Disciplining Managers : Shareholder Cooperation in the Shadow of Shareholder Competition

In theory, large institutional investors are in an excellent position to overcome collective action problems and form voting coalitions to actively monitor and discipline managers of public corporations. This article argues that it is highly unlikely that voting coalitions of institutional investors will ever become an effective form of corporate governance. The general argument is straightforward. Institutional investors not only act as potential cooperators in shareholder voting, but also as competitors in the capital markets. In order to form a stable voting coalition, institutions will need to reveal private information about the firm in question – even if they all have the same private information, this fact is unlikely to be common knowledge. When faced with an opportunity of forming a coalition with other institutional investors, an institution will have to decide whether to share its private information or use it for trading. Even when the arbitrage profits from trading on that information are less than the expected benefits from joining a coalition, each institution may choose for the trading option out of fear that the receivers of the information may themselves use it for trading. In short, voting coalitions are subject to a prisoners’ dilemma. As a result, potential coalitions are likely to falter from the start, and those that get formed will be highly unstable; moreover, one would expect that rational corporate managers will use this knowledge to undermine potential coalitions. After setting forth the general theory, the article develops various legal implications