At the heart of any free economy is its capital markets. Investors put their money in these capital markets with the expectation of a return on their investment. What assurance do these investors have that they will receive a fair return on their investment? Corporate governance is the set of processes and procedures that ensures investors a fair return on their investment. In practical terms, corporate governance includes n the articles of incorporation of the company, n the mechanics of the election of the board of directors, n the responsibility of the board to act as fiduciaries of the shareholders, n the responsibility of the board to hire, compensate, and fire senior management, and the public auditors of the company.

Roe (1997): The Political Roots of American Corporate Finance n Roe (1990): “Legal Restraints on Corporate Control,” Journal of Financial Economics, v. 27. Table 1 (Show me the money!) n Who has the money in U.S.? (in order of importance) n Banks n Pension funds n Insurance companies n Mutual funds n Bank trust funds and holding companies

Roe (1997): The Political Roots of American Corporate Finance n Roe (1990) Table 1 n Institutions that have the money are restricted from owning significant fraction of the voting stock of any company. n How did we get to this situation?

American Populism The widespread attitude in the U.S. that large institutions and concentrations of political or economic power are inherently undesirable, and should be reduced, whether or not the concentration serves a useful productive function.

American Populism n Today populist sentiments are directed at the government, mostly the federal government. n In the 19th century, the populist movement, representing farmers in particular, gave impetus to the passage of the Sherman Antitrust Act. n Frederick Jackson Turner in his Frontier Thesis: “Democracy, in our traditions, has rich connections to the yeoman farmer, involving … freedom from the urban banker.” n William Jennings Bryan in his Cross of Gold speech, “On the one side stand the moneyed interests, aggregated wealth and capital, imperios, arrogant, compassionless… On the other side stand an unnumbered throng.”

Roe (1997) n Page 16: In the early 1990s, the SEC relaxed its view that made informal communications among investors in the same company come under rules requiring proxy filings. n Page 17: When monitoring of managers is likely to be important? n Concentrated market, large fixed costs, and few growth opportunities. n When monitoring of managers is NOT likely to be important? n Highly competitive market, with little fixed long- term capital, and lots of growth opportunities.

Roe (1997): Page 19: The Case for Competing Corporate Governance Systems n The current U.S. corporate governance system and the corporate control market has much to recommend for itself on both the economic and political dimensions. n However, it would not be unwise to look at other corporate governance systems. n Japan: The keiretsu system: Cross-holdings of stock. Banks lend to companies and own their stock. n Germany: Banks and insurance companies own many large blocks of stock. n Perhaps we might allow features of other corporate governance systems to compete with our existing governance system.