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Corporate Voting vs. Market Price Setting

By Harvard Law School Program on Corporate Governance

(Editor’s note: This post is by Yair Listokin of Yale Law School.)

Corporations have two primary means of aggregating dispersed information and making decisions?voting and price setting. When shareholders vote on a merger or in a contested director election (two examples of ?proxy fights?), they aggregate diffuse opinions through voting; the corporation pursues the outcome favored by the holders of a majority of shares. Corporations also receive feedback from diffuse investors through stock prices. When price-setting shareholders support a company?s actions, the price of the company will rise. Indeed, the market?s ability to aggregate diffuse information into prices forms the basis for all event studies.

My paper entitled ?Corporate Voting vs. Market Price Setting? evaluates these two information aggregation mechanisms from an empirical perspective. I estimate how the price-setting shareholder perceives the decisions of the median voter in a corporate election. I do this by examining stock market responses to the announcement of the outcomes of close votes. The stock market response to close votes has two desirable attributes for measuring the price setting market participant?s view of the median voter?s opinion. First, the outcome of close votes is uncertain, providing information to price setting shareholders.

Second, close votes suggest that the median shareholder/voter is nearly indifferent between the two voting options in a proxy contest. The median voter in a proxy contest is the shareholder in the exact middle of a ranking of voters along the dimension of preference for one side in a proxy contest. If shareholders vote for management so long as they prefer management and the vote is a perfect tie, then the median voter is exactly indifferent between management and ?dissidents?. If the vote is not a perfect tie but closely favors existing management, then the median voter slightly prefers the winning option, but is relatively ?close? to indifference.

The market response to close votes in proxy voting contests is striking. In close elections?when the median voter should be close to indifferent regarding either outcome– the price setting shareholder is far from indifferent. Stock price responds systematically to the announcement of vote outcomes. When management wins a close election, market value declines; when a dissident wins, the value goes up.

I conclude that the price-setting shareholder places lower value upon management control of companies than the median voter. If price-setting shareholders provide a reasonably accurate gauge of value (a proposition that underlies every event study) and value maximization is the goal of corporate law (as most assume)?then the results suggest a need for corporate voting reforms.

The full paper is available for download here.

Full post as published by The Harvard Law School Corporate Governance Blog on August 18, 2008 (boomark / email).