Corporate Governance in America 1950-2000: Major Changes but Uncertain Benefits

Abstract

Robert W. Hamilton` I. INTRODUCTION Corporate is a term that in the United States generally refers to the relationships among the professional managers of a publicly held corporation, its board of directors, and its shareholders. There has been a revolution in corporate governance in the United States over the last half century. This Essay describes this revolution and attempts to assess its benefits. 11. CORPORATE GOVERNANCE AS OF 1950 I have chosen the year 1950 as a starting point because it has two characteristics: ( 1 ) it was a time when management enjoyed a very favorable reputation within the United States, based on the performance and contribution made by American industry during World War II; and (2) by 1950, management in most corporations had shifted from the initial founders of major corporations to professional managers who held their offices not because of their stock holdings, but because of their competence.1 Writing in 1932, Adolf Berle and Gardiner Means developed a model of publicly held corporations that largely dominated theoretical analysis of the corporation for several decades, and was reasonably descriptive of boards of directors as late as 1950.2 Berle and Means assumed that typical shareholders in publicly held corporations were individuals who were widely scattered, often not well informed about corporate affairs, and relatively disorganized. Corporations in 1950 generally met this basic criterion: with few exceptions, no one shareholder in any of the two hundred largest American corporations owned more than a tiny fraction of the company's stock. In modem terminology, this structure of share holdings creates a major free riding problem: no individual shareholders were willing to invest the necessary time and effort to monitor management because their interest was small and, if they did so, other shareholders would free ride on their efforts. As a result, according to Berle and Means, shareholders who were unhappy with management exercised the Wall Street Rule and simply sold their shares into the market. In tum, this process of self selection meant that shareholders of a corporation at any one time tended either to have a favorable view of management's performance or at least an acquiescent attitude toward management-a pro-management bias. With this composition of the body of shareholders, management was assured that shareholders would routinely approve management proposals, and that as a practical matter, the power of shareholders to select directors was purely theoretical. The real decision point for the selection of directors was at an earlier time, when management prepared the proxy statement and decided which persons to nominate as candidates for election to the board. The actual shareholders' vote by proxy was simply a ratification of these earlier decisions because shareholders either approved of or acquiesced in management's performance. Berle and Means thus concluded that the decision as to who was to be nominated was made by the CEO himself, or at least under his direct oversight or control. He would personally decide which of his subordinates should be nominated to serve as inside directors and would get potential outside directors and decide who should be invited to join the board of directors.3 In short, the CEO determined both the size and the composition of his own board of directors. Boards of directors during this era often had between ten and twenty members, most of whom were inside directors and all of whom were personally approved by the CEO. In addition, the CEO largely dominated the decisional process within the board of directors. This domination was based on factors in addition to his control over the selection process: (1) The CEO had the power to control the career advancement of the inside directors who comprised a majority of the board. It was therefore unlikely that they would ignore the wishes of the CEO or make decisions inconsistent with his interests. …