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Peter C. Kostant [*]
Striking changes in the norms and practices of corporate governance have occurred since the 1980s. Corporate directors have become more independent and diligent and institutional investors have become more activist. If we apply Albert O. Hirschman's insights about the interactions of exit, voice and loyalty, we find that over-reliance on exit as the remedy of choice of shareholders failed to discipline and educate managers effectively. After the wave of hostile takeovers, the extent of management failure became apparent and the increased power of voice was an important factor in accelerating changes in conduct and norms. The new Team Production Model is useful in describing how public corporations are increasingly being governed. The model helps to explain why corporate boards should function as independent arbitrators among the corporate constituents that have invested in the entity. Mechanisms to increase stakeholder voice and loyalty can help the board function effectively and may increase both efficiency and fairness. The role of corporate counsel, as co-agent with corporate management, and having an independent fiduciary duty to the entity and not its management, is essential to assist the corporate board in meeting its obligations within the Team Production Model. Lawyers, as honest brokers with duties to the enterprise can play an important role in increasing stakeholder voice and loyalty. (c) 1999 Elsevier Science Inc. All rights reserved.
Albert O. Hirschman's elegant and wholly original Exit, Voice and Loyalty  was written nearly 30 years ago and has had an enormous impact throughout and beyond the social sciences.  It provides an illuminating interpretation of "responses to decline" in firms. Hirschman has explained that Exit, Voice and Loyalty was written to dispel the "axiom that competition (exit) is the unfailing and exclusive remedy against all ills of economic organization."  It is especially odd, therefore, that when Hirschman's ideas were applied in theoretical works about corporate governance, they were used mostly to underscore the preeminence of exit for shareholders in public corporations. Thus, the concept of exit was used to explain how shareholders, following the so-called "Wall Street Rule," either voted their proxies as management suggested or sold their shares in the liquid public trading market.  In this article, I will examine why this understanding of exit, both in practice and as a simple theoretical basis for describing shareholder behavior in large public corporations, has failed to explain the sudden and drastic changes in corporate governance of the past decade. In fact, exit served as a weak mechanism for solving the magnitude of new problems that corporations faced in the 1980s. Further, to the extent that theory has a practical impact, theorists paid little attention to searching for alternative mechanisms.
An understanding of the recent course of events in corporate America requires a model of the interrelationship between exit, voice and loyalty that is both fuller and more complex. Such a model should provide insights about the construction of voice and loyalty enhancing institutions. The model should also provide an account of the salutary role that corporate lawyers can play in the normative task of helping to shape the future course of corporate governance. 
Section 1 briefly discusses Hirschman's model. In Section 2 I use exit, voice and loyalty  to describe conditions before the "tidal wave" of hostile mergers and leveraged buyouts that "tore apart and rearranged many large American firms" in the 1980s.  Over-reliance on exit, much of it a non-ameliorative kind that I call faux exit, left large American corporations exposed to new challenges because management was relatively unable to detect and correct organizational decline. Hirschman's concept of "slack,"  helps to explain why the over-reliance on exit as the sole mechanism of corporate governance went unnoticed until the hostile takeover boom of the 1980s.  A facile view of the availability of exit seemed to suffice in describing how corporate governance worked. The recognition that corporate governance prior to the 1980s overly relied upon an ineffective type of exit helps explain why corporate governance was so susceptible to change.
Section 3 looks at the drastic changes in corporate governance since the 1980s and uses the concepts of voice and loyalty to explain how corporate social norms have changed so quickly.  Since the 1980s there has been an "upheaval" in the relations between shareholders, boards of directors, and inside senior management, especially chief executive officers ("CEOs"). CEOs, in fact, have become much more accountable, and many high-profile ones have even been summarily discharged;  corporate directors have become more independent of inside management and are generally perceived as working more diligently;  and, shareholding has become less fragmented as ownership has become more concentrated in institutional intermediaries. In fact, if the holdings of United States pension funds were aggregated, they would today own a controlling block of most large public corporations.  Institutional investors, often led by activist public pension funds, are "flexing their muscles," proposing corporate charter am endments and otherwise prodding management for change. 
Though legal and institutional changes have made the exercise of shareholder voice easier, it would have been possible to utilize voice earlier had institutional structures been formed to galvanize its use.  Although voice today is becoming an important feature of corporate governance,  it could have helped improve long-term corporate performance yesterday. On a theoretical level, Hirschman's understanding of recovery mechanisms provides an especially powerful explanatory framework when paired with the new Team Production Model of corporate governance proposed by Margaret Blair and Lynn Stout. 
Section 4 looks to the future of American corporate governance and is explicitly normative. It suggests a more democratic system of corporate governance utilizing loyalty and voice enhancing institutions for all stakeholders. This new system does not require sweeping changes in the current law and is compatible with important aspects of both the modern civic republican tradition  and traditional economic republicanism.  Finally, I propose a new role for corporate legal counsel based upon the recognition and strict enforcement of their independent fiduciary duty to the corporate entity. This represents a change from traditional practice in which counsel often "finesse" this duty by treating senior inside managers as if they were the actual client. This new lawyer role will be especially helpful as boards of directors of public corporations become independent and subject to expanded fiduciary duties. I will also argue that corporate counsel can nurture voice and loyalty among corporate stakeholders, th ereby increasing cooperation and efficiency. When this strict duty for lawyers is more clearly recognized and followed, the entire corporate entity, rather than just inside senior managers, should benefit.
2. Exit, voice and loyalty
Hirschman's work set out to examine the devices that organizations use to correct lapses in productive behavior.  He observed that firms and other organizations tend to deteriorate over time, losing rationality, efficiency, and the energy to produce a surplus. These negative developments, however, are sometimes able to generate their own cure. The cure can come in the form of one of two counter-forces: either "exit," which Hirschman calls an "impersonation" of economics; or "voice," the active expression of dissatisfaction, which is an "impersonation" of politics.  Both these counter-forces, exit and voice, are endogenous to organizations and can co-exist. Although one will tend to dominate at a given time, exit and voice may act either as complements or as functional alternatives. 
Exit occurs in one of two ways, either by customers no longer buying a product, or by members leaving an organization. Hirschman's central thesis is that easily repairable organizational lapses often go uncorrected because exit is insufficiently effective in triggering corrective actions by those in charge.  Traditionally, the study of exit has been the domain of economists who examine competition and how it can threaten organizational extinction. As a corrective device, exit operates indirectly through the market, where revenue loss may sometimes alert management to problems.  Although economists have paid relatively little attention to how exit works as a curative device,  they presume its overall effect to be "wholesome."  In actual practice, however, exit alone is frequently an ineffective mechanism for correcting an organization's problems. The traditional faith that exit will guarantee that only efficient firms will compete successfully assumed that accurate information would be readily available to managers. These deductive assumptions did not reflect reality. 
Voice is best defined as any attempt to change, rather than escape from an unsatisfactory situation. Voice can be individual or collective,  and unlike exit, is often "messy."  It can vary from grumbling to violence, and is generally more public than exit.  Economists have traditionally ignored voice or viewed with "incredulity" the suggestion that it could be a recuperative mechanism for firms,  leaving voice for political scientists to study as "interest articulation" in the political arena.  Hirschman's work expressly connects the political with the economic to study the choices and possible interactions between articulation (voice) and desertion (exit) as ameliorative forces.  When exit and voice, the market and non-market forces, work together effectively, this combination becomes hydraulic.
In addition to studying the effects of exit and voice, and the results of their varied interactions, Hirschman also examines "what institutions could serve to perfect each of the two options as mechanisms of recuperation."  In performing this analysis, Hirschman provides normative prescriptions and adds a third key component: "loyalty." Loyalty serves as a brake on exit, preventing it from occurring when its use would otherwise be rational. Thus, loyalty often tends to activate voice.  Loyalty can be generated by a rational or irrational belief that one's own influence, or that of others, can move an organization in the direction of improvement. Either way, loyalty helps replace the certainty of exit with the uncertainty of voice.  Loyalist behavior is a "bet" on recovery.  By helping to neutralize exit, loyalty helps keep the most knowledgeable and perceptive members or customers of an organization in a position where they can contribute to ameliorating a bad situation. 
Hirschman wrote that he "dreams" of influencing others to bring out "the hidden potential of whatever reaction mode is currently neglected."  For corporate governance, that neglected mode is voice. This article will explore how, even without changing the existing legal rules either of corporate governance or the law governing corporate lawyers, the voice of corporate constituents can be nurtured. The loyalty of corporate constituents to the corporate entity can also be enhanced, and could serve as an important catalyst for further increasing the use of voice. The board of directors, the ultimate decision makers for the corporate entity, armed with more comprehensive information derived from constituents with greater voice and loyalty, could hold managers more accountable. Firms would thus be better able to anticipate and solve problems to adapt to a more competitive global economy.  A full understanding of the argument requires some familiarity with yesterday's and today's models of corporate governa nce. Yesterday's corporate governance relied excessively on exit.
3. Yesterday's corporate governance--powerful inside managers served by deferential legal counsel
This section examines the structure of corporate governance before the changes that began in the 1980s. The over-reliance on exit by corporate personnel and corporate lawyers made both the corporation and its lawyers subject to the violent changes of the last decade. At the same time, theorists began to question models of corporate governance that relied solely upon exit.
3.1. Theory and practice
For most of the twentieth century, the public corporation was usually accepted as an organizational structure in which managers held power and shareholder/owners were fragmented and weak.  Students of corporate governance generally agreed that the key question of corporation law was determining the degree of management's accountability to the shareholder/owners. On one hand, the so-called managerialist scholars believed that management's essentially autonomous exercise of power was legitimate and efficient. By contrast, anti-managerialists decried the fact that inside senior management had little accountability to the owners; that senior managers effectively controlled the board of directors; and, that the financial community treated management with almost automatic deference. 
At the same time, it was generally accepted that corporate management, the directors and officers of public corporations, served as agents for the shareholders, the purported principals that owned the entity. This agency model was also accepted in the rhetoric used by corporate managers to describe their role. As agents, management had a duty to maximize shareholder wealth.  In achieving this result, management had broad discretion protected by an expansive business judgment rule.  Shareholders were protected, at least in theory, against excessive agency costs such as the shirking, stealing or empire building of management, by management's fiduciary duties of care and loyalty, and by the legal structure of corporate governance.  To insure that fiduciary duties were not violated, shareholders had the right to sue on behalf of the corporation and the power to vote to elect the board. There were also extreme remedies available such as proxy challenges and hostile takeovers. All these "remedies" exis ted largely in name only because of the expense and the procedural difficulties faced by anyone trying to assert them. Free rider problems also worked to limit the value of these remedies.
Whenever the decisions of managers were threatened in litigation, the business judgment rule offered so much protection that management was rarely, if ever, found liable for alleged misdeeds.  In the governance mechanisms senior inside management, especially the chief executive officer, selected the board of directors, and while the board in theory had ultimate authority for the management of the corporation, it largely deferred to the policies and practices of the senior inside managers. Direct challenges to the CEO by the board were rare, and the board usually followed the directives of the insiders in opposing derivative suits. If derivative suits had any merit, or were being waged aggressively enough to have nuisance value, they were settled with minimal effect on the corporation and a small shifting of wealth to the plalntiff s bar.
Although the agency metaphor was the subject of scholarly criticism,  it continued to dominate the theoretical landscape  because it meshed nicely with the practical view of many that corporations were structures run by powerful agents. Under the agency metaphor, shareholder/owners were protected by the fiduciary duty of their management agents. If these powerless "owners" were unhappy with the organizational developments, their real remedy was to sell. Voice was not a factor. Even those few scholars who considered voice deemed that its use would both be too expensive for shareholders and involve insoluble free-rider and collective action problems. Moreover, it was assumed that voice was irrational because it would cause others to exit, actually reducing the value of one's own investment. 49]
The agency model was accepted by both managerialists and anti-managerialists and continues to survive among most of today's neoclassical theorists. Although a key feature of the principal-agent relationship is the principal's power to control the agent, the fact that shareholders have almost no power to control management seems not to trouble theorists. On the contrary, progenitors of the agency model, like Berle and Means, believed that shareholders actually benefitted by having minimal rights of control because exercising control would interfere with their liquidity, their safety through exit. 
This focus on exit, a purely economic analysis, rather than the richer and more nuanced combination of economic exit and political voice processes working together,  did not recognize that exit alone cannot do much to help falling corporations. For example, the exitof shareholders does not give as clear a warning to managers as exit by customers. First, the price of stock may not accurately reflect the corporation's value due to slack, and may not really measure management's effectiveness.  Second, management often raises capital for corporate growth by long-term debt and the use of internally generated funds, so equity markets were also not a useful "message board."  Signals from capital markets were often too weak at first to affect managers. Moreover, stock price may not reflect "soft" information and is skewed to favor the short term. Finally, managers have a limited direct interest in the stock price of their companies. Although managers often owned stock and held stock options, these holdings usually constituted only a small portion of management's compensation. 
Shareholder exit, despite depressing stock price, provided little discipline and, was thus a classic example of the kind of exit that Hirschman describes as a poor indicator to improve performance. It became a kind of "faux exit." The stock being sold and bought was fungible so that there was exit compensated by new entry that "ceases to be a threat to deteriorating organizations."  Moreover, the most knowledgeable and alert shareholders would be the first to sell, thereby removing the voice from those who might have the most useful things to say. In this way, the ease of exit caused the possibility of meaningful voice to atrophy. A simple view of exit seemed to explain the Wall Street Rule but it was not the kind of exit that worked to improve corporations. Nonetheless, efforts were not made to design institutions to nurture voice, an instrumentality that may need active, initial support. Exit was used to explain the absence of voice, but not why generating voice might be important.
Inside managers were powerful, in part, because they were relatively unchecked by weak exit or non-existent voice. Management had also largely captured the mechanics of corporate governance. William Simon says that many corporations became "managerial satrapies."  Commentators have explained that for most of this century, the state statutes governing corporate governance have reflected the desires of management.  Public choice theorists argue that local legislators were influenced by wealthy and organized corporate managers "at the expense of the diffuse and disoriented citizenry" of shareholders.  The ready availability of exit for knowledgeable and dissatisfied shareholders made it easier for ineffective managers to hold power. Ironically, a different kind of exit enabled competent managers to leave for other firms, and increased the level of mediocrity of those who did not leave.
The easy availability of shareholder exit also helped to generate management entrenchment. Hirschman has pointed out that Roberto Michels' formulation of the Iron Law of Oligarchy, that elites continually design mechanisms to retain and increase their power, arose in the context of a multi-party European political system in which easy exit to other political parties limited the growth of voice and loyalty. Michels' political elite were able to exploit the ready availability of exit.  Similarly, corporate managers are another elite that have followed the Iron Law and have used readily available shareholder exit to perpetuate their power. Although there can be no loyalty without the possibility of exit, the threat of exit (made by one who has some loyalty) strengthens the power of voice. The willingness to use voice is reduced by the opportunity of exit, but the effectiveness of voice is increased by the threat of exit. Thus, if exit is extremely easy, but really not noticeable, as it has been for shareholders, it helps managers to increase their power and reduce their accountability and th e exit itself provides little leverage. Moreover, following the Iron Rule of Oligarchy, management continually designs mechanisms to retain and increase its power. Traditional corporate governance in the United States, at least until the recent developments discussed below in Section 4, was so despotic, in part, because democratic institutions could not develop when one key constituency, the shareholders, had such little loyalty  and such easy exit. When exit is readily available, "organizations can resist, evade and postpone the introduction of internal democracy even though they function in a democratic environment."  Management manipulated governance to increase its own power. Thus, the so-called "power" of shareholders to vote by proxy was really a management entrenchment tool because most of the shareholders who chose not to exit, voted as management suggested. Writing in 1988, at the time of the "Ancien Regime" in Eastern Europe, Louis Lowenstein characterized the vote by proxy of shareholders f or the board of directors of an American public corporation as following the "Polish State Model,"  the unanimous election of one slate of candidates.
Management was also able to entrench itself by withholding information as well as ignoring exit and marginalizing voice. Withholding information can be a useful mechanism used by management to increase loyalty and reduce both exit and voice. Although the long-term interests of corporations were harmed, managers were able to act in their "short-term interest to entrench themselves and to enhance their freedom to act as they wish, unmolested as far as possible by either desertions or complaints of members."  Voice requires the availability of information that can be difficult or costly to obtain. Managers therefore used confidentiality to entrench themselves by withholding information. Sometimes managers even attempted to prevent the board from learning about important developments.  Thus, because voice can be a function of the availability and cost of information, even the …