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Strong Managers, Weak Owners

Strong Managers, Weak Owners: The Political Roots of American Corporate Finance

Mark J. Roe
Copyright Date: 1994
Pages: 342
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  • Book Info
    Strong Managers, Weak Owners
    Book Description:

    In this major reinterpretation of the evolution of the American corporation, Mark Roe convincingly demonstrates that the ownership structure of large U.S. firms owes its distinctive character as much to politics as to economics and technology. His provocative examination addresses essential issues facing American businesses today as they compete in the new international marketplace.

    eISBN: 978-1-4008-2138-9
    Subjects: Economics

Table of Contents

  1. Front Matter
    (pp. i-iv)
  2. Table of Contents
    (pp. v-vi)
  3. Preface
    (pp. vii-xii)
  4. Introduction
    (pp. xiii-xvi)

    In 1990, two of General Motors’ largest institutional shareholders, unhappy with GM’s declining market share, declining employment, and declining profits during the 1980s, sought to talk to GM’s leaders about how to choose the successor to the retiring CEO. GM’s management rebuffed the shareholders, two of the company’s largest; it could get away with that rebuff because each ownedlessthan 1 percent of GM’s stock.

    GM’s ownership structure was not inevitable. One could imagine a halfdozen shareholders, each owning 5 to 10 percent of GM’s stock and sitting in GM’s boardroom. For GM’s managers to rebuff such powerful shareholders...


    • CHAPTER 1 Diffuse Ownership as Natural Economic Evolution
      (pp. 3-8)

      The public corporation—with its distant shareholders buying and selling on the stock exchange—is the dominant form of enterprise in the United States. Why? Technology dictated large enterprises as an engineering matter. The large throughput technologies that developed at the end of the nineteenth century—doubling the diameter of the pipe quadrupled the pipe’s throughput—meant that cheaper production accrued to the firm with the largest scale. Only the United States had a continent-wide economy with low internal trade barriers, providing a market to those who could achieve the technologically feasible large-scale efficiencies. But getting the tremendous outputs from...

    • CHAPTER 2 Fragmentation’s Costs
      (pp. 9-18)

      General Motors lost billions in the 1980s and early 1990s, laid off tens of thousands of employees, and saw a big part of its once huge share of the American automotive market go to foreign competitors. Its managers were said to be out of touch and its board inattentive until GM lost an awesome$7 billionin 1991 in core North American automotive operations. Although ownership structure could not explain all of GM’s problems, it might explain some of them, particularly its decade-long slowness in reacting to crisis. Could the costs of some of the problems afflicting firms with dispersed...


    • CHAPTER 3 Diffuse Ownership as Political Product
      (pp. 21-25)

      The size and technology story fails to explain the fragmented ownership patterns of American corporations fully. Think about it. Fragmented securities markets are not the only way to move savings from households to the large firm. There is at least one clear contender with the securities markets, namely, the powerful financial intermediary, which would move savings from people to firms and could take big blocks of stock, sit in boardrooms, and balance power with the CEO. Enterprises could have obtained economies of scale and investors could have obtained diversificationthroughlarge intermediaries that brought small investors and large firms together....

    • CHAPTER 4 A Political Theory
      (pp. 26-50)

      The first step in the political paradigm is to show that law restricted the dominant financial institutions from the end of the nineteenth century onward. American banks were fragmented geographically, lacking the size to take big slices of capital of the large American firms emerging at the end of the nineteenth century. Banks’ products and portfolios have been further restricted: they were barred from the securities business and from owning stock. Their affiliates were also restricted in the stock they could own. Insurers could not buy stock for most of this century. Mutual funds cannot easily devote their portfolios to...


    • CHAPTER 5 Banks
      (pp. 54-59)

      When financial restrictions are mentioned, the New Deal laws of the 1930s come to mind, and the Glass-Steagall Act, which separated commercial banks from investment banks, comes to the forefront. But the most serious restrictions on financial institutionspredatedthe New Deal and were in place at the end of the nineteenth century for banks and shortly after the beginning of the twentieth century for insurers. Until the rise of mutual funds and pensions in recent decades, banks and insurers were the key financial institutions.

      At the end of the nineteenth century, when large-scale industry became technologically feasible, the key...

    • CHAPTER 6 Insurers
      (pp. 60-93)

      At the beginning of the twentieth century, several of the largest American financial institutions were insurers, not banks. Banks were confined to a single state, and often to a single location; insurers were not. The largest New York insurers were twice as large as the largest banks and were moving intoadjacent financial areas. They were underwriting securities. They were buying bank stock and controlling large banks. They were assembling securities portfolios with control potential. Some had already put as much as 12 percent of their assets into stock. The three largest insurers were growing rapidly and seemed to be developing...

    • CHAPTER 7 Banks Again
      (pp. 94-101)

      In 1932, when Berle and Means “discovered” the modern corporation, with its distant shareholders and centralized managers, they were discovering a business organization partly produced by weaknesses in the organization of the early twentieth century’s principal intermediaries, banks and insurers. While one might attribute the splintered American financial system to the New Deal, the origins of fragmentation lie deeper in the country’s past.

      The New Deal law’s importance is inconfirming, and not so much in creating, a fragmented banking structure by (1) keeping bank branching restrictions; (2) severing commercial from investment banking, thereby creating two deep but separate financing...

    • CHAPTER 8 Mutual Funds
      (pp. 102-123)

      Mutual funds, despite huge financial resources of $1.2 trillion—half in stock—rarely participate in corporate governance. They channel funds from distant individuals to industry, gather information about industrial investments that their owners cannot easily get and evaluate, and do the paperwork that individuals begrudge. They are not intermediaries that get funds from disparate investors, combine them into concentrated holdings, and then enter the corporate boardroom to represent their shareholder beneficiaries and, if need be, check management.

      In the 1930s some funds began to act as monitoring intermediaries. They underwrote securities, were active in bankruptcy reorganizations, and participated in management.¹...

    • CHAPTER 9 Pension Funds
      (pp. 124-146)

      With banks and insurers out of the picture, and mutual funds nearly so, pension funds—the fastest-growing stock market player in recent decades— are the final frontier for finding powerful intermediaries. From 1970 to 1993, pension funds grew from owning only $81 billion in equity, less than 9 percent of the stock market, to owning over $1.5 trillion, nearlyone-thirdof the market (see Table 4), more than mutual funds, insurers, and bank trusts combined.¹ If aggregated, today’s pension funds have a control block in most major American firms.

      Social change induced the rise of huge pension funds: rising wealth...


      (pp. 149-150)

      The historical evidence is that American ideology favored fragmentation, and politically powerful interest groups—primarily small-town bankers in the past and managers today—benefited from that ideology. Political actors sometimes sincerely sought to implement public interest goals—including at times the goal of fragmentation for its own sake, but frequently the more technical public interest goals could have been obtained through other means.

      The political paradigm predicts that if a political system fragments intermediaries, the Berle-Means outcome is inevitable; if a political system does not fragment them, they could be organized differently than they are in the United States. Differently...

    • CHAPTER 10 Takeovers
      (pp. 151-168)

      The United States entered the 1980s with ownership of the large public firm fragmented, making managers freer than they otherwise would have been from financial influence. Institutions with big blocks might influence managers; big blockholders might also stymie takeovers. Scattered ownership in small blocks was a benefit and a curse for managers in the 1980s: although it freed them from day-to-day institutional influence, it made takeovers possible; institutions with small blocks were usually thought to tender their stock in the 1980s takeover wars.

      A raider would have had trouble mounting a takeover if two or three financial institutions controlled the...

    • CHAPTER 11 Corporate Ownership in Germany and Japan
      (pp. 169-186)

      If the construction of large firms requires the ownership structures found in the United States, then similar ownership and governance structures should eventually emerge in other countries. If large firms in different countries have persistently different ownership structures, the differences would cast doubt on the prevailing paradigm: there might be several ways to solve the organizational problems of large firms, and politics might help to determine the choice among them. Differences would especially support the political paradigm if they tied in to different political histories. If we found the structures abroad to be identical to those in the United States,...

    • CHAPTER 12 A Small Comparative Test of the Political Theory
      (pp. 187-197)

      Could American firms and intermediaries imitate the German or Japanese structures without violating basic financial laws?

      The disparity in size is central. The numbers show that large American banks play a role in the American economy equal to onlyone-quarterof the role played by large banks in Germany and Japan.¹ It is not so much that the United States relies less on intermediaries as that its largest intermediaries are not very big. This difference in size correlates with law. American legal restrictions have historically kept American banks small and weak, by banning them from operating nationally; from entering commerce;...

    • CHAPTER 13 Counterpoint I
      (pp. 198-209)

      Several arguments tend toundermine the thesis that politics was a key determinant of intermediaries and the ownership structure of the large firm. I have addressed several as they have come up. For example, some restrictions were sound and inevitable, and even some of the unsound ones had public-spirited aspirations. But political forces created enough rules, and influenced enough others, that the political theory makes sense. Several arguments, which are worth addressing separately, are variations on the theme that intermediaries would fragment their holdings anyway, despite the American political history of fragmentation. Evidence for this view includes the possibility that financial...

    • CHAPTER 14 Political Evolution in Germany and Japan?
      (pp. 210-221)

      Even if we knew that Germany and Japan would evolve to Americanstyle diffuse ownership (and even if we saw no American ownership trends toward concentration), the incompleteness of current corporate theories would persist. We would need to determine the degree to which politics in Germany and Japan was inducing financial evolution. Financial fragmentation could be inherent in twentieth-century democracy, rather than merely inherent in American democracy, as I hypothesized earlier. Foreign nations’ political and corporate histories could have evolved together: large industry and big finance emerged abroad when nondemocratic governments kept fragmenting forces in check. Indeed, today’s foreign democracies affect...

    • CHAPTER 15 Trends in the United States
      (pp. 222-225)

      In the 1980s a tidal wave of mergers and leveraged buyouts tore apart and rearranged many large American firms. Today, the structure of American intermediaries and their role in corporate governance are in upheaval. Some intermediaries seek new, active roles. Regulators are also reexamining old patterns. The Treasury Department proposed ambitious plans, which stalled in Congress, to mix banking and commerce in ways that have been volatile in American history. The SEC reduced some restrictions on institutions’ governance role. The 1990s trends for institutional investors may well be the result of trying to bridge the huge fault line that separated...

    • CHAPTER 16 An American Crossroads
      (pp. 226-230)

      Managers might havesoughtfinanciers with big blocks of stock and a voice in corporate governance in the mid-1980s, when managers were seeking to stabilize their firms and boardrooms against takeovers. Managers and owners were at a crossroads: in seeking stability, managers could have shut owners out, or they could have stabilized the boardroom with big blocks. Managers’ first efforts to stabilize their world were attempts to beat back hostile takeovers; managers’ legal defenders in the early 1980s invented financial and legal devices designed to ward off hostile takeovers. Some devices were struck down by courts, but the most potent—...


      (pp. 233-234)

      Is concentrated ownership beneficial? Is foreign corporate governance a source of competitive advantage? Although my basic goal in this book is to show that we need a political theory to fully explain corporate forms, the next obvious inquiry is normative: should U.S. firms have a more concentrated ownership structure? While the analysis here is complex, the bottom line is simple: there is not enough evidence to support using law toforceconcentrated ownership structures, but there are enough tantalizing possibilities that we should permit them, by loosening some American restrictions.

      Neither I nor anyone else will offer a corporate governance...

    • CHAPTER 17 Managers as the Problem?
      (pp. 235-239)

      Institutions are unfit to run enterprises; the hopes for them must be more modest. The model institutional overseer would not micromanage the firm from day to day, but be ready tomake changes during crisis and hold the managers accountable during the interim. Enhanced institutional voice could improve managerial performance, not by directing day-to-day operations, but rather (1) by enhancing managerial accountability, (2) by personifying shareholders (which could make managerial disloyalty psychologically harder), and (3) by improving the flow of informationtosenior managers from outside the firm.

      In this chapter, we analyze the basics: making managers more accountable. This matters...

    • CHAPTER 18 Short-Term Finance as the Problem?
      (pp. 240-247)

      Thus far we have treated managers as the problem and enhanced institutional voice as a possible solution. But maybe managers are doing just fine, butinstitutionsare the problem. And perhaps concentrated ownership is a partial solution to theinstitutionalproblem.

      Managers complain that the short-term bias of a stock market of furious traders makes it hard for managers to concentrate on the long term. Hence, managers must spurn the long term and underinvest in building up their organizations and their employees. While this sounds true to many, it has theoretical problems. Even furiously trading shareholders include buyers as well...

    • CHAPTER 19 Industrial Organization as the Problem?
      (pp. 248-253)

      Let us now shift from financiers, short-term thinking, and monitoring of managers to the organization of industrial production. A recurrent task in organizing industry is to coordinate long-term investments, especially simultaneous long-term investments by suppliers and customers. A supplier considers a massive investment in new machinery to make a good that only a specific customer can use. But what will stop the customer from reneging or extorting concessions from the supplier later on, after the supplier builds the specific machines? Although a detailed contract between the supplier and the specific customer may protect the supplier, many ways that the customer...

    • CHAPTER 20 Counterpoint II
      (pp. 254-262)

      The issue of industrial organization leads to another issue. Can one identify the superiority or inferiority of institutional voice by comparing the performance of national economies where it is strong with the performance of those where it is weak?

      In the end, enhanced institutional voice in the United States must be justified in American terms, not by using the foreign systems as blueprints. But the post– World War II successes of Germany and Japan with different governance systems pique our curiosity. Might they have a better system? This possibility, vivid until the German and Japanese economic setbacks of the early...

    • CHAPTER 21 Changing the American Ownership Structure?
      (pp. 263-282)

      Even if we could identify the best structure (which we cannot, because today’s best structure is not tomorrow’s and each one has distinctive pluses and minuses), there would be no reason to force reconstruction via new regulation or new taxes. We have little reason to want law thatencouragesactive intermediaries and concentrated stock ownership; we do want law thatpermitsmore variation, allowing more competition in the United States between organizational forms.

      This chapter has four parts. First, I examine how bank-based structures similar to those abroad could be permitted to compete in the United States, and I conclude...

  10. Conclusion
    (pp. 283-288)

    The analytic result is fundamental: the modern American public corporation is not an inevitable consequence of technology that demands large inputs of capital. Technology combined with the diversification demands of investors to yield the fragmented ownership of the public firm and the shift to centralized managerial authority, but that result became inevitable only because the United States fragmented its financial intermediaries. Politics confined the terrain on which the large American enterprise could evolve. That confinement allowed the public corporation with dispersed ownership, and not some other organization, to evolve.

    The fragmentation of institutional capital meant that owners’ power would shift...

  11. Bibliography
    (pp. 289-308)
  12. Acknowledgments
    (pp. 309-310)
  13. Index
    (pp. 311-324)