William W. Bratton Peter P. Weidenbruch, Jr., Professor of Business Law Georgetown University Law Center Michael L. Wachter William B. Johnson Professor of Law and Economics Co-Director, Institute for Law and Economics University of Pennsylvania Law School SASE Annual Meeting June 25, 2010

2 Corporate legal theory Dominant view – Management power is the problem – The legal model empowers managers – Shareholder power is the answer – Defenders of the system bear the theoretical burden of proof

3 This papers objective Reverse the theoretical burden of proof to fall on the law reform proponent Means to the end – (1) Clear the field of the conceptual inheritance of Berle and Means – (2) Make transparent the theoretical assumptions that motivate the shareholder case – (3) Show that management agency costs are not as salient as claimed – (4) Show that shareholder empowerment would implicate significant agency costs – (5) Decouple the financial crisis from the shareholder case and recouple it with the case against

4 (1) Clear the field of the conceptual inheritance of Berle and Means Fama and Jensen (1983) – Separation of ownership and control is a rational allocation of management functions Ultimate control in board Shareholders dont know anything – Property is split among decision initiators, monitors, and residual claimants

5 (2) Make transparent the theoretical assumptions that motivate the shareholder case Ultimate control in shareholders Incentives – Managers are conflicted and self-serving – Shareholders have a pure incentive to maximize value But shareholders dont know anything – Market price = objective and accurate measure of pure shareholder maximand Manage to maximize the market price

6 (3) Show that management agency costs are not as salient as claimed Shareholder win-win – Static agency cost picture dating from the 1980s Jensen and Meckling – Dynamic process of agency cost reduction Post 1980s developments – Managers become sensitive to shareholder value – Boards become better monitors – Discipline: Private equity buyouts – Hostility: Activist hedge funds

7 (3) Show that management agency costs are not as salient as claimed

8 (4) Show that shareholder empowerment would implicate significant agency costs What does the market price teach? – (1) If markets were strong form efficient, the shareholders would have a great case Markets are not strong form efficient – (2) The strength of the shareholder case varies depending on the content of public information and the governance issue – (3) Information asymmetries are real and persistent – (4) Market prices are subject to speculative distortion

9 (5) Decouple the financial crisis from the shareholder case and recouple it with the case against They say – Management caused the financial crisis – Shareholder empowerment will restore trust We say – Shareholder empowerment is about market control and the financial crisis follows from market failure – Managers and shareholders made the same mistakes

10 (5) Decouple the financial crisis from the shareholder case and recouple it with the case against

11 (5) Decouple the financial crisis from the shareholder case and recouple it with the case against