Corporations are republics. The ultimate authority rests with voters (shareholders). These voters elect representatives (directors) who delegate most decisions to bureaucrats (managers). As in any republic, the actual power-sharing relationship depends upon the specific rules of governance. One extreme, which tilts toward a democracy, reserves little power for management and allows shareholders to quickly and easily replace directors. The other extreme, which tilts toward a dictatorship, reserves extensive power for management and places strong restrictions on shareholders’ ability to replace directors. Presumably, shareholders accept restrictions of their rights in hopes of maximizing their wealth, but little is known about the ideal balance of power.As they say, though, "the cat jumped up on the table and the vase fell" doesn't mean the cat broke the vase—though that is a handy way to "alert" the people from whom you're renting a house that you broke their vase, ahem—and just because autocratic firms did worse in the 1990s, doesn't mean autocracy was the cause. Of course. Trying to pin this down though, the researchers do find that "autocratic" firms engaged in "an unexpectedly large amount of inefficient investment in the 1990s." I still don't quite understand why this might be: is it because entrenched managers are more likely to make a lot of moves for their own private, rather than for their shareholders', benefit? Hm. Meanwhile, the most fun hypothesis here—that corporate insiders realized their firms were going to do badly in the 1990s and hence gave themselves strong protections from shareholders—seems to have no evidence in support of it. Sad; I enjoy the truly dastardly stuff. But the lesson is clear here: democracy is the best antidote to these freedom-hating regimes.
From a theoretical perspective, there is no obvious answer. In this paper, we ask an empirical question -- is there a relationship between shareholder rights and corporate performance? Twenty years ago, large corporations had little reason to restrict shareholder rights. Proxy fights and hostile takeovers were rare, and investor activism was in its infancy. By rule, most firms were shareholder democracies, but in practice management had much more of a free hand than they do today. The rise of the junk bond market in the 1980s disturbed this equilibrium by enabling hostile-takeover offers for even the largest public firms. In response, many firms added takeover defenses and other restrictions of shareholder rights. Among the most popular were those that stagger the terms of directors, provide severance packages for managers, and limit shareholders’ ability to meet or act. During the same time period, many states passed antitakeover laws giving firms further defenses against hostile bids. By 1990, there was considerable variation across firms in the strength of shareholder rights. The takeover market subsided in the early 1990s, but this variation remained in place throughout the decade….
We combine a large set of governance provisions into an index which proxies for the strength of shareholder rights, and then study the empirical relationship between this index and corporate performance. Our analysis should be thought of as a “long-run event study”: we have democracies and dictatorships, the rules stayed mostly the same for a decade -- how did each type do? Our main results are to demonstrate that, in the 1990s, democracies earned significantly higher returns, were valued higher, and had better operating performance.