By Robert A. G Monks, HarperBusiness (December 1991)

"A provocative answer to anyone alarmedby Barbarians at the Gate"

"Corporations determine far more than any other institution the air we breath, the quality of th water we drink, even where we live. Yet they are not accountable to anyone."

"Power & Accountability" contends that institutional investors are changing U.S. corporate governance for the better, and that the law should encourage those changes. In my view, the thesis is both positively and normatively flawed.

The empirical evidence on institutional investor activism is mixed, at best. There is some anecdotal evidence that institutions are becoming more active, using the proxy system to defend their interests. Less visibly, institutions supposedly influence business policy and board composition through negotiations with management. Yet, there is little concrete evidence that shareholder activism matters. Even the most active institutions spend trifling amounts on corporate governance. Institutions devote little effort to monitoring management. They rarely conduct proxy solicitations or put forward shareholder proposals. They do not to try to elect representatives to boards of directors.

Even if institutional investor activism matters, it is not clear that it should be encouraged. U.S. public corporations are characterized by a separation of ownership and control: the firm's nominal owners, the shareholders, exercise virtually no control over either day to day operations or long-term policy. Instead, control is vested in the hands of professional managers, who typically own only a small portion of the firm's shares. This separation is carved into stone by U.S. corporate law-under all corporation statutes, the key players in the formal decision making structure are the members of the board of directors. The separation of ownership and control has costs, the most significant of which are referred to as agency costs, incurred to prevent shirking by managers. The agency cost model forces one to confront the question: who will monitor the monitors? In any team organization, one must have some ultimate monitor who has sufficient incentives to ensure firm productivity without himself having to be monitored. Otherwise, one ends up with a never ending series of monitors monitoring lower level monitors. Institutional investors, at least potentially, may behave quite differently than dispersed individual investors. Because they own large blocks, and have an incentive to develop specialized expertise in making and monitoring investments, they could play a far more active role in corporate governance than dispersed shareholders. Institutional investors holding large blocks have more power to hold management accountable for actions that do not promote shareholder welfare. Their greater access to firm information, coupled with their concentrated voting power, will enable them to more actively monitor the firm's performance and to make changes in the board's composition when performance lagged. As a result, concentrated ownership in the hands of institutional investors might lead to a reduction in agency costs.

Reviewer:Stephen M. Bainbridge "www.professorbainbridge.com" (Los Angeles, CA USA)

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