Vigilant boards and attentive stockholders are relatively new developments, argues Brian R. Cheffin

Cheffins, Brian R.

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4/5/2016How corporate governance moved to the forefront ofmanagementblogs.lse.ac.uk /businessreview/2016/04/05/how-corporate-governance-moved-to-the-forefront-of-management/While the term “corporate governance” is now used universally when managerial accountability in publicly tradedcompanies is under consideration, the term was largely unknown until the 1970s. In a recent paper, I explain howand why corporate governance moved to the forefront in the manner it did in the United States, the country wherethe term first came to prominence.Managerial revolutionThe United States experienced in the late 19 th and early 20th centuries a “managerial revolution,” where a growingdivision between ownership and control was accompanied by the promulgation of increasingly sophisticatedmanagerial hierarchies. The trend climaxed with an era of “managerial capitalism” running from the end of the WorldWar II to the 1970s. During this era corporate scandals were rare amidst sustained economic prosperity. The dearthof corporate wrongdoing cannot be attributed to present-day mainstays of theoretically sound corporate governance,namely vigilant boards and attentive stockholders . Boards deferred to management absent a crisis and, withretail investors collectively owning a majority of outstanding shares, the prospects for meaningful shareholderengagement were bleak.Various factors kept public company executives on the straight and narrow during the managerial capitalism eradespite deferent boards and passive shareholders. In key economic sectors, industry-level regulation curtailedexecutive discretion. With the U.S. experiencing an era of “boring” banking due to tight regulation, restrictedaccess to finance helped to keep managerial ambition in check. Finally, unions were powerful and to avoiddebilitating strikes executives accepted numerous changes to work rules that limited their managerial prerogatives.Strong corporate governance as a reaction to mismanagement in the 1970’sIn the 1970s, with U.S. public companies under growing pressure due to foreign competition and challengingmacroeconomic conditions, evidence of mismanagement and corporate malfeasance proliferated. This set the1/3scene for greater emphasis on the governance mechanisms largely ignored during the heyday of managerialcapitalism. Throughout the 1970s boards were reconfigured to considerably bolster the role of independent directorsas managerial monitors. The balance of power between management and stockholders in public companies alsobegan to shift in the stockholders’ favour. A wave of hostile takeovers in the 1980s meant the fate of publicly tradedcompanies hinged to an unprecedented degree on shareholder perceptions of the capabilities of the incumbentmanagement team. Also, institutional investors, which had replaced retail investors as the dominant owners ofshares, successfully lobbied companies to reconfigure executive pay to ensure top management would be rewardedgenerously if shareholder returns were robust.Dramatic changes affecting the discretion available to executives of U.S. public companies enhanced still further theprofile of corporate governance as the 20th century drew to a close. With commercial and investment banks —formerly conservative allocators of capital — competing intensely for business, executives of public companies hadunprecedented scope to finance new acquisitions and ambitious expansion plans. A marked decline in union powerand a wave of deregulation likewise increased the latitude executives had available to them. In this newenvironment, executive performance likely mattered more for corporate success than it had during the managerialcapitalism era. The proper functioning of corporate governance logically became a higher priority.Corporate governance had very much “arrived” by the 1990s. Nevertheless, corporate scandals that engulfedprominent U.S. corporations in the early 2000s demonstrated the arrangements in place were not sufficiently robustto cope appropriately with the imperial-style chief executive who had moved to the forefront as managerialdiscretion expanded. Matters changed quickly. Due to a combination of regulatory reforms prompted by the scandalsand a dramatic surge in activism by hedge funds lobbying aggressively for the unlocking of shareholder value, chiefexecutives would soon be more embattled than imperial.Banks were a temporary exception. Due to strong financial results, top executives of freewheeling financial firmsenjoyed something of a corporate governance “free pass” for much of the 2000s. The 2008 financial crisis endedany special treatment. The regulatory and governance changes which ensued restored at least some of theboringness that had been a hallmark of banks of the managerial capitalism era.Post managerial capitalismWhile in the U.S. the managerial capitalism era ended in the 1970s, a consensus has yet to emerge on what to callwhat has replaced it, with contenders including “fiduciary capitalism,” “investor capitalism,” and “shareholdercapitalism”. Regardless of what label ultimately moves to the forefront, corporate governance has emerged as asignificant feature of this new era. There is mixed evidence concerning the impact of theoretically sound corporategovernance on corporate performance. Regardless, today’s public company executives are clearly facing aconsiderably different menu list of opportunities and constraints than their managerial capitalism era counterpartsand the growing prominence of corporate governance has contributed substantially to that process.♣♣♣Notes:This post is based on the author’s paper Corporate Governance since the Managerial Capitalism Era,in Business History Review / Volume 89 / Issue 04 / Winter 2015, pp 717-744The post gives the views of its author, not the position of LSE Business Review or the London School ofEconomics.Featured image credit: icannphotos CC-BY-SA-2.02/3Brian R. Cheffins has been since 1998 the S.J. Berwin Professor of Corporate Law at CambridgeUniversity, having begun his academic career at the University of British Columbia’s Faculty ofLaw. Professor Cheffins has held visiting appointments at Columbia, Duke, Harvard, Oxford,Stanford, the University of British Columbia and the University of Western Ontario. He was nameda Guggenheim Fellow in 2002, was in 2014 the Thomas K. McCraw Fellow in U.S. BusinessHistory at Harvard Business School and will in 2016-17 and 2017-18 be working on “TheTransformation of the Public Company” under the auspices of a Leverhulme Major ResearchFellowship.  Professor Cheffins is the author of Company Law:  Theory, Structure and Operation(1997), The Trajectory of (Corporate Law) Scholarship (2004), Corporate Ownership and Control:  British BusinessTransformed (2008), is the editor of The Modern History of U.S. Corporate Governance (2011) and has writtennumerous articles on corporate law and corporate governance. Copyright © 2015 London School of Economics3/3

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