Person:

Dobbin, Frank

Institutional investors have come to play a central role in financial markets since the early 1970s. They controlled about three out of ten shares of Fortune 500 companies in 1970. Today they control seven out of ten. The aging of the baby boom generation, coupled with new fiduciary requirements for defined benefit pension plans, contributed to this change. Agency theory offered a litany of innovations designed to ensure that executives pursued the interests of shareholders, rather than feathering their own nests. Institutional investors promoted the theory with a vengeance, encouraging firms through shareholder proposals and private bidding to put its prescriptions into place. This article examines the role of institutional investors in promoting changes in corporate management under the banner of shareholder value. It reviews evidence that these changes did little to promote share value and that they resulted in several disadvantages for the American worker-owner.

Women now make up a sixth of corporate board members in the Fortune 500. Some scholars suggest that women board members boost financial performance, and thus stock price, by making boards more effective. Indeed, early studies showed a correlation between women on boards and both profits and stock price. But more rigorous studies have suggested that women have little effect on profits and may have negative effects on stock price. In a quantitative study of the consequences of female board member appointments, using data from over 400 leading corporations for the period 1997 to 2005, we find little evidence that women undermine board effectiveness but some evidence that institutional investors disfavor firms that appoint women board members. Following the appointment of a woman board member, firms do not experience decreases in profitability but do see decreases in share value. We then explore the effects of female appointments on shareholding by different groups of institutional investors. We predict that fund managers holding large positions in leading firms, whose actions are followed by the investment community, will take care not to sell off stock following accession of women to boards. We predict that the same will be true of all public pension fund managers, who have long been advocates of board diversity. But we suggest that small-holding institutional investors, and investors that do not manage public pension funds, may react negatively to the appointment of women to boards due to unwitting bias. The statistical results are consistent with the interpretation that bias among institutional investors who do not carefully scrutinize their own motives leads to reductions in shareholding after firms appoint women board members, and ensuing declines in share price.

Agency theorists diagnosed the economic malaise of the 1970s as the result of executive obsession with corporate stability over profitability. Management swallowed many of the pills agency theorists prescribed to increase entrepreneurialism and risk-taking; stock options, dediversification, debt financing, and outsider board members. Management did not swallow the pills prescribed to moderate risk: executive equity holding and independent boards. Thus, in practice, the remedy heightened corporate risk-taking without imposing constraints. Both recessions of the new millennium can be traced directly to these changes in strategy. To date, regulators have proposed nothing to undo the perverse incentives of the new “shareholder value” system.

At the turn of the century, regulators introduced policies to control bank risk-taking. Many banks appointed chief risk officers (CROs), yet bank holdings of new, complex, and untested financial derivatives subsequently soared. Why did banks expand use of new derivatives? We suggest that CROs encouraged the rise of new derivatives in two ways. First, we build on institutional arguments about the expert construction of compliance, suggesting that risk experts arrived with an agenda of maximizing risk-adjusted returns, which led them to favor the derivatives. Second, we build on moral licensing arguments to suggest that bank appointment of CROs induced “organizational licensing,” leading trading-desk managers to reduce policing of their own risky behavior. We further argue that CEOs and fund managers bolstered or restrained derivatives use depending on their financial interests. We predict that CEOs favored new derivatives when their compensation rewarded risk-taking, but that both CEOs and fund managers opposed new derivatives when they held large illiquid stakes in banks. We test these predictions using data on derivatives holdings of 157 large banks between 1995 and 2010.