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Institutions and Entrepreneurs in American Corporate Finance |
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| Proponents of the "political model" of corporate finance claim that large- scale institutional investors could play a key role developing a solution to the "problem" of the "separation of ownership and control" in American corporate practice. As financial institutions grow larger, political model proponents argue, they could purchase larger stakes in operating companies and thereby acquire more leverage over management affairs. If legal obstacles were removed, institutions could use their special expertise in corporate governance to make management more efficient and accountable. This Article argues that the political model theory is deeply flawed. The primary function of institutional investors, the author contends, is to insulate their customers from risk. The author maintains that institutional investors cannot acquire large shares in fewer companies without significantly compromising diversification and thus increasing the riskiness of their portfolio. The author also observes that management reforms would have to be imposed on a significant number of the firms in an institution's portfolio if these changes were to have any measurable impact on returns. Since there are no sure-fire reforms, this sort of large-scale activism inevitably entails a great deal of risk and puts activist institutions at a decided disadvantage to their more passive competitors. The author considers three techniques that might be used to manage risks implicit in institutional activism--portfolio insurance, risk-capital reserves, and government guarantees--and concludes that all three are impractical. The author suggests that entrepreneurial firms may be better suited for an activist role since entrepreneurs, unlike institutional investors, are not in the business of providing financial guarantees to their customers. Rather, entrepreneurs deliberately take on the risk of uncertain ventures in order to achieve high returns. | |
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Copyright
© 1997 by California Law Review, Inc. |
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