The Symbolic Management of Stockholders: Corporate Governance Reforms and Shareholder Reactions
Westphal, James D., Zajac, Edward J., Administrative Science Quarterly
In recent years, scholarly and popular concern about corporate governance arrangements in large corporations has increased in intensity. Institutional investors and the popular business press have decried the apparent absence in many corporations of strong governance mechanisms that adequately promote managerial accountability to stockholders (e.g., Charan, 1993; Economist, 1994; Pozen, 1994). This concern has been reinforced by extensive academic research on the effectiveness of existing governance structures in protecting shareholders. Thus, while agency theory suggests that managerial incentives and boards of directors represent the primary mechanisms by which differences between managerial and shareholder interests are minimized (Jensen and Meckling, 1976; Fama and Jensen, 1983), a large body of empirical research suggests that neither mechanism is used sufficiently to represent shareholders. For example, research on executive compensation has led many observers to conclude that traditional management incentive practices are inadequate to reduce agency costs significantly (Finkelstein and Hambrick, 1988).(1) Large-scale empirical research on corporate boards suggests that boards have traditionally lacked the structural power needed to monitor effectively (e.g., Wade, O'Reilly, and Chandratat, 1990), and extensive qualitative evidence also indicates that boards have often been minimally involved in monitoring and controlling management decision making (e.g., Mace, 1971; Vance, 1968; Lorsch and MacIver, 1989).
This stream of research has bolstered claims by dissatisfied shareholders, and institutional investors in particular, that significant changes in governance structure are needed to enhance managerial accountability to shareholders. Several changes have gained currency as legitimate improvements in corporate governance, such as the adoption of new long-term incentive plans that align management compensation more closely with stock performance, or changes in board structure that increase the board's monitoring and control capacity. These changes are seen as increasing top management's attention to shareholders' interests and have been advocated by increasingly active investors, represented by groups such as the Council of Institutional Investors and the United Shareholders Association, both of which were founded in the 1980s (Kim and Ocasio, 1995). Advocates for such reforms have also pointed to the extensive empirical literature in financial economics that shows positive stock market reactions to the adoption of new governance mechanisms, such as long-term incentive plans.
Other behaviorally oriented studies, however, have emphasized that while there may be organization-wide benefits to such reforms, top managers would prefer to avoid or even resist them (Harrison, Torres, and Kukalis, 1988; Tosi and Gomez-Mejia, 1989; Hill and Phan, 1991). Both the economic and behavioral literatures on executive compensation suggest that, ceteris paribus, chief executive officers will prefer a pay package with a small pay-for-performance component (Zajac and Westphal, 1994). From a normative agency theory perspective, CEOs, as risk-averse agents, prefer less risk in their compensation contracts (Harris and Raviv, 1979), and incentives add uncertainty to a CEO's compensation (Beatty and Zajac, 1994). Research from the managerialist perspective (Williamson, 1964) suggests that CEOs prefer self-aggrandizing, growth-maximizing goals over profit-maximizing goals for their firms and would be reluctant to accept incentive plans tied closely to profit maximization or to give up decision-making autonomy vis-a-vis the board of directors.
While prior research has tended to emphasize the overtly political nature of top executive behavior, Westphal and Zajac (1994) and Zajac and Westphal (1995) have recently introduced a symbolic management perspective on corporate governance (see also Wade, Porac, and Pollock, 1997). They suggest that top managers can satisfy external demands for increased accountability to shareholders while avoiding unwanted compensation risk and loss of autonomy by adopting but not implementing governance structures that address shareholder interests and by bolstering such actions with socially legitimate language. …