35. How does competition for authority within the corporation give rise to issues in corporate governance?
The corporate structure is designed to establish limited authority in shareholders, directors, and officers. While the general responsibilities of each are clearly established, the strength of influence on decision making is often distorted by the amount of authority demanded or exercised by each stakeholder.
• Internal Power Struggles – The most notable power struggles come between the board of directors and shareholders. These matters are often settled through shareholder votes or derivative actions by shareholders against the board. In this process, shareholders may seek to assert additional control over director decision making; while directors often seek to diminish shareholder input.
⁃ Note: Shareholders do not approve of a strategic course for the corporation as decided by the directors. Shareholders seek to exert influence over the directors to influence their decision making or request that certain actions be submitted to shareholder vote for approval. If the directors decline to follow shareholder urging and it leads to a corporate loss, shareholders have the option of bringing direct or derivative actions against the directors. Further, shareholders may seek to unseat uncooperative directors at election time.
• Friendly Takeovers – A common point of conflict may arise between the existing board of directors and prospective acquirers (purchasers of a controlling percentage of outstanding shares) of the corporation. This transaction is known as a corporate “takeover” or “buyout”. A takeover is where third parties purchase the outstanding shares of corporate stock and thereby gain control of the corporation. The prospective acquirer(s) may be unrelated third parties, managers, or existing shareholders. The acquirer may petition the board of directors to accept a takeover bid. If the board endorses the offer, it will submit the proposal to existing shareholders. If a majority (or supermajority) of shareholders approve the purchase, the board will repurchase all of the outstanding shares from shareholders at the proposed price. The shares are then surrendered to the acquiring firm. If, however, the board or shareholders reject the acquirer’s offer, the acquirer may seek alternative methods to acquire control over the corporation, such as through a “hostile takeover”.
⁃ Note: In some cases, a takeover can appear to be friendly but is really hostile. For example, a “bear hug” is a situation where an acquirer offers a purchase price to the board that is far above expected value. The board may be required to accept or endorse the offer in order to meet its obligations to represent the best interest of shareholders.
⁃ Example: I am an activist investor. I see opportunity for creating value in ABC Corp. I make a tender offer to the board to purchase all (or a majority) of outstanding corporate shares. Directors will evaluate the offer and either accept or reject it. In some case, directors are obligated to submit the offer to shareholders for approval or rejection.
• Discussion: Why do you think power struggles between shareholders and directors often lead to corporate governance issues? Do you believe that the default division of corporate responsibilities is efficient in avoiding or reducing these types of struggles? Why or why not? How do you feel about the concept of a takeover bid from prospective shareholders? Should directors be obligated to submit any offer to shareholders for approval or rejection? Why or why not?
• Practice Question: Karl is an activist investor who regularly assumes a large ownership stake in corporations in order to make changes in the corporations that will drive value and produce a return on his investment. He looks at ABC Corp and believes that the CEO is causing a loss of corporate value. He believes that he could replace the CEO with a higher performer and instantly create significant value in the corporation. He could then sell his shares and make a hefty profit. What are Karl’s first steps in achieving his objectives?