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This chapter discusses the German experience with supervisory codetermination, in which shareholder and employee representatives share governance of large corporations. After discussing the basic features of the system, we examine how it has been viewed by American corporate law scholars as an anomaly that could only arise through legislative fiat. In fact, the German system was born of consensual agreement at a time when labor and capital had roughly equal bargaining power, and only later became enshrined in law. We then discuss recent studies that evaluate how well codetermination serves the needs of various corporate constituents, including employees, creditors, and shareholders, and the role it played in Germany's relatively rapid recovery from the global financial crisis. In the end, the success of the German system serves as an empirical rejoinder to the hypothetical arguments used by law and economics scholars to justify the exclusive shareholder franchise, as well as a sort of proof of concept of the shared governance model.
This chapter critically examines the claim that shareholders have a homogeneous interest in wealth maximization. This claim, which is central to several arguments for the exclusive shareholder franchise, is not accurate. Shareholder preferences diverge along a number of dimensions, including those in or out of a control group; those with differential voting power; those involved in vote buying or voting trusts; hedged shareholders; management, employee, and pension fund shareholders; sovereign wealth funds; and corporate social responsibility investors. Even shareholders with shared goals of wealth maximization may have differing timelines, risk tolerances, and ways of defining “wealth.” Thus, actual shareholders have a range of preferences far too great to support many of the arguments that rely on their shared agreement.
This chapter provides an introduction to the basic structure and themes of the book. We begin with a description of the basic features of a corporation. We then discuss the intellectual foundations of corporate governance, including an overview of the doctrine of shareholder primacy and the view that a corporation is merely a nexus of contracts. We begin to catalog some of the cracks in these foundations, focusing on the shortcomings of the long-standing arguments for the exclusive shareholder franchise. Next, we make clear that our the criticisms of shareholder primacy and the exclusive shareholder franchise do not question, but indeed make extensive use of, the basic principles of standard economics and social choice theory. In other words, both our critique and our positive theory come from within the very tradition that gave rise to the original arguments for shareholder control. We conclude the chapter with a detailed plan for the rest of the book.
This chapter sets out the second of two positive arguments for extending corporate voting rights to employees. Democratic participation theory provides a unique argument for extending governance rights to both shareholders and employees. The theory is derived from the uncontroversial propositions that governance rights should be tied to interest and that we must be able to assess that interest in a way that is both accurate and manageable. These notions largely spring out of political theory, but are also consistent with economic and social choice theory and their focus on preference fulfillment and the construction of incentive structures designed to promote good decision-making. And, like the theory of the firm, democratic participation theory generally counsels in favor of adding employees to the corporate electorate, but also tells us when we might be in one of those rare situations where governance rights should be extended to other stakeholders. That is, both aspects of the shared governance model of the corporation – the theory of the firm and the theory of democratic participation – have a flexibility that the arguments for the exclusive shareholder franchise seem to lack.
This chapter sets out the first of two positive arguments for extending corporate voting rights to employees. The long-standing theory of the firm, in confronting the question why firms even exist, explains the separation of corporate insiders from outsiders in a way that allows firms to most efficiently carry out joint production. Those inside the corporation should have their preferences captured through more direct governance mechanisms such as voting, those outside the firm through processes like contract or regulation. Under this understanding of the firm, employees are, of course, the classic insiders, a conclusion that’s only reinforced by more recent work on the generation and flow of information within firms. The economic theory of the firm, then, provides a powerful argument for extending the corporate franchise to employees.
This chapter lays out some of the basic aspects of how political institutions identify and aggregate the preferences of their constituents. Most democratic political systems use elections to aggregate preferences, and the contours of those political systems are mapped out in a number of voting rights. Voting rights, though, are not unidimensional: they cover everything from casting a ballot to ensuring that ballots are properly weighted to policing the very ability to place alternatives on a ballot in the first place. At the core of all these rights, though, is the recognition that voting should be tied in some way to a person's interest, or stake, in the outcome of an election. Because there are problems with relying upon self-reports of that interest, democratic institutions typically rely upon markers of that interest that allow them to identify and regulate those voting rights. Those markers, though, need to be both accurate descriptions of voter interest (not over- or underinclusive) and manageable.
This chapter critically examines the rise of board primacy as an alternative theory of firm governance. The chapter begins by categorizing such theorists as either “wise ruler” theorists or “long-term interest” theorists. In either case, board primacy theorists have responded to the revelation that shareholders, like other corporate constituents, have quite heterogeneous preferences not by extending voting rights to those constituents but by further distancing the shareholder electorate from real corporate decision-making. Their move conflates two different aspects of group decision-making processes: the responsiveness of the system and composition of the electorate. And by holding fast to exclusive shareholder voting, the theorists have just further detached their governance structures from the underlying preferences of corporate constituents without substituting anything in their place. We should instead investigate treating other constituents more like shareholders rather than the other way around.
This chapter critically examines the argument for giving shareholders alone the right to vote based on their ownership of the corporate residual. The argument is that shareholders are only paid what's left over after all other contractual participants – employees, customers, creditors, and suppliers – have been satisfied. Because shareholders receive the marginal gains, they have the best incentives to exercise discretion on the part of the entire firm, and hence should be accorded ultimate control. Shareholders, though, are not the unidimensional profit maximizers used to get this argument up and running. Moreover, shareholders do not, by virtue of their relationship with the firm, have ready access to the information necessary to cast informed votes, and many shareholders – such as index fund shareholders – lack real incentives to seek out that information. Finally, this vision of shareholders as the sole owners of the residual is just descriptively wrong – employees, too, are invested in the long-term interest of the firm, cannot easily diversify that interest, and often possess firm-specific skills as well as contributions to the ongoing value of the business.
This chapter lays out the some of the basic aspects of how corporations identify and aggregate the preferences of their constituents. Unlike democratic political institutions, corporations restrict voting rights to one class of constituents – shareholders – when it comes to electing members of the board or authorizing major transactions. The remaining constituents – employees, creditors, customers, and suppliers – are limited to expressing their preferences through contracts with the corporation. The chapter concludes by exploring this corporate governance structure through three controversial issues – the system of one share, one vote; proxy access; and say on pay – to illustrate the fierce debates within corporate law as well as the creative possibilities permitted by the corporate form.
In the preface, we set the stage for the rest of the book. Corporations have a tremendous amount of power and play a major role in a number of contemporary issues, including income inequality, global warming, and the financial crisis. The principal theory of corporate governance – shareholder primacy – is well entrenched in law and practice, but its intellectual foundations are falling apart. Academic groups are split into different camps advocating for more or less shareholder empowerment. The traditional, law and economics arguments for the core governance feature – the exclusive shareholder franchise – have been revealed to rest on faulty assumptions and flawed reasoning. And both corporate governance theorists and corporate and economic luminaries are openly questioning the stability of shareholder primacy as a continuing regulatory norm. There are, however, a dearth of alternative approaches, so shareholder primacy lumbers on toward the point of crisis. It is time to assess where we are and offer a new way forward.
This chapter critically examines the contractarian argument for the exclusive shareholder franchise. That argument comes out of the view that the corporation is merely a nexus of contracts among all the corporate constituents, and thus all have essentially agreed that shareholders alone should have voting and control rights. The nexus of contracts argument, though, is descriptively wrong, as corporations cannot be reduced to a set of contracts. Proponents fall back on using the concept as a metaphor, one that posits that “hypothetical” constituents would, if given the chance, all bargain for such an arrangement, but this, too, misdescribes actual constituent preferences and admits of too many degrees of freedom. The final part of the chapter examines the new corporate contract, where the contract metaphor has been redeployed to describe the role between shareholders and the board. This, like the nexus of contracts conception that it springs from, is also descriptively wrong and normatively hollow.
This chapter critically examines the argument that Arrow’s theorem supports giving the corporate vote to shareholders alone. We begin by laying out the argument and distinguish it from two, related arguments: the argument from politics and the argument for absolute delegation. We then show that the Arrow’s theorem argument is flawed on many fronts. Shareholder preferences are not, as supposed, homogeneous. Even if they were homogeneous, they would not translate into the kind of agreement on board candidates necessary to avoid intransitive corporate election results. Finally, restricting voting rights to shareholders gives up a fundamental condition of democracy in a situation where the likelihood and impact of intransitive results are already negligible.
In this concluding chapter, we note some of the societal problems associated with corporations, such as income inequality, and explore the relationship between those problems and the fact that shareholders have ultimate control of corporate decision-making. We then catalog the ways in which the theoretical underpinnings of this arrangement – shareholder primacy – appear to be in decline and the accompanying law and economics arguments in favor of the exclusive shareholder franchise have fallen apart. The chapter, and the book, conclude with some thoughts about how incorporating employees into firm governance is the best path forward.