NBER Report: Blockchain Could Shift Balance of Corporate Power

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corporate governance, power balance

The blockchain could dramatically change corporate governance by reducing legal insider trading and making shareholder voting more reliable, according to a new report published by the National Bureau of Economic Research (NBER).

Authored by New York University (NYU) professor David Yermack, the second working paper by the US non-profit explores how the widespread adoption of distributed ledgers could impact investors, shareholders, auditors and other participants in corporate governance.

Citing recent proofs-of-concept at major stock exchanges, the NBER paper explores a future where blockchains are used to record equities in corporations, providing real-time insight into corporate share transfers.

The report goes on to label the blockchain as potential enabler of the most important changes to corporate governance “since the 1933 and 1934 securities acts in the US”, stating:

”Managerial ownership could become much more transparent, with insider buying and selling detected by the market in real time, and chicanery such as the backdating of stock compensation becoming much more difficult, if not impossible. Corporate voting could become more accurate, and strategies such as ‘empty voting’ that are designed to separate voting rights from other aspects of share ownership could become more difficult to execute secretly.”

“Any and all of these changes,” it says, “could dramatically affect the balance of power between directors, managers, and shareholders.”

Notably, the report sees the technology as being first adopted in developing nations where existing recordkeeping systems are inadequate, market regulators are ineffective and smartphone penetration levels are high.

That said, the report speculates that the open, public bitcoin blockchain may not be the version of the technology that becomes widely embraced as a solution to these issues.

Though Yermack states that bitcoin has proven its reliability as the world’s longest-running decentralized ledger, he notes drawbacks to its model.

“If a manager sells shares of his own stock, I assume that the public will see not only the sale but will also discern the selling manager’s identity. In practice, this may or may not occur, because assets on blockchains are typically held in anonymous ‘digital wallets’ identified only by complex labels akin to serial numbers,” he continues.

Checks and balances

In a section on corporate governance, the report suggested that registering equities and securities on the blockchain would lead to “faster, cheaper trade execution” and greater transparency as all transactions on such a blockchain would be visible to the network.

However, Yermack noted that this was based on several assumptions about how such a blockchain network would be constructed.

“This claim assumes not only that a distributed ledger of share ownership can be viewed by the public, but also that observers can identify the holders of individual shares and the counterparties of important transactions,” the paper reads.

Here, the paper states that activist shareholders, those whose equity stakes serve as a strategic way to influence the company, might become less common due to the proliferation of the technology.

Investment managers, in turn, would likely trade less often due to what the paper said would be heightened concern about “sending adverse signals to the market” for fear of reputational risk.

“The net effect would likely cut into managers’ profits from legal insider trading, and firms might have to pay them more to offset this loss,” the report reads.

Voting transparency

Perhaps the most impactful change the technology could bring about, according to the report, would be to motivate shareholders to more directly participate in corporate decision-making through voting.

Due to the transparency and accuracy of digital ledgers, stock managers would be less able to manipulate outcome, the report argues, while votes themselves would lead to more verifiable results.

“The net effect would be more frequent election of dissident outside candidates representing shareholder activists or other groups and more frequent defeats of management proposals related to compensation and governance,” the report reads.

So-called empty voting, whereby investors borrow shares to acquire voting rights in secrecy would also be eliminated, the paper argues, as they would now be visible to the public, enabling opponents of such actions to counteract such measures.

“Such a stock loan would be immediately transparent, providing notice to shareholders, management, and regulators of a redistribution of voting power,” it reads, adding:

“Opponents could take steps to counteract the acquisition of votes by an empty voter, and regulators could enjoin voting of the shares.”

Overhauling accounting

In what may be its boldest prediction, the paper indicates that blockchains could automate the accounting industry, thus shaving $ 50bn a year in corporate expenditures.

“Instead of relying on the auditing industry, which itself has been subject to moral hazard and agency problems, each user could costlessly create their own financial statements from the blockchain’s data, for whatever time period they wished,” the report reads.

Though eliminating the accounting practices of today, the paper speculated that the industry could reinvent itself through services that interpret blockchain data.

Elsewhere, the report predicts real-time accounting would make it difficult for earnings reports to be manipulated, while reducing the likelihood of suspicious or illegal asset transfers in times of financial distress.

Still, such a future is not without its own drawbacks, as the paper concludes by noting that both open and permissioned blockchains need strong governance models to operate effectively:

“Just as is the case with a stock exchange, the regulations embedded in a blockchain’s software code could favor some participating companies at the expense of others, and therefore the authority to change these underlying rules could be critically important.”

For more information, download the full report here.

Balance of power image via Shutterstock

Academic Research

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