Research Handbook on the Economics of Corporate Law
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Research Handbook on the Economics of Corporate Law

Edited by Claire A. Hill and Brett H. McDonnell

Comprising essays specially commissioned for the volume, leading scholars who have shaped the field of corporate law and governance explore and critique developments in this vibrant and expanding area and offer possible directions for future research.
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Chapter 4: The Role of Shareholders in the Modern American Corporation

D. Gordon Smith


D. Gordon Smith* 1. INTRODUCTION Shareholders participate in the governance of the modern American corporation in three principal ways: they vote, they sell, and they sue (Thompson 2000). Large shareholders also exert informal influence in public corporations (Smith 1996). In closely held corporations, shareholders often exercise control through contracts (Easterbrook & Fischel 1986).1 This chapter describes the evolving governance role of shareholders in the modern American corporation, focusing on public corporations. The ability of shareholders to participate in corporate governance depends partly on the legal rules defining shareholder rights and partly on the transaction costs of collective action. For most of the past century, corporate law and corporate scholarship in the United States were based on a stylized view of the corporation in which shareholders were widely dispersed (Berle & Means 1932). Under this traditional conception of corporations, shareholders were passive investors who relied on directors and officers to manage the corporation’s assets and on various market forces to provide the directors and officers with incentives for good behavior (Bebchuk 2007). The ‘Wall Street Rule’ dictated that dissatisfied shareholders ‘vote with their feet’ by selling their shares, rather than attempting to participate in governance of the corporation. State corporate laws and federal securities laws impose obligations on directors and officers to be honest, diligent, and loyal in discharging their responsibilities. When they stray, shareholders may pursue a remedy through litigation, either in the form of a ‘derivative action’, in which shareholders sue managers on behalf of the corporation, seeking compensation for...

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