This paper considers a principal-agent environment in which a privately informed principal can communicate with the agent and then intervene if the agent ignores her recommendations. The main result shows that communication is more effective with intervention than without it, if and only if the cost that intervention imposes on the agent is large relative to the cost that is incurred by the principal. Thus, intervention can in fact harm communication, echoing the common wisdom that the capacity to make unilateral decisions can discourage effective deliberation and cooperation. The analysis sheds light on the effectiveness of different governance arrangements and provides novel predictions about expected patterns of intervention. Applications of the model to regulation and corporate governance are discussed in detail.
This paper studies the corporate governance and asset pricing implications of investors owning blocks in multiple firms. Common wisdom is that multi-firm ownership weakens governance because the blockholder is spread too thinly. We show that this need not be the case. In a single-firm benchmark, the blockholder governs through exit, selling her stake if the firm underperforms. With multiple firms, the blockholder may sell even a value-maximizing firm, to disguise her exit from another underperforming firm as being motivated by a portfolio-wide liquidity shock. This reduces the manager's effort incentives and weakens governance. On the other hand, governance can be stronger, because selling one firm and not the other is a powerful signal of underperformance. Common ownership leads to firms' stock prices being correlated, even if their fundamentals are uncorrelated. We derive empirical predictions for the direction of correlation and for whether governance is stronger or weaker with multiple firms.
This paper examines how the labor market for directors and directors' reputational concerns affect corporate governance. We develop a model in which directors can influence corporate governance of their firms, and corporate governance, among other things, affects firms' demand for new directors. Whether the labor market rewards directors for having a reputation of being shareholder-friendly or management-friendly is endogenous and depends on the aggregate level of corporate governance. We show that directors' desire to be invited to other boards creates strategic complementarity of corporate governance decisions across firms. Directors' reputational concerns amplify the corporate governance system in the sense that strong systems become stronger and weak systems become weaker. We derive implications for director appointments, multiple directorships, transparency of the corporate governance system, and board size.
This paper studies informal communications and exit as alternative ways through which investors can influence managers when obtaining control is not feasible or too costly. The first result shows that exit relaxes the tension between investors and managers, and thereby enhances the effectiveness of communications as a form of shareholder activism. The second result shows that public communications are more effective than private communications if and only if managers are concerned about the stock price and their decisions are observed by the market. Overall, the analysis relates the effectiveness of communications to market liquidity; entrenchment and compensation structure of managers; and investors' expertise, investment horizon and ownership size.
Shareholder proposals are a common form of shareholder activism. Voting for shareholder proposals, however, is non-binding in the sense that the management has the authority to reject the proposal even if it received majority support from shareholders. We analyze whether non-binding voting is an effective mechanism for conveying shareholder expectations. We show that in contrast to binding voting, non-binding voting generally fails to convey shareholder views when the interests of the manager and shareholders are not aligned. Surprisingly, the presence of an activist investor who can discipline the manager may enhance the advisory role of non-binding voting only if there is substantial conflict of interest between shareholders and the activist.
This paper studies the optimal structure of the board with an emphasis on the expertise of directors. The analysis provides three main results. First, the expertise of a value-maximizing board can harm shareholder value. Second, it is optimal to design a board whose members are biased against the manager, especially when their expertise is high. Third, directors' desire to demonstrate expertise can shift power from the board to the manager on the expense of shareholders. In this sense, the "friendliness" of the board is endogenous. The effect of these reputation concerns is amplified when the communication within the boardroom is transparent.
This paper studies the advisory role of the board in takeovers. Corporate boards can alert target shareholders when a takeover offer is inadequate and assist them to coordinate their collective decision. The analysis relates the characteristics of the bidder and the target firm to the influence the board has on target shareholders and the value of their shares, and shows that they can both increase with the board's bias. Importantly, the board can be influential even if in equilibrium its recommendation is uninformative and ignored by shareholders. The analysis also provides a novel rationale against the use of takeover defenses.