This Article offers a novel theory of the optimal balance of power between boards and shareholders. It does so by shedding light on the information structure of the shareholder-manager relationship, showing that shareholders face problems of adverse selection in addition to classic problems of managerial opportunism, i.e., moral hazard. Adverse selection arises when a manager’s private information on her skills or the transactional environment makes shareholders unable to separate “good” managers, who respond to incentives for optimal project selection, from “bad” ones. This framework identifies a fundamental tradeoff, as mitigating adverse selection by strengthening the shareholders’ right to remove bad managers might conflict with attempts to control moral hazard. Indeed, struggling to avoid removal, good managers may likewise become unresponsive to incentives and engage in “strategic signaling”: preferring short-termist projects to more valuable long-term projects that can be mispriced in the near term and thus foster the belief that a manager is bad.
Against this analytical background, the Article defends a corporate model with strong board authority in the short term and enhanced shareholder rights in the longer term. A board protected from shareholder pressure is more likely to be biased toward tolerating a disappointing firm outcome, which reduces the risk of strategic signaling. In the longer term, however, market prices tend to more accurately gauge information on managerial decisions, while a board’s “bias” might grow excessive, calling for greater shareholder involvement in decisions about managerial accountability. The Article concludes by discussing the implications of the analysis for corporate law policy and doctrine.