Stockholder Interests Managerial Interests and Management Buyouts

In a management buyout, the managers of the firm buy out the existing stockholders and make the company a private firm. Is this a way of reducing the conflict of interests between stockholders and managers?

More Effective Boards of Directors

In the last few years, there have been encouraging trends both in the composition and the behavior of boards, making them more effective advocates for stockholders. Korn Ferry's survey of boards of directors at 900 large US corporations in 1998 revealed the following:

Warrants: A warrant is a security issued by a company that provides the holder with the right to buy a share of stock in the company at a fixed price during the life of the warrant.

• Boards have become smaller over time. The median size of a board of directors has decreased from 16 to 20 in the 1970s to between 9 and 11 in 1998. The smaller boards are less unwieldy and more effective than the larger boards.

• There are fewer insiders on the board. In contrast to the 6 or more insiders that many boards had in the 1970s, only two directors in most boards in 1998 were insiders.

• Directors are increasingly compensated with stock and options in the company, instead of cash. In 1973, only 4% of directors received compensation in the form of stock or options, whereas 78% did so in 1998. This stock compensation makes it more likely that directors will think like stockholders.

• More directors are identified and selected by a nominating committee rather than being chosen by the CEO of the firm. In 1998, 75% of boards had nominating committees; the comparable statistic in 1973 was 2%.

Is there a payoff to a more active board? MacAvoy and Millstein (1998) present evidence that companies with more activist boards, where activism was measured based both up assessments by CALPERS and indicators of board behavior, earned much higher returns on their capital than firms that had less active boards.

Increasing stockholder power

There are many ways in which stockholder power over management can be increased. The first is to provide stockholders with better and more updated information, so that they can make better judgments on how well the management is doing. The second is to have a large stockholder become part of incumbent management, and have a direct role in decisions that the firm makes. The third is to have more 'activist' institutional stockholders, who play a larger role in issues such as the composition of the board of directors, the question of whether to pass anti-takeover amendments and overall management policy. In recent years, some institutional investors have used their considerable power to pressure managers into becoming more responsive to their needs. Among the most aggressive of these investors has been the California Public Employees Retirement System (CALPERS), one of the largest institutional investors in the country. Unfortunately, the largest institutional investors - mutual funds and pension fund companies - have remained largely apathetic. The fourth change, pushed by these activist stockholders, is to make boards of directors more responsive to stockholders, by reducing the number of insiders on these boards and making them more independent of CEOs.

It is also critical that institutional constraints on stockholders exercising their power be reduced. All common shares should have the same voting rights and state restrictions on takeovers have to be eliminated and shareholder voting should be simplified. The legal system should come down hard on managers (and boards of directors) who fail to do their fiduciary duty. Ultimately, though, stockholders have to awake to the reality that the responsibility for monitoring management falls to them. Like voters in a democracy, shareholders get the managers they deserve.

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