Einde inhoudsopgave
The Decoupling of Voting and Economic Ownership (IVOR nr. 88) 2012/3.2
3.2 Defining Efficiency
mr. M.C. Schouten, datum 01-06-2012
- Datum
01-06-2012
- Auteur
mr. M.C. Schouten
- JCDI
JCDI:ADS598273:1
- Vakgebied(en)
Ondernemingsrecht / Rechtspersonenrecht
Voetnoten
Voetnoten
John Armour, Henry Hansmann & Reinier Kraakman, FVhat is Corporate Law, in The Anatomy of Corporate Law: A Comparative and Functional Approach 28 (Reiner Kraakman et al. eds., 2009) (noting also that the advancement of the general welfare should be understood as the pursuit of Kaldor-Hicks efficiency).
See Levmore, supra note 17, at 158 (arguing that there is a case to be made for application of the Jury Theorem because there is the metric of value maximization); Thompson & Edelman, supra note 17, at 155 (noting that 'the franchise is limited to shareholders because the law bas decided that each corporation is best served by focusing on its own stock price, not overall social welfare'); Surowiecki, supra note 16, at 269 (contrasting the problem that in political voting there is no standard that allows us to judge a political decision to be 'right' or 'wrong' to the case of the corporation, 'where there is a simple and coherent definition of what's in 'the corporate interest'—namely, legally increasing the discounted value of the company's future free cash flows'); see also Goshen, Controlling Strategic Voting, supra note 17, at 745, 750 (defining the goal as assuring transactionefficiency).
Kurz v. Holbrook, 989 A.2d 140, 178 (Del. Ch. 2010), aff 'd, Crown Emak Partners v. Kurz, 992 A.2d 377, 388-89 (Del. 2010).
See Armour et al., supra note 23, at 29.
See Easterbrook & Fischel, supra note 8, at 403.
But see Jill E. Fisch, Measuring Efficiency in Corporate Law: The Role of Shareholder Primacy, 31 J. Corp. L. 637, 658 (2005) (scrutinizing the argument).
See, e.g., Lynn A. Stout, Bad and Not-So-Bad Arguments for Shareholder Primacy, 75 S. Cal. L. Rev. 1189, 1194 (2002); Bernard Black, Corporate Law and Residual Claimants 4-5 (Stanford Law Sch. John M. Olin Program in Law and Econ., Working Paper No. 217, 2001), available at http://www.ssm.com/abstract=1528437.
See infra note 146 and accompanying text. Another example is offered by the financial crisis. When govemments step in to rescue firms deemed too big to fail, shareholders are effectively substituted as residual claimants by the government, and ultimately the taxpayer.
Fisch, supra note 28, at 660. The notion is also undermined by other issues, such as the possibility that individual firm decisions may create negative externalities. Id.
A focus on shareholder value also enables us to distinguish between voting as a mechanism for information aggregation and voting as a mechanism for preference aggregation. The latter is often—though not always—associated with political voting, where voters may prefer different outcomes. For an epistemic approach to political voting, see Hélène Landemore, Democratic Reason: Why the Many Are Smarter than the Few and Why It Matters 6 (2009) (unpublished manuscript), available at http://yale.academia.edu/HeleneLandemore/Papers/158385/Democratic-Reason—Why-the-Many-Are-Smarterthan-the-Few-and-Why-It-Matters.For example, some voters may prefer an outcome that maximizes economic growth, while others may prefer an outcome that minimizes social inequalities. To aggregate heterogeneous preferences and obtain transitive outcomes is challenging if not impossible, as Arrow's Theorem shows. This issue features prominently in social choice theory. Corporate constituencies such as employees and shareholders, too, have heterogeneous preferences, and arguments from social choice theory have therefore also been invoked in the scholarly debate on corporate voting. See Easterbrook & Fischel, supra note 8, at 405 (arguing that a consistent system of choices is only possible when voters hold the same ranking of choices (or when rankings are at least single peaked), and that shareholders form such a homogenous group because of their shared interest in profit maximization); see also Jeffrey N. Gordon, Shareholder Initiative: A Social Choice and Game Theoretic Approach to Corporate Law, 60 U. Cin. L. Rev. 347,359-63 (1991) (exploring the risk of cycling). But see Grant Hayden & Matthew Bodie, Arrow's Theorem and the Exclusive Shareholder Franchise, 62 Vand. L. Rev. 1217,1229-37 (2009) (arguing that the likelihood of cyclical outcomes in cases of corporate voting by multiple constituencies with heterogeneous preferences may not be that significant and questioning whether occasional transitivity would do much harm to organizations, at least when it comes to corporate board elections).By contrast, shareholders generally prefer the same outcome, namely the outcome that maximizes the firm's future cash flows. Later in the Chapter, we will see that shareholders do not always have homogenous preferences. See infra notes 101-06 and accompanying text. But starting from the assumption that they do, we can see how shareholders, based on the bits and pieces of information available to each of them, merely have different beliefs on what the most suitable means are to achieving the common goal of shareholder value maximization. Thus, it becomes clear that voting can serve as a mechanism for information aggregation.
To be precise, given that shareholders are typically presented with a binary choice (e.g., approve or reject a merger with company X), the 'option that maximizes shareholder value' refers to the option that creates relatively more shareholder value than the other option, not to the option that maximizes shareholder value in an absolute sense (which could, for example, be a merger with company Y, an option that may not be presented to the shareholders). And while it is obvious that with respect to mergers and acquisitions the present value of future cash flows of one option is necessarily higher or lower than the value of the altemative option, this is also true when it comes to less dramatic issues that shareholders vote on, such as amending the corporate charter. Such decisions, too, have value implications, however small and however difficult it may be to estimate them. See Vicente Cufiat et al., The Vote is Cast: The Effect of Corporate Governance on Shareholder Value (Feb. 17, 2010) (unpublished manuscript), available at http://ssm.com/abstract=1555961 (measuring abnormal returns around the passing of shareholder resolutions relating to corporate governance).Notice that in the scholarly debate on market efficiency, a distinction is sometimes made between informational efficiency and fundamental efficiency. An informationally efficient market implies the absence of a profitable trading strategy based on publicly available information, whereas fundamental efficiency implies that the market price represents the best current estimate of the present value of future cash flows. If the definition of voting efficiency used in this Chapter would need to be likened to one of these two interpretations of market efficiency, it would presumably be closest to fundamental efficiency. But see Ronald J. Gilson & Reinier Kraakman, The Mechanisms of Market Efficiency Twenty Years Later: The Hindsight Bias, 28 J. Corp. L. 715, 716 n.4 (2003) (expressing skepticism about the usefulness of the distinction between informational efficiency and fundamental efficiency).
Thompson & Edelman, supra note 17, at 150.
See generally Robert J. Shiller, Irrational Exuberante (2005) (discussing the impact of structural and psychological factors on market prices).
See Edelman, supra note 14, at 338 (noting that the information aggregation model requires an exogenous choice of the right answer).
See Patrick Bolton, Jose Scheinkman & Wei Xiong, Executive Compensation and ShortTermist Behaviour in Speculative Markets, 73 Rev. Econ. Stud. 577, 597 (2006) (modeling a market in which investors have heterogeneous beliefs and concluding that '[w]hen it is possible for future investors to overvalue the firm due to their optimism, it is in the interest of current shareholders to cater to such potential sentiment even at the expense of firm longterm fundamental value'). Notice that this description of how shareholders make voting decisions tracks John Maynard Keynes's description of how shareholders make investment decisions, namely by 'anticipating what average opinion expects the average opinion to be.' John Maynard Keynes, The General Theory of Employment, Interest, and Money 156 (1935). Similar problems arise when management is asked to run the business with a view to maximizing the share price. See, eg., Michael C. Jensen, Agency Costs of Overvalued Equity, 34 Fin. Mgmt. 5, 6 (2005) (arguing that when the firm's equity is overvalued, management will become desperate to meet the market's unrealistic expectations and engage in negative net present value investments that the market thinks will generate value); William W. Bratton & Michael L. Wachter, The Case Against Shareholder Empowerment, 158 U. Pa. L. Rev. 653 (2010).
Before studying the mechanisms leading to voting efficiency, we need to address a preliminary question: When should corporate voting be deemed "efficient"? This section will argue that for present purposes, corporate voting may be deemed efficient when a majority of the shares is voted in favor of the option that maximizes shareholder value.
At the broadest level, the appropriate goal of corporate law is to advance the general welfare of all who are affected by a firm's activities, including shareholders, employees, suppliers, and customers.1 In principle, the efficiency of shareholder voting should therefore be measured in terms of general welfare. In practice, though, shareholders vote with a view to maximizing shareholder value, not general welfare. Remarkably, scholars whose view of corporate voting turn on information aggregation do not seem to view this as a problem. The reason is that implicitly or explicitly they subscribe to the widely held view that shareholder value maximization is the appropriate corporate objective.2 This view is also held by the Delaware Chancery Court, which recently opined that "[w]hat legitimizes the stockholder vote as a decisionmaking mechanism is the premise that stockholders . . . are expressing their collective view as to whether a particular course of action serves the corporate goal of stockholder wealth maximization."3
And yet, whether the pursuit of shareholder value is an effective means of advancing general welfare is a question on which reasonable minds can and do differ.4 The classic law and economics argument for why shareholder value is an effective means is based on the earlier notion that shareholders are the residual claimants, whereas other stakeholders have fixed claims.5 If shareholders are the residual claimants, they receive the surplus that remains after all fixed claims are paid; maximizing this surplus means maximizing total value, or so the argument goes.6 Critics of this argument reject the notion that shareholders are the sole residual claimants. On the one hand, other stakeholders, notably employees, can also be characterized as residual claimants7. On the other hand, individual shareholders cannot always be considered residual claimants since they may, for example, hedge away their economie interest by using derivatives.8 If the characterization of shareholders as sole residual claimants is inaccurate, this undermines the notion that maximizing shareholder value is an effective means of maximizing general welfare.9
For present purposes, it is not necessary to join the debate on whether shareholder value maximization is the appropriate corporate objective. That is because our purpose is to explore the mechanisme leading to a predefined notion of efficiency rather than to define the notion of efficiency. To avoid overly complicating the analysis, the remainder of this Chapter assumes that shareholder value maximization is the appropriate objective.10 Accordingly, voting is deemed efficient when a majority of the shares is voted in favor of the option that maximizes shareholder value.11
When we assume that shareholder value maximization is the appropriate objective, we are presented with the question of how shareholder value should be measured. Some proponents of a theory of corporate voting based on the Jury Theorem have used share price as a proxy for shareholder value, arguing that when voters face the question whether or not to approve a merger, the "right" answer is the option that increases the share price.12 In light of this Chapter 's primary goal to examine mechanisms that affect the relative efficiency of voting, it is not necessary to measure voting efficiency in absolute terms. But in light of its secondary goal of providing a basis for future empirical research, it is important to at least acknowledge possible objections to a focus on market prices—objections that arise from the fact that market prices may deviate from fundamental values.13 In particular, it might be objected that asking shareholders to judge which option increases the share price introduces a degree of endogeneity. After all, the share price represents the judgment of the market about the value of the firm. Shareholders, then, are essentially asked to judge how the market, including they themselves, will value the firm if, for example, it makes an acquisition. This is different from asking shareholders to judge what the marginal value of the acquisition is, a question that has a fully exogenous answer.14 The differente is subtle but relevant. Suppose management proposes the acquisition of a hyped Internet company for a hefty premium. If shareholders who vote individually believe the project has a negative net present value but expect the market as a whole to optimistically believe it has a positive net present value, a focus on share price implies that they will vote to approve the acquisition, which, after all, is the option that increases the share price.15 When shareholders ignore their private information, voting efficiency is undermined, a problem we return to later in the Chapter.
In sum, while this Chapter assumes that shareholder value maximization is the appropriate corporate objective and accordingly deems voting efficient when a majority of the shares is voted in favor of the option that maximizes shareholder value, two cautionary notes are in order. If voting is efficient in the sense that shareholder value is maximized this need not imply that general welfare is maximized, nor need it imply that the share price is maximized. With this in mind, let us turn to the mechanisms of voting efficiency.