Shareholders and Stakeholders

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Shareholders and Stakeholders
"The Business of America Is Business"
Can We Still Compete When the Business of the World Becomes Business?
The Key to Corporate Vitality
What Works: The Tyco Example
Legitimacy and Accountability: The Tie That May Not Bind Enough
The Corporate Citizen
The Tower of Babel
Strange Bedfellows
Accountability, Trust, and the 900-Pound Gorilla
Endnotes

Shareholders and Stakeholders


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I was driving through Maine one late summer day when I stopped to admire a river running through a pretty wooded area. I noticed big, slick bubbles of industrial discharge corroding the vegetation along the riverbank, and I wondered: Who wants this to happen? Not the owners of the company, the shareholders. Not the managers or employees, who want to live in a healthy environment. Not the board of directors, not the community, not the government. I could not think of anyone connected with the company emitting the effluent who wanted the result I saw. This was an unintended consequence of the corporate structure. The very aspects of the company's design that made it so robust, so able to survive changes in leadership, in the economy, in technology, were the aspects that led to this result pollution that no one wanted, and everyone would pay for.

I realized I was part of the problem some time later, while in my office at the Boston Safe Deposit and Trust Company, where I was Chairman of the Board. I was looking over the proxies that it was our responsibility, as trustee for $7 billion in assets, to vote, and I was preparing to do what we had always done - vote with management on all of them. I picked up the proxy for the company that produced the industrial sludge I had seen, and I realized that if I voted for management, I was endorsing this activity. Those of us who managed money on behalf of others had the opportunity, and the responsibility, to tell management that this activity was unacceptable. But none of us was doing it.


No Innocent Stockholders

There is no such thing to my mind . . . as an innocent stockholder. He may be innocent in fact, but socially he cannot be held innocent. He accepts the benefits of the system. It is his business and his obligation to see that those who represent him carry out a policy which is consistent with the public welfare.

Louis Brandeis


Many companies violate the law. Beech-Nut sold sugar water as apple juice for infants. Alleco was convicted for price-fixing. E.F. Hutton pled guilty to 2,000 felony counts in 1985. An Exxon ship spilled 240,000 barrels of oil in Prince William Sound.1 Over $2 billion was spent on cleanup by Exxon as of January 1991.2 Other companies operate within the law, but they abuse their investors with outrageous compensation packages for management or entrenchment devices that prevent a beneficial sale of the company. These activities are not just bad for the shareholders; they are bad for the market, bad for the community, and bad for the economy.

This book is about how these kinds of things happened, and why, and how to make it harder for them to happen again. It is also about how changes in the composition of the shareholder community over the past decade have made it possible to restore the corporate organization to its original design. And this will revive the management accountability that is the best guarantee not just of corporate performance in the public interest, but of competitiveness and productivity as well. If all of our recommendations are followed, does that mean there will no longer be pollution in a remote river in Maine? No, it doesn't. But it does mean that it will be much more difficult for corporations to ensure their survival by making everyone else pay the costs.


"The Business of America Is Business"


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We begin with some background about the development of corporations in this country. Corporations have an immeasurable impact on every aspect of American life - not just what we buy, where we work, and which diseases we cure, but much, much more. Retailing corporations were responsible for changing the date on which we celebrate the oldest of American holidays. In 1941, Congress moved Thanksgiving up a week to create more time for Christmas shopping.3

It has been said that "I Love Lucy" is playing somewhere in the world every moment, 24 hours a day - sort of the twentieth-century equivalent of "the sun never sets on the British Empire." The people across the world who watch that program will think that the word lucky does not exist in the American vocabulary. The sponsor banned it because it was the name of a rival cigarette. Corporations fund, and therefore help to direct, our universities, our charitable institutions, our political campaigns. More than that, they are, in a way, our art form.

The United States has not yet produced a Michelangelo, a Beethoven, a Plato, or a Mohammed. The great genius of our republic has been in creating and preserving a free and open environment in which citizens can prosper. The most conspicuous demonstration of this goal is the surge of America over the last century to a leadership position in worldwide manufacturing and commerce. The very land and air of America has not only ensured domestic prosperity but also has enticed and inspired hardworking immigrants from many lands. Their names and accomplishments are key components of the national soul.

The idea of the private corporation was not unique to America back in the eighteenth century, but it was perhaps uniquely suited to America, the first country established as a constitutional democracy. Ours was the first society where a person could achieve the highest levels of fortune and status through commerce, and it is no coincidence that the United States and its corporations have been very good for each other and to each other. Capitalism was as much a part of America as the frontier; both were infinite resources waiting for someone to tame them. The famous statement of former General Motors president Charlie Wilson at his confirmation hearing for secretary of defense still rings with his absolute conviction: "For years I thought what was good for the country was good for General Motors, and vice versa."4 He was not the only one who found it unthinkable that there could be any conflict of interests between the corporate good and the national good.

An impoverished Scottish family named Carnegie arrived in Pittsburgh in the middle of the nineteenth century. The spirit that had been ground down by centuries of marginal existence in Dunfermline, Scotland, acquired in the New World such vigor and purpose that it brought forth in Tom and Andrew Carnegie a new breed. The importance of commerce was already established. Just emerging was the realization that new technologies could cure disease, alleviate burdens, improve communications, and change the physical aspect of the world. Openness was the key - openness to new people, new ideas, and new ways of doing things. It was as if the commercial potential of the human spirit had been given its first real opportunity.

America welcomed all the "wretched refuse" and provided the framework for commercial accomplishment that made those that succeeded not merely rich but themselves world leaders, entitled to the respect of every man, emperor, pope, and field marshal. Carnegie lived long enough to direct the application of this tremendous wealth into public libraries, a World Peace Palace, and great foundations endowed to ensure the permanent enrichment of public dialogue. The immigrant boy grew into a man who called the kaiser of Germany "Bill."


Can We Still Compete When the Business of the World Becomes Business?


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What Americans like to think of as the generic aspects of the national character - energy, self-confidence, a certain naivete, tinkerer's skills, and courage - incarnate the elements necessary for business success. Those elements still exist in this country, but apparently they are not enough. In the last few decades, we have had to accept that American business is no longer competitive, a realization that is profoundly conflicting with our deepest notions of ourselves.

Evidence of our decline is inescapable. World consumers - even Americans - prefer automobiles, television sets, cameras, clothes, and virtually all kinds of products made in other countries. Across the entire spectrum of industry we are confronted daily by the reality that others are doing better what we did best in former times. We may have expected that we could not maintain our position of dominance after World War II, but after only a few decades our advantages in a limited number of areas, such as computers and aircraft manufacturing, suggest a return to the earliest days of the republic, when the colonies were the "hewers of wood and drawers of water." This is more than just a commercial failure, a loss of money; it is as if the very essence of Americanism, so long the envy of the entire world, has been tested and found wanting.

There have been many places to assign blame. Some people suggest that our government policies are at fault, while others point to the lack of skill of labor and management, the cost of capital, or even the seeming invincibility of our foreign competitors. The inefficiencies of our educational system and our tax and accounting policies, as well as the vagaries of currency valuation and short-term profit orientation by managers and shareholders, are also frequently named factors in our predicament.

Much can be - and should be - done about each of these problems, but even improvement in all these areas seems inadequate to the scope of the problem. And some of the complaints are so narrow in focus that they obscure the point. Can cost of capital really be the ultimate problem in a time when the largest American corporations are buying back their own common stock? When some "experts" blame it on a weak dollar, and others blame a strong one, the problem has to be something else. Is the diversion of management attention to the risk of a hostile takeover more harmful to competitiveness than an atmosphere of entrenchment?

Our failure is so pervasive, so broad across all sectors of industry, that the problem must be dysfunction of the corporate system. The source of its failure is found in its success. The corporate structure was as important in transforming commerce as the assembly line. Both were based on the same principle, specialization. You didn't need to know how to make a chair to work in a chair factory; all you needed to know was how to put the chair leg into the chair seat. And you didn't need to know how to make a chair to invest in a chair company; all you needed to do was buy some stock. But either system works only if it is based on accountability. The foreman needs to make sure that the workers are putting chairs together correctly, or the customers will stop buying them. And the company has to produce returns, or the investor will sell out.


The Key to Corporate Vitality


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The genius of the corporation, the factor that accounts for its almost universal use in the modern industrialized world as the preferred form for large commercial enterprises, is its internal dynamic of accountability. The corporation's vitality is based on trust, bridging law, tradition, and management theory - trust that managers will work loyally and effectively to realize the full potential of value for the owners, and that the owners can be counted on to ensure that the venture operates in their interest, their interest standing for everybody's interest. If the corporate structure is inadequate to maintain that trust, then all of the changes in laws, monetary policy, and trade agreements cannot solve the problem. In this book, we demonstrate that it has been inadequate.

Trust has been more myth than reality. The aspects of the system designed to help the corporation preserve itself have worked, but the aspects of the system designed to make sure that this self-preservation was consistent with the public interest have not. As we document in Part II, state government, local government, boards of directors, and even the marketplace itself have all been unable to keep the interests of the corporation aligned with those of the community, or, to put it another way, to keep the corporation from making everyone else pay the costs of its profits.

But we have found that there is still magic in America, not only in the justly fabled products of individual genius - the Polaroid of Edwin Land, Steve Jobs' Apple, and Ross Perot's many ventures - but also in those companies that have remained faithful to the discipline of trust and the spirit of openness. We want this book to be read in the context of our unshakable optimism and our conviction that what is wrong with American business can and will be fixed.

The exciting story of America's post-World War II economy is how many new companies have been started, how many have prospered and grown. The new, the open, and the energetic are as welcome as in the most expansive days of the republic.


What Works: The Tyco Example


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As a director since 1985, I have had a front-row seat to watch one good example of corporate success, Tyco Laboratories. In the creative atmosphere of greater Boston in the 1950s, it was said that two men, a wheelbarrow, and an abandoned textile mill were all that was needed for a successful new venture. Throw in a few Ph.D.s, at a million dollars a pop, and you could have a successful public offering of the nascent company's stock. Arthur Tyler's idea was to provide organization and financing for inventors, and thus Tyco was born. With worldwide sales of $3.5 billion, it is one of the Fortune 200. The company has been far afield, from joint ventures with Mobil to a variety of attempted hostile takeovers before the concept was popular. The company has grown rapidly in recent years, under the leadership of John Franklin Fort, into an integrated worldwide leader in automatic sprinkler equipment. Fort, a Princeton engineering graduate with an industrial management degree from the Massachusetts Institute of Technology, has risen through the operating ranks of the company. There is no corporate jet, there are no corporate clubs, and there are only 35 employees at the corporate headquarters in Exeter, New Hampshire. A simple incentive system is key to the decentralized management style. Compensation is based on profits of individual business units.

Tyco's acquisition record is impressive. All four of its acquisitions in the last five years fit its current business mix and offer genuine merger benefits without causing dilution of earnings. Acquisitions are not made to increase size; they are made to further industrial integration and to improve profits.

The company demonstrates many of the elements that have given American business its deservedly high reputation in the years following World War II. These include strong leadership from a chief executive officer who focuses on technology, operations, and profits. Compensation is direct and to the point; there are no footnotes on the corporate balance sheet for yachts, farms, consultancies, and the like, just direct grants of stock on top of a modest cash base. The company has an industrial purpose. Corporate resources are not diverted to unrelated technologies.

There will certainly be times when the Tyco story is not as favorable as it is today. However, a company with a worldwide product niche, no frills, and a 23 percent compound growth rate over the past five years makes a compelling example.

There is nothing "magic" in Tyco's technology. There is no reason any well-run manufacturing company could not approach Tyco's performance record. Shareholders should reasonably expect their directors to choose managers who can either emulate the "lean" management style or explain the correlation between higher expenses and profit realization.

Discipline in business should emanate from adding value, from quality, and from productivity, but discipline is diluted by management style that is circumscribed by numbers. The problem is that, at some point in growth or in the conglomeration of unrelated businesses, the discipline of having an industrial purpose is lost, and management becomes a matter of numbers. Even the most reputable accounting systems can be manipulated. The very mass of numbers tends to cloud the capacity to require specific accountability.

Tyco shows us one answer to those who denigrate America's companies and management. It can be done; it is being done. Like Smith Barney's celebrated advertisement about making money "the old-fashioned way," the Tyco secret is focus - focus on producing quality goods to meet customers' needs at a competitive cost. Tyco has its biggest challenges ahead. It is not a mature company. It has not had to struggle to maintain the keenness of youth. Like other companies, it will need to continue to evaluate whether yesterday's choices will work for tomorrow. For now, though, it is thriving in an environment that other companies find prohibitively restrictive.


Legitimacy and Accountability: The Tie That May Not Bind Enough


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Many of these restrictions faced by companies like Tyco can be traced back to concerns about power being exercised by private entities. The early days of corporate development reflect a deep suspicion of private power. This power was made legitimate in the same way as the exercise of public, or government, power - through a system of accountability to those affected.

At least, that was the theory. However, it became clear that corporations did not have the human capacity of responsibility. Limiting the liability of investors in corporate enterprises to the amount of their investment had a potentially pernicious effect in decreasing the personal responsibility on which the integrity of democratic institutions depends. But, as we show in Part II, this did not fit well with the corporation's tendency to act in its own interest without reference to individual concerns.5


Citizenship in Corporate America

He discovers, in fine, that citizenship in his country has been largely meta-morphosed into membership in corporations and patriotism into fidelity to them.

John P. Davis


Source: Corporations, Capricorn Books, New York, Vol. 2, 1981, p. 280 (originally published in 1905).

There were thus two continuing challenges to maintaining some connection between management and ownership (as representing the public interest). The first was limited liability, and the second was the fragmentation of ownership into shares so small that the whole concept of ownership was diluted to the point of disappearance. Shareholders were no longer owners so much as investors or even speculators. No institution for collective action by owners developed. The absence of a human element in corporations made necessary the design of other mechanisms to limit corporate power. But, as we describe in Part II, none of them has been successful.

The combination of state and federal governmental power is not sufficient to ensure that corporations act in the public interest. In Chapter 4, we discuss the trend characterized as the "race to the bottom," which has eliminated substantive requirements in the state laws authorizing corporate formation and operation. It has now found its international counterpart in the domiciles of convenience for modern corporations seeking tax and regulatory leniency. The sociological trend will lead to a time when where one works is a more important affiliation than the country where one holds citizenship.


Rights of the Corporate Citizen

A State grants to a business corporation the blessings of potentially perpetual life and limited liability to enhance its efficiency as an economic entity. It might reasonably be concluded that those properties, so beneficial in the economic sphere, pose special dangers in the political sphere. Furthermore, it might be argued that liberties of political expression are not at all necessary to effectuate the purposes for which States permit commercial corporations to exist. So long as the judicial branches of the State and Federal Governments remain open to protect the corporation's interest in its property, it has no need, though it may have the desire, to petition the political branches for similar protection. Indeed, the States might reasonably fear that the corporation would use its economic power to obtain further benefits beyond those already bestowed.

William Rehnquist


Source: Dissenting opinion, First National Bank of Boston v. Bellotti, 435 U.S. 765, 825, 826 (Sup. Ct. 1978).

The Corporate Citizen


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As corporations have become increasingly large, the confusion in American society about an appropriate role for them is still evident, at least in some contexts. The Supreme Court of the United States has made a number of rulings reflecting concerns about the role of corporations in politics. In March 1990, a bitterly divided court upheld a Michigan statute that prohibited the use of general corporate funds (contrasted with PAC funds) for independent expenditures in connection with state elections.6 The issue was whether corporate managers can use shareholder assets to promote a political agenda. The language of the majority opinion was surprisingly shrill. Justice Marshall referred to the "corrosive and distorting effects of immense aggregations of wealth that are accumulated with the help of the corporate form and that have little or no correlation to the public's support for the corporation's political ideas.... We emphasize that the mere fact that corporations may accumulate large amounts of wealth is not the justification for [the challenged statue]; rather, the unique state-conferred corporate structure that facilitates the amassing of large treasuries warrants the limit on independent expenditures."7 The Court spoke of "the special benefits conferred by the corporate structure," referring to "limited liability, perpetual life, and favorable treatment of the accumulation and distribution of assets,"8 and concluded: "These state-created advantages not only allow corporations to play a dominant role in the nation's economy, but also permit them to use 'resources amassed in the economic market place' to obtain 'an unfair advantage in the political marketplace.'"9 As Justice Brennan pointed out, the problem is that corporate managers can use corporate assets to promote views not necessarily shared by the corporation's owners. Indeed, the American tradition of denying express power to government encouraged the belief that power granted to corporations would further the interests of the individual against the state.


Pro: Corporations Bring Ideas to the Marketplace

The advocacy of [AT&T or General Motors] will be effective only to the extent that it brings to the people's attention ideas which despite the invariably self-interested and probably uncongenial source - strike them as true.

Justice Antonin Scalia


Source: Dissenting opinion, Austin v. Michigan State Chamber of Commerce (#881569), March 27, 1990, p. 5.

Con: The People Who Pay for It Might Not Approve

While the State may have no constitutional duty to protect the objecting chamber member and corporate shareholder: in the absence of state action, the State surely has a compelling interest in preventing a corporation it has chartered from exploiting those who do not wish to contribute to the chamber's political message. "A's right to receive information does not require the state to permit B to steal from C the funds that alone will enable B to make the communication."

Justice William Brennan


Source: Concurring decision, Austin v. Michigan State Chamber of Commerce (#881569), March 27, 1990, p. 7.
Free speech as contemplated in the Bill of Rights bears little relationship to the use of a corporation's resources to amplify its "speech" without any guarantee that it accurately reflects the views of the corporation's shareholders or even its employees.


The Tower of Babel


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Through the centuries, corporate power has been the focus of a great deal of scholarship and debate; but each of the professions has described the phenomenon in its own language. Lawyers, economists, financial analysts, political scientists, ethicists, and managerialists are like the builders of the Tower of Babel, all working toward the same goal but unable to communicate because they speak different languages.

The problem that all of them try to address is that managers will never be as scrupulous in creating value for investors as they will in creating value for themselves, yet that is precisely what the corporate structure requires - investment of the capital from one group, the labor of another, and the management skills of a third, all geared to maximizing profit, with the primary obligation to the investors. All of the disciplines recognize that there must be some accountability from those who exercise power to those who are affected by it. All try to provide for and characterize the optimal accountability. But, as we will show in Part II, the corporate structure was so successfully designed for self-preservation that it has been able to counter every attempt at imposing accountability. And the Babel of languages has only obscured the picture.

The language of economics calls this accountability problem one of "agency costs." Economics has stressed that managements, acting as agents, will be imperfectly linked to their owner principals. It has suggested a set of institutional cures for this problem that ranges from better structuring of managerial contracts to adjusting the workings of the market for corporate control.

The law calls the same problem "conflicts of interest," because each party wants its own interests to come first. And the law has developed its highest standard, the fiduciary standard, to govern the relationship of managers to owners. But the language of law is the language of contracts, and the law has also traditionally viewed corporate governance within the framework of the duty of management to a number of constituencies with contractual claims on the corporate entity. Legal precedents have established the right of shareholders to hold management accountable through a system of voting and, when all else fails, through litigation. Litigation has its own language, very process-oriented, with a lot of emphasis on "standing" to sue, and the timing of the suit [it can be thrown out if it is too early (not "ripe") or too late ("moot")].

Management studies show that companies, confronted with conflicting pressures and opposing interests, actually make decisions in the interest of the companies' continuing existence, without reference to the concerns of the traditional constituencies. Political science and economics have provided evidence on how the system of public power - the political system - tries, with limited success, to hold management accountable to changing social and political mandates over time.

Ethicists have described how corporate structure and corporate culture further, or fail to further, "moral" conduct and decision making among managements.

Those standing in different spots in the corporate structure also have fragmented understanding, something like the blind men and the elephant, each one interpreting the part he is holding on to as the whole. Those who represent corporate management conclude that "shareholders will do better if management tends to all these responsibilities."10 In other words, "trust me." Shareholders claim they are management's allies, at least good management's allies. In other words, "trust me." The financial community wants to decide which management deserves support. In other words, "trust me."

In the current environment, these contributions, important as they are, are too specialized and too divisive to serve as a broad conceptual framework for analyzing corporate governance problems. We lack the capacity to understand the problem because we lack the language. The problem is beyond our capacity to describe and understand because it transcends the specialized disciplines that have been developed to analyze, govern, and monitor corporations.

What is needed, instead, is a reexamination and synthesis of the language, concepts, and evidence of corporate governance research as contained in economics, finance, political science, law, and other disciplines. This kind of reexamination can create a new framework for understanding the concept of the corporation and the power it exercises, and for developing new theories about how to ensure that it is exercised responsibly. The violence of the market for corporate control over the past decade, and its resulting turbulence, lend urgency to this effort. The 1980s may not have been the decade when traditional governance notions were first eclipsed by developments in finance, policy, and law, but it was the decade that made it indisputably clear that what was left was just not working.

To begin to understand the problem and develop a solution, we must step back and look at specific aspects of corporate governance within a historical and economic framework. At the core, there is a common theme: the need to understand the exercise of private power by modern corporations in the United States - how it is created, how it is used, and how it is manifested. The relationship between power in the private and public sectors continues to be the central question of our political system. Some on the right are inherently suspicious of government and want as much as possible to be established privately. Libertarian extremists even urge that the government get out of the "business" of schools, highways, and everything else but defense. Some on the left are inherently suspicious of private power in general and corporations in particular. They want policy to be made by the government. Those decisions that are left to the private sector must be heavily influenced by government, through regulation.


Strange Bedfellows


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However, debates over the appropriate limits on private power do not always reflect party lines. Despite his Republican credentials, Richard Nixon reflected the political spirit of the time by presiding over the creation of some of the most intrusive regulatory agencies ever to sit across the table from American business, including the Occupational Safety and Health Administration, the Consumer Product Safety Commission, and the Environmental Protection Agency. He also instituted wage and price controls. Jimmy Carter, running as a Washington outsider, decried government regulation and promised to reform it. But it was Ronald Reagan who really began to dismantle government regulation on a large scale, creating the Presidential Task Force on Regulatory Relief and issuing reports that tracked the declining number of pages in the federal register. Reagan's first secretary of the interior, James Watt, presided over a massive plan to privatize many of the department's programs. Eight years later, the controversial rollbacks in regulation of the environment and the financial industry have led the chairman of that task force, George Bush, to begin to reregulate.

Despite its prominence in political debate, corporate power and its systems of checks and balances are not well understood. Corporate power at its current level was not foreseen by early lawmakers and constitutional scholars, and its foundation in law is uneasy and inconsistent. But it is clear that the question of the legitimacy of corporate power in the United States has been transformed. Originally, the government had to review and specifically approve each corporate charter as being essential for a specific purpose that was in the public interest. Now one does not ask so much as notify the state that a corporation has been created. Anyone can incorporate for any activity that is not illegal. And the corporation, granted at least some of the constitutionally protected right of free speech originally contemplated for individual citizens, has now been accorded the right to question and challenge whether government is acting in the public interest.

In fact, government is now as much a creation of business as the other way around. Businesses grew so fast that there was no opportunity for other national institutions to develop adequate power to filter the impact of commerce on civil life. So Big Business begot Big Government. Because the goals of business are not always identical to the goals of society (which is partially a failure of the corporate governance system, as we will show), some institution was needed to harmonize the undoubted benefits of active commerce with the various needs of other constituencies. In the United States, this organization was the federal government, the only other major national institution.

There have been three principal eras of federal government regulation of business: (l) turn-of-the-century antitrust legislation; (2) "New Deal" bills of the 1930s addressing particular elements in the economy that had failed (the securities and banking industries, for example); and (3) health and safety "externality legislation" of the 1960s, which established new federal standards and enforcement mechanisms for business impact ranging from the environment to workplace safety to discrimination in employment.

The number of federal employees engaged in business regulation, the number, length, and complexity of proposed rules, and the expense of lawyers, arbitrations, and court proceedings have created the impression of a constantly increasing federal "control" over business. But, as we discuss in Part II, in virtually every case business has neutralized or even co-opted these efforts. The expense of confrontation between business and government may be one of the critical reasons for American noncompetitiveness in the world economy, but the actual impact of all the laws, all the regulations, and all the bureaucrats on large corporations is surprisingly small.

Although there is a plethora of organizations representing every element of private life, there is no single credible spokesman for the capitalist system, the industrial sector, or the interests of business as a whole. The Business Roundtable represents management. The unions represent labor. Trade associations represent their members. And, in general, the stakeholders in American corporations - investors, customers, workers, and the community - have traditionally used government as the medium through which they relate to each other. In the United States, we do not have institutions to force business to resolve conflicting claims; competing interests have been reconciled through the law. By contrast, other countries have private structures to resolve such issues, as we discuss in Chapter 7.


Accountability, Trust, and the 900-Pound Gorilla


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In a way, economic legitimacy (competitiveness) and political legitimacy (accountability) are two sides of the same thing. The foundation of our concept of corporations is our belief that because shareholders can be counted on to require that their own long-term interests be accommodated, corporations will be directed along the lines most beneficial to society. This accountability allows us to give corporations enormous power to make decisions that affect every aspect of our lives.

For that reason, it is worthwhile to examine the nature and extent of the accountability. For instance, if owners are entitled to the residual benefits from corporate activity, why are they not accountable for its liabilities? Limiting owners' liability to the extent of their investments, combined with the development of liquid markets, has changed the essential character of shareholders. Having only a day-to-day interest in the value of a piece of paper, they have lost any long-term interest in the value of the company and now bear little resemblance to the owner so venerated by tradition and law.

But, as we describe in detail in Part III, we are now witnessing the reagglomeration of ownership of the largest corporations, so that longterm shareholders are well on the way to majority ownership of America's companies. They are, of course, the institutional shareholders, who invest collections of individuals' assets through pension funds, trusts, insurance companies, and other entities.

We recognize that there is an irreducible difference of objectives between owners and managers. This has resulted in notorious failures in the system during the recent decade of hostile takeovers. Both owners and managers have, on occasion, acted in outrageous disregard of each other's rights. Coercive bust-up takeovers on the one hand and outrageous compensation and entrenchment tactics on the other have all demonstrated the absence of an effective and constructive relationship between owner and manager.

Individual shareholders can make their own trade-offs in deciding whether to exercise their rights as owners of a corporation. But as fiduciaries, institutional investors have no such out. Institutional shareholders are the famous 900-pound gorilla, entitled to respect on account of size and might. More important, as fiduciaries, they are legally obligated to use that muscle and act as owners. For institutions, ownership is not so much a right as a responsibility. That is a key distinction. So long as voting and other ownership characteristics were seen as rights, failing to exercise them was considered at worst inconvenient, but not as harming or diminishing the value of the property. When ownership is recognized as a responsibility, the legal liability for failing to exercise it is undeniable.

The evolution of the market has produced, in institutional investors, a small group of easily identifiable owners who have the capacity to understand and act. They also have two indisputable motives for paying close attention to ownership: avoiding liability for breach of fiduciary duty and enhancing portfolio values by promoting management accountability. There seems every reason to reestablish the accountability of management to ownership that has been the historical underpinning of capitalism. The violence of hostile takeovers in the 1980s challenged all the myths and realities, all the historical and legal theories of corporate existence. The question "to whom are the mangers of the great corporations accountable?" has not yet been satisfactorily answered. If trust is to be reestablished, initiative and sustaining energy will have to come from the institutional investors. That is what the next five chapters will show. The last chapter will show how it is done.



Endnotes


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1 Allanna Sullivan, "Exxon's Holders Assail Chairman Rawl over Firm's Handling of Alaska Oil Spill," Wall Street Journal, May 19, 1989, p. A3.
2 Announced at Exxon meeting for shareholders (New York, January 10, 1991).
3 Robin Toner, "Quiet Acts, Silent Halls, as a City Gives Thanks," New York Times, November 28, 1985, p. B6.
4 Maryann Keller, Rude Awakening: The Rise, Fall, and Struggle for Recovery of General Motors, William Morrow, New York, 1989, p. 20.
5 John P. Davis, Corporations, vol. 1, Capricorn Books, New York, 1961, p. 20, (originally published in 1905).
6 Austin v. Michigan State Chamber of Commerce (#88-1569), March 27, 1990.
7 Ibid., Marshall opinion, pp. 6-7.
8 Ibid., p. 5.
9 Ibid.
10 For the arguments of representatives from each field (Martin Lipton, Jesse Unruh, John Phelan), see Nathaniel Nash, "Shareholders' Rights: Three Views: Vying for Control of the Public Corporation," New York Times, February 15, 1987, p. D5.