A case for Director Primacy: Meand and Ends in Corporate Governance, by Bainbridge. Against shareholder empowerment theories

The theory of the firm has been developed so that different models can be classified in a two axe table:

 –         Means axis: managerial models are placed at one side, (firm as a hierarchical organization, where directors are figureheads, and shareholders are out of the picture); at the other side, models where shareholders keep a privileged position, (as owners, or special production factors, to whom directors and managers owe fiduciary duties).

–         Ends axis: in one side models defending shareholder`s wealth as the firm goal, and in the other, those defending stakeholder theories.

 Shareholder primacy models somehow accept shareholders control the means and are the correct beneficiaries of director fiduciary duties. Managerial models differ as to what extent they (must) serve shareholders` interests, or all constituencies`s ones.

But Bainbridge suggests a new model, the director primacy (DP) model, (1). As to the means axis, he states that none side is correct; the board controls the firm`s resources. And this model support fiduciary duties are owed to shareholders. The model is based on the concept of the firm as a nexus of contracts.

 

Disclosure and Corporate Governance.

It is often understood that Corporate Governance is highly connected to “transparency and disclosure”. But there is a need to clarify the actual relationship between the two, not only in one direction, but in both.

Adrian Fong from the Faculty of Law, Chinese University of Hong Kong, in his working paper “ Practicing Corporate Governance Through Corporate Disclosure?”, does a good contribution to this effort. (1)

As he points out, “Corporate disclosure is the timely and accurate release of all material matters regarding the [company], including the financial situation, performance, ownership, and governance of the company”. “The purpose of corporate disclosure is to release ….. information to shareholders, employees, possible investors, and the broader community about the company”.

What do Buffet and Munger say (and do) about corporate governance?

Every year before Spring arrives, we use to find some interesting readings about Berkshire Hathaway`s shareholders meeting, the company investment decisions or views, and some other topics. In this post I will choose one of the more relevant themes Mr. Buffet and Mr. Munger refer to when they describe their management style and investment decisions: Corporate Governance Buffett and Munger`s preferences.

In June Rhee`s post in Harvard`s blog, (1), Mr Buffet`s choice when addressing corporate governance is described; it should be noted though that we are talking about firms where there is a controlling shareholder, (BH), so that the main conflicts are the choice of a Ceo, compensation, minority shareholders and others.

The first Buffet`s concern is communication between managers and shareholders; messages must be sent in simple language and relate to facts, with no predictions. Secondly, he is not interested in complex organizational structures, but in recruiting honest, capable, and hard working managers, and particularly in the case of Ceos, (their performance is difficult to isolate and there is no one senior to them). Third, directors need to be chosen for their savvy and owner orientation, as their main function is to select the best Ceo and to oust him in case expectations are not met. According to Buffet, other assets, such as independence or diversity, are not valuable by themselves.

The Team Production Theory of Corporate Law

I had recently access (thanks to a post at Corpgov.net) to a video by Margaret Blair in which she fantastically described her Corporate Law Theory, the “Team Production Theory”, which she defends with Lynn Stout and others. (1) (2).

This led me to recover an article by Margaret Blair, (3) to which I will dedicate this post.

Mrs Blair first brings forward the fact that the previous main advocates of the Principal-Agent theory of Corporate law have somehow changed their views. Those that strongly defended that the corporate purpose should be maximizing shareholder value and that boards should have primarily an “oversight” role, (such as Jensen , Jack Welch, Lucien Bebchuk and others) at least admit now some loopholes in their previous statements.

She then presents a different theoretical framework, that arises after recognizing the firm as a tool where a “team production problem” is solved, where all participants in a complex productive activity want others to “fully cooperate providing their inputs”, but are unable to draft the complete and detailed contracts that would help them achieve that objective. (4)

The theory challenges the Principal-Agent proposal, as it doesn`t make a choice as to who in the team is the principal; all of them are interested in obtaining the maximum cooperation from the rest of participants, and, according to the theory supporters, it explains better actual boards` behavior and depicts a different picture of how they should act.