Watching the Watchers: Corporate Governance for the 21st Century

Rating:
Summary: A dissenting vote
Review: In "Watching the Watchers," Monks and Minow update - some might say recycle - the arguments advanced in their earlier book "Power and Accountability." As with that earlier book, "Watching the Watchers" makes a case for increased shareholder activism, especially by institutional investors. Unfortunately, the root claim - that shareholder activism is a good thing - is both positively and normatively flawed. There is some anecdotal evidence that institutions are becoming more active, using the proxy system to defend their interests and influencing policy through negotiations with management. Yet, there is little concrete evidence that shareholder activism matters. Even the most active institutions devote little effort to monitoring management. They rarely conduct proxy solicitations or put forward shareholder proposals. They do not to try to elect representatives to boards of directors.

U.S. public corporations are characterized by a separation of ownership and control: the firm's nominal owners, the shareholders, exercise virtually no control over either day to day operations or long-term policy. Instead, control is vested in the hands of professional managers, who typically own only a small portion of the firm's shares. This separation has costs, the most significant of which are referred to as agency costs, incurred to prevent shirking by managers. The agency cost model forces one to confront the question: who will monitor the monitors? In any team organization, one must have some ultimate monitor who has sufficient incentives to ensure firm productivity without himself having to be monitored. Institutional investors, in Monks' theory, function as such ultimate monitors. Because they own large blocks, and have an incentive to develop specialized expertise in making and monitoring investments, they could hold management accountable for actions that do not promote shareholder welfare, which should lead to a reduction in agency costs.

The benefits of institutional control, however, may come at too high a cost. There is good evidence that bank control of the securities markets has harmed that Japanese and German economies by impeding the development of new businesses. More importantly, there is a risk that institutional investors will abuse their control by self-dealing and other forms of over-reaching. If management becomes more beholden to the interests of large shareholders, it may become less concerned with the welfare of smaller investors. The U.S. experience with social investing by public pension funds, moreover, suggests that politicization of stockownership will be an economic drag. In general, the greater the extent to which a public pension fund is subject to direct political control, the worse its investment returns.

In my view, moreover, the separation of ownership and control is a highly efficient solution to the decisionmaking problems faced by large corporations. Separating ownership and control by vesting decisionmaking authority in a centralized entity distinct from the shareholders is what makes the large public corporation feasible. To be sure, this separation results in the agency cost problem described above. A narrow focus on agency costs, however, easily can distort one's understanding. Corporate managers operate within a pervasive web of accountability mechanisms that substitute for monitoring by residual claimants. Agency costs, in any event, are the inevitable consequence of vesting discretion in someone other than the residual claimant. We could substantially reduce, if not eliminate, agency costs by eliminating discretion; that we do not do so suggests that discretion has substantial virtues.

The root economic argument against shareholder activism thus becomes apparent. Large-scale institutional involvement in corporate decisionmaking seems likely to disrupt the very mechanism that makes the modern public corporation practicable; namely, the centralization of essentially nonreviewable decisionmaking authority in the board of directors. Given the significant virtues of discretion, one ought not lightly interfere with management or the board's decisionmaking authority in the name of accountability. Preservation of managerial discretion should always be the null hypothesis. The separation of ownership and control mandated by U.S. corporate law has precisely that effect. Monks and Minow make their living promoting institutional investor activism that undercuts the null hypothesis. But it is still bad public policy.

Rating:
Summary: A dissenting vote
Review: In "Watching the Watchers," Monks and Minow update - some might say recycle - the arguments advanced in their earlier book "Power and Accountability." As with that earlier book, "Watching the Watchers" makes a case for increased shareholder activism, especially by institutional investors. Unfortunately, the root claim - that shareholder activism is a good thing - is both positively and normatively flawed. There is some anecdotal evidence that institutions are becoming more active, using the proxy system to defend their interests and influencing policy through negotiations with management. Yet, there is little concrete evidence that shareholder activism matters. Even the most active institutions devote little effort to monitoring management. They rarely conduct proxy solicitations or put forward shareholder proposals. They do not to try to elect representatives to boards of directors.

U.S. public corporations are characterized by a separation of ownership and control: the firm's nominal owners, the shareholders, exercise virtually no control over either day to day operations or long-term policy. Instead, control is vested in the hands of professional managers, who typically own only a small portion of the firm's shares. This separation has costs, the most significant of which are referred to as agency costs, incurred to prevent shirking by managers. The agency cost model forces one to confront the question: who will monitor the monitors? In any team organization, one must have some ultimate monitor who has sufficient incentives to ensure firm productivity without himself having to be monitored. Institutional investors, in Monks' theory, function as such ultimate monitors. Because they own large blocks, and have an incentive to develop specialized expertise in making and monitoring investments, they could hold management accountable for actions that do not promote shareholder welfare, which should lead to a reduction in agency costs.

The benefits of institutional control, however, may come at too high a cost. There is good evidence that bank control of the securities markets has harmed that Japanese and German economies by impeding the development of new businesses. More importantly, there is a risk that institutional investors will abuse their control by self-dealing and other forms of over-reaching. If management becomes more beholden to the interests of large shareholders, it may become less concerned with the welfare of smaller investors. The U.S. experience with social investing by public pension funds, moreover, suggests that politicization of stockownership will be an economic drag. In general, the greater the extent to which a public pension fund is subject to direct political control, the worse its investment returns.

In my view, moreover, the separation of ownership and control is a highly efficient solution to the decisionmaking problems faced by large corporations. Separating ownership and control by vesting decisionmaking authority in a centralized entity distinct from the shareholders is what makes the large public corporation feasible. To be sure, this separation results in the agency cost problem described above. A narrow focus on agency costs, however, easily can distort one's understanding. Corporate managers operate within a pervasive web of accountability mechanisms that substitute for monitoring by residual claimants. Agency costs, in any event, are the inevitable consequence of vesting discretion in someone other than the residual claimant. We could substantially reduce, if not eliminate, agency costs by eliminating discretion; that we do not do so suggests that discretion has substantial virtues.

The root economic argument against shareholder activism thus becomes apparent. Large-scale institutional involvement in corporate decisionmaking seems likely to disrupt the very mechanism that makes the modern public corporation practicable; namely, the centralization of essentially nonreviewable decisionmaking authority in the board of directors. Given the significant virtues of discretion, one ought not lightly interfere with management or the board's decisionmaking authority in the name of accountability. Preservation of managerial discretion should always be the null hypothesis. The separation of ownership and control mandated by U.S. corporate law has precisely that effect. Monks and Minow make their living promoting institutional investor activism that undercuts the null hypothesis. But it is still bad public policy.

Rating:
Summary: The pioneers in the field continue to throw off sparks
Review: Monks and Minow practically invented the intellectual framework for the field of corporate governance in such early, visionary works as Power and Accountability. In this book, the authors draw upon a wealth of history and current events to update their prior work and advance the state of the art in what has now become a popular and highly respectable cause. As with their prior work, this book is an incubation chamber for fresh insights and original ideas. If you want to know where the rest of the world will be on these issues tomorrow, this is the book to read today.

Rating:
Summary: Masterful update by top experts in corporate governance!

Review: Monks and Minow update and expand on their previous books Power and Accountabilityand Corporate Governance. As practitioners and theorists they providedozens of examples from personal experience which enable the reader to quickly grasp the importance of corporate governance to wealth creation and social progress. In a few short hours of reading they cover the evolution of the corporation as a social construct, as well as the developing roles of shareholders, directors, and management. The book concludes with concrete recommendations which deserve thoughtful consideration.

Monks and Minow trace the evolution of corporate governance and note that "there was no conscious choice in favor of treating shares of stock as though they were betting slips for races that were over at the end of each day." "Every 'improvement' in the system for owning stock was designed to make it easier to trade. No one seemed to notice or care that each of these 'improvements' also made it harder to exercise classic ownership rights." "During the takeover era, it became clear that, though the system was designed to promote transferability above all, there was one kind of transfer that the system would not tolerate: the transfer of power from one group to another."

Monks and Minow are concerned with increasing corporate accountability. They argue that any attempt to do so through chartering restraints is doomed to failure because the company's managers can move virtually any place in the world. In addition, "the political process is too dependent on money to make it possible for the government to be the ultimate guardian of accountability." "The only answer is a system of governance that originates from within the corporation itself and that includes the participation of an informed and effectively manifested broad class of owners." They point out that the tax cost of pensions is in excess of $50 billion per year, the largest item in the budget after defense. Because pension funds are subsidized by public funds it is, therefore, "appropriate for government to define broadly how pension fund trustees should function in their capacity as owners of the country's industrial establishment."

They call for a "Federal Law of Ownership" to coordinate the action of relevant agencies. For example, "the government must set the standard for interpreting and enforcing the 'exclusive benefit' rule or ERISA to provide guidance for private sector fiduciaries." However, the prime responsibility falls not to government but to the pension funds and corporations.

In the end, "whether ERISA trustees will ultimately become effective monitors depends on two factors - DOL's willingness and capacity to enforce its regulation and, more importantly, the conclusion by corporate management that an ownership-based governance system is ultimately in their best interest." Government needs to draw a "bright line" on conflict of interest; management needs to acknowledge that "creative tension" between themselves and owners is preferable to the current system of unaccountable "phony governance." Pension funds would then create a market for new institutions offering "ownership services" and companies with effective governance performance would realize the benefit of lower capital costs.

reviewed by James McRitchie, editor of the Corporate Governance site at
http:/www.wp.com/CORPGOV