Weak Shareholder Rights: A Product Market Rationale

Abstract

In product markets where customers care about firm survival, strong shareholder power, by affecting the likelihood that the firm will be acquired, can have detrimental implications on firm performance. We use a framework where firms choose their level of shareholder rights after comparing the costs of acquisition exposure, i.e, the loss of customers, with the synergistic benefits of an acquisition to generate two testable implications. First, we show that it is optimal to have weak shareholder rights in competitive markets. Second, we show that the link between weak shareholder rights and competition is stronger when the number of firms in the industry is lower. Using data on shareholder rights in the corporate charter, we find that indeed firms have stronger shareholder rights in concentrated industries and that this link is stronger in industries with fewer firms. Additionally, the link between concentration and shareholder rights is stronger in industries characterized by long-term customer relationships. We also document that weak shareholder rights are associated with worse performance only in non-competitive industries. We then discuss the implications of this framework for the design of various governance mechanisms. In conclusion, the paper provides a rationale for why shareholders themselves might not want strong shareholder rights.