Top Management, Company Directors and Corporate Controlwebuser.bus.umich.edu/gfdavis/Papers/davis_useem_02.pdfstrongly tied to share price may act as a sub-stitute for a vigilant board,

Theory and research on the relations amongtop managers, company directors, investors,and external contenders for corporate control –broadly, the field of corporate governance –experienced a remarkable flowering duringthe 1990s. Early work addressed the centralpuzzle raised by the widespread separation ofownership and control among large Americancorporations, namely, why would any sensibleperson – much less thousands or millions ofthem – invest their savings in businesses runby unaccountable professional managers? AsBerle and Means (1932) framed the problem,those who ran such ‘managerialist’ corpora-tions would pursue ‘prestige, power, or thegratification of professional zeal’ (1932: 122)in lieu of maximizing profits. Weak share-holders could do little to stop them. Yet gener-ations of individuals and financial institutionscontinued to invest in these firms. Why?

Answering this question led to the creationof a new theory of the firm that portrayed thepublic corporation as a ‘nexus of contracts.’ Inthe contractarian model, the managers of thecorporation were disciplined in their pursuit ofshareholder value by a phalanx of mecha-nisms, from the way they were compensated,to the composition of the board of directors, tothe external ‘market for corporate control.’Taken together, these mechanisms worked tovouchsafe shareholder interests even when

ownership was widely dispersed. Research inthis tradition flourished in the 1980s, astakeovers of under-performing firms becamecommon and restive institutional investorsmade their influence known. Studies focusedon assessing the effectiveness of devices suchas having boards numerically dominated byoutsiders, tying compensation to share price,or ensuring susceptibility to outside takeover(Walsh and Seward, 1990, provide a review).Following the dictates of financial economics,‘effectiveness’ was commonly measured viastock market reactions to various actions bytop management and/or the board. The resultsof these studies provided proof of whichactions and structures promoted shareholdervalue, and which promoted ‘managerialentrenchment’ of the sort feared by Berle andMeans.

Corporate governance research during the1990s expanded from a narrow focus on largecorporations to a broader concern with issuesof political economy. The transition of statesocialist societies to market economies, andthe spread of financial markets to emergingeconomies around the globe, infused thepuzzle of managerialism with enormous policyrelevance. What mechanisms could be put inplace to inspire the confidence of investors inbusinesses housed in distant and often unfa-miliar cultures? The place of financial markets

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in the project of globalization, as a means tochannel investment funds from wealthynations to emerging markets with limited localcapital, assured that corporate governancewould be a topic of intense interest for yearsto come.

The decade of the 1990s saw three develop-ments that moved the governance literaturebeyond the simple assessment of mechanismsin US firms. The first development was theexamination of the governance structure ofthe firm – the set of devices that evolve withinthe organization to guide managerial decision-making – as an ensemble. Rather than regard-ing any particular aspect of the firm’s structureas essential, researchers began to study themas complements or substitutes. Compensationstrongly tied to share price may act as a sub-stitute for a vigilant board, for instance, whilea vigilant board is not sufficient to make up fora poorly integrated top management team.Governance structures, in short, were configu-rations of interdependent elements (Beatty andZajac, 1994; Anderson et al., 1998).

The second development was the growth ofcomparative and historical governanceresearch, which highlighted the idiosyncrasyof the American system. American-style cor-porate governance, aimed at ‘solving’ theproblems created by the separation of owner-ship and control, is only one of several possi-ble governance systems and reflected apath-dependent developmental trajectory. Arange of alternatives is consistent with eco-nomic vibrancy, and the American system isnot the crown of creation (Roe, 1994). Indeed,even among wealthy economies with well-developed corporate sectors, corporations withseparated ownership and control were quiterare as late as the mid-1990s (LaPorta et al.,1999). Moreover, empirical findings on thedynamics of the American system often heldonly for specific times; for instance, thetakeover market of the 1980s, when hostile‘bust-ups’ were common, was much differentfrom takeovers of the 1990s, when friendlydeals were the norm (Davis and Robbins,1999). The nexus of contracts approachseemed increasingly like a theory of US cor-porate governance in the 1980s rather than ageneral theory of the firm.

The third development was the articulationof a reflexive stance on the theory of gover-nance. While agency theory can be viewed as

an empirical theory of the corporation, it canequally be considered a prescriptive theory,that is, not an explanation of what is but avision of what could or should be. Its influenceon public policy debates during the 1980s isevident in documents of the time (Davis andStout, 1992) and in the subsequent spread ofthe rhetoric of shareholder value. But it isimportant to recognize that corporate man-agers are quite skillful in their use of thisrhetoric (Useem, 1996). Declarations of sharebuy-backs are met with share price spikes,whether or not they are subsequently imple-mented (Zajac and Westphal, 1999). Theannouncement of a new compensation plan ismet by more positive reactions from the stockmarket when described as means of aligningmanagement with shareholder interests thanwhen the identical plan is described as ahuman resources tool; naturally, managersgravitate toward the sanctioned rhetoric(Westphal and Zajac, 1998). And even earnestattempts to meet the demands of shareholdersfor transparency and accountability, as pre-scribed by the agency theory of governance,often have unintended consequences. Firmsthat improve the quality of their disclosureattract more transient institutional investors,which in turn increases the volatility of theirshare prices – exactly the opposite of what wasanticipated (Bushee and Noe, 1999). In short,the dominance of the American systemdescribed by the agency theory of governancemay take the form more of rhetoric than real-ity, a point worth bearing in mind in the ongo-ing debates about the convergence of nationalsystems of corporate governance.

If the prototypical research question in thecorporate governance literature of the 1980swas ‘Is it better for shareholders for a corpora-tion’s board to have more “outside” direc-tors?’, the characteristic question of the early21st century is ‘What ensemble of institutionsbest situates a nation for economic growth in aglobal, post-industrial, information-based eco-nomy?’ Put another way, the vital questionsgoing forward are not about why some stalksof corn in a field grow taller than others, butabout the characteristics of soil and farmingtechniques that make corn in some fields growtaller than in others. Thus, research has cometo span levels of analysis from within theorganization to the nation-state and beyond.Behind this development is a recognition that

HANDBOOK OF STRATEGY AND MANAGEMENT234


what works for a particular firm is highlycontingent on its institutional surround, thatthe institutional surround in a particular nationreflects its history and level of economic devel-opment; and that ‘what works’ for a nationaleconomy depends in turn on its place in thelarger world system. Firms and economies, inshort, are embedded in larger social and insti-tutional structures that critically condition theirstructures and performance (Polanyi, 1957;Granovetter, 1985; Bebchuk and Roe, 1999).

We would like to be able to report that theearlier questions have now been answered

definitively. Much prior research relied onarchival data several steps removed from thephenomenon (for example, crudely classifyingdirectors as ‘insiders’ or ‘outsiders’ dependingon whether they were current employees of thefirm). Crude data led, unsurprisingly, to cruderesults (see Pettigrew, 1992 for a critique).Progress has certainly been made in movingbeyond simple dichotomies of directors asinside or outside. Pettigrew and McNulty (1995,1998), for instance, have done much to unpackthe processes and power dynamics of the board-room through gathering extensive qualitative

CORPORATE CONTROL 235

With and across societies

One capitalism or many?

Varieties of capitalismEconomic institutionalismDependency theoryWorld systems analysis

Within the corporation

Who are top managers and

company directors?

Top management teamsBoard compositionSocial origins of company leaders

Does top management

leadership make a difference?

Comparison of top management across companiesEvaluation of top management’s impact within companies

How do shareholders and

other stakeholders influence

the corporation?

Power and dependency theoriesStakeholder frameworksSocially-responsible business models

How do corporations shape

society?

Company impact on national political economiesPolitical influence of corporate elitesPerpetuation of stratification

Between the

corporation

and its

stakeholders

Figure 11.1 Research on top management, company directors and corporate control


data from directors on ‘critical incidents.’ Butan ‘embedded’ perspective makes clear thatthere is unlikely to be a generalized answer toquestions of corporate governance.

Moreover, global financial integration hasspurred major changes in corporate gover-nance regimes around the world, for better orworse. Policy in this area is guided to a greatdegree by research and theory, making it botha vibrant intellectual domain and a consequen-tial one. Law and economics scholars becomeFederal judges and treasury secretaries, well-known economists serve at the World Bankand IMF, and corporate directors take shortcourses at business schools to learn their trade.Corporate governance is an area where, at alllevels of analysis, good research can have animpact.

Figure 11.1 maps out the terrain and locatesresearch on top management, company direc-tors, and corporate control in the larger acade-mic discourse. Our aim in this chapter is toassay developments in this area at the begin-ning of the 21st century and outline promisingareas for future research. We must, of neces-sity, be highly selective: research on top man-agement and corporate governance spansmultiple disciplines, from accounting andfinance, to management and strategy, to socio-logy and political science. As research hasproliferated, so have reviews (see, for instance,Blair, 1995; Shleifer and Vishny, 1997;Zingales, 1997). Even definitions of the objectof study vary widely: Shleifer and Vishny statethat ‘Corporate governance deals with theways in which suppliers of finance to corpora-tions assure themselves of getting a returnon their investment’ (1997: 737), while Blair(1995: 3) argues that corporate governanceimplicates ‘the whole set of legal, cultural, andinstitutional arrangements that determine whatpublicly traded corporations can do, who con-trols them, how that control is exercised, andhow the risks and returns from the activitiesthey undertake are allocated.’ We take thebroadest definition, and as such implicate awide range of disciplines.

As our embedded framing would suggest,we review research across levels of analysis.We start by outlining and critiquing the con-tractarian model of corporate governance,which has dominated the academic discoursein law and economics as well as the policydebates around economic development. Within

the firm, we then ask, who are top managersand corporate directors, and does their leader-ship make a difference? These questions con-nect to studies in diverse disciplines, includingthe sociology of elites, strategy research on topmanagement teams, the study of organizationaldemography, and research across fields onleadership. Relevant chapters elsewhere in thishandbook include Thomas and Porac’s chapteron ‘Strategy and cognition;’ Chakravarthy andWhite’s ‘Strategy Process’; and McGrath’s‘Entrepreneurship, small firms and wealth cre-ation’. Between the firm and its stakeholders,we ask, how do shareholders and stakeholdersinfluence the corporation, and how do corpo-rations in turn shape society? These questionslink to stakeholder models of the corporation,research on power and dependence in organi-zation theory, studies of business and society,socially responsible business, the study ofpolitical economy, power elites, and inequal-ity. Whetten, Rands and Godfrey’s chapter‘What are the responsibilities of business tosociety’, elsewhere in this handbook, reviewsadditional relevant work. Finally, at the levelof the nation-state, we ask, is there evidence ofconvergence in management practice and cor-porate governance around the world? Thequestion of societal convergence or diver-gence has been an animating question ineconomics – particularly in the work ofinstitutionalists such as Douglass North – inthe political science literature on ‘varieties ofcapitalism,’ in sociological theories of moderni-zation, dependency, and world systems, andin the popular literature on globalization.Interested readers are encouraged to readKogut’s chapter in this handbook on ‘Strategy,management, and globalization.’

ONE CAPITALISM OR MANY?

Around the world, large corporations are themost visible institutions of modern capitalism.A few thousand corporations produce the bulkof the world’s economic output and employ asignificant part of the world’s labor force.What forces determine who wields corporatepower and how it is used? The answer is bestframed in terms of institutions – ‘the humanlydevised constraints that structure political, eco-nomic and social interaction’ (North, 1991: 97).



A nation’s system of corporate governancecan be seen as an institutional matrix (North,1990) that structures the relations among own-ers, boards, and top managers, and determinesthe goals pursued by the corporation. Thenature of this institutional matrix is one of theprincipal determinants of the economic vital-ity of a society. By hypothesis, getting theinstitutions of corporate governance rightmeans ensuring that those who run corpora-tions make decisions that lead to superiornational economic performance. This meansmaking sure that top managers and their super-visory board are appropriately responsive tosignals from the product markets and the capi-tal markets (Gordon, 1997). Thus, corporategovernance can be seen as the institutionalmatrix that links market signals to the deci-sions of corporate managers.

According to Douglass North (1990: 6),‘The central puzzle of human history is toaccount for the widely divergent paths of his-torical change. How have societies diverged?What accounts for their widely disparate [eco-nomic] performance characteristics?’ Acceptedtheory in economics predicts that throughtrade, national economies would converge ininstitutions and thus performance, as inferiorinstitutions were weeded out and politicians inweaker economies adopted the policies ofstronger ones. Yet economies are immenselydiverse in their institutional structures and per-formance, leading to an enormous gapbetween rich and poor nations (see Firebaugh,1999 for a recent assessment). Two questionsarise from this observation. First, given thatlarge corporations are disproportionatelyresponsible for the economic wellbeing of asociety, is there a best model of corporate gov-ernance? That is, is there an institutionalmatrix that reliably encourages corporatemanagers to make choices leading to eco-nomic growth for a society? Second, can aninstitutional matrix be emulated? The struc-tures of particular organizations may becopied with more or less fidelity, but the insti-tutions of corporate governance, such as asystem of corporate and securities law, operatelargely at a national level and thus entail politi-cal choices. Is it possible for a nation to movefrom one system of corporate governance toanother?

The first question – what is the rightmodel? – is deceptively simple. It should be a

straightforward matter to rank economies bytheir economic vitality, select the top per-former, and abstract the crucial elements of itsinstitutional matrix. The experience of the1990s suggested to many commentators thatthe American model of investor capitalismwas the obvious winner (see, Soros’s [1998]critical account and Friedman’s [1999] affir-mative account of free market triumphalism).The American economy experienced thelongest expansion in its history, generatingmillions of new jobs, countless new businessstarts, and a long stock market boom. Thiscontrasted sharply with its rich-country rivals,particularly Japan, as well as with the emerg-ing markets that entered deep slumps in thelate 1990s. Moreover, the American modelappeared especially amenable to a world ofborderless capital, in which geography was oflittle concern in the process of matchinginvestment flows to business opportunities. Inprinciple, even a nation with little indigenoussavings could achieve prosperity by adopting asystem of American-style investor capitalismand opening itself to foreign investment. In thewords of Treasury secretary Larry Summers,‘Financial markets don’t just oil the wheels ofeconomic growth – they are the wheels’ (WallStreet Journal, 8 December 1997).

The institutional matrix that makes up theAmerican system of corporate governance iscodified in the contractarian approach to thefirm, also known as agency theory. Agencytheory was developed primarily within finan-cial economics to describe the various mecha-nisms that ‘solve’ the agency problems createdby the separation of ownership and control, byensuring managerial devotion to increasingthe company’s share price:

Managers’ wealth is tied to share price throughnumerous devices, including outright owner-ship, stock options, and compensation keyed tostock performance that align executive andshareholder interests. Because share pricedoes not necessarily reflect detailed insideinformation about how well the firm is beingmanaged, firms have adopted other devices tomonitor managers, including shareholder-elected boards of directors that ratify importantdecisions (Fama and Jensen, 1983), concen-trated and thus powerful ownership blocks forfirms whose performance is difficult to monitor(Demsetz and Lehn, 1985), efficient managerial



labor markets that ensure that managers arepaid over the long run according to their con-tribution (Fama, 1980), and high debt that com-pels managers to meet regular payment hurdlesand optimal returns to capital markets (Jensen,1986). If all these mechanisms fail and badmanagement drives the firm’s share price downfar enough, superior managers will acquirecontrol of the firm, fire incumbent managers,and run the firm better themselves; they arerewarded for their trouble by their personalgain from the recovery of firm value, whileshareholders are compensated by the premiumpaid. Thus, capital markets ensure that thestructure of the nexus of contracts that survivesis the one that minimizes agency costs andmaximizes shareholder wealth. Managers whosought to sell company shares that, say, made ittoo difficult for shareholders to remove them ifthey did a poor job or paid themselves toomuch would find few buyers. Thus, managershave built-in incentives to propose organiza-tional structures that limit their own discretion(Davis and Thompson, 1994: 144–5).

Each element of the theory – from manage-ment compensation and board composition tothe structure of ownership and dynamics oftakeovers – has received extensive researchattention as it applies to large US corporations,particularly during the 1980s (see virtually anyissue of the Journal of Financial Economicspublished during this period). If a cross-national adoption of American corporate gov-ernance institutions proved desirable, agencytheory provides the blueprint: in the words ofone recent review, ‘the Anglo-American gov-ernance system, born of the contractarian par-adigm, is the most flexible and effectivesystem available. Indeed, notwithstanding itsidiosyncratic historical origins and its limita-tions, it is clearly emerging as the world’sstandard’ (Bradley et al., 1999: 8).

But questions of institutional transfer arepremature. Those with long memories recallthat at the beginning of the 1990s, it was theJapanese and German systems that served asthe world’s models, and pundits advocated asystem of bank-centered relationship capital-ism to cure the social disruption caused byAmerica’s myopic shareholder orientation.The virtues of ‘Toyotaism’ and the remarkablesuccess of East Asian economies emulatingJapanese business organization led the business

press to herald the emergence of American-stylekeiretsu. ‘Unfettered Anglo-Saxon capital-ism is finding it difficult to cope with thepresent’ and thus American corporationsshould be encouraged to form keiretsu-likegroups, which ‘insulate management fromshort-term stock-market pressures without cre-ating incompetent managers’ (Thurow, 1992:19, 281). In short, the most productiveeconomies got that way because their systemsof corporate governance, sometimes calledcommunitarian or relationship capitalism,muffled the signals from impatient financialmarkets and encouraged cooperation amongfirms and their suppliers – exactly the oppositeof the American system of investor capitalism.

Determining the best system of governance –investor capitalism, ‘crony capitalism,’ orsomething else – thus turns out to be far fromtrivial. Indeed, choosing which measure of per-formance to use and which time period to focuson yields rather divergent results – while the USeconomy expanded continuously from 1992through 1998, expanding the time horizon to afull decade creates a rather different picture.From 1989 to 1998, both Germany and Japanexperienced substantially higher productivitygrowth than the US, Germany displayed ahigher per capita growth in GDP, and Japanrecorded lower average unemployment (TheEconomist, 10 April 1999). Locating the effec-tive ingredient in a national economy’s institu-tional matrix may be a hopeless endeavor andthe safest course may be to call it a draw amongthe three major contenders (cf. Roe, 1994).

Even the pleasing simplicity of an abstract‘governance model’ may imply more coher-ence than is warranted. The American systemis often referred to as the Anglo-Americansystem because key elements are held to becommon between the US and the UnitedKingdom. Yet even these two are rather diver-gent on several dimensions, which suggestsstrong limits on the extent to which institutionscan be adopted across cultures. In the UK, forinstance, the positions of chairman of theboard and the chief executive officer are heldby different persons on more than four out offive boards among the largest 500 firms; theshared understanding is that ‘the CEO runs thecompany and the Chair runs the board’(Pettigrew and McNulty, 1998). In contrast,three quarters of Fortune 500 firms in 1999were led by CEOs who also held the chair’s job,



and seasoned directors are virtually unanimousin viewing the forced separation of the twojobs as undesirable because of the ambiguityit creates about ‘who’s in charge’ (Neiva,1995). On another contrasting front, 22%of the typical Fortune 1000 firm’s directorsare ‘insiders’ (executives of the firm), whilethe comparable figure in the UK is roughly50% These facts are attributed to culturaldifferences in the boardrooms of the twonations, and neither nation shows much signof budging in the other direction (Davis,1998). Thus, even between the two namedpractitioners of Anglo-American corporategovernance, there are sharp divergences onsuch basic matters as the organization andcomposition of the board. There are also,notably, sharp differences in economic perfor-mance, favoring the US. Adopting Anglo-American governance practices is evidentlynot sufficient to ensure superior economic per-formance for an economy, even supposing onecould determine what these practices were.

These cultural differences notwithstanding,the attractions are undeniable in emulatingAmerican corporate governance for firms seek-ing outside investment. The number of non-USfirms listed on the New York Stock Exchangeincreased from 96 in 1990 to 379 in 1998, whilethe value of US equity investment abroadincrease more than six-fold during the sameperiod (Useem, 1998; New York StockExchange, 1999; Federal Reserve, 1999).Effectively borderless financial markets are per-haps the strongest force in encouraging theadoption of American corporate governance andits valorization of ‘transparency’ and ‘account-ability.’ But while a particular firm may come toadopt an American model of governance – justas many manufacturers sought to adopt theToyota model of production in the 1980s and1990s – a system of governance, as an institu-tional matrix embedded in a particular culture, isfar less prone to such wholesale change (cf.Coffee, 1998). Species may adapt, but it is farmore difficult for an entire ecosystem to do so.

WHO ARE TOP MANAGERS AND

COMPANY DIRECTORS?

Though market capitalism can epitomize imper-sonality – and some company headquarters

seem as remote as Kafka’s castle – they arenonetheless intensely personal at the top. Ahandful of individuals make the definingdecisions, whether to launch a new product,enter a promising region, or resist a tenderoffer. It is they who set the rules and fix theprocedures that come to constitute the imper-sonal bureaucracy.

Top management is the catch phrase forthose who work at the apex, and companiesoften define their ‘top’ as no more than theseven or eight most senior officers. Their colorphotos adorn the annual report’s early pages.They speak for the company to inquisitivejournalists and skeptical analysts. They are the‘they’ when employees grumble about nastywork or shareholders gripe of shortchangedexpectations.

To much of the world beyond the companywalls and capital markets, however, top man-agement is personified almost solely by thechief executive. Readers of the Americanbusiness press know that Jack Welch ‘runs’General Electric, Michael Eisner rules WaltDisney Company, and Warren Buffett isBerkshire Hathaway. Attentive Japanese recog-nize that Fujio Cho drives Toyota and Germansthat Jurgen Schrempp steers DaimlerChrysler.It is enough to know the commanding general,it seems, to anticipate the strategy of attack.The upper apex of top management is whatreally counts.

Academic researchers had long been drawnto the same pinnacle of the pyramid, partly onthe conceptual premise that the chief executiveis the manager who matters, and partly on thepragmatic ground that little is publicly knownabout anybody except the CEO. We have thusbenefited from a long accumulation of work ontheir family histories, educational pedigrees,and political identities, and we know as a resultthat their origins are diverse, credentials splen-did, and instincts Republican. More contem-porarily, we have learned much about theirtangled relations with directors and investorsas well. To know the CEO’s personal rise andboard ties is to anticipate much of the firm’sstrategic intent and performance promise. Theyare also a good predictor of the CEO’s ownfortunes – an elite MBA degree acceleratesmovement to the top, a prestigious backgroundattracts outside directorships, and a handpickedboard enhances pay and perquisites (Belliveauet al., 1996; Useem and Karabel, 1986).



The conceptual and pragmatic underpinningsfor shinning the light solely on the CEO, how-ever, have eroded in recent years, as compa-nies redefined their operations and researchersreconceived their methods. A central thrust ofcompany restructuring during the past twodecades has been to transform the chief execu-tive’s office into the office of the executive. Atmany companies, CEOs have fashioned teamsamong their top officers that meet frequentlyand resolve jointly, their vertical control giv-ing way to lateral leadership. Henry Schachtserved as chief executive of Lucent Techno-logies from 1995 to 1997, and upon takingoffice, he devoted his first six months to build-ing a shared strategy and culture among his top14 officers. Unless his top managers were allworking from the same script, he believed, thespin-off from AT&T would not succeed. Hecertainly would not be capable of making itsucceed on his own.

Observers and consultants during the 1990sconsequently came to extol the pragmaticvirtues of ‘top management teams.’ If wellformed, executive teams could assure prosper-ity; if poorly led, they could spell disaster.Predictably, stock analysts and professionalinvestors frequently came to appraise not onlythe capabilities of the chief but also the lieu-tenants before they recommend stock or buyshares (Hambrick et al., 1998; Katzenbach,1997; Katzenbach and Smith, 1992).

Similarly, academic researchers expandedtheir field of view from the chief executive tothe entire upper echelon. They applied freshstrategies, ranging from personal interviews todirect observation and internet surveys, toacquire data on top managers other than thechief executive who now matter far more tocompany performance and stock analysts – ifstill not to the editors of Who’s Who. A host ofstudies have subsequently confirmed what manyexecutives already appreciated – a better predic-tor of a company’s performance than the chiefexecutive’s capability is the quality of the teamthat now runs the show. To pinnacle analysis hasbeen added top team appraisal (Finkelstein andHambrick, 1996; Useem, 1995).

In conducting such studies, researchers havealso discovered that the devil is in the detail,with a top team’s composition and cultureaffecting company actions and results in waysthat do not neatly fit into tidy frameworks.Some research results are straight-forward. A

study of 54 US multinational corporations, forexample, found when top managers broughtmore foreign experience to the executive suite,their companies moved more production off-shore and booked more sales abroad.

But other inquiries yielded more complexresults, as seen in a study of 32 US airlinecompanies in the wake of industry deregulationin 1979. The researchers focused on competi-tive moves such as price-cutting, advertisingcampaigns, and fresh routes. They assessedthe extent to which the companies’ top execu-tives varied in their educational backgrounds(engineering, economics, business, law), func-tional specialization (finance, marketing, oper-ations), and years with the company, and theydiscovered that the airlines with top manage-ment teams diverse in these areas were morelikely to take competitive actions but slower tomake their moves. Overall, they found thatcompanies with greater diversity at the topbuilt greater market share and generatedgreater operating profits (Sambharya, 1996;Hambrick et al., 1996).

Yet even this widening of research attentionbeyond the chief executive has not broadenedenough. Many companies have expanded theconcept of top management to include one,two, or even three hundred senior managerswhose decisions have significant bearing onfirm performance. Prior to its merger withTravelers in 1998, for instance, Citibank haddesignated the bank’s senior-most 300 execu-tives as its ‘corporate leverage population,’and its 300 most vital jobs as its ‘corporateleverage positions.’ For Citibank, its future layin the hands of 300 managers, not 3. Orconsider how top management is definedat ARAMARK Corporation, a $6.5-billionmanaged-services firm with 150,000 employ-ees worldwide. Its chief executive, JosephNeubauer, formed an Executive LeadershipCouncil in the 1990s comprising the top 150executives in the company, including businessunit presidents, staff vice presidents, top gen-eral managers, and corporate departmentheads. The Council charts company strategyand exchanges best practices, and it is, in thewords of Neubauer, the firm’s ‘leadershipteam.’ Its members are ‘free to make their owndecisions,’ says the CEO, but also ‘as leaders,’they’re ‘all accountable’ for company results.

Top management, then, has expanded in theminds of company managers and, to lesser



extent, academic researchers, from the boss tothe boss’s team to the boss’s court. Presidingover them are the directors, those elected rep-resentatives who in law must serve as fiducia-ries of the investor electorate but in fact havevirtually no contact with their electoral base.Their working contact is almost entirely con-fined to the top management team, and in thenexus of that relationship – the ‘commandingheights’ of the market economy – are fash-ioned the strategies and decisions that drive thecompany’s future and determine the country’sprosperity (Yergin and Stanislaw, 1998).

If companies make semiconductors and con-crete much the same way the world around, theyorganize their directors in almost as many waysare their national economies. Boards of largepublicly-traded companies in the US range insize from 4 to 35 directors (at least among theFortune 1000), averaging 11 members. Boardsaverage 12 directors in Italy, 11 in France, and9 in UK, with standard deviations of 3 to 4directors. But cross-national comparability insize is about as far as it goes. American boardstend to include only two or three insiders, whileJapanese boards rarely include even two out-siders. German and Dutch governance isbuilt around a two-tier governance structure,employees holding half of the upper tier seats.British and Swiss governance is designedaround a single-tier, management-dominatedstructure. Some systems give formal voice tolabor, others none – German law requires thatlabor representatives serve on the board, whileFrench law places labor observers in the board-room. American law mandates nothing, butsome boards have added a labor leader on theirown (Charkham, 1994; Charkham and Simpson,1999; Chew, 1997; Conyon and Peck, 1998;Franks, 1997; Hunter, 1998).

Such variety of national practices may welldiminish for two reasons. First, as equity mar-kets internationalize, with companies seekingcapital from all corners of the globe, investorspredictably prefer relatively consistent directormodels that they believe will optimize share-holder value and performance transparency.Their mental models of what’s right may notindeed by right, but that is beside the point.Consider the preference expressed by someinstitutional investors in the US for a boardchair who is not a sitting executive, believingthat separation improves monitoring. Under pre-ssure from investors in the wake of a $6 billion

loss in 1992, for instance, General Motors didsplit the roles, installing an outside chairman –John G. Smale, retired chief executive ofProcter & Gamble – to breathe down the neckof new chief executive Jack Smith. Whateverthe separatist penchant and however well it mayhave served General Motors, research revealsthat such a division creates no advantage forcompany performance. But for some investors,persuasive preconceptions still prevail overresearch facts, and they press for common prac-tices around the world (Baliga et al., 1996).

Another example can be seen in US investorpreference for non-executive directors, believ-ing the board’s capacity for vigorous monitor-ing of top management to be a direct function ofits independence from top management. TheCalifornia Public Employees’ RetirementSystem advocates that ‘a substantial majority ofthe board consists of directors who are inde-pendent.’ The Council of Institutional Investorsavows that ‘at least two-thirds of a corpora-tion’s directors should be independent.’ TIAA-CREF prefers that ‘the board should becomposed of a substantial majority of indepen-dent directors.’ Yet recent studies yield ambi-guous support for the premise. Yes, independentdirectors often behave in more shareholder-friendly ways, but they also may be less likelyto dismiss under-performing executives andless prone to render useful strategic guidance(California Public Employees’ RetirementSystem, 1999; Council of Institutional Inves-tors, 1999; Millstein and MacAvoy, 1998;TIAA-CREF, 1999; Ocasio, 1994; Westphal,1999; Bhagat and Black, 1999).

The diversity in directorship practices islikely to diminish, however, for a second, morefactual reason. Certain practices do engenderbetter performance, regardless of the setting,and as companies increasingly compete world-wide for customers and investors, they arelikely to adopt what indeed does prove best. Acase in point here is the number of directors onthe board. Research on team success suggeststhat bigger is not better when boards exceed 15or 20 members. When the number of directorsclimbs far above middle range, the engagementof each diminishes, and so too does their capa-city to work in unison. Study of the boards of450 large US industrial firms in 1984–91reveals that, net of company size, manufacturingsector, and inside ownership, companies withsmaller boards displayed: stronger incentives



for their chief executive, greater likelihood ofdismissing an under-performing CEO, andlarger market share and superior financial per-formance. In parallel study, the same is foundto prevail among large companies in Denmark,France, Italy, Netherlands, and UK (Yermack,1996; Conyon and Peck, 1998).

It is not surprising, then, to see companiesworldwide migrating toward smaller boards ina search of improved performance. In their1999 report to the stockholders, Sony’s chiefexecutive Norio Ohga and co-CEO NobuyukiIdei, wrote that they had launched a new ‘cor-porate reorganization’ to ‘maximize shareholdervalue.’ A central feature of their reorganiza-tion is to improve their directors’ ‘monitoringability,’ and, to that end, Sony reduced its ros-ter of 35 directors to just 9. Japan Airlinesmoved parallel fashion. The company hadreported losses during three of its past fiveyears, and its largest investor, Eitaro Itoyama(holding 3.4% of its shares), had announced acampaign to oust top management to ‘saveJAL.’ To improve its directors’ effectivenessand, hopefully, company performance, the air-line shrank its board from 28 directors to 15and required that they stand for election yearlyrather than bi-annually (Institutional Share-holder Services, 1999; Sony, 1999).

Directors in principle protect owner inter-ests, direct company strategy, and select topmanagement. In practice, they had concen-trated more on strategy and selection and lesson owner interests. But the rising power ofinvestors has made for greater director focuson creating value and less coziness with topmanagement. American and British directors,following the ‘Anglo-Saxon’ model, arealready more focused on value than most. Butdirectors in other economies can be expectedto slowly gravitate toward the mantra of share-holder supremacy as well.

HOW DO SHAREHOLDERS AND OTHER

STAKEHOLDERS INFLUENCE THE

CORPORATION?

The Uncommon Problemof the Separation of Ownership

and Control

Imagine that the owners of a public corpora-tion had a simple goal: to maximize the value

of their investment at minimum risk. The moststraightforward measure of the achievement ofthis goal is growth in the price of the firm’sshares, and effective managers are those thatsuccessfully endeavor to maximize shareprice. Governance systems vary widely inthe means by which owners can influencemanagers – owners might have a direct say incorporate strategy and in selecting members ofthe top management team, they might delegatethese functions to a board but ensure that com-pensation and other incentives are alignedwith share price maximization, or they mightrely on mechanisms such as takeovers to ensuremanagerial devotion to share price. Corpora-tions where management was not held account-able for achieving the corporation’s goalswould attract little outside support: as Gilson(1996: 333) puts it, ‘any successful [gover-nance] system must have the means to replacepoorly performing managers.’ This is theessence of the ‘agency problem’ identified byBerle and Means (1932) in managerialist cor-porations with dispersed ownership.

The problem of managerialism, however,turns out to be of surprisingly little relevanceoutside the US and the UK. In virtually everyother economy, even the largest businesses aretypically owned by controlling shareholders.A study of the largest 20 corporations in 27 ofthe world’s richest economies found that ‘con-trolling shareholders – usually the State orfamilies – are present in most large companies’(La Porta et al., 1999: 473), while anothersurvey found that ‘a large majority of listedcompanies from Continental European coun-tries have a dominating outside shareholder orinvestment group’ (Goergen and Renneboog,1998: 2). While minority shareholders mayhave little direct influence on the managementof such firms, controlling shareholders pre-sumably act to ensure the pursuit of share-holder value since it is their own. Outside thewealthiest tier of nations, stock markets are ofrelatively less significance, and thus manageri-alist corporations are unimportant. The influ-ences of owners on managers are direct andunproblematic.

The general idiosyncrasy of the Americansystem received surprisingly little attentionfrom corporate governance scholars before thepublication of Mark Roe’s book StrongManagers, Weak Owners in 1994. Prior to this,‘the corporate governance systems of other



nations were largely ignored because theAmerican system was though to represent theevolutionary pinnacle of corporate gover-nance. Other systems, with different institu-tional characteristics, were either furtherbehind the Darwinian path, or at evolutionarydead-ends; neither laggards nor Neanderthalscompelled significant academic attention’(Gilson, 1996: 331).

In the late 1990s, however, a flourishingresearch interest focused on documenting andexplaining the diversity of systems of gover-nance. New systems of corporate and securi-ties laws were installed in transitional EastEuropean economies to facilitate the processof privatization (with varied success – seeSpicer and Kogut, 1999), and enthusiasm forfinancial markets as a tool for development inemerging markets created a practical need forunderstanding of cross-national variation ininstitutional structure (see the World Bank’scorporate governance agenda at www.world-b a n k . o r g / h t m l / f p d / p r i v a t e s e c t o r / c g /index.htm). Nations vary in the extent of legalprotection for shareholders and the quality ofenforcement, and the strength of legal protec-tion for shareholders is positively related tothe degree of ownership dispersion. In otherwords, managerialist corporations are mostcommon in countries with strong investor pro-tections, while concentrated ownership is mostcommon when investor protection is weak (LaPorta et al., 1998). Stock markets are larger,and there are more public corporations perperson, when investor protections are stronger(La Portaet al., 1997).

The single biggest factor distinguishingnations with strong legal protections forinvestors, and thus large capital markets andmore dispersed ownership, was the origin of thelegal system. Countries whose commercial lawderived from a common law tradition, whichincludes most English-speaking countries aswell as former British colonies, have strongershareholder protections than countries withcivil or ‘code’ law (La Porta and Lopez-de-Silanes, 1998). Absent strong legal protectionsagainst the types of self-aggrandizing managerscontemplated by Berle and Means, and sensiblepeople would avoid investing in companieswith dispersed ownership because they wouldfear the loss of their investment. Concentratedownership allows control of management with-out relying on uncertain legal enforcement.

The pole for market-centered (as opposed torelationship-based) capitalism is clearly theUnited States. In contrast to corporationsthroughout the rest of the world, large Americancorporations have relatively dispersed owner-ship. Roughly three-fourths of the 100 largestUS corporations lack even a single ownershipblock of 10% or more. Of the 25 largest com-panies in 1999, the largest single shareholderaveraged only 4% of the holdings, while thecomparable percentages are 11 in Japan, 18 inGermany, and 19 in France (Brancato, 1999).

The dispersion of ownership in the USeffectively rules out the direct control avail-able in firms where a single family or bankowns most of the shares. Dispersed sharehold-ers therefore delegate control to a board ofdirectors that they elect to act as their agents inchoosing and supervising the top managementteam. Control by minority shareholders gener-ally extends only as far as buying and sellingshares, and voting for directors and other mat-ters on the annual proxy. Minority sharehold-ers almost never have a say in the selection oftop managers, or even in who ends up on theboard. Indeed, by some accounts inattention isthe only sensible course of action for dispersedshareholders (‘rational ignorance’), as the costof being well informed about the governanceof the firm is not outweighed by the marginalbenefit of improved corporate performancethat might result from informed voting oractivism (Fama, 1980). But while in othercontexts this collective action problem wouldresult in management unaccountable to share-holders, investors in US corporations can resteasy because of the well-developed set ofinstitutions that have arisen to ensure shareprice maximization without their active partici-pation (see Easterbrook and Fischel, 1991).

Takeovers

The most essential mechanism for enforcingattention to share price is the takeover marketor ‘market for corporate control.’ By hypothesis,a poorly-run corporation will suffer a low stockmarket valuation, which creates an opportu-nity for outsiders with better managementskills to buy the firm at a premium from share-holders, oust the top management team, andrehabilitate the firm themselves, thus increas-ing its value (Manne, 1965). This provides an



economic safety net for shareholders and anopportunity for outsiders who detect underval-ued firms. Moreover, it provides a mechanismto discipline top managers that fail to serveshareholder interests, as they generally end upunemployed following a takeover. In the con-tractarian model, the market for corporate con-trol is the visible hand of Darwinian selection,weeding out badly run firms and protectingshareholders from bad management. Internalcontrol mechanisms may fail, as boards arecompromised by ‘cronyism,’ and thus the hos-tile takeover – as an objective, market-basedmechanism – is an essential weapon in thearmory of the contractarian system (Jensen,1993). US public policy in the 1980s made itconsiderably easier for outsiders to mount hos-tile takeover bids, and the result was a massivewave of takeovers in which nearly one-third ofthe largest publicly-traded manufacturersfaced takeover bids (Davis and Stout, 1992).

Reams have been written about the UStakeover wave of the 1980s (see Blair, 1993)but the high points are easily summarized. Thetypical target had a low stock market valuationrelative to its accounting or book value, as onewould predict based on the contractarianmodel (Manne, 1965; Marris, 1964), and thesource of this low valuation was often exces-sive diversification by conglomerate firms(Davis et al., 1994). Conglomerates were typi-cally purchased with the intention of bustingthem up into more focused components, whichwere sold to buyers in related industries(Bhagat et al., 1990), while non-targets restruc-tured to achieve industrial focus and avoidunwanted takeover (Davis et al., 1994). In theUS, takeovers are regulated both at the federaland state level, and by the early 1990s moststates had passed legislation to make takeoversattempted without the consent of the target’sboard of directors extremely difficult. Thus,hostile takeovers virtually disappeared in theUS after 1989.

Two results of the 1980s hostile takeoverwave stand out. The first is that the manufac-turing sector overall ended the decade muchmore focused than when it began, and thetrend toward within-firm focus continuedunabated through the mid-1990s (Davis andRobbins, 1999). With a few notable excep-tions, such as General Electric, the industrialconglomerate would appear to be a thing ofthe past in the US, in spite of its prevalence

elsewhere in the world. The second result is adecisive shift in the rhetoric of managementtoward ‘shareholder value,’ to the virtual exclu-sion of other conceptions of corporate purpose.This is realized in efforts at managing investorrelations (Useem, 1996), in the kind of spinthat management puts on practices such ascompensation plans (Westphal and Zajac,1998), and in more tangible actions such asacquisition and divestiture strategies. US manu-facturers in the 1990s eschewed diversifica-tion in favor of ‘strategic’ (horizontal) mergersand acquisitions, resulting in behemoths in oil,defense, autos, and other sectors that wouldhave been unthinkable in previous decades.Notably, this shift toward a monomaniacalfocus on shareholder value occurred in spite ofthe fact that – in stark contrast to the 1980s –hostile takeovers had virtually disappeared inthe 1990s, and takeover targets were no longer‘underperforming’ firms but rather those thatwere strategically attractive to acquirers(Davis and Robbins, 1999). Evidently, thehostile takeover is less essential to investorcapitalism than had previously been thought.

Shareholder Activism

Hostile takeovers are a rather blunt instrumentfor transferring corporate control, and themessage they send is not especially fine-grained. But short of takeover, the channels ofshareholder influence are surprisingly limitedin the US (see Davis and Thompson, 1994).The formal means of shareholder voice isthrough proxy voting at the annual meeting.Shareholders vote on who serves on the boardof directors, which accounting firm audits thefirm’s books, whether to approve certain typesof executive compensation plans, and othersignificant matters such as mergers, changes inthe corporate charter, or changes in the state ofincorporation. Almost without exception,these votes consist of approving (or not) pro-posals put forth by the current board ofdirectors–competing director candidates, orcompeting proposals, are extremely rare. Theprimary means of direct shareholder voice isthrough shareholder proposals. Any share-holder owning a non-trivial stake in the corpo-ration can submit a proposal relevant to thecorporation’s business to be included in theproxy statement and voted on by shareholders.



But the board may exclude proposals relatingto the ‘ordinary business’ of the corporation, aterm of art defined fairly broadly by the Secu-rities and Exchange Commission, the regula-tory body responsible for governing the proxyprocess.

The most famous and controversial case ofthe 1990s involved Cracker Barrel OldCountry Stores, Inc., a restaurant chain head-quartered in Tennessee. In 1991, the corpora-tion announced a policy that it would notemploy individuals ‘whose sexual preferencesfail to demonstrate normal heterosexual values’and fired more than a dozen gay employees.Subsequent public protests led the company torescind the policy, but it did not explicitlyinclude gays in its anti-discrimination policy,and gays continued to be fired. An institutionalinvestor, the New York City Employees’Retirement System (NYCERS), submitted aproxy proposal in 1991 calling for CrackerBarrel to add explicit prohibitions againstemployment discrimination based on sexualpreference to its employment policy state-ment. Cracker Barrel sought to exclude theproposal under the ordinary business excep-tion, which had previously been considered tocover employment matters, and in October1992 the SEC issued a ‘no-action letter’ (indi-cating that it would not take action againstCracker Barrel for excluding the proposalfrom its proxy materials). The SEC’s positionprevailed in court in 1994, and thus allemployment-based matters were put beyondthe scope of shareholder voice. The businesscase for NYCERS’ position seemed clear:employment discrimination may subject thecorporation to protests, tarnished reputation,lost business, and class action lawsuits, to thedetriment of shareholder value; yet the SECheld even such highly consequential employ-ment matters to be ordinary business by defi-nition (McCann, 1998). In May 1998, the SECeventually reversed its position on CrackerBarrel to allow ‘employment-related propos-als that raise sufficiently significant socialpolicy issues’ (cited in Ayotte, 1999). InOctober of that year, after a year-long battle,NYCERS’ proposal appeared on CrackerBarrel’s proxy statement, receiving 5.5 millionvotes (shares) in favor and 26.5 million votesagainst.

What is perhaps surprising is that even ifNYCERS’ proposal had won a solid majority,

it would have had no binding force on CrackerBarrel’s board. Shareholder proposals areadvisory (‘precatory’) only and cannot be usedto compel management or the board to takeany specific actions (see Davis andThompson, 1994, for a discussion of the limitsof shareholder voice). In other words, oncethey have delegated authority to the board ofdirectors, dispersed shareholders have almostno legal standing to intervene further on mat-ters of strategy and management. Why, then,do activist shareholders bother? In the US,the most prominent corporate governanceactivists are public pension funds run by politi-cal appointees, and thus some skeptics seetheir motivation as political rather than eco-nomic, and their qualifications as wanting(Useem et al., 1993). One seasoned directorsaid of activist pension fund officials, ‘Theseguys are not part of the business community.They’re politicians’ (Neiva, 1996). In its 1994proxy statement, Cracker Barrel managementsaid of NYCERS: ‘Your management is con-vinced that the proponents of Proposal 3 areattempting to circumvent the legislativeprocess by using corporate proxies as a forumto promote a ‘social policy’ concerning gayand lesbian sexual preferences, thereby forc-ing your Company to do what Congress hasdeclined to force companies to do. Your man-agement is also convinced that the proponentsof this proposal are more interested in gay andlesbian concerns as a social issue than in anyeconomic effect these concerns may have onyour Company.’

Yet research suggests that activist pensionfunds are motivated by financial concerns, notpolitics. Funds that pursue a buy-and-holdindexing strategy (which benefit from a gene-ral rise in the value of their portfolios) tend tofield generic proposals for the purpose of pro-moting shareholder-oriented governance gene-rally, while actively-managed funds (whichcan realize shorter-term trading gains) tend tofocus on firm-specific governance proposals,consistent with the argument that the econom-ically appropriate style of activism varies withthe fund’s investment style (Del Guercio andHawkins, 1998). Proposals sponsored by pen-sion funds (as opposed to individuals or reli-gious groups) get higher favorable votes onaverage, occasionally achieving a majorityvote (Gillan and Starks, 1998). And whilethere is little evidence that shareholder



activism has an immediate positive impact onthe share price of target firms, targeted firmsdo respond with significantly more gover-nance changes than non-targets (Del Guercioand Hawkins, 1998). Thus, one survey of theliterature on shareholder activism concludesthat activism has had modest effects on gover-nance structures but negligible impact on earn-ings and share price (Karpoff, 1998). It ispossible that activism has a more diffuseimpact by raising the visibility of directorswho had previously toiled in anonymity; asone director put it, ‘If you kill one wildebeest,then all the other wildebeests will start runninga little faster’ (Neiva, 1996). Perhaps activismserves to raise the general awareness of share-holder value and shareholder-oriented gover-nance practices. It is hard not to conclude,however, that this would be pushing throughan open door.

Financial Analysts

If takeovers are too blunt an instrument andshareholder activism too diffuse, then finan-cial analysts may serve as a more intermediateform of influence on behalf of shareholders.Analysts investigate companies in order torender judgments on their prospects (to berealized in future earnings) and thus to esti-mate their appropriate valuation. Analysts areoften allowed privileged access to corporateexecutives and facilities and are in a positionto give strategic and governance advicedirectly to senior managers, something rarelyafforded to the firm’s own shareholders(Useem, 1996). In principle, the rewards go tothe most accurate analysts, giving them incen-tives to act as corporate watchdogs. In prac-tice, however, analysts are rarely dispassionateobservers: those that work for firms doingbusiness with a corporation they follow givesystematically more positive evaluations thanthose that work for other firms, and analystsare discouraged from giving negative evalua-tions of potential clients of their employer(Hayward and Boeker, 1998). As New YorkTimes financial writer Gretchen Morgensternput it, ‘What analysts are selling increasinglytoday is not the ability to plumb a company’sbusiness and uncover investment gems orscams but rather the ability to make investorsbuy the stocks they follow’ (New York Times,

July 18, 1999). ‘Sell’ recommendations aretherefore almost non-existent. Moreover, onaverage analysts are not especially accurate:according to Malkiel (1996: 169), ‘Securityanalysts have enormous difficulty in perform-ing their basic function of forecasting earningsprospects for the companies they follow.…Financial forecasting appears to be a sciencethat makes astrology respectable.’ In short,while analysts may be seen as a means to pro-mote shareholder interests, this function fre-quently goes unrealized.

Although takeovers, shareholder activism,and financial analysts are fixtures on theAmerican corporate landscape, and are uniquelysuited to managerialist corporate governance, inthe 1990s they spread beyond the borders of theUS and the UK. In continental Europe, 1999was a watershed year for hostile takeovers. Inthe first three months of the year, 13 hostile bidswere unveiled, compared to 55 in the prior nineyears, and the value of the proposed deals wasfar greater than the value of all prior hostiledeals in the history of Europe (Economist, 17April 1999). In Italy, Olivetti made a successfulbid for the far lager Telecom Italia, the formerItalian state telephone company and the sixth-largest telecom organization in the world. InFrance, Banque Nationale de Paris (BNP)simultaneously bid for banking rivals SocieteGenerale and Paribas, while oil giant TotalFinabid for Elf Aquitaine. Remarkably, Paribas,which was advising Total on its bid, had execu-tives on the boards of both Total and Elf;Societe Generale’s chair was on the board ofTotal, BNP’s chair was on the board of Elf;Elf’s chair was on the board of BNP, whileTotal’s chair was a BNP director. Even thedense ties of the French financial elite were notsufficient to withstand the economic attractionsof these deals. Due to much more stringent legalrestrictions, it remains to be seen whether hos-tile takeovers will catch on outside Europe.

Shareholder activism, on the other hand, hasachieved a global reach, partly through theactions of American institutional investors andpartly through indigenous governance activists.The California Public Employees’ RetirementSystem (CalPERS), a pension fund for govern-ment employees in California, promulgatedcorporate governance standards for Britain,France, Germany and Japan, and formedan alliance with Hermes (the pension fundmanager for British Post Office and British



Telecom staff) to increase their mutual heft inissues of international corporate governance(CalPERS document can be found at www.calpers-governance.org/principles/interna-tional/). Given the vast growth of US institu-tional investment in equities outside the US,American-style investor activism is poised togo global. Already, investor pressures are cred-ited with forcing the ousters of Cie. De Suez’schair in 1995 and Olivetti’s chair in 1996(Useem, 1998). In South Korea, Jang Ha Sungformed the People’s Solidarity for ParticipatoryDemocracy to press for corporate governancereform, and while he met with little successprior to the Asian financial crisis of 1997, hehas subsequently become ‘the darling of theinternational crowd’ and has formed successfulalliances with foreign institutional investors topress for governance changes (Economist, 27March 1999). In France, Colette Neuvilleformed the Association for the Defense ofMinority Shareholders to push for corporategovernance reform and to strengthen investorprotections in takeovers (Business Week, 18September 1995). Both non-local and indige-nous investors can draw on the principles andtactics of shareholder activism in the US. Giventhe relatively weak minority shareholder pro-tections outside common law countries, how-ever, it is likely that any such activism will havemodest impact at best (La Porta et al., 1998).

DO TOP MANAGERS REALLY MAKE

A DIFFERENCE?

If shareholders are increasingly insistent thatboard directors require top managers to deliversteadily rising returns on their investments,investor activism is premised on a criticalassumption that top managers can make thedifference. While the premise may seem intu-itively obvious to those inhabiting this world,it is far from self-evident to those who study it.Observers diverge from the assumption of influ-ential executives in two opposing directions,one viewing top managers as all-powerful,others seeing them as all but powerless. JayLorsch had examined company boards withboth views in mind, and his book title wellcaptures the bi-polar thinking about the cloutof company executives as well: Pawns orPotentates (1989).

Gaetano Mosca, Vilfredo Pareto, andkindred ‘elite’ theorists early articulated theall-powerful view, but C. Wright Mills cap-tured it best in his classic work, The PowerElite (1956). Company executives, in his acidaccount, had joined with government officialsand military commanders in an unholy alliancethat later observers, including US presidentDwight D. Eisenhower, would later dub the‘military–industrial complex’. Seen from thisparapet, top management and their allies exer-cise commanding control over the companyand the country. In E. Digby Baltzell’s cri-tique, The Protestant Establishment (1987)and G. William Domhoff’s rendering, WhoRules America (1967), they have even come toconstitute a self-conscious class, favoringdescent over deed. Others discern comparablecustoms in British business and elsewhere(Bottomore, 1993; Scott, 1990, 1997). To theextent that top management is indeed all-powerful, shareholders and directors possess asilver bullet for righting whatever has gonewrong: install new management.

For the community of management schol-ars, Jeffrey Pfeffer (1978, 1981) well articu-lated the opposite, all-powerless view with thecontention that market and organizational con-straints so tied top management’s hands that itwas much the captive, not a maker, of its ownhistory. Production technologies and competi-tive frays in this view are far more determin-ing of company results than the facelessexecutives who sit in their suites. Structuresmatter, personalities don’t. It counts little whoserves in top management, and, by extension,on the board. Managers and directors are con-trolling and caste-conscious in Mills’ andDomhoff ’s critique, while they are bothpowerless and classless in Pfeffer’s hands. Iftop management is quite as powerless as thelatter imagery suggest, investors seeking newmanagement are surely wasting their time.

Though probably less often than universitydeans, company executives do complain of aseeming helplessness at times. Yet almostanybody in personal contact with top managersreports just the opposite. Direct witnessestypically describe instead a commanding pres-ence of their top management, an organiza-tional dominance. It is the senior executiveswho shape the vision and mobilize the ranks,and it is they who make the differencebetween success and failure (Tichy, 1997;



Charan and Tichy, 1998). Also consistent withthe concept of the prevailing executive is evi-dence from the flourishing executive searchindustry, where companies pay hundreds ofheadhunting firms millions of dollars to findthe right men and women for the executivesuite. They are engaged, in the phrasing of awidely circulated assessment by McKinsey &Co. (1998), in a ‘war for talent.’ It wouldhardly be deemed warfare or worth millions ifsenior managers made so little differencewhen they arrived in office.

Investors themselves think otherwise aswell. When companies announce executivesuccession, money managers and stock ana-lysts are quick to place a price on the head ofthe newly arrived, and, depending on the per-sonality, billions can be added to or subtractedfrom the company’s capitalization. On theaddition side, consider the appointment ofChristopher Steffen as the new chief financialofficer of Eastman Kodak in 1993. Steffen hadbeen hired to help turn around a companywhose earnings and stock price had been lan-guishing. He was characterized as the ‘white-knight chief financial officer who could savestodgy Eastman Kodak.’ Investors applaudedhis hiring. The company’s stockprice soared inthe days that followed, adding more than $3billion to the company’s value. In an immedi-ate clash with chief executive Kay Whitmore,however, Steffen resigned just 90 days later.Investors dumped Kodak shares with vigor,driving the company’s value down the nextday by $1.7 billion, further affirming his worthin the eyes of discerning investors. It wouldseem that just a single individual with the righttalent could augment a company’s value bybillions in days (Useem, 1996).

On the subtraction side, consider the selec-tion of John Walter as the new chief operatingofficer and CEO-apparent of AT&T in 1996.In the five trading days that followed, in aperiod when little else was transpiring in themarket, AT&T’s value dropped by $6 billion.One business writer had hailed ChristopherSteffen as the ‘three-billion-dollar man.’ JohnWalter might comparably be dubbed the ‘six-billion-dollar disappointment’ (Rigdon, 1993).

The importance that investors and directorsattribute to top management for growing theirfortunes can also be seen in the ultimate pun-ishment for failure to do so: dismissal.Whether the US, Japan, or Germany, the

likelihood of a CEO’s exit in the wake of astock free fall is increased by as much as half.And investors are often the engines behind theturnover. Study of Japanese companies stunnedby a sharp reversal of fortune, for example,reveals that those whose top ten shareholderscontrol a major fraction of the firm’s stock aremore often than others dismiss the presidentand even bring in new directors (Kaplan,1994a, 1997; Kang and Shivdasani, 1997).

To obtain a metric for the longer-term valuethat a chief executive brings to a company, weturn to several studies that have examinedcompany results several years after a chiefexecutive has left office, not just several days.The successor brings a distinctive blend of tal-ents to the office, and if those talents make adifference, the firm’s performance should bedifferent as well. Net of confounding factorssuch as the company’s sector and economy’smomentum, investigators do find that com-pany performance does vary with executivepersonality. Yet compared to the firm’s struc-ture and identify, the chief executive’s contri-bution can seem modest. After all, if Bill Gatesretired as chief executive at Microsoft or JackWelch at General Electric, these companiesare such product juggernauts that their succes-sors are sure to look good for some years tocome. But in absolute terms, the studies report,performance can rise or fall by as much as 10to 15% over several years after the CEO’sdeparture depending upon the specific succes-sor. To put that in perspective, think of a newmanager of a professional baseball team thathad won 80 games and lost 80 games duringthe past season. If the new manager’s limitedtalents lead the team to win 15% fewer gamesnext season, the team’s win-loss record woulddrop from .500 to .425, and the coach willbecome the heel. If instead the new manager’sexcellent talents would yield 15% more wins,the team’s record rises to .575, and coach willbe the hero (Lieberson and O’Connor, 1972;Thomas, 1988).

As strong as they are, these results may stillunderestimate the difference that top manage-ment makes now compared to the past. In astudy of 48 large manufacturing firms amongthe Fortune 500, the researchers asked twoimmediate subordinates of the chief execu-tives of the extent to which their boss, theCEO: was a visionary: showed strong confi-dence in self and others, : communicated high



performance expectations and standards,personally exemplified the firm’s vision,values, and standards, and demonstrated per-sonal sacrifice, determination, persistence, andcourage. The investigators also assessed theextent to which the firms faced environmentsthat were dynamic, risky, and uncertain.Taking into account a company’s size, sector,and other factors, they found that these execu-tive capabilities made a significant differencein the firm’s net profit margins among compa-nies that faced highly uncertain environments.When the firms were not so challenged, how-ever, the chief executive’s qualities had farless of an impact on performance (Waldmanet al., 1999).

Top management matters more, it seems,when it is less clear what path the companyshould pursue. Given the intensification ofglobal competition and technological changein many markets, leadership is thus likely tomake more of a difference in the future than init has in the past. We remember wartime primeministers and presidents better than peacetimeleaders, and the same is likely to be true forcompany executives. Thus, it not surprisingthat directors are observed to replace failingexecutives more quickly now than in yearspast (Ocasio, 1994). Similarly, directors areobserved to more generously reward success-ful executives than in the past. For each addi-tional $1,000 added to a company’s value in1980, directors on average provided their chiefexecutive an extra $2.51. By 1990, the differ-ence in their payments had risen to $3.64, andby 1994 to $5.29. Put differently, in 1980 theboards of companies ranked at the 90th per-centile in performance gave their CEOs $1.4million more than did boards whose firmsranked at the 10th percentile (in 1994 dollars).But by 1990, the boards had expanded that gapto $5.3 million, and by 1994 to $9.2 million(Hall and Liebman, 1998).

The specific leadership or teamwork capa-bilities that do account for the varying perfor-mance among top managers is beyond thescope of this chapter. But broadly speaking,leadership within the company is a criticalcomponent. Unless the troops are mobilizedand their mission understood, they areunlikely to deliver the value top managementwants. But so too is leadership out and up,building confidence and understanding amongthe money managers and stock analysts who can

turn against a poorly appreciated or understoodcompany as quixotically as they did againstthe Asian nations when Thailand devalued itscurrency in July 1997.

Skillful top management work with profes-sional investors is thus becoming more of avirtue since money managers and stock ana-lysts have become less tolerant of languishingresults and are better able to demand stellarperformance. Moreover, globally mindedinvestors are now comparing opportunitiesworldwide, and top managements and theirperformance are judged less against theirdomestic neighbors and more against the bestanywhere. To assure investor favor andassuage doubt, companies and directors aretherefore increasingly likely to stress execu-tive ability to deliver the strategy story to thestock analysts and, ultimately, share value tothe money managers. Research confirms thatwhen chief executives present their strategiesto groups of stock analysts, institutional inter-est and stockholding does indeed rise (Byrdet al., 1993). While some top managementswill be tempted to create defenses againstshareholder pressures, more are likely to bedrawn to affirmative measures, includingimproved disclosure of information andstronger governing boards (Useem, 1998).

HOW DO CORPORATIONS SHAPE

SOCIETY?

At stake in discussions of corporate gover-nance and top management are questions ofcorporate power and accountability, and ulti-mately of the welfare of society. Corporationsare legal fictions, created by systems of law toserve social ends for consumers, workers, andinvestors. Systems of corporate governanceare, in essence, genres – styles of thinkingabout the corporation, its purposes, to whom itis accountable. There is a long-standing antin-omy between the social entity model of thecorporation and the property or contractarianconception (Allen, 1992). The entity concep-tion, central to organization theory, sees cor-porations as ‘containing’ members, for whomthe corporations provide various goods (forexample, income security, social identity) aspart of a social contract. In the most expansiveversion of this view, corporations directly



shape almost every aspect of society. Accordingto Perrow (1991), ‘the appearance of largeorganizations in the United States makes organi-zations the key phenomenon of our time, andthus politics, social class, economics, technol-ogy, religion, the family, and even social psy-chology take on the character of dependentvariables.… [O]rganizations are the key tosociety because large organizations haveabsorbed society.’ The social entity concep-tion of the corporation is associated with com-munitarian or relationship-based capitalism, inwhich law and custom accord the corporationobligations beyond shareholder wealth maxi-mization (Thurow, 1992; Bradley et al., 1999;Blair and Stout, 1999).

In contrast, the contractarian model takesthe notion of the corporation as a legal fictionto its logical extreme: it is nothing more than anexus of contracts among freely contractingindividuals, with no further ‘entitivity.’ Thisyields a substantially more circumscribedview of how the corporation shapes society,namely, through its impact on economicgrowth. Although the contractarian modeldenies the existence of the corporation as asocial entity with obligations to any con-stituencies other than shareholders, the mostsophisticated theoretical rationale for the con-tractarian model is framed in terms of socialwelfare. In stylized form, it runs as follows.Firms maximize social welfare by maximizingprofits. The pursuit of profit leads firms tooffer goods or services that the public will vol-untarily pay for (thus benefiting consumers),and creating those products provides employ-ment (thus benefiting workers). A firm’s shareprice is the best measure of its sustainableprofitability into the future, according to thewell-documented efficient market hypothesis(according to Jensen [1988] ‘no proposition inany of the sciences is better documented’ thanthe efficient market hypothesis). Thus, as ameasure of corporate performance, share priceis ideal, and devices that encourage corporatemanagers to maximize share price therebyachieve a trifecta of benefiting consumers,workers, and shareholders simultaneously.These benefits may be unintentionally under-mined when firms pursue other ends in addi-tion to shareholder value (as advocated in thesocial entity conception), because serving two(or more) masters may lead in effect to servingnone (Friedman, 1970). As ‘residua claimants’,

shareholders are the appropriate constituencyfor the corporation to serve because maximi-zing their interests automatically serves theinterests of the corporation’s other constituen-cies. Shareholders have the best incentives tomonitor and, if necessary, replace manage-ment that goes astray. As Gilson (1981) mem-orably put it, ‘if the statute did not provide forshareholders, we would have to invent them’.

Note that this case does not rest on anythingsacred or mystical about shareholders and theirproperty rights. Compare the apologia pro-vided by Al Dunlap, former CEO of Sunbeamfamous for his expansive approach to layoffs:‘The shareholders own the company. They aremy number-one constituency, because theytake all the risk. If the company goes bust, theylose their life’s savings. I can’t give them theirmoney back.’ Of course, actual ownership pat-terns are quite different from this ‘widows andorphans’ portrayal: most large US firms areowned primarily by highly diversified institu-tional investors, and individuals who focustheir investments in one particular firm aretypically employees of that firm, whose inter-ests are more complex. In the sophisticatedversion of contractarianism, shareholders areas much a legal fiction as the corporationitself. It just happens that they are, by hypoth-esis, part of a social welfare-maximizing genreof corporate governance. As Allen (1992) putsit, this conception of the corporation ‘is notpremised on the conclusion that shareholdersdo “own” the corporation in any ultimatesense, only on the view that it can be better forall of us if we act as if they do’.

As a corporate genre, the contractarianapproach is as distinctive to the US asFaulkner and Hemingway. The emphasis onvoluntarism and individual liberty, and thesuspicion of viewing the corporation as asocial entity with obligations to constituenciesother than shareholders, are recurrent themesin American law and economics (Allen, 1992;Bradley et al., 1999). According to Roe(1994), these individualist themes coupledwith a populist mistrust of concentrated eco-nomic and political power to produce the man-agerialist corporation as we know it. Roe’s(1994) study told a path-dependent tale of theAmerican system in which the obvious ‘solu-tion’ to the problem of managerialism – con-centrated ownership in the hands of financialintermediaries – was repeatedly prevented by



legislation driven by fears of concentratedeconomic power. At each point when corpo-rate control threatened to become concentratedin a few hands, populist political pressuresprevented such centralization. Thus, Americancorporate governance evolved like an eco-system in an idiosyncratic climate, getting byas best it could, given its constraints. Alongthe way a number of means to ensure corpo-rate attentiveness to share price evolved,including most notably the takeover mecha-nism. In many cases, these were second-bestsolutions that arose because the first-best wasruled out; the end product is the institutionalequivalent of a Rube Goldberg invention: itain’t pretty, but it gets the job done – in thisinstance a riveting on shareholder value.

The histories of present-day institutionslend themselves to alternative interpretations,even within a general evolutionary frame-work. In contrast to Roe, Coffee (1998) arguesfrom the recent evidence that the managerial-ist corporations characteristic of the Americansystem are the product of legal success. Ratherthan seeing political pressures as preventingconcentrated ownership, he sees strong legalprotections as allowing managerialism and allthe benefits of a system of arms’ length invest-ment without the intervention of powerfulintermediaries. Along similar lines, Modiglianiand Perotti (1998) portray arms’ length finan-cing (via securities markets) and network-based relationship capitalism as functionalalternatives–if reliable legal enforcement isavailable, then a managerialist system cen-tered on financial markets is possible. In con-trast, the absence of reliable legal enforcementprompts the formation of ‘noncontractualenforcement mechanisms’– often realized inbank-centered networks. In other words, it isrelationship-based systems that are the poorcousins of the more arms’ length system, andnot the other way around.

The value of having a dominant corporateowner with direct control over management,as opposed to dispersed (and presumably pow-erless) shareholders that delegate authority toa board, has been an object of faith since Berleand Means wrote their famous book. Butresearch in the 1990s, echoing the populistsentiments described by Roe (1994), hasinstead emphasized the social and economiccosts of concentrated economic power. Afterthe East Asian financial crisis of the late

1990s, systems of relationship capitalism, inwhich dominant owners (banks or families)are tied together into social networks, came tobe called ‘crony capitalism,’ reflecting thechanging evaluations of personalistic vsarms’ length business ties. Dominant share-holders may encourage profit maximizing, butthey may instead use the corporation to pursuetheir own ends, which need not contribute togeneral economic welfare. Managers infamily-controlled firms are difficult for out-side shareholders to oust, no matter how badtheir performance, and the impact can extendto dozens of firms through control pyramids(Morck et al., 1998). While the ventures ofwell-connected cronies may be lavishlyfunded, promising business ideas generated bythose outside the network are denied access tocapital and die on the vine. ‘The opacity andcollusive practices that sustain a relationship-based system entrench incumbents at theexpense of potential new entrants,’ renderingthe economic system resistant to reform(Rajan and Zingales, 1999: 14). Moreover,economies characterized by concentratedwealth in the hands of ‘old money’ familiesgrow more slowly than economies withoutsuch families, again suggesting a politicalentrenchment that limits economic adaptabil-ity (Morck et al., 1998).

Recent research in financial economics thussuggests that social welfare is enhanced by astrong independent state and undermined byconcentrated inherited wealth and power. Theimplications are ironic. Whereas Berle andMeans feared that dispersed ownership wouldcreate a class of managers with control overlarge corporations but little accountability toshareholders, the late 20th century assessmentsuggests that concentrated ownership leadsto cronyism, political favoritism, and weakeconomic growth. The irony runs deep.‘Managerialist’ firms in the US pursue share-holder value with little regard for otherstakeholders, while firms with concentratedownership elsewhere in the world cannot helpbut attend to other stakeholders. Yet the explicitignoring of other stakeholders may ultimatelyyield more favorable benefits for them.

The tradeoffs in social welfare of treatingthe corporation as a social entity vs as a nexus-of-contracts are thus quite subtle. The difficultyof displacing managers that are unsatisfactoryto investors is seen as a critical failing of



relationship capitalism because it rendersfirms too lethargic in the face of change (seeGordon, 1997). Without the prospect of out-side takeover or other mechanisms that focusdecision making on shareholder value, corpo-rations are too slow to exit low-growth indus-tries by closing plants and laying off employees(Jensen, 1993). When Krupp-Hoesch Groupmade a hostile takeover bid for steel rivalThyssen in March 1997, Thyssen workersfearful of the inevitable job losses mounted ademonstration at Krupp headquarters, peltingKrupp’s CEO with eggs and tomatoes. Kruppwas convinced by local political leaders to sus-pend the bid and enter into friendly negotia-tions. As the two firms sought to hammer outa joint venture agreement, 25,000 workersmassed at Deutsche Bank headquarters inFrankfurt to protest the bank’s role in thetakeover – Deutsche Bank was helping tofinance Krupp’s bid, but it also had a repre-sentative on the Thyssen board – and the final,friendly agreement resulted in considerablyfewer lost jobs at Thyssen. One person’s‘industrial lethargy’ is another person’s jobsecurity.

In the US, by contrast, layoffs are so com-mon as to arouse little comment, and it is dif-ficult to imagine mass protests in response totakeovers. (The US Department of Labor esti-mates that 40% of the American labor forcechanges jobs in any given year.) It is hard toimagine mass protests against dispersed share-holders, and public debate over the socialobligations of the corporation has virtuallydisappeared. Indeed, those corporations thattry to serve the ends of stakeholders other thanshareholders find it difficult to do so. In the1919 case of Dodge vs Ford Motor Co., theMichigan Supreme Court laid down a founda-tional view of the purpose of the corporation ina contractarian world:

There should be no confusion of the dutieswhich Mr. Ford conceives that he and thestockholders owe to the general public and theduties that he and his co-directors owe to pro-tecting minority shareholders [i.e., the Dodgebrothers]. A business corporation is organizedand carried on primarily for the profit of thestockholders. The powers of the directors areto be employed for that end. The discretion ofdirectors is to be exercised in the choice ofmeans to attain that end, and does not extend to

a change in the end itself, to the reduction ofprofits, or to the nondistribution of profitsamong stockholders in order to devote them toother purposes.

Indeed, as we have seen from our discussionof the Cracker Barrel case, the board of anAmerican corporation would not necessarilybe required to attend to other constituencieseven if their own shareholders wanted it!(Blair and Stout [1999: 251] make a com-pelling case that the discretion of the board ofdirectors over the use of corporate resources is‘virtually absolute’ under American corporatelaw, and this discretion can be used to imple-ment something like a social entity model.They recognize, however, that custom amonglaw and economics scholars – if not the lawitself – treats the shareholders as the sole own-ers and legitimate ‘stakeholders’ of the corpo-ration, and this notion has achieved the statusof doxology among American corporate man-agers in the 1990s [Davis and Robbins, 1999].)

The beneficial effects of the shareholder-oriented corporation on society thus rest on thestylized argument at the beginning of thissection – that corporations serve consumers,workers, and shareholders best when theyfocus exclusively on maximizing share price.

IS A WORLDWIDE MODEL FOR TOP

MANAGEMENT AND CORPORATE

GOVERNANCE EMERGING?

We have described corporate governance as aninstitutional matrix that structures the relationsamong owners, boards, and top managers anddetermines the goals pursued by the corpora-tion. The corporation is a legal fiction, and dif-ferent systems of governance representdifferent genres, with relationship capitalism(in which the corporation is treated as a socialentity) and investor capitalism (in which thecorporation is a nexus-of-contracts) as the twomajor distinct sub-types. Can both types sur-vive, or will global trade and investment flowsprompt a Darwinian struggle in which onesystem drives out the other, leading to globalconvergence?

The question of societal convergence – isit possible, likely, or desirable – has beenmulled over by sociologists (Guillen, 1999)



and economists (North, 1990) for decades. It isfair to say that the majority opinion, if not theconsensus, is that convergence has notoccurred in the past and is unlikely to occur inthe future. But the institutions of corporategovernance, and the means of organizing topmanagement, are considerably more circum-scribed in scope. While the flow of tradeacross national borders may not induce con-vergence (North, 1990), the flow of globalcapital dwarfs that of trade and can have farmore important impacts for corporate organi-zation. The economic benefits of opening aneconomy to international investment, particu-larly through financial markets, are great, atleast in theory – it can increase the availabilityand reduce the cost of capital for both new andestablished businesses, thereby boosting eco-nomic growth overall. But these benefits offinancial markets require corporate gover-nance practices that reassure arms’ lengthinvestors that they will get a return. The US inparticular is seen as having evolved a well-articulated system of institutions for ensuringthat shareholders can make arms’ lengthinvestments in corporations with a reasonabledegree of confidence that management will doits job as well as possible. Given the manifestbenefits of the contractarian model, somecommentators see movement toward thissystem as ‘inexorable. . . . The nature of thismovement is unarguably in the Anglo-American direction rather than the other wayaround’ (Bradley et al., 1999: 80). Others seea global spread of American-style manage-ment as extremely unlikely, and the purportedbenefits as ephemeral (Guillen, 1999). Inshort, there is no sign of convergence in thescholarly literature on convergence.

Before answering the question, it is worthasking it well. Those examining convergenceoften focus on very different unit of analysis.At the national level, impediments to conver-gence on American-style corporate gover-nance institutions are imposing. Common law,which is an inheritance of many former Britishcolonies and relatively few other nations, isespecially shareholder-friendly, civil law,which characterizes most nations in the world,is not (La Porta et al., 1998). The quality oflegal enforcement also varies widely bynation. Entrenched and politically powerfuleconomic interests are unlikely to abandon thebasis of their economic dominance easily

(Morck et al., 1998). Moreover, relationshipcapitalism centered around powerful financialinstitutions has clear advantages over financialmarket-based in facilitating rapid economicdevelopment; a well-trained governmentbureaucracy guiding investment flows throughaffiliated banks can create an infrastructure ofbasic industry quite rapidly (Evans, 1995).Thus, the most sophisticated accounts of thelink between national systems of corporategovernance and economic vitality do notassume that there is one best way, but that thebest system is contingent on a nation’s level ofeconomic development. In an exemplary workof this sort, Carlin and Mayer (1998) find that‘there is a positive relation in the less devel-oped countries between activity in bankfinanced industries and the bank orientation ofthe countries and a negative relation betweenconcentration of ownership and activity inhigh skill and external financed industries. Inmore developed countries, the relations areprecisely reversed.’ Thus, forcing an Americansystem of governance on less-developednations could be disastrous. On the other hand,it suggests that nations that have moved from‘emerging’ to ‘developed’ may benefit byaffecting a shift from relationship capitalismto investor capitalism, however unlikely thismay be in practice (Rajan and Zingales, 1999).

The picture shifts when one considers notnations but firms. For the largest global corpo-rations with the greatest need for capital, suchas those listing on the New York StockExchange, movement toward the Americanstyle appears almost inevitable, just as adop-tion of the Toyota system of manufacturingseemed inevitable for the largest manufacturers(see Useem, 1998). In his thoughtful discus-sion of the convergence debate, Coffee (1998)argues that formal convergence is unlikely but‘functional convergence’ is plausible. Hisargument runs as follows. Firms with higherstock market valuations have advantages inacquiring other firms around the globe and thusare more likely to survive global industry con-solidations. As large global corporations seekthe benefits of higher market valuations by list-ing on American stock exchanges, they therebybecome subject to US legal standards. Thismoots the issues raised by La Porta et al.(1998): firms, in effect, choose their legalregime, and nations need not seek to become‘more American’ for their indigenous firms to



gain the benefits of American-style governance.The outcome of this process could be a worldin which the largest global corporations ‘lookAmerican,’ while nations retain their distinctnational institutions of governance for smallerdomestic firms.

In short, the most plausible scenario is for aglobal standard of governance to emerge forthe largest global corporations, while nationalvariation persists both in institutions ofgovernance and in the practices of small- andmedium-sized domestic corporations. Theimpediments for nations to move substantiallytoward the American system are almost cer-tainly too large to be readily overcome, even ifsuch a transition were desirable: manynational distinctions will inevitably persist.

THE ROAD AHEAD

Top company managers have always drawnacademic and applied interest, if for no otherreason than they can seem larger than life atthose pivotal moments when a company’sownership and its executive careers hang inbalance. The loss of control of RJR Nabiscoby chief executive F. Ross Johnson to lever-age-buyout king Henry Kravis in 1987 pro-vided ample material for a best-selling bookand subsequent film (Burroughs and Helyar,1991). The two CEOs – Gerald M. Levin andStephen M. Case – who merged AmericaOnline and Time Warner in 2000 drew enor-mous media interest. Corporate directors haveattracted less attention, partly because theyavoid the limelight but also because few out-siders believed directors brought much to thetable, vanquished as they were by Berle andMeans’ managerial revolution. For under-standing company strategy, production tech-nologies, and market dynamics, neither seniorexecutives nor company directors could beviewed as fertile ground for theory building.

With the rise of professional investors andtheir subjugation of national boundaries, how-ever, those who occupy the executive suite andthose who put them there are drawing far moreresearch and policy attention, and justifiablyso. In a bygone era when markets were moresteady and predictable, when airline andtelephone executives confidently knew whatto expect next year, the identity of top

management mattered little. When shareholderswere far smaller and decidedly quieter, whenairline and telephone directors comfortablyenjoyed inconsequential board meetings, thecomposition of the governing body matteredlittle either. During the past decade, however,all of this has changed in the US and UK, withother economies close behind. As shareholdershave sought to reclaim authority over what theyowned, they have brought top managementand company directors back in. Companystrategy and financial results can no longer beunderstood without understanding the capabi-lities and organization of those most responsi-ble for delivering them.

Research investigators have risen to theoccasion. A solid flow of studies has sought todiscern and dissect the dynamic relations thatnow characterize the world of investors, direc-tors, and managers. The market is no longerviewed as so impersonal, the company nolonger so isolated. Economic and financialdecisions are embedded in a complex networkof working relations among money managers,stock analysts, company directors, seniorexecutives, and state regulators. Given theright combination of features, that lattice canyield high investment returns and robustnational growth. Given the wrong amalgam, itcan lead instead to self-dealing, frozen form,and economic stagnation.

The road ahead will thus depend on howwell researchers understand what governancearrangements and leadership styles work wellboth within national settings and across cul-tural divides, and on the extent that top man-agers, company directors, and active investorslearn and apply what is best. Five key areasdeserve concerted research attention if we areto know what works and what does not, andwhich theories are useful and which are not:

Boards and directors: What does the deci-sion process inside the boardroom look like?What are the sources of power and influenceof inside and outside directors? How are thedecision process and director influence contin-gent on the ‘institutional matrix’ in which aboard is embedded? (Example: Pettigrew andMcNulty, 1998a, b.)

Comparative governance: What reallyaccounts for the astonishing and remarkablypersistent diversity in the national systems ofcorporate governance? How do national insti-tutions, cultures, and social structures shape



and constrain the evolution of corporategovernance systems? (Examples: Kogut andWalker, 1999; Bebchuk and Roe, 1999.)

Financial globalization: If the surge of cross-border investing is a major driver of corporatechange, what can we expect of financial flowsand their regulation in the years ahead? How isthe evolving organization of investors andcompanies likely to affect the internationaliza-tion of capital flows? What aspects of corpo-rate governance will affect the attractivenessof a national economy for internationalinvestors? How are actions by the Inter-national Monetary Fund and World Banklikely to affect national systems of corporategovernance? (Example: Evans, 1995;Mizruchi, 2000.)

Inequality in a ‘globalized’ world: How dosystems of corporate governance affect distri-butions of wealth within and among nations?What is the likelihood that social movementsfor change may mobilize in the face of – or toresist – globalization? Does the globalizationof finance lead to a leveling up or a levelingdown of national standards for labor relations,environmental protection, and income inequal-ity? (Example: Firebaugh, 1999.)

Business and Political Leadership: To whatextent is a shared leadership style emergingamong top company managers and govern-ment officials around the world? Are suchinstitutions as the World Economic Forumcreating a global network among those whogovern the major commercial and politicalinstitutions in the leading economies? Asworldwide relations among business and polit-ical elites do emerge, are they underminingtraditional relations among elites withineconomies? (Examples: Davis and Mizruchi,1999; Khanna and Palepu, 2000.)

The research is unlikely to reveal worldwidebest practices in corporate governance, but itis likely yield a host of better measures that,when deftly combined, adapted to legal con-text, and sensitive to cultural nuance, shouldproduce what executives, directors, and stock-holders all want. The academic and policydebate will wisely focus not on whether theopening of capital markets and ascendance ofglobal companies will flatten alternativeforms, but rather on what forms of organiza-tion and leadership are best suited for successin local or regional operations in an era whenequity investing and company competitors can

move in and out of markets with the click ofmouse.

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Top Management, Company Directors and Corporate Controlwebuser.bus.umich.edu/gfdavis/Papers/davis_useem_02.pdfstrongly tied to share price may act as a sub-stitute for a vigilant board,