Corporate Alignment In An Era Of Shareholder Power
In recent years, shareholders have consolidated their clout and pressed for a greater say in corporate governance. In response to proxy fights, hostile takeover offers, and quiet negotiations, many firms have cut costs, tightened their focus on core units, and dumped executive perks.
July 1 1992 by Michael Useem
As business historians look back on the 1980s and early 1990s, the era is likely to be seen as one of those fateful periods when American business underwent fundamental restructuring. Though spurred by a recession, recent changes announced by IBM, General Motors, Xerox, and many other companies can be seen as part of that broader transformation.
Earlier periods of restructuring exhibited distinctive characteristics. Large multi-divisional firms emerged from the business turbulence near the turn of the century, and diversified multinational firms emerged during the post-war era. A still different cast characterized the tumult of the past decade. The form that will emerge is yet uncertain. What is certain, however, is that new principles of organizational design are in the offing.
One reason: After years of near-absolute acquiescence in corporate strategies and compensation policies, company owners-shareholders-are on the march. They are gradually pressuring senior management at many companies to cut costs and restructure organizations in line with their demands.
The turbulence from which the new forms have emerged is evident in almost any measure of the era. Consider just three:
Mergers and acquisitions soared. The number of mergers and acquisitions did not increase during the 1980s, but their aggregate value did. Annual ownership turnover grew fivefold between 1980 and 1988, from $44 billion to $247 billion. Increasingly, publicly traded firms were at the center of the turnover. Between 1980 and 1985, fewer than one in ten transactions involved a publicly-traded firm. By the second half of the decade, that proportion had doubled.
Public companies privatized. Reversing an historic trend, a number of major companies were taken private during the 1980s. At the start of the decade, only 4 percent of the dollar value of mergers and acquisitions by public companies involved buyouts. By 1988, the peak year, that proportion had increased nearly tenfold. The purchase value of divisions and companies taken private during the decade exceeded $200 billion.
Corporate employment declined. Also reversing a trend, employment among major manufacturers sharply declined. While total manufacturing employment dipped modestly during the decade, that of Fortune 500 companies dropped by more than a fifth, from 15.9 million to 12.4 million. Employment at many large service firms declined as well.
The primary forms of turbulence shifted by the early 1990s. The market for hostile acquisitions and leveraged buyouts all but closed; a market for proxy struggles and shareholder proposals rapidly opened. Like earlier eras, the turmoil generated calls for change. Unlike the past, however, a new kind of alignment forced organizational change. Driving much of it was newfound shareholder muscle.
SHAREHOLDER POWER AND ECLIPSE OF THE MANAGERIAL REVOLUTION
In decades past, there had been a gradual-but seemingly inexorable-shift of control of large corporations from founding owners and shareholders to nonowning professional managers. This was the “managerial revolution,” identified by Adolph Berle and Gardiner Means in their 1932 landmark study of corporate governance. Dissatisfied shareholders were left with the sole option of selling. The “Wall Street Rule” of disinvesting ownership rather than challenging management had become a norm of necessity.
Later analysis confirmed what Berle and Means were witnessing. In 1900, only a fifth of the nation’s largest companies were management controlled. By 1970, only a fifth were still under ownership control. True, top management retained large numbers of shares, but its ownership stake had been reduced to a tiny fraction of the total. By the mid-1970s, the CEO of a large firm and his family typically held a mere 0.05 percent of the company’s stock.
Events of the past decade, however, began to stand this managerial revolution on its head. At root was a reconcentration of shareholding among far fewer hands. Institutional shareholding soared, as money poured into pension funds, insurance companies, bank trusts, and mutual funds. Institutions held 29 percent of the value of all corporate equities in 1980. But by decade’s end they held 46 percent.
The ten largest private and public pension funds, led by the
This concentration of holdings made the Wall Street rule less practical, leading discontented investors to construct a new rule. Impatient with results but unable to trade their large holding, Ca1PERS and other funds instead pressed for changes in company policies. Other investors quietly threw their voting weight behind the charge. Through early support for buyout funds, hostile tender offers and, later, shareholder resolutions and proxy battles, large investors created the “Institutional Investor Rule.” The essence of that rule: For companies lagging their industry, press for changes in policy. Failing that, press for changes in corporate governance, compensation, or even management.
Between 1985 and 1990, the number of dissident shareholder resolutions-primarily focused on rescinding poison pills, creating confidential voting for directors, and like measures-rose tenfold (see chart in this story’s illustration). By the 1990s, dissidence had grown from petty annoyances to ominous challenges: On average, poison pill recisions were attracting better than 40 percent of the shares voted.
In response, many large firms took the offensive by establishing creative defenses. A host of governance measures were introduced to ward off unwanted takeovers and undue shareholder pressures. The number of Fortune 500 firms with a poison pill doubled between 1985 and 1990 from one-third to nearly two-thirds. Threatened firms pressed for-and readily obtained-anti-takeover statutes from their home states. At the end of the decade, both the number of states with statutes and the annual number of new statutes themselves steeply increased (see chart).
RESTRUCTURING WITHIN THE FIRM
The newly erected corporate defenses provided an invaluable umbrella. With hostile raiders now held at bay, senior managers could turn to redesigning their firms from within. Quietly implemented, the transformations markedly changed cultures and organizations. Though changes were rarely made in explicit response to shareholder pressures, they were, nonetheless, often intended to bring company actions into accord with stockholder concerns.
The intensified focus on shareholder value has led many corporations to reemphasize consistent, integrated linkages among their major elements. Some firms tightened their focus on core businesses, shedding marginal divisions. Others disposed of office perquisites, extolling the virtues of a lean operation. Still others pushed more authority into the hands of those responsible for key operations. While the specific strategies for restructuring varied from firm to firm, a common, underlying objective was enhancement of the company’s worth to its owners.
Restructuring companies I have studied had eight features in common. They are:
- Authority to succeed and fail was pushed lower in the organization, giving managers and operating units greater operating autonomy.
- Information was more widely distributed among managers and more focused on shareholder value.
- Headquarters staffs were scaled back, in some cases to a fraction of the original.
- Managerial decisions were more explicitly judged on the basis of the anticipated value to stockholders.
- Top managers invested more time in managing and developing their successors.
- More stringent selection criteria were used in filling management positions.
- Management compensation was more contingent on performance, and performance measures were more tightly linked to shareholder value.
- Incentive and decision-making systems were designed to transform senior managers into de facto owners.
The changes in each of these areas were pronounced. Figures tracking changes in the makeup of senior management compensation underscore their magnitude. Between 1982 and 1990, base salary declined from 44 percent to 34 percent of total compensation, while long-term incentives rose from 16 percent to 33 percent (see chart). Moreover, the incentives were increasingly tied to enhanced dividends and share price.
The changes in these eight areas were also simultaneously enacted. Sometimes management compensation served as a vehicle for transformation, at other times management succession provided the leading edge. But the eight features were generally seen as a package, each requiring the others for effective reinforcement.
The alignment of shareholder and managerial interests isn’t yet complete. Toward that end, few devices so far offer longstanding, proven value. In testing new systems, managers have moved experimentally and incrementally. Occasional retreats, however, have served only to slow, not to deflect, the evolutionary thrust.
RESTRUCTURING BEYOND THE FIRM
Companies also have reorganized their ways of doing business outside the firm. Investor relations had long been the province of the chief financial officer, but true communication came only periodically, usually when special shareholder concerns arose. But now full-time, professional investor relations staffs are in place. These use technology to track, inform, and cultivate stockholder interest. Proven strategies for marketing company products are finding fresh applications in the marketing of company shares.
Until recently, the political actions of businesses had been directed at warming public opinion and cooling regulatory sentiment. Now companies are redirecting their energies to resisting shareholder challenges and pressing for state protection. Timeworn techniques for managing the political environment are being redeployed to manage proxy fights, resist dissident shareholders, and prevent forced disclosure.
Company directors had long felt little need to communicate directly with the shareholders who had elected them to serve. But these days, traditional channels of communication are being used toward that end as well. If directors had seemingly come to serve at the pleasure of the CEO, they are acquiring fresh respect for the wishes of the investor.
CONCLUSION: THE ALIGNED COMPANY
After a half century of nearly unchallenged supremacy, senior management at many corporations faced a revolt from one of the least likely sources: investors. Shareholder acquiescence had seemed a fixed quality of American enterprise.
But the ownership challenges of the 1980s and early 1990s shattered such conceptions. The surge of corporate mergers and acquisitions was not just another of the phases through which American businesses historically have passed. That surge was unique, and it presaged the owners’ revolt. The waning of takeovers at the close of the decade signaled more a shift in strategy than any stilling of the revolt. Stockholding was concentrated in fewer hands, and these larger hands became adept at bringing corporate management to heel through new means. Less radical but often more powerful, shareholder proposals, proxy fights, and quiet negotiations moved to the cutting edge.
As institutional investors gained ground-and occasionally even the upper hand-a new assessment logic emerged. This logic comprised a distinctive set of organizational principles. In effect, the company was being asked to measure up to different objectives. As a consequence, major companies moved to restructure their operations, in an effort to mollify, if not always satisfy, their critics. In the process, organizations were redesigned, better linking company structure to shareholder objectives.
This organizational alignment was marked by three general features. First, the change was systemic. This meant that the basic building blocks of the organization-decision-making procedures, manufacturing methods, information technologies, divisional boundaries, prevailing cultures, and human resource systems-were changed together.
Second, the change bundled new operating principles: Authority was devolved into operating business units; headquarters staffing was sharply curtailed; managerial succession received greater attention; and performance-based compensation was extended far down into the ranks. The home office began to resemble a holding company, insisting on financial objectives but declining to detail how to get there.
Third, managers sought more consistent support for their central objectives from constituent parts of a corporation.
Companies have long rewarded superior managerial performance. But until recently, they had not always sought to link that performance with shareholder desires. It was a textbook case of “rewarding A while hoping for B.”
But times have changed: Now A is being aligned more consistently with B.
Michael Useem is a professor of management at The Wharton School and a professor of sociology at the