Book Review: Macey’s Corporate Governance

Jonathan R. Macey, Corporate Governance: Promises Kept, Promises Broken (Princeton University Press) (2008).

I make the following three promises.  First, I promise to describe and defend the controlling premise upon which Macey bases his analysis of corporate governance.  Second, I promise to summarize and synthesize Macey’s conclusions.  Third, I promise to provide commentary and criticism on the book and its ideas.  These are my three promises, and I intend to keep them.  If I keep those promises, you and I should both consider this review successful.  If that seems like an intuitively fair way to evaluate this review, then you’ll agree with Macey’s mechanism for evaluating corporate governance and accept the unifying theme of this book.

“Corporate Governance is about promises.  I believe that it is more accurate to characterize corporate governance as being about promises than it is to characterize corporate governance as being about contracts.”

Macey’s controlling idea is that corporate governance is about promises.  He evaluates the institutions and mechanisms of corporate governance according to the degree to which they facilitate the making and keeping of promises by corporations to investors.  He chooses the “Promise Premise” instead of the more traditional nexus-of-contracts premise because “the idea of promise captures the primordial fact that trust rather than reliance on the prospect of enforcement is the focal point of a successful system of corporate governance.”  As Macey’s analysis reveals, investors rely largely on trust and reputational capital when they participate in the capital markets, and even those mechanisms that are designed to offer some degree of enforcement power fall short.

Macey’s “Promise Premise” works as the governing theme because it is intuitively appealing and allows for private ordering.  Intuitively, it seems fair that there is no one-size-fits-all set of metrics with which to evaluate corporate performance.  On a basic level, consider two companies, “Income” and “Growth.”  Income consistently pays dividends, operates in a stable industry with a sustainable capital structure, and attracts risk-averse investors.  Growth, meanwhile, retains its earnings, operates in emerging markets and developing industries and with high leverage, and attracts risk-hungry investors.  If in twenty years, Income has continued paying its quarterly dividend and retained its stable position in its stable industry, and Growth has survived some investments that didn’t pay off and hit it big in emerging markets, sending its volatile share price temporarily skyrocketing, which company has been more successful?  Both companies have been successful by doing what they set out to do.  But which company has been more effectively governed?  We won’t know if we look to board and management turnover, leverage, and share price whose management has performed better over the time period.  But applying Macey’s Promise Premise, we can evaluate the governance approaches of any company by measuring the degree to which they facilitate the keeping of the promises the company has made to its investors.  This approach therefore allows for useful governance comparisons between two companies that may have completely different agendas.

For most of a century, the Delaware court system has helped to facilitate the making and keeping of promises from companies to investors.  A voluminous body of case law communicates to potential investors and to newly formed businesses that certain default promises are embodied in the charter and sale of stock in a Delaware corporation.  These promises include fiduciary review, the business judgment rule, the appraisal remedy, the equitable jurisdiction of the Court of Chancery, expedited litigation, and all the other familiar features of Delaware corporate law.  Delaware corporations capitalize on economies of scale.  Rather than making a lengthy set of explicit promises to their potential investors, they send a powerful signal to the capital markets when they charter in Delaware.  Delaware judges help retain the state’s title as the jurisdiction of choice for investors and business entities because the Delaware courts effectively communicate these default Delaware promises to capital market participants.

“One of the principal contributions of this book is to point out that many of the most effective corporate governance devices, such as certain kinds of trading and activities in the takeover market, are either heavily regulated or banned outright.  On the other hand, the mechanisms and institutions that I regard as the least effective, corporate boards of directors and credit rating agencies, are facilitated, encouraged, and even directly or indirectly required by regulation.”

Macey evaluates all the major institutions and mechanisms of corporate governance according to his Promise Premise described above.  He comes down in favor of market-based institutions such as the markets for corporate control and initial public offerings.  As compared with markets, Macey is far less confident in people, whether they be managers, directors, regulators, judges, or legislatures.  On an individual level, Macey places little faith in a person’s ability to overcome decision-making biases.  On a group level, as with legislatures and boards of directors, effective governance is lacking because of capture.

Macey universally praises market mechanisms and institutions; chief among these is the “market for corporate control” or takeover market.  Macey describes the takeover market as the “most important market-inspired component of the U.S. corporate governance infrastructure.”  An unimpeded and robust takeover market disciplines managers because the most effective defense against an unwanted takeover is a consistently high share price.  The takeover market therefore provides immediate and powerful incentives for corporate directors and managers to deliver on their primary promise to their investors—that they will maximize shareholder value.  The market for corporate control thus earns high marks according to Macey’s Promise Premise.

Macey details, however, how the takeover market has been hindered by the actions of well-intentioned courts, legislatures, and lawyers.  The hindrances began with “the Williams Act, which deterred corporate takeovers by dramatically increasing both the out-of-pocket costs and the legal risks that bidders face when launching a tender offer.”  Second, corporate managers and their lawyers crafted new ways of defending against takeovers (and entrenching themselves), including staggered boards, limits on shareholders rights to remove directors and call special meetings, and supermajority voting requirements.  Third, and most fatal to the effective operation of the takeover market, lawyers and managers adopted the anti-takeover devices known as poison pills, and the use of these devices passed judicial scrutiny.

Macey concludes his chapter on the market for corporate control with a political explanation of its development and subsequent failure to live up to its potential as a governance institution.  The shareholders who would benefit the most from a robust and unimpeded market for corporate control suffer from a classic collective action problem, while managers are a discrete and well organized group with every incentive to protect themselves against market forces.  The regulations that have developed are a natural outgrowth of the political climate in which the market for corporate control exists.

Macey advances similar structural and political arguments for why other mechanisms of corporate governance are ineffective, including the corporate board of directors.  In his chapter on boards, Macey notes that though much is expected of boards of directors, little is delivered.  According to Macey, the U.S. model for the board of directors I structurally flawed.  Directors are asked to be both managers and monitors, two tasks which are almost impossible to be carried out successfully in tandem.

First, directors are tasked with a monitoring function.  Directors hire and evaluate the performance of management, and oversee all aspects of corporate policy.  Macey notes the obvious presence of bias, though, when directors must evaluate the performance of the managers they themselves chose to hire.  There is a strong incentive for directors to cast management in the best light, since ultimately the decision to hire those managers fell to the board.  Second, directors are supposed to provide ongoing strategic and managerial input on high-level corporate decisions.  This requires directors to seek information about the company and its operations and to provide critical advice.  The problem, though, is that “the more directors become engaged with management in making strategic decisions the more likely they are to become firmly convinced that their decisions, and the decisions made by their managers, are correct.”  Macey and other scholars refer to the “entrenchment of this conviction in management’s infallibility” as “capture.”

The problem of capture cannot be easily solved even though it can be easily described.  Capture arises in part from having directors involved in corporate decision-making, but director involvement is seen as one way to improve the quality of corporate decision-making.  Macey summarizes his views on the board of directors as a corporate governance mechanism simply:  “the institution of the board of directors, as we know it, is not a reliable corporate governance device.”

On the whole, Macey studies thirteen different institutions or mechanisms of corporate governance.  He deems five of them effective (the market for corporate control, the IPO market, insider trading and short selling, hedge funds, and banks and other fixed claimants), but notes that none of them are encouraged in our legislative and regulatory environment.  He deems the remaining eight ineffective (the SEC and stock exchanges, boards of directors, the accounting industry, litigation, whistle-blowing, shareholder voting, credit rating agencies, and stock market analyst) and notes that they are encouraged.  Macey offers political and path-dependence explanations to resolve this paradox in some of the book’s chapters.

Overall, the book is detailed, thorough, and easy to read and follow.  Macey’s great strength as a writer lies in his ability to move effortlessly between levels of abstraction; he’ll talk on the highest theoretical level about the effectiveness of boards of directors and then support his ideas with discussions of individual case studies on the effectiveness of boards of directors.  Macey’s thoughts are obviously well-considered and thoroughly researched, and this book should be considered a must-read for anyone interested in the governance of U.S. companies.  The book, or excerpts from it, would make a great companion to a corporations course because of its disagreements with the status quo.

I would be particularly interested in Macey’s writing in the wake of financial reform legislation.  Based on his findings, I predict that he is underwhelmed and unsurprised by the Dodd-Frank bill.  Macey does not consider the SEC an effective tool for corporate governance, so he would likely not support giving the SEC more funding and more regulatory authority.  He would not be surprised about this result, though, giving the political climate.  In my estimation, Macey would also be put off, though not surprised, by the increased regulation of hedge funds.  Macey considers hedge funds an effective mechanism for corporate governance, so he would be disappointed to see hedge funds face greater scrutiny.  The new Dodd-Frank bill seems to perpetuate Macey’s observed paradox:  the more effective a corporate governance mechanism is, the less it is encouraged.

If I endeavored to find points of criticism about the book, I would note Macey’s dry legal writing style and the fact that the book consists of discrete and largely independent chapters, lacking an overarching set of practical and politically feasible ideas for how to fix some of the problems Macey identifies.  The paradox that results from Macey’s analysis teaches that because of structural or political problems, effective corporate governance devices are discouraged while ineffective devices are encouraged.  Unfortunately, Macey does not suggest a panacea would cure the ills of the system.

On the style point, Macey writes like a law professor would be expected to write.  His prose is organized, economical with his words, and organized into easily digestible parts.  At times, though, to a non-law trained reader especially, his writing style could begin to appear rote.  To a law trained reader, though, this can be considered a strength.

All things considered, my two criticisms of the book are that he writes like a law professor, and that the majority of the book is organized into a series of discrete and largely independent chapters.  But all I was promised was a book written by a law professor and organized into a series of discrete and largely independent chapters, and so I consider the book a monumental success.

_____________________________________________________________________

Michael Sirkin is a member of the Delaware bar and law clerk to Vice Chancellor J. Travis Laster of the Delaware Court of Chancery.  Following his clerkship, he will join the firm of Morris Nichols Arsht & Tunnell LLP in Delaware.

You may also like...

3 Responses

  1. A.J. Sutter says:

    1. Your (and perhaps Macey’s) reference to investors’ participation “in the capital markets” implicitly assumes that the purpose of those markets is to provide capital. But in fact less than 1% of the total value of shares traded on the NYSE and NASDAQ each year is new capital. Moreover, a large portion of trades on those exchanges is high-speed, automated trading. Does Macey address these realities in his book, and how they might affect the deference that the law should accord to investors??

    2. You implicitly attribute to Macey the notion that incentives in the takeover market facilitate directors’ and managers’ keeping their “primary promise” to investors of “maximiz[ing] shareholder value.” (a) Does Macey consider this to be their primary promise outside the takeover context as well? (b) Does he consider the irony that “shareholder value” in the takeover context means the value one receives to terminate one’s status as shareholder?

    3. Does Macey consider that promises are made to any stakeholders other than shareholders?

  2. Mike Sirkin says:

    Hi A.J.,

    Thank you for reading and asking your questions. I will address each of them and will try to clearly differentiate between my own thoughts and Professor Macey’s expressed views.

    1. I appreciate your distinction between investors and traders. My personal view is that investors are interested in corporate governance because they part with their money in reliance on the corporation’s managers to put the money to a productive use and earn a return. Traders, by contrast, are not interested in corporate governance. They part with their money based on directional bets on companies, sectors, or the broad market indices, and are not interested in the governance of the underlying firms or in business performance. My own Coasean view is that the law promises traders functioning markets and information flows, and little else.

    Macey does not really address this reality in his book. My guess would be that he made a conscious choice not to address the topic in this work because it doesn’t really fit–if corporate governance is about promises, traders don’t rely on the same universe of promises from corporations as investors do.

    2.
    (a) Macey’s “Promise Premise” as I refer to it above is broad enough to allow for meaningful comparison between companies that make different sets of promises. Macey’s application of that premise in individual chapters to the different mechanisms or institutions of corporate governance reflects the reality that, in their current form, U.S. public companies exist for the benefit of their shareholders. This is not the only possible universe; Macey notes that some public companies in certain European countries exist for the benefit of a wider category of stakeholders. Under the law and the norms existing in the United States, though, public companies are primarily required to maximize shareholder value, in the takeover context as well as most other contexts. Under Delaware corporate law, directors owe fiduciary duties to their shareholders. Those duties become more pointed in the takeover context, where, in certain circumstances, the duty becomes that of an auctioneer determined to get the highest possible price. In the zone of insolvency, meanwhile, Delaware law allows for the circumstance that the duties owed to creditors become more prominent.

    (b) Macey does not explicitly consider the irony you point out, but there is another important irony to note. His emphasis on the efficacy of the takeover market is not based on the accomplishment of takeeovers at all. Rather, he values the incentives created by a well-functioning and unimpeded takeeover market. If one accepts that the primary promise made to shareholders in the U.S. is that the company will try to maximize shareholder value, then the constant threat of a takeovver is at least as important as the takeover itself. In the absence of antitakeover regulations and of defensive measures like the poison pill, the only effective defense against a potential takeover is to maintain a consistently high share price. Therefore, the true irony is that the unimpeded takeover market would work as an effective governance device even if no takeovers ever happened.

    3. As mentioned above, Macey allows for promises to stakeholders in his premise. He mentions firms in other countries who place greater emphasis on other stakehholders, including creditors and employees. The strength of his Promise Premise is that it allows for firms who openly make promises to stakeholders to exist and be evaluated according to their promises. In his application, though, Macey doesn’t discuss other stakeholders much, because of the fact that U.S. companies don’t either.

  3. Hi …

    Forex – On-Line Manual For Successful Trading

    An Introduction to MQL Programming Language

    MQL ویژه برنامه نویسان ، تحلیل گران و تاجران فارکس و بازارهای مالی

    Included:

    Introduction to Metatrader and programing

    آشنایی با متاتریدر و محیط برنامه نویسی

    Introduction to and History of the Fibonacci Sequence

    شرح کامل زبان برنامه نویسی MQL
    Other Applications of the Fibonacci Retracements and Extension
    طراحی و پیاده سازی برنامه های MQL
    Application and Common Errors in Fibonacci Timelines
    طراحی ایندیکاتورهای سفارشی و اشیا گرافیکی
    Other Interesting Studies Using Synthetic Ratios

    آشنايي با محيط و امکانات Meta Trader
    MQL – آشنايي و معرفي محيط طراحي و پياده سازي برنامه هاي MQL آشنايي و معرفي محيط طراحي و پياده سازي برنامه هاي MQL
    MQL – Test Strategy اجرا و تست برنامه ها ي MQL
    MQL – آشنايي با امکانات و قابليت هاي زبان MQL آشنايي با امکانات و قابليت هاي زبان MQL
    MQL – طراحي و پياده سازي برنامه هاي MQL طراحي و پياده سازي برنامه هاي MQL
    MQL – طراحي و برنامه نويسي اينديکاتورهاي سفارشي طراحي و برنامه نويسي اينديکاتورهاي سفارشي
    MQL – روش هاي پياده سازي استراتژي هاي مختلف معامل روش هاي پياده سازي استراتژي هاي مختلف معامله
    Forex – On-Line Manual For Successful Trading

    Contents

    1. Introduction to and History of the Fibonacci Sequence
    2. Application to Financial Market Analysis
    3. Other Applications of the Fibonacci Retracements and Extension
    4. Charting and Difficulties: A Historical Perspective
    5. Common Errors in Application of Fibonacci Retracements and Extension
    6. Application and Common Errors in Fibonacci Fanlines
    7. Application and Common Errors in Fibonacci Timelines
    8. Total Analysis – Pulling All the Skills and Techniques Together
    9. Gann, The Misunderstood Analysis
    10. Other Interesting Studies Using Synthetic Ratios
    11. Conclusion