Shareholder Initiative: A Social Choice and Game Theoretic Approach to Corporate Law

When it comes to specific business matters, it seems that an objecting shareholder can do no more than offer a precatory resolution that provides shareholder advice on the issue. Adoption of such a resolution obviously sends a strong signal to management, as do informal contacts by important shareholders, that a management seeking to avoid a control contest may be well-advised to heed. Nevertheless, management can ignore such expressions of shareholder. preference and, indeed, can pursue policies and extraordinary transactions that it knows shareholders would reject. Thus for the large public corporation the pattern of delegation gives management virtually unbounded decisionmaking authority over business matters and agenda control over significant changes in the management-shareholder relationship. The shareholders\u27 power consists almost exclusively of the power to revoke the delegation through a control contest, or more problematically, through acceptance of a hostile tender offer. There is no power of shareholder initiative. This pattern of shareholder-manager relations may be called the absolute delegation rule. The question is why this pattern has arisen and persisted and the circumstances under which it might be changed. Why shouldn\u27t Carl Icahn be able to take to shareholders for resolution the question of whether USX would be more valuable if broken up into two separate corporations? There is a substantial argument that the conglomeration of oil and steel was the result of an agency problem: management pursued diversification to protect its jobs against the bankruptcy risks of the steel business at the expense of shareholders, who could have obtained such diversification at the portfolio level more cheaply, since common ownership entails the potential cross-subsidization of steel losses from oil profits. Such agency problems could more easily be controlled were shareholder initiative available as an alternative to a full-scale control contest. Alternatively, on some particular business matters, shareholders may believe their perceptions and judgement are superior to management\u27s. Carl Icahn may in fact have had a better view of the long term comparative futures of steel and oil than the USX management. In both cases it may be that the incumbent management otherwise ably runs the enterprise, but is tempted to serve its particular interests or makes a mistaken prediction about the future. Why leave shareholders with only one avenue – an election contest aimed at the board of directors – to force a particular change in business strategy? This paper argues that the two standard justifications of the absolute delegation rule are incomplete, the first, based on management\u27s informational advantage; the second, based on the management/agent\u27s success in maintaining power over the shareholder/principal. I argue on behalf of a third explanation: that the absolute delegation rule avoids several sorts of pathologies that would emerge in the strategies of shareholder voting. Shareholders give away power because, in many circumstances, the effects of the shareholder initiative would be wealth-reducing. In particular, shareholder initiative would produce strategic behavior designed to maximize private gains at the expense of common gains. I hope to demonstrate these points with analysis drawn from the social choice and game theory literatures