Flexing Their Muscles

Based on research by Robert E. Hoskisson (George R. Brown Emeritus Professor of Management), Brian L. Connelly, Laszlo Tihanyi and S. Trevis Certo

• Owners influence company management decisions.
• Ownership, in fact, is a form of corporate governance.
• As ownership becomes more varied and sophisticated, owners and managers both need to understand how ownership affects governance and management.

Skim the headlines of the Wall Street Journal, and it’s clear that owners interact with their corporations in a kaleidoscope of ways. Similarly, when owners sell, it’s not simply because the investment no longer fits their interests.

Instead, shareholder activists such as Carl Icahn use a broad range of sophisticated strategies to force corporate boards and management to take specific actions. Mutual funds do the same. A prime example: Ralph Whitworth’s mutual fund, Relational Investors, which drove Home Depot’s management to divest in its contractor services business.

How owners interact with firm management, in other words, has become an increasingly potent form of corporate governance. This is especially true now that activist investors hold a significant portion of U.S. and UK public equity.

But research about the ways that different ownership types governmanagerial actions has not caught up with this trend. In response, now retired Rice Business emeritus professor Robert Hoskisson and a team of colleagues surveyed the research in finance, accounting, economics, law and management to assess the existing body of knowledge.

As a first step, Hoskisson and colleagues differentiated between corporations with inside ownership and those with outside ownership. Inside ownership types include executives, board members and non-executive employees. Outside owners include blockholders, agent owners and private equity owners.

Inside ownership, the researchers noted, lends itself to coordinating owner and corporate interests. The idea is that owners may be more inclined to align their choices with managers’ interests if they have skin in the game. 

Outside owners complement inside owners, the researchers write, by more closely monitoring managers’ choices.

The researchers next delved into the effect of ownership structure on firms. Historically, owners shaped management they didn’t like simply by threatening to leave the business. Today, however, disgruntled owners have more options than taking the Wall Street walk. Depending on the owner and motivation, investors can make their wishes known with steps including triggering restructuring, plunging into activism or buying-and-holding.

Activist investors use a variety of tactics, including private meetings with management, hostile media campaigns or filing shareholder proposals through the proxy voting process or through the SEC, which allows owners to band together to influence firm or management behavior. Alternatively, one owner with a significant share position can influence behavior singlehandedly.

Finally, owners such as Warren Buffett, who buy and hold can play the long game. These investors are often especially valuable to companies because their loyalty lets management focus on action with longer-term benefits. General Mills' 2000 acquisition of Pillsbury exemplifies this: Although its initial quarterly earnings dropped, the corporation better positioned itself to compete with Kellogg in the long-term.

Overall, the researchers write, ownership affects firm outcomes, performance, strategy and governance processes. And this impact is substantive. Evidence shows that influence from internal ownership, outside blockholder ownership and long-term ownership all results in better firm performance.

So keep checking the headlines. After Occidental Petroleum acquired Anadarko Petroleum, for instance, Warren Buffet, T. Rowe Price and Carl Icahn each weighed in with a different strategy to advance shareholder interests. As Hoskisson’s team confirmed, such ongoing tussles and maneuvers between managers and owners are signals that much corporate governance takes place outside the office walls.

Robert E. Hoskisson is the George R. Brown Emeritus Professor of Management at Jones Graduate School of Business at Rice University.

To learn more, please see: Connelly, B. L., Hoskisson, R. E., Tihanyi, L., & Certo, S. T. (2010). Ownership as a form of corporate governance, Journal of Management Studies, 47(8), 1561-1589.