Agency versus Hold-up: Benefits and Costs of Shareholder Rights

Many policy-makers appear to subscribe to the view that granting shareholders more rights is better. The recently revised EU Shareholder Rights Directive contains a significant push for the enhancement of shareholder rights, the UK government is considering a binding say-on-pay on compensation amounts (rather than just on compensation systems), etc.

However, theoretical work highlights that it can, in fact, be in the interest of shareholders not to maximize their power. The intuition is that if shareholders are too powerful, this may distort extra-contractual investments on the part of managers, who may fear that they will not get the full return on their human capital investments – inducing a classic hold-up problem.

While this idea is theoretically convincing, so far there is no empirical evidence that tests this conjecture. To fill this gap, the paper "Agency versus Hold-up: Benefits and Costs of Shareholder Rights" by Alexander Wagner and Christoph Wenk studies market reactions and company policy responses to the introduction of binding say-on-pay in Switzerland.

The Swiss case offers the rare occasion of within-country variation, over time, of the specific calibration of the binding say-on-pay rules. By looking at the cross-sectional variation in how shareholders themselves perceive the benefits and costs of shareholder rights, the hold-up conjecture can be tested empirically.  

The study reveals substantial evidence that shareholders do indeed care about the costs of hold-up, and weigh these against the benefits they can obtain by exerting more control over management. The analysis also yields evidence regarding alignment benefits of say-on-pay. Here, too, the investigation can exploit differences in the design of binding say-on-pay policies (retrospective votes vs. prospective votes), thus significantly adding to existing (single-country and international) studies. The paper thus provides input for the ongoing policy debate.

Finally, because the policy shift in Switzerland was launched in a direct democratic fashion, our analysis can also shed light on the political economy of corporate governance, in particular the topical tension between shareholders and the general public.