21st Century Corporate Governance
21st Century Corporate Governance
Better democracy for a better future
In the modern world, corporations are a chief source of jobs, growth, and technology, but their governance has seen little innovation in recent years. It is imperative that we start thinking about how we can fully optimize decision-making at the corporate level, to reduce agency costs and improve profits. Better decision-making at corporations means a better future for us all.
Modern Corporate Governance
A corporation’s day-to-day big decisions are generally undertaken by its Chief Executive Officer, or CEO, under the loose auspices of its Board of Directors. Major decisions, however, like mergers, charter amendments, and stock issuances, are often subject to a shareholder vote. These elections are undertaken how one would expect, with one share corresponding to one vote. Large shareholders, naturally, have more say in the election outcome.
In theory, the power of the vote enables shareholders to hold managers accountable. But in reality, like anything else, corporations are beset by principal-agent challenges. Shareholders, particularly small shareholders, cannot realistically control managers as their vote is virtually meaningless against large investors.
The standard one-share-one-vote democratic structure is highly flawed. In the corporate setting, it paradoxically allows for the “tyranny of the majority” where large shareholders can overwhelm and outvote the majority of voting individuals, imposing their will on this shareholding “minority.”
As a consequence, corporate managers are able (and sometimes do) take actions that do not maximize the value of the corporation, as is their fiduciary duty, but rather transfer some of that value to themselves and/or large shareholders. This may come in the form of excessive pay or bonuses or stock issuances that dilute minority interests.
To counter the most egregious of such fiduciary violations, a complex and cumbersome arena of corporate law and regulation has developed. This patchwork of lawyers, legislation, and courts, is intended to correct for the failure of the corporate voting system to properly aggregate the will of shareholders and hold managers accountable.
An Alternative: Quadratic Voting
Eric A. Posner & E. Glen Weyl have proposed a potential solution, a radical departure from standard corporate voting schemes. This system, which they call Quadratic Voting, or QV, seeks to improve the democratic process such that the will of the people is properly and efficiently aggregated.
They propose detaching shareholding from voting rights. Instead, anyone with an interest in a major corporate decision can buy votes for the purpose of participating in that election. The key is that the cost of votes grows exponentially. That is, 1 vote might cost $1.00, but two votes will cost $4.00, three $9.00, four $16.00…and so on.
As I discussed here, QV is a wonderfully parsimonious method for registering both the desire of a particular voter alongside the intensity of that desire. For instance, a voter who believes that a corporate merger will not benefit the company long-term might buy ten votes to signal extremely unfavorable feelings about that merger.
Unlike most other democratic systems, QV guarantees an efficient outcome. Because votes become increasingly expensive, QV gives greater power to large numbers of small vote purchases, thus giving the majority of stakeholders true power to hold large stakeholders and managers accountable. It does this while still protecting the rights and voices of large stakeholders as well.
The money raised by the election would be returned to the corporate treasury to be distributed back to shareholders. Under Posner and Weyl’s scheme, large shareholders, however, would only receive 1 percent of the money collected from that which they personally bought.
Anyone Can Vote?
Naturally, the concept of “vote buying” has a negative connotation as, on the surface, it would seem to disproportionally benefit the “wealthy.” This is not the case. Remember that corporate votes are already purchased in the form of shares. In fact, QV blunts the power of the “wealthy” by making additional votes exponentially more expensive.
Some also might be concerned about non-shareholders having an equal right to vote in corporate elections. Remember though, under the current system, all one needs to do is buy shares to participate in a vote anyway. The vast majority of people have no interest in the outcome of a corporate election and will not exercise this right. Even if they did, they would have tremendous difficulty outvoting those who have a pecuniary interest in the outcome of an election.
One might also worry that giving non-shareholders the ability to buy votes would enable a sufficiently large number of people to band together and “shut down” a corporation they dislike. While possible, it is extremely unlikely. Again, due to QV, the cost of such a move would be enormous. In fact, this can already be done more easily under the current shareholder voting system; a band of individuals could buy up shares of a company and terminate its existence…if they were so inclined.
Square Root Voting
Understandably, QV makes many uncomfortable and remains, for the current legal system at least, out of reach. For this reason, Posner and Weyl propose a more modest half-step toward QV that is more in line with social and legal norms: Square Root Voting or SRV.
SRV restricts voting to current shareholders only, giving them voting rights equivalent to the square root of the number of shares they own. A shareholder with 1 share gets one vote, a shareholder with 10 shares gets 3.1 votes, one with 50 shares gets 7.07…etc. The result is a system that resembles modern corporate elections and fits neatly in established legal norms, but provides much of the benefits of QV because the “cost” of votes still increases exponentially.
Like QV, SRV curtails the power of large shareholders, protecting the rights of the “minority,” which in this case, could actually be the “majority,” reducing agency costs and optimizing the efficiency of the corporate democratic process.
Broader Implications
I prefer SRV as viable near-term means of improving corporate governance. But such a system need not be limited to corporations. An SRV-like voting system can be used to manage DAOs, Non-Profits, and even government institutions by issuing voting tokens instead of shares.
In theory, such a system could reduce manager opportunism and may help curb the compensation gap between employees and managers, while allowing for more streamlined and better decision-making. The net effect, hopefully, would be higher profits and shareholder value, while largely sweeping away the need for cumbersome legal and regulatory restrictions that are often self-defeating.