Abstract
The Firm Divided is an excellent introduction to corporate governance and the conflict between managers and shareholders over control of the modern corporation. Taking the separation of ownership and control of the largest U.S. corporations as the starting point, Guthrie provides a comprehensive description of the causes and consequences of the resulting manager–shareholder conflicts and the governance arrangements that have evolved to resolve or minimize them. Guthrie is obviously not the first to address the problems stemming from the separation of ownership and control, but his approach to describing the problems and bringing us up to date on recent corporate governance arrangements is unique. He masterfully uses carefully chosen case studies of individual firms and the executives, directors, and shareholders faced with thorny corporate governance problems to provide a richly textured description of the many aspects of those problems and their solutions. This approach is particularly useful because Guthrie effectively integrates theoretical and empirical corporate governance research in his case studies to guide and strengthen his case analyses.
The book has five parts. The first part (chapters 1 to 3) places the board of directors at the center of corporate governance and focuses on its monitoring role. Shareholders elect and delegate responsibility to the board, and the board appoints and delegates responsibility to the Chief Executive Officer (CEO). To ensure that the CEO acts in the interests of the shareholders and not in his or her own personal interest, the board is charged with routinely monitoring and advising the CEO. Guthrie uses Occidental Petroleum and Yahoo and the conflicts between their CEOs and shareholders to illustrate that boards of directors may not always be able to monitor their CEOs effectively due to a lack of director independence, directors being too busy to prioritize their board duties, and CEOs controlling information flows.
The second part (chapters 4 to 7) shifts attention from how boards of directors can monitor CEOs to how they may try to motivate CEOs to act in the interests of their shareholders. Guthrie uses Hospital Corporation of America, Disney, and KB Home to illustrate how executive compensation can be used to align the interests of CEOs and shareholders but also how tying executive compensation to corporate performance can actually hurt shareholders because of short-termism and excessive compensation. A particularly intriguing chapter outlines the steps powerful CEOs with complacent boards of directors can take to hide excessive compensation by camouflaging compensation as perks, backdating option grants, using friendly performance measures, choosing favorable comparison peers, and relying on friendly external compensation experts. Guthrie also uses the troubled story of Palm, Inc. to illustrate how powerful boards motivate CEOs by using the ultimate threat of dismissal following poor performance and motivate other executives with the promise of promotion following good performance.
The third part of the book (chapters 8 to 10) is my favorite. Rather than boards of directors monitoring and motivating CEOs to act in shareholders’ interests, boards may effectively delegate these functions to external capital markets, financial analysts, and large shareholders. Guthrie uses Cablevision Systems and Home Depot to discuss how external capital markets and large activist shareholders discipline CEOs by controlling access to capital and being highly motivated to voice their opinions to CEOs squandering free cash flows and diversifying excessively. The chapter on SPX Corporation, which explores delegating monitoring to financial analysts, is the most novel and intriguing chapter in the book. Guthrie beautifully mixes concerns about information asymmetry and reputation with the career concerns of financial analysts and the conflicts of interest of analysts who work for investment banks favoring positive recommendations; the result is a coherent assessment of how effective (or not) delegating monitoring to financial analysts can be.
The fourth part of the book (chapters 11 to 13) focuses on how shareholders can sell or threaten to sell their shares to end a conflict between managers and shareholders. Guthrie uses InBev’s acquisition of Anheuser-Busch and Malcolm Glazer’s acquisition of Manchester United to illustrate how the market for corporate control and hostile takeovers allow shareholders to replace ineffective CEOs and other top executives (with or without golden parachutes to soften the blow). Guthrie is particularly effective in using Carl Icahn’s attempt to take over Lions Gate Entertainment to illustrate the use of defensive tactics to prevent hostile takeovers, featuring a colorful cast of black knights, white knights, white squires, scorched earth, poison pills, greenmail, and proxy fights. The fourth part of the book ends with the conclusion that boards of directors are at the center of corporate governance and that a strong board is the best response to manager–shareholder conflicts.
The fifth part of the book (chapter 14) focusing on the legal and regulatory environment of corporate governance is the weakest. It glances quickly over the U.S. Securities and Exchange Commission (SEC) and other regulatory institutions and how disclosure rules and laws pertaining to shareholder voting rights affect the effectiveness of boards of directors and shareholders’ ability to use proxy votes to influence their corporations. This chapter seems like an afterthought.
Although The Firm Divided is an excellent introduction to corporate governance, it is not without limitations. Its main strength, the use of detailed case studies to illustrate different aspects of the manager–shareholder conflict, is also the main limitation. The idiosyncratic circumstances of each case dominate over reporting what research tells us more generally about corporate governance. The occasional overemphasis on idiosyncratic circumstances of individual cases is aggravated by a chatty writing style with unnecessarily flippant comments (such as “That soap opera again” on page 185) and repetition of case information (read the top of pages 199 and 202). Perhaps more importantly, Guthrie rarely ventures beyond the traditional corporate governance paradigm from financial economics to examine other perspectives on corporate governance and the conflict between managers and shareholders, including the social psychological and sociological perspectives on corporate governance advanced by scholars such as James D. Westphal, Gerald F. Davis, and Mark S. Mizruchi. Despite these limitations, I highly recommend The Firm Divided to anybody interested in corporate governance and the conflict between managers and shareholders. I particularly recommend it to audiences interested in embellishing their understanding of corporate governance theory with real-world examples of corporate governance in practice.