M & A Law Prof Blog

Editor: Brian JM Quinn
Boston College Law School

Wednesday, June 9, 2010

Exit, Voice, and Corporate Governance

In the wake of the collapse Prudential - AIA transaction FT columnist John Kay reminds us to beware the cult of the heroic CEO and the mega-merger:

Many Prudential shareholders are relieved at the collapse of the company’s attempt to buy the Asian operations of American insurer AIG. The business history of the past two decades is studded with failed mega-mergers. Time Warner gave away half the world’s most successful media business for a web portal that proved to be worth almost nothing. Royal Bank of Scotland bid for ABN Amro at the peak of the credit boom and had to be rescued by the state.

Alongside these catastrophes are many smaller disasters. The story of Jean-Marie Messier, the French water company boss who used his shareholders’ and customers’ money to become a US media tycoon, borders on farce. The destruction of great companies of seemingly unchallengeable stability, such as GEC and Swissair, through inept acquisition strategies can only be rendered as tragedy.

Most of these deals are the product of a style of thought popular in business schools and consultancies. The Great Leader concerns himself with corporate strategy, and remains aloof from ordinary operational matters. He manages a collection of activities as a fund manager manages a collection of stocks. The scope of his vision is the key to success; price is secondary. “This is a strategic acquisition” is a euphemism for “we are paying more than this business is worth”.

Now comes word that Prudential’s Chairman will be meeting with major shareholders over the next week to discuss the future of Prudential’s management team.  According to Reuters investors are, it seems, upset.

This investor also said management should forgo bonuses in the light of the money spent on the failed bid.  "They spent a lot of shareholders' money on a deal that didn't happen. I think they should be hit as well."

Earlier today, Sky News reported that some of Prudential's largest investors, including Legal & General Investment Management and Fidelity, are demanding a shake-up of the company's leadership.

Richard Buxton, head of UK equities at Schroders, said: "Someone has to be accountable for 450 million pounds ($650 million) of losses as a result of the bungled deal.

"Otherwise it's carte blanche to every investment banker in town to encourage CEOs to do deals -- there's no downside. (It will be case of) 'Don't worry, if (the deal) doesn't happen, you'll still be safe in your job'."

So much of corporate governance has to do with norms and not legal rules.  From a legal point of view, Thiam is safely ensconced in his position.  His and the board’s decision to pursue AIA are protected by the British version of the business judgment presumption.  But the business judgment presumption doesn't mean that boards can act in an unrestrained manner.  True, the law and a court won't penalize a board for pursuing an ill-conceived, though rational, transaction.  Here, it's the marketplace that will make its voice heard - and voice is what managers who pursue these kinds of transactions should expect. 

Given the large share holdings of institutional investors who may not have the option of selling (exit) their positions in a company like Prudential because of Prudential's position in an index or the nature of a particular fund, voicing their objections is the only avenue left for investors.  Voice, as Hirschman reminds us, is a "non-market force" characterized by politics rather than economics.

In a first approximation, the role of voice would increase as the opportunities for exit decline, up to the point where, with exit wholly unavailable, voice must carry the entire burden of alerting management to its failings. 

It's in this context that we can think about a new kind of shareholder activism.   I'm thinking about an institutional activism of the kind that's hard to really get kick started.  In a world where index funds compete on costs, there's not a whole lot of incentive any investment manager to expend the resources required to influence management - or have their voice heard.  But yet, if investors are increasingly locked into index funds, finding a way to generate voice for shareholders will be critical to the long-term success of what some call fiduciary capitalism.  If not, then we may be required to accept heroic CEOs and their occasional expensive decisions.

I'm going to be thinking more about this and would be interested in hearing from people with ideas.  I suspect the Carl Icahn's of the world - activists with high-powered incentives - will play an increasingly important role - if they don't already - going forward. 




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While in agreement with most of what's said in your post, I have a couple quick comments:

I disagree with the idea that voice is purely political. After all, in the case of the Pru-AIA deal, shareholder reaction reflects a real business snafu that underlines the misguided views of Thiam. It's clear that he didn't understand that AIG thought $35.5bn was fair (or at least that Pru's shareholders' AIA valuation was inadequate) and that shareholders couldn't stomach such a large share issue. That's a real liability to Pru and its shareholders. The debate from here on may be political, but the argument for kicking around management has its merits in economics.

This deal illustrates that the principal-agent problem highlighted in financial services companies recently is endemic to any corporation. In this case, management simply had a bigger appetite for risk and shareholders did not. Management also had a more long-term vision for the deal's payoff, assuming that shareholders thought the deal to be nothing more than overpriced. In large deals, shareholder and management views must align. And though in this case management probably got it all wrong, it doesn't mean that shareholders will get the next one right.

Posted by: Jason DaCruz | Jun 9, 2010 9:51:37 AM

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