Legal Commentary

David Zaring raises some interesting questions about a paper that Grant Hayden and I have written, ?The False Promise of One Share, One Vote.? The paper builds on recent work by Partnoy and Martin, as well as Hu and Black, discussing use of derivatives to manipulate one?s stake in a company. Zaring mentions the case in which the hedge fund Perry Corp. used derivatives to hedge its interest in King Pharmaceuticals. This would have been unremarkable, except that Perry then voted to approve a controversial merger between King and Mylan Labs. Perry's actions raised the spectre of certain shareholders (particularly hedge funds) secretly voting their shares against the interests of the corporation. In light of these external and potentially conflicting interests, Partnoy and Martin suggested that regulation of voting rights might be in order, while Hu and Black took a disclosure-oriented approach.

In our paper, however, we are raising broader concerns. Using a mix of democratic, social choice, and economic theory, we are challenging both a premise and a central argument for restricting corporate voting to shareholders.

First, we're arguing that one of the traditional premises of shareholder primacy -- the shareholders' homogenous interest in wealth maximization -- is false.  Here, we expand upon the research of those who have questioned the existence of this shared norm among shareholders.  We expand the field to point out a much broader array of situations in which shareholder interests diverge, and explain how the shareholder wealth maximization norm must bow to the aggregated preferences reflected in an actual shareholder vote.

Second, we challenge an important part of the theoretical justification for the restriction of the franchise to shareholders alone.  The argument is based on Arrow's Impossibility Theorem.  As stated by Easterbrook and Fischel (and endlessly repeated ever since):  when voters hold dissimilar preferences, Arrow's Theorem says we cannot aggregate their preferences into meaningful, consistent choices.  Corporations that make inconsistent choices will self-destruct; therefore, we need to restrict the corporate franchise to those with similar preferences -- namely, shareholders.  As we demonstrate in the article, this argument, which has never really been fleshed out, is based on a faulty understanding of Arrow's Theorem.  In the end, the invocation of Arrow's Theorem involves little more than an opportunistic hand-waving.  It is not a serious argument for restricting the corporate franchise to shareholders.

With respect to Zaring's question about the constitutive value of voting, we're not saying anything about the various ways to better structure the (political or corporate) voting process to encourage voters and those they elect to become more deeply engaged in their collective enterprise.  Michael Kang argues that majority-minority districts have this important side benefit in the political sphere.  And we're sure there are many ways to structure corporate voting processes to provide similar benefits (and they've been debated elsewhere) .  We, however, are concerned with voting rights at a more fundamental level -- who receives the power to vote to begin with.

Grant and I hope that this paper will prove the starting point for an extended reevaluation of the theory and structure of corporate governance.  We welcome your comments.