No full-text available
To read the full-text of this research,
you can request a copy directly from the author.
Special Interest Race to CEO Primacy and the End of Corporate Governance Law
Abstract
Recently, many respected business leaders have voiced concern that corporate governance in American public companies has moved toward CEO primacy or a dictatorship of the CEO, and away from traditional notions of shareholder primacy. This article shows that this concern is well-founded. The current system of corporate governance tends toward management indulgences. This is clearly reflected in key legal elements of corporate governance, which embrace increasing laxity. New empirical evidence also suggests that the trend of corporate governance is away from more demanding standards that seem to reduce agency costs and enhance financial and economic performance. The model that best explains corpo-rate governance dynamics are economic models of special interest influence rather than any largely mythical race to ever more optimal corporate governance standards. This article concludes that the sub-optimality of corporate governance is crisis prone and subject to challenge from competing nations. Therefore as currently constructed the system is unsustainable.
We use an agency model to analyze the impact of judicial review on the incentives of elected leaders to “posture” by enacting bold but ill-advised policies. We find that judicial review may exacerbate posturing by rescuing leaders from the consequences of unwise policies, but may also discourage posturing by alerting voters to unjustified government action. We further find that judges will defer to the decision of elected leaders unless posturing is sufficiently likely. We then show how judicial review affects voter welfare, both through its effect on policy choice and through its effect on the efficacy of the electoral process in selecting leaders. We also analyze how the desirability of judicial review is affected by characteristics of the leaders and the judges.
In 2008, share prices on U.S. stock markets fell further than they had during any one year since the 1930s. Does this mean corporate governance “failed?” This paperarticle argues generally “no,” based on a study of a sample of companies at “ground zero” of the stock market meltdown, namely the 37 firms removed from the iconic S&P 500 index during 2008. The study, based primarily on searches of the Factiva news database, reveals that institutional shareholders were largely mute as share prices fell and that boardroom practices and executive pay policies at various financial firms were problematic. On the other hand, there apparently were no Enron-style frauds, there was little criticism of the corporate governance of companies that were not under severe financial stress and directors of troubled firms were far from passive, as they orchestrated CEO turnover at a rate far exceeding the norm in public companies. The fact that Given that corporate governance functioned tolerably well in companies removed from the S&P 500 and given that a combination of regulation and market forces will likely prompt financial firms to scale back the free-wheeling business activities that arguably helped to precipitate the stock market meltdown, implies that the case is not yet made out for fundamental reform of current corporate governance arrangements practices as a general matter.
Changes in information technology, in combination with changing popular and political opinion (including concern over climate change) are moving the subject of corporate social responsibility ('CSR') to the forefront of policy reform, consumer and investor behavior, and graduate business education. Nevertheless, up to the present, CSR has not thrived within law schools’ curricula, or mainstream graduate or undergraduate programs. First, the subject is too synthetic to fit neatly within the core, established framework of academic subject areas (e.g. history, economics, sociology and management), or law schools’ conventional teaching of corporate, securities, employment, administrative, or environmental law. CSR is relevant to all these areas but has not become central in any one of them. This essay charts the intellectual history of CSR and explains how the traditional corporations and securities regulation courses have marginalized the study of CSR. It suggests ways these courses could be expanded to address CSR issues and contends that law schools will be falling behind if they do not prepare future corporate lawyers to do so. The global nature of modern commerce and financial markets, and the greater accountability facilitated by the internet, will ensure continued, widespread interest in CSR subjects. The Appendix presents my Congressional testimony in favor of the Extractive Industries Transparency and Disclosure Act – an act which raises fundamental CSR issues which could be explored in law and business schools, as well as in graduate programs in political science and economics, inter alia.
Delaware makes the state corporate law governing most large American corporations. Since Washington can take away any, or all, of that lawmaking authority - and, via the securities laws, already has taken away much - a deep conception of American corporate law should show how, when, and where Washington leaves that lawmaking authority in state hands. The interest groups and ideas in play in Delaware are narrow, the array in Congress wide. Three key public choice results emanate from this difference. First, the major state-level players usually want to minimize federal authority in making corporate law because a federal deal splits the pie with outsiders while a local deal cuts in fewer players. Second, because federal players may act if they see state results as lopsided, interest groups who could dominate Delaware lawmaking have reason to forgo a winner-take-all strategy. The Delaware players can be seen as a local caucus within national lawmaking, with Delaware as the institution that allows them to caucus and usually make corporate law first. Third, we can delineate the space where the states have room to maneuver from where federal authorities loom. Federal authorities can change the initial state-made result, with players and ideologies absent in Delaware but big in Washington affecting the federal outcome. Those new players and ideas usually give the original Delaware players reason to resist federal action. And because the federal agenda is large and Delaware's is small, Delaware's decisions often become a stable status quo. But when media saliency puts the matter on the federal agenda or when Delaware's primary players disagree or when the matter strikes Washington players as important to the American economy, Delaware loses its dominance. Delaware has wide discretion and first-mover advantages, but its independence even when wide is not without limit, ending when Washington is provoked.
This is an EARLY version of our published article, Outside Director Liability, which is also on SSRN at http://ssrn.com/abstract=894921. A companion article, Brian Cheffins & Bernard Black, Outside Director Liability Across Countries, Texas Law Review (forthcoming 2006), http://ssrn.com/abstract=438321), studies six comparison common-law and civil-law countries (Australia, Britain, Canada, France, Germany, and Japan). These two articles are the most fully developed of our articles on outside director liability. This early version was completed before the Enron and WorldCom settlements in 2005. We have left it on SSRN because Parts III and IV were not included in our published work. ABSTRACT FOR THIS PAPER: Outside directors can do a bad job, sometimes spectacularly. Yet outside directors of U.S. public companies who fail to meet what we call their vigilance duties under corporate, securities, environmental, pension, and other laws almost never face actual out-of-pocket liability for good faith conduct. Their nominal liability is almost entirely eliminated by a combination of indemnification, insurance, procedural rules, and the settlement incentives of plaintiffs, defendants, and insurers. The principal risk of actual liability is under securities law, for an insolvent company (which can neither pay damages itself nor indemnify the director) and a seriously rich (hence worth chasing) director, where damages exceed the D&O insurance policy limits and the director does not represent an institution that can indemnify him. The principal sanction against outside directors is harm to reputation, not direct financial loss. Other pieces of our overall research on Outside Director Liability are listed below. http://ssrn.com/abstract=878135 (policy analysis) http://ssrn.com/abstract=628223 (study of Korea) http://ssrn.com/abstract=682507 (summary article for a finance audience) http://ssrn.com/abstract=800584 (Germany-centered) http://ssrn.com/abstract=800604 (German language version of Germany-paper) http://ssrn.com/abstract=590913 (summary for practitioner audience)
This Article focuses on what is right about the modern publicly held corporation and attempts to decouple these attributes from the debate about what needs to be fixed. It attempts to show that much of this "blame game" is ill-founded and misdirected. It instead argues for a more austere restructuring that would actually transcend the corporation per se and focuses on the apparent locus of the difficulties: The management of the large, publicly held business enterprise.The essence of the modern corporation consists of two important elements: (1) limited liability; and (2) the ability to lock in capital regardless of the desires of individual owners or creditors. This Article seeks to highlight these central points, in the specific context of race in America. Part I will seek to show what is right and wrong with the modern corporation. Part II will demonstrate, in general, how the law should respond to this realization of the fundamental strengths and the more "minor" weaknesses of the modern corporation. Part III will apply these lessons to the problems of race in America in 2005. The Article concludes that law plays an important role in the dementia of corporate wrongdoing but that the legal foundation of the corporation itself is not to blame. Instead, the blame lies largely in the legal infrastructure (or lack thereof) surrounding the corporation. In particular, corporate governance law in the US devolved to a CEO primacy model. The real question that recent corporate misconduct raises is whether it is now past time to insist upon professional management of publicly held companies. This Article suggests a road map for racial reformers thinking about the central role that the corporation has played in our economy.
Smith v. Van Gorkom led to the death of the duty of care for directors of public corporations in the United States. Nothing in Smith justifies this "drastic" change in American corporate law. On the contrary, once Smith is viewed in accordance with the narrative proffered in this article, it fails to explain the death of the duty of care, since the case did not change the law or the risks facing directors. This suggests that the death of the duty of care following in the wake of Smith was not the product of a highly interventionist court, which required legislative constraint, as many commentators suggest. Moreover, combined with increased laxity in constraints on management of public corporations with respect to other issues of corporate governance, such as the PSLRA, Smith's legacy left us with a most radical outcome: the onset of CEO primacy in the American public corporation.Excessive laxity in legal constraints has now resulted in excessive CEO power. It also resulted in political reaction: the Sarbanes-Oxley Act of 2002. Unfortunately, the end result of political overreaction may not be beneficial. The Sarbanes-Oxley Act greatly increased the cost of accessing the public capital markets upon all issuers without improving the quality of corporate governance. The system has shifted from wild indulgence to wild over-regulation. This fact suggests that the underlying legal structure of our corporate governance system results in standards and laws that are difficult to predict and are untethered to any policy analysis. The system seems best explained by Chaos Theory.
This paper analyzes the history of federal intervention in corporate law and draws from it lessons for the future. We show that the replacement of state law arrangements by federal ones has not been sometimes in favor of investors and sometimes in favor of corporate insiders. Rather, the federal government has systematically replaced state law arrangements with ones imposing tighter constraints on insiders. Without federal intervention, state law would have produced a corporate system that provides substantially weaker investor protection than the U.S. enjoys today. We also show that federal interventions have systematically taken advantage of additional tools (including public enforcement, criminal sanctions, gatekeeper liability, and agency-based regulations) beyond those that state law has chosen or been able to use. Thus, unless one views existing levels of investor protection as substantially excessive, past patterns suggest that state competition is unlikely to produce by itself an adequate level of investor protection. Furthermore, the recurring need for federal officials to rectify state law failures in order to provide investors with adequate protection suggests that, going forward, federal lawmaking should be proactive rather than reactive. We thus recommend that Congress appoint a National Corporate Law Commission that will review all corporate law issues governed by state law to identify those that should be partly or fully federalized either because tighter restrictions on insiders are needed or because the additional tools available to federal law would be useful.
It appears that our society has tacitly agreed to spare corporate directors any significant legal liability - which includes both financial and incarceration - for failing to perform their duties as board members. Thus, over the last twenty years, there has been a virtual elimination of legal liability - particularly in the form of financial penalties - for directors who breach their fiduciary duty of care. This is true despite the fact that we entrust directors with the awesome responsibility of monitoring all of America's corporations as well as the officers and agents within those corporations. More surprisingly, this tacit agreement against legal liability for directors has persisted even reform efforts designed to prevent corporate governance failures. Thus, while Sarbanes-Oxley imposes increased responsibilities on directors, that Act fails to impose any direct legal penalties on directors when they breach those responsibilities. Most corporate scholars appear to support this failure, not only insisting that other extra-legal measures sufficiently ensure directors' compliance with their fiduciary duties, but also arguing that legal remedies are both costly and ineffective. This Article disagrees. Instead, this Article uses Sarbanes-Oxley and events which led to its enactment to demonstrate that most arguments rejecting director liability inappropriately assess the costs and benefits of legal penalties, while failing to appreciate the degree to which extra-legal market or reputational sanctions depend upon legal measures for their effectiveness. Thus, this Article concludes that legal sanctions represent a vital aspect of any system seeking to regulate director misconduct. As a consequence, this Article also concludes that many of our corporate governance reforms may be defective because they impose new and significant obligations on directors, but make no specific provisions for sanctioning directors' failure to fulfill such obligations.
Much of our understanding of corporations builds on the idea that managers, when they are not closely monitored, will pursue goals that are not in shareholders' interests. But what goals would managers pursue? This paper uses variation in corporate governance generated by state adoption of antitakeover laws to empirically map out managerial preferences. We use plant-level data and exploit a unique feature of corporate law that allows us to deal with possible biases associated with the timing of the laws. We find that when managers are insulated from takeovers, worker wages (especially those of white-collar workers) rise. The destruction of old plants falls, but the creation of new plants also falls. Finally, overall productivity and profitability decline in response to these laws. Our results suggest that active empire building may not be the norm and that managers may instead prefer to enjoy the quiet life.
This paper examines both empirically and theoretically the growth of US executive pay during the period 1993--2003. During this period, pay has grown much beyond the increase that could be explained by changes in firm size, performance, and industry classification. Had the relationship of compensation to size, performance, and industry classification remained the same in 2003 as it was in 1993, mean compensation in 2003 would have been only about half of its actual size. During the 1993--2003 period, equity-based compensation has increased considerably in both new-economy and old-economy firms, but this growth has not been accompanied by a substitution effect, i.e. a reduction in non-equity compensation. The aggregate compensation paid by public companies to their top-five executives during the considered period added up to about $350 billion, and the ratio of this aggregate top-five compensation to the aggregate earnings of these firms increased from 5 per cent in 1993--5 to about 10 per cent in 2001--3. After presenting evidence about the growth of pay, we discuss alternative explanations for it. We examine how this growth could be explained under either the arm's-length bargaining model of executive compensation or the managerial-power model. Among other things, we discuss the relevance of the parallel rise in market capitalizations and in the use of equity-based compensation. Copyright 2005, Oxford University Press.
Refining and extending the methodology introduced by Daines (2001), I present evidence that small Delaware firms were worth more than small non-Delaware firms during the period 1991--1996 but not afterwards. I also present evidence that larger firms, which comprise 98% of my sample by size, exhibit no Delaware effect for any year during the period 1991--2002. Thus the Delaware effect "disappears" when examined over time and when examined for firms that are economically meaningful. These new contours of the Delaware effect suggest that the benefit associated with Delaware incorporation was an order of magnitude smaller than estimated by Daines (2001) during the early 1990s, and nonexistent by the late 1990s. The trajectory of the Delaware effect further suggests that it cannot provide support for the "race to the top" view of regulatory competition, as some commentators have argued, and may in fact provide support for the "race to the bottom" view. Finally, the findings presented here identify two puzzles: (1) Why did small Delaware firms exhibit a positive Delaware effect during the early 1990s but larger firms did not? (2) Why did this effect disappear in the late 1990s? I identify doctrinal changes in Delaware corporate law in the mid-1990s, increased managerial incentives to sell during this period, and a cohort selection effect during the 1980s as potential explanations. Copyright 2004, Oxford University Press.
This Article challenges the conventional wisdom that states compete for incorporations. Delaware aside, no state stands to gain meaningful tax revenues or legal business from chartering firms, and no slate takes significant steps to attract incorporations. The explanation for this apathy lies in a combination of economic entry barriers and political factors. This analysis of the market for incorporations has implications for the present structure of corporate law, for the desirability of federal intervention, and for theories of regulatory competition in general.
165 (rev. ed. 1.971) (stating that very large groups will not pursue organizations to influence public goods like law because rational actors will instead assume that they can free ride on the efforts of others) Olson's
- Mancur Olson
- Thelogicofcollective Action
MANCUR OLSON, THELOGICOFCOLLECTIVE ACTION 2, 11, 165 (rev. ed. 1.971) (stating
that very large groups will not pursue organizations to influence public goods like law because
rational actors will instead assume that they can free ride on the efforts of others). Olson's
2007]