The Incompatibility of the American Public Firm with Social
Democracy"
BY: MARK J. ROE
Columbia University School of Law
Document: Available from the SSRN Electronic Paper Collection:
http://papers.ssrn.com/paper.taf?abstract_id=165143
Contact: MARK J. ROE
Email: Mailto:mroe at law.columbia.edu
Postal: Columbia University School of Law
435 West 116th Street
New York, NY 10027 USA
Phone: (212)854-5441
Fax: (212)854-7946
ABSTRACT:
The large public firm dominates business in the United States
despite its critical infirmities, namely the frequently fragile
relations between stockholders and managers. Managers' agendas
can differ from shareholders'; tying managers tightly to
shareholders has been central to American corporate governance.
But in other economically-advanced nations ownership is not
diffuse but concentrated. It is concentrated in no small measure
because the delicate threads that tie managers to shareholders
in the public firm fray easily in common political environments,
such as those in the continental European social democracies.
Social democracies press managers to stabilize employment, press
them to forego even some profit-maximizing risks with the firm,
and press them to use up capital in place rather than to
down-size when markets no longer are aligned with firm's
production capabilities. Since managers must have discretion in
the public firm, how they use that discretion is crucial to
stockholders, and social democratic pressures on managers induce
them to stray from their shareholders' preference to maximize
profits. Moreover, the means that align managers with diffuse
stockholders in the United States--incentive compensation,
transparent accounting, hostile takeovers, and strong
shareholder-wealth maximization norms--are harder to implement
in continental social democracies. Hence, public firms in social
democracies will, all else equal, have higher managerial agency
costs, and large-block shareholding will persist as
shareholders' next best remaining way to control those costs.
Indeed, when we line up the world's richest nations on a
left-right continuum and then line them up on a close to diffuse
ownership continuum, the two correlate powerfully. True, the
effects on total social welfare are ambiguous; social
democracies may enhance total social welfare, but if they do,
they do so with fewer public firms than less socially-responsive
nations. We thus uncover not only a political explanation for
ownership concentration in Europe, but also a crucial political
prerequisite to the rise of the public firm in the United
States, namely the absence of a strong social democracy and the
concomitant political pressures it would have put on the
American business firm.