The False Promise of One Share, One Vote: A Response to Larry Ribstein

In our paper, “The False Promise of One Share, One Vote,” Grant Hayden and I argue that the traditional justifications for the one-share, one-vote paradigm fail to hold up under scrutiny. In a recent post, Larry Ribstein argues that “[t]he basic problem with this approach is that it doesn't clarify what's at stake.” In reading over Ribstein’s discussion, we think that he may have overestimated the nature of our claims.

Our paper addresses shortcomings in the theoretical justifications for restricting the corporate franchise to shareholders. The mainstream law-and-economics thinking on the issue is that shareholders will vote to maximize the residual interested because they have homogeneous preferences with respect to wealth maximization. That assumption is false. And even assuming that shareholders have this unique set of similar preferences, one of the principal lines of reasoning from that assumption—based on Arrow’s Theorem—is deeply flawed. That, in a nutshell, is the bulk of the paper.  We believe that corporate law theorists need to reevaluate some of these foundational principles that, upon examination, provide insufficient support.

Ribstein’s primary concerns with our argument seem to be that (a) corporations are contracts, not political institutions, and (b) the market has determined that one-share, one-vote is the preferable form for the contract. We agree with (a) – corporations are not political institutions. We do claim (not uniquely, mind you) that corporate and political entities are similar in the sense that both are, at some level, about advancing some collective goal. Their voting systems, however, are strikingly dissimilar—and part of the point of the paper is getting a handle on why, exactly, that is so. All voting systems are, at some level, about preference aggregation, which immediately raises the basic question—whose preferences are being aggregated? Who gets to vote? And how much are their votes weighted?

In political democracies, we tend to extend the right to vote to those with a sufficient interest in the outcome of the election and even, when possible, tailor the weight of their votes to the level of their interest. This is, of course, constrained by our ability to find accurate and manageable proxies for their interest. In the past, we’ve relied on things like property-holding and tax-paying requirements—people’s economic participation told us that they had enough at stake to vote. We now tend to rely on other proxies that seem to better capture interest—like residency.

Most corporations don’t have anything close to a voting system that extends the franchise to all of those with an interest in the corporation. Shareholders vote, but suppliers, customers, employees, and creditors do not. As mentioned above, our paper addresses a couple of the justifications offered for this state of affairs—ones based on shareholder homogeneity and Arrow’s Theorem.

There are certainly other arguments for corporate voting schemes. They are not the subject of our paper. For example—it’s clear that other stakeholders have their interests captured through contracts that don’t involve voting. (Though, as others have pointed out, the contracts may incompletely capture their interests). But just as corporations are not political institutions, they are also not simply contracts. Corporations are legal entities created and certified by state governments. State law requires that shareholders have the right to vote, and that they elect directors who run the corporations. These arrangements may be contractual in flavor, but they are legal requirements. And these state-created institutions convey benefits. Corporations allow participants to avoid personal liability for the corporation’s debts; they also (as Hansmann and Kraakman pointed out) allow the corporation to separate its assets from its participants. Just like marriage, the state sets and controls the terms of the “contract” that the participants enter, and then provides certain benefits if the requirements are met.

Ribstein says, “Maybe Hayden and Bodie are saying that the current system does not allow investors to enter into their preferred contracts. In other words, they may be for deregulating the corporate form. It's not clear to me what, exactly, they want.” On this point, we’d have to agree. Perhaps a more contractual approach to business organizations -- one that did not offer benefits such as asset protection from third parties -- would be appropriate.  For now, we’ll settle for saying that some of the theoretical arguments for restricting voting to shareholders are flawed.

Ribstein ends by saying that “[I]f you don’t start from the premise that we now have a market in which individual preferences are expressed, you’re going to end up in the wrong place.”  But the issue isn’t whether the some of the preferences of some of the interested stakeholders are expressed in some way, but how well the corporate structure captures those interests. And if you really start from the position that corporate governance structures perfectly capture the preferences of interested parties, you’ve started with a conclusion rather than a premise.