Commitment and Entrenchment in Corporate Governance

Over the past twenty years, a growing number of empirical studies have provided evidence that governance arrangements protecting incumbents from removal promote managerial entrenchment, reducing firm value. As a result of these studies, "good" corporate governance is widely understood today as being about stronger shareholder rights. This Article rebuts this view, presenting new empirical evidence that challenges the results of prior studies and developing a novel theoretical account of what really matters in corporate governance. Employing a unique dataset that spans from 1978 to 2008, we document that protective arrangements that require shareholder approval-such as staggered boards and supermajority requirements to modify the charter-are associated with increased firm value. Conversely, protective arrangements that do not require shareholder approval-such as poison pills and golden parachutes-are associated with decreased firm value. This evidence suggests that limiting shareholder rights serves a constructive governance function as long as the limits are the result of mutual agreement between the board and shareholders. This function commits shareholders to preserve a board's authority to exploit competitive private information and pursue long-term wealth maximization strategies. By documenting that committing shareholders to the longer term matters as much as, if not more than, reducing entrenchment for good corporate governance, our analysis sheds much needed light on the allocation of power between boards and shareholders, managerial accountability, and stakeholder interests. We conclude by outlining the implications of our analysis concerning the direction corporate governance policies ought to take.