Classifying Institutional Investors

I. INTRODUCTION Shareholders as such are not entitled to participate in corporate decision-making except by electing directors periodically and approving major corporate changes first proposed by the board. This feature of the corporation-centralized management-is fundamental to corporate law. Yet the past several years have seen a heated debate among academics, practitioners, and lawmakers over whether shareholders' power to intervene in corporate decision-making should be increased.1 The general problem, faced as much by agency, guardianship, trust, and partnership as by corporate law, is how best to allocate decision-making authority when appointed managers manage a business for owners. The optimal allocation of decision-making authority depends on the decision-making goal, maximizing owner wealth, for example, and on the incentives and competence of managers and owners relative to that goal. Because these factors differ in different areas of the law, the optimal allocation of decision-making authority-and the allocation the law has actually achieved-is different in agency, guardianship, trust, partnership, and in corporate law as well. Allocations of decision-making authority range from those that perfectly insulate managers to those that subject them to a perfect duty of obedience. Dutch corporate law2 and the common law of guardianship and trust3 are at one extreme: managers are not even elected. The German law of close corporations4 and the common law of agency5 are at the other extreme: owners can bind managers on any subject related to the business. Delaware law falls between these extremes: shareholders periodically elect directors and ratify board-proposed organic changes, but cannot make corporate decisions on their own initiative. Academics, Professor Lucian Bebchuk most prominently, have recently urged that shareholders be empowered to make major corporate decisions-on dividends, sales of the firm, and reincorporation, for instance-on their own initiative.6 In this Article, I argue against such "shareholder-initiative" proposals and defend the existing allocation of decision-making authority.7 The argument for shareholder initiative depends on two claims: first, that shareholder initiative would allow shareholders to use shareholder voting effectively; and second, that they would use it to do something good-viz., to increase shareholder wealth.8 In Articles published late last year, Bebchuk and I took opposite positions on the first of these claims. Bebchuk contended that shareholder initiative solves the bundling problem, which is the foremost obstacle to effective shareholder voting. Hence shareholder initiative would make shareholder voting an effective corporate control mechanism.9 I contended that other obstacles explain shareholder voting's ineffectiveness, obstacles that would only be compounded by shareholder initiative. Hence shareholder initiative would not make shareholder voting an effective control mechanism.10 In this Article, I take up the second claim of the argument for shareholder initiative and contend that even if shareholder initiative allowed shareholders to vote effectively, shareholders would still not vote to maximize shareholder wealth. Institutional investors, because their holdings are large, are the shareholders most likely to overcome the myriad of obstacles to the effective use of shareholder voting.11 Part II offers a brief argument in support of this claim, which I take to be uncontroversial. If shareholder initiative would allow institutional investors to use shareholder voting effectively, and if institutional investors would use shareholder voting to increase shareholder wealth, then, insofar as increasing shareholder wealth is corporate law's goal, shareholder initiative is desirable. As Part III explains, however, market, political, and social incentive-creating forces drive institutional investors to value things other than shareholder wealth: for union pension funds, higher wages; for public pension funds, the interests of the electorate. …