Bernard Sharfman and I recenty uploaded a draft article to SSRN. Comments are welcome. Here is the abstract:
Under an Arrowian framework, centralized authority and management provides for optimal decision making in large organizations. However, Arrow also recognized that other actors within the organization, outside the central authority, occasionally may have superior information or decision making skills. In such cases, such actors may serve as a corrective mechanism within the organization. In the context of public companies, this article finds that such a corrective mechanism comes in the form of hedge fund activism, or more accurately, offensive shareholder activism.
Offensive shareholder activism exists in the market for corporate influence, not control. Consistent with a theoretical framework where the value of centralized authority must be protected and a legal framework in which fiduciary responsibility rests with the board, authority is not shifted to influential but unaccountable shareholders. Governance entrepreneurs in the market for corporate influence must first identify those instances in which authority-sharing may result in value-enhancing policy decisions, and then persuade the board and/or other shareholders of the wisdom of their policies so that they will be permitted to share the authority necessary for the policies to be implemented. Thus, boards often reward offensive shareholder activists that prove to have superior information and/or strategies by at least temporarily sharing authority with the activists by either providing them seats in the board or simply allowing them to directly influence corporate policy. This article thus reframes the ongoing debate on shareholder activism by showing how offensive shareholder activism can co-exist with — and indeed, is supported by — Arrow’s theory of management centralization which explains and undergirds the traditional authority model of corporate law and governance.
Empirical studies have repeatedly shown that certain types of offensive shareholder activism lead to an increase in shareholder wealth. However, the results of empirical studies must be interpreted carefully so as not to overstate their informational value. Empirical research supports the argument that certain types of offensive shareholder activism have value, but it does not provide conclusive proof that they have value at any specific company at any specific time. Instead, the use of empirical evidence supporting offensive shareholder activism should be understood as providing proof that offensive shareholder activists may on occasion successfully rebut the presumption of the superiority of existing managerial strategies.
Available for download here.