My friend and law school classmate Charles Elson is a leading expert on corporate governance. Although we have much in common, including membership in the Federalist Society, we often do not see eye-to-eye on corporate governance issues. A case in point is offered by today's major WSJ article on related party transactions between directors or officers and the corporations they serve. Elson favors banning such transactions:
All these deals present the risk of conflicts between a company official's two roles: representative of the shareholder and individual seeking to get the best deal for himself. Some argue that the risks outweigh any potential benefits of such arrangements. "I think we should just have a blanket prohibition on any significant related-party transactions," says Charles Elson, director of the Weinberg Center for Corporate Governance at the University of Delaware. Only minor deals would escape Mr. Elson's ban, such as the director of a bank having a checking account at the institution.
In contrast, I think a complete ban would be overkill. At an abstract level, prohibiting conflicted interest transactions fails to give due deference to the principles of party autonomy and freedom of contract, which are important values both in themselves and because they promote efficient transactions. At a practical level, many transactions between the corporation and a director prove beneficial to both sides. If a director owns a valuable piece of property, which would be useful to the corporation, should not the director be allowed to sell it to the firm? As the WSJ observed, I think correctly:
[M]any public companies began as family enterprises and employment and business relationships involving family members arose as a natural part of the company's growth. Likewise, a company might want the head of a key supplier as a director in order to get that person's business insights. As more and more women have been employed at all levels of corporations, the workplace has become a much more common place to meet one's spouse.
All in all, some argue, a ban on related-party dealings could deprive a company of talented employees or beneficial business arrangements.
In sum, it's worth remembering that a conflict of interest is just a state of affairs, not a crime to which we should ascribe moral blameworthiness. Corporate law has a long tradition of policing rather than prohibiting conflicts of interest, including related party transactions. Because of the potential conflict of interest, such transactions indeed should be policed quite closely, being subjected to exacting scrutiny under the duty of loyalty's entire fairness standard, but not banned.
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