Corporate Governance And Blockchains

David Yermack

New York University (NYU) – Stern School of Business

November 29, 2015

Abstract:

Blockchains represent a novel application of cryptography and information technology to age-old problems of financial record-keeping, and they may lead to far-reaching changes in corporate governance. During 2015 many major players in the financial industry began to invest in this new technology, and stock exchanges have proposed using blockchains as a new method for trading corporate equities and tracking their ownership. This essay evaluates the potential implications of these changes for managers, institutional investors, small shareholders, auditors, and other parties involved in corporate governance. The lower cost, greater liquidity, more accurate record-keeping, and transparency of ownership offered by blockchains may significantly upend the balance of power among these cohorts.

Corporate Governance And Blockchains – Introduction

This essay explores the corporate governance implications of blockchain database technology. Blockchains have captured the attention of the financial world in 2015, and they offer a new way of creating, exchanging, and tracking the ownership of financial assets on a peer-to-peer basis. Major stock exchanges are exploring the use of blockchains to register equity issued by corporations. Blockchains can also hold debt securities and financial derivatives, which can be executed autonomously as “smart contracts.”

These innovations have the potential to change corporate governance as much as any event since the 1933 and 1934 securities acts in the United States.

Using blockchains to record stock ownership could solve many longstanding problems related to companies’ inability to keep accurate and timely records of who owns their shares (Kahan and Rock, 2008). Simple extensions could allow blockchains to hold self-executing smart contracts, such as stock options held by employees or warrants owned by outside investors. These smart contracts could extend into areas such as the pre-contracted resolution of financial distress. Perhaps most importantly, blockchains could provide unprecedented transparency to allow investors to identify the ownership positions of debt and equity investors (including the firms’s managers) and overcome corruption on the part of regulators, exchanges, and listed companies. If a firm elected to keep its financial records on a blockchain, opportunities for earnings management and other accounting gimmicks could drop dramatically, and related party transactions would be much more transparent.

For shareholders, blockchains could offer lower costs of trading and more transparent ownership records, while permitting visible real-time observation of transfers of shares from one owner to another. For activists, the technology could allow for quicker, cheaper acquisitions of shares, but with far less secrecy than under the current system. 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 could dramatically affect the balance of power between directors, managers, and shareholders.

In this paper, I identify in more detail how the use of blockchains could affect corporate governance from the perspective of corporate managers, institutional investors, debt investors, auditors, and other groups. I also discuss issues related to the internal governance of blockchains themselves, a topic that could become important to corporations in the way that the organization of stock exchanges and other capital market institutions is important today.

Blockchains were introduced by Nakamoto (2008) to track ownership of the virtual currency bitcoin. After more than six years of successful use with bitcoin, blockchains have become recognized as an alternative to ownership ledgers based on classical double-entry bookkeeping. Blockchains offer potential advantages in cost, speed, and data integrity compared to classical methods of proving ownership, and the scale of these potential savings has motivated investments by venture capitalists and by established players in the financial services industry. Entrepreneurs are actively investigating blockchains’ suitability for recording ownership of a wide range of assets, from stocks and bonds to real estate, automobile titles, and works of art.

Blockchains

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