ProfessorBainbridge.com

Rodney Strong Charlotte's Home Sauvignon Blanc (Sonoma County)

Pears, lemon meringue, flint, and grass. Clean and crisp, Recommended. Grade: B+

European Corporatism

I get very tired of left-liberal econopundits and econobloggers praising the merits of Old Europe's economic model. On the WSJ($)'s web site, Sam Gregg of the Acton Institute offers a provocative critique of European corporatism:

Partly inspired by certain schools of Christian social thought, corporatism seeks to reduce social tensions -- what France calls le fracture social -- by corralling business leaders and employees into confederations of employer associations and workers' councils that, under government supervision, negotiate everything from salaries to pension benefits.

These systems proved successful at neutralizing radical left-wing elements within West European trade unions. Gradually, however, they became engines for stagnation. They have, for instance, a vested interest in more regulation. Growing regulation gives corporatist bodies reasons to build empires of bureaucrats to help employers and workers negotiate their way through the jungle of rules and by-laws.

The same regulations give corporatist bodies every reason to discourage anyone who suggests that reducing regulations might encourage the emergence of new businesses built by entrepreneurs.

Sam also criticizes "Western Europe's increasingly secularist -- that is, practically atheist -- moral culture":

The idea that there is something wrong with foisting the payment for one's present comfort onto future generations (as many Western Europeans seem content to do) is incomprehensible to secularist minds. For if we believe that all that matters is our own present satisfaction and that no one owes anything to others, then it does not seem unjust to mortgage the future of others -- even our own children. The same deadly logic lies just beneath the surface of Lord Keynes' celebrated quip that "in the long run, we are all dead." ...

If Western Europe is to become an entrepreneurial society, it requires more than greater access to capital. It demands nothing less than a cultural revolution: one that not only sweeps away corporatist structures and complaisant attitudes towards regulation, but also relights the fire of hope that only comes from the virtue of faith. And that is the work of evangelization.

Justin Justification (Paso Robles) 2002

A very tasty blend of Cabernet Franc (76%) and Merlot (24%). On the nose: olives, italian herbs, and rich berries. On the palate: the same, plus a blast of chocolate, coffee, and dill. Highly recommended for short to medium-term drinking, as it lacks the acids and tannins for the long haul. Grade: B++

Chi Trib Quotes ProfB re Disney

Some experts, including UCLA corporate law professor Stephen Bainbridge, argue that if boards can provide evidence of an adequate decision-making process, courts would defer to their decisions, right or wrong. (Link)

And I'm right. See my article The Business Judgment Rule as Abstention Doctrine for an analysis of the relevant case law. As for the policy issues surrounding executive compensation cases, like the Disney suit, see my new essay Execut ive Compensation: Who Decides?

Qupe Bien Nacido Hillside Estate Syrah (Santa Barbara) 1996

Perhaps a bit past it, as it seemed to be fading, but still tasty and a deep ruby in color. Blackberry, black pepper, burnt rubber, beef, and brambles and herbs. Grade: B

Chateau St. Jean Pinot Noir (Sonoma County) 2002

Smooth and fruity. Berries, cola, and a trace of oak. Easy to enjoy with a wide range of foods or by itself. Good value. Grade: B/B+

La Crema Chardonnay (Sonoma) 2003

Tart apple, citrus, lightly oaked, a little green. More like a Chablis than a California Chardonnay, which is decidedly not a criticism. Good seafood wine. Grade: B/B+

Corporate Social Responsibility: Conference Papers

I’m running a conference today, which is why I haven’t been blogging. As part of the conference, I commented on four very interesting papers by Einer Elhauge, Larry Ribstein, Lynn Stout, and Cindy Williams. I commend the papers to you, and offer up the comments I gave on them:

Back in 2001 Henry Hansmann and Reinier Kraakman published a well-known essay The End of History for Corporate Law, in which they argued that global corporate governance rules are converging towards “the ‘standard shareholder-oriented model’ of the corporate form.” The title of their article, of course, was a riff on Francis Fukuyama’s book The End of History.

As we’ve all learned, Fukuyama was wrong. History has definitely not ended.

I think these four papers demonstrate that Hansmann and Kraakman also erred. All four to some extent call into question what Hansmann and Kraakman called the “standard shareholder-oriented model” and I call shareholder primacy.

These four papers thus each go to the core goals we set for this conference.

As our call for papers put it, most of us here at UCLA believe that shareholder primacy operates in a two dimensional space. Along one axis are the means of corporate governance: i.e., who is in charge? Lynn Stout’s presentation forcefully makes the case for what she and I have taken to calling “director primacy”: i.e., the idea that the corporation is a vehicle by which directors hire factors of production and the corollary proposition that shareholders have only the very limited set of control of rights for which they have bargained. (You know, Lynn, if we could just get together on the ends issue, we would have the makings of a distinctive UCLA School of Thought.) I should acknowledge that my thinking on this subject owes much to the work of Mike Dooley, especially his article Two Models of Corporate Governance, but he should not be blamed for the misuses to which I’ve put it. In any case, at the other end of the spectrum on this axis lie folks like Lucian Bebchuk, who equally forcefully argue for reuniting ownership and at least ultimate control in the hands of shareholders.

The other axis along which the shareholder primacy debate plays out relates to the ends of corporate governance. What is the decisionmaking norm that guides corporate governance? At one end of that axis lie folks like myself who believe that Dodge v. Ford Motor Co. meant what it said; namely, that the end of corporate governance is shareholder wealth and that the discretion of directors must be exercised towards that end. Larry clearly is with me on this. In contrast, Einer, Lynn, and Cindy have all staked out positions towards the stakeholderism end of the spectrum. Each seeks to temper the Friedmanesque notion that the corporation’s social responsibility is to maximize its profits.

Let me now say just a few words about the individual papers. Cindy Williams mounts a provocative challenge to Hansmann and Kraakman’s claim that the world is converging on shareholder primacy. I don’t think any of us can quibble with Cindy’s positive account. As last week’s Economist magazine observed:

Companies at every opportunity now pay elaborate obeisance to the principles of corporate social responsibility. They have CSR officers, CSR consultants, CSR departments, and CSR initiatives coming out of their ears.

Of course, the Economist isn’t convinced that that’s a good thing; and neither am I. Since Cindy’s paper assumes the normative desirability of CSR, however, let me turn to Einer, whose paper expressly sets out to make the case for CSR.

I’m afraid I must disagree with Einer’s account of the relevant legal rules. Yes, the business judgment rule gives directors a lot of discretion, including the kind of non-profit-maximizing discretion we see in that old chestnut Shlensky v. Wrigley. As I explained in my Northwestern article on director primacy, however, the case law, properly understood, does not stand for the proposition that directors have discretion to make trade-offs between nonshareholder and shareholder interests. Instead, the cases stand for the proposition that courts will abstain from reviewing the exercise of directorial discretion even when the complainant alleges that directors took nonshareholder interests into account in making their decision.

As Mike Dooley argued over a decade ago, the business judgment rule ensures judicial deference to the board’s authority as the corporation’s central and final decisionmaker. Put another way, the business judgment rule is the doctrinal mechanism by which courts on a case-by-case basis resolve the competing values of authority and accountability.

The discretion to pursue non-profit-maximizing behavior of which Einer makes so much is thus a byproduct rather than an intended consequence of the law and policy. (It is a question here of means versus ends.) I’ll refer you here to my recent article in Vanderbilt on the business judgment rule for my usual verbose working out of the argument.

As for the fact that none of the 50 states has a statute mandating wealth maximization, this is not very probative. In general, the fiduciary duties of directors have been worked out in the case law rather than by statute.

Yes, states have charitable contribution statutes. But their adoption was driven mostly by the historical anachronism of the old ultra vires rule. And, in any case, given the feeble level of corporate philanthropy, these statutes cannot be read as having given executives wide license to pursue non-profit-maximizing conduct.

Finally, as for the nonshareholder constituency statutes, Einer’s paper nicely summarizes my view of them – special interest legislation designed to insulate managers from takeovers. And here’s a key fact. In my corporate governance seminar last semester, I had a very pro-CSR student do a paper on these statutes. He could not find a single case in which these statutes were dispositive; indeed, he could only find a couple in which they were even mentioned. They are at the margins of corporate law.

Attention also should be paid to how executives describe their function. What do executives think the law requires of them? A 1995 National Association of Corporate Directors (NACD) report stated: “The primary objective of the corporation is to conduct business activities with a view to enhancing corporate profit and shareholder gain,” albeit with some mushy qualifying language. A 1996 NACD report on director professionalism set out the same objective, without any qualifying language on nonshareholder constituencies. The 2000 edition of Korn/Ferry International’s well-known director survey found that when making corporate decisions directors consider shareholder interests most frequently, although it also found that a substantial number of directors feel a responsibility towards stakeholders. In contrast, a 1999 Conference Board survey found that directors of U.S. corporations generally define their role as running the company for the benefit of its shareholders.

As for Einer’s normative argument, this is an issue for which more than a few trees have given their lives. I will not detain you with a lengthy rehash. Instead, let me offer a cautionary anecdote. Cindy is right that many institutional investors are getting on the CSR bandwagon. One of them is CalPERS. Back during the Southern California grocery strike a year or so ago, CalPERS made a very bid deal about Safeway’s allegedly socially irresponsible behavior. As it happens, Sean Harrigan, then head of CalPERS board was also the president of the main union representing Safeway employees. The take home lesson? CSR advocates often have an agenda inconsistent with the interests of shareholders. Indeed, as the Economist observed last week, they often have an agenda inconsistent with capitalism itself. Managers with the sort of discretion with which Einer wishes to vest them are rendered all too vulnerable to that agenda.

This brings me to Larry’s paper. For a number of years now, Larry has been pushing the question: Why Corporations? In his paper for our conference, Larry rebuts Einer’s normative argument by claiming that markets effectively constrain anti-social corporate conduct. Accordingly, he argues, the real issue is the principal-agent problem: managers have too much slack and we should deprive them of that discretion by moving to partnership-like governance.

Hence, he makes the provocative proposal that we could retain the decisionmaking efficiencies of centralized management while adapting certain features of partnership law that would dry up management’s control over free cash flow.

Count me a skeptic; mostly for prudential reasons – the devil you know and all that. The director primacy-based system of U.S. corporate governance has served investors and society well. John Micklethwait and Adrian Wooldridge recently opined, for example, the corporation is “the basis of the prosperity of the West and the best hope for the future of the rest of the world.” A comprehensive review of the evidence by Holmstrom and Kaplan is temperate only by comparison:

Despite the alleged flaws in its governance system, the U.S. economy has performed very well, both on an absolute basis and particularly relative to other countries. U.S. productivity gains in the past decade have been exceptional, and the U.S. stock market has consistently outperformed other world indices over the last two decades, including the period since the scandals broke. In other words, the broad evidence is not consistent with a failed U.S. system. If anything, it suggests a system that is well above average.

And so I ask: Why mess with success?

Update: Tom Smith of the Right Coast blog (his day job is corporate law professor at University of San Diego) weighs in with comments on my conference last week:

Well, I spent Friday and Saturday morning at Steve Bainbridge's conference up in LA on the Means and Ends of the Corporation, sponsored by the Sloan Foundation (a billion and a half dollars, started by the first CEO of GM, looking for ways to advance our understanding of business). It was actually a pretty good conference, and this comes from someone who usually regrets going to any given conference. There were a number of papers that were that rare thing in a piece of legal scholarship, interesting. Einer Euhlange of Harvard started off with a very closely argued paper that, for all of its logical rigor, managed to avoid addressing what I thought were some pretty obvious objections. He wanted to explain why it was good corporate directors should have lots of discretion, as this would allow them to do good things. But what to do if shareholders didn't concur on what was good, he did not really address. I was grateful for the paper, though, as it gave me something to attack in my five minutes in front of the class. Henry Manne nodded and smiled approvingly at my complaints, so I least I knew I was appealling to the law and econ crustaceans in the crowd, of whom I suppose I count as one. Ed Rock of Penn had a very interesting paper applying the "discursive dilemma" to corporations. Without getting into it, this is a way that promises to revive somewhat the wrongly discredited idea of corporate personality. Two economists from Harvard gave more or less incomprehensible presentations, but one of them, by Oliver Hart, a very distinguished theorist of the firm, seemed very promising, even if I didn't really follow a lot of it. He had a simple model that purported to explain why parties sometimes agree to some terms (such as price) and then go on to negotiate the rest of the deal later, still holding the fixed term as fixed. Of course, we do that all the time in contracts, and it is a bit hard to understand theoretically. So that may be a paper worth struggling through at some point. Bill Bratton gave a very interesting historical paper on the evolution of corporate law reforms, using some evolutionary game theory as part of its story. I like evolutionary game theory, and the paper had the ring of truth about it. Stephen Presser made the point in his paper, which I think is a profound truth about corporate law, but I didn't know anybody else thought so, that it has a strong republican strain, having the object of democratizing ownership (and I would say control, too) of business enterprizes across this land of ours.

You can download all the papers here.

Update: Law professors and bloggers Larry Ribstein and Gordon Smith have posted some thoughts on the corporate governance conference I ran on Friday and Saturday. Both offer substantive analysis of some of the issues that came up during the sessions. My thanks to both for their thoughts and participation. The papers presented at the conference were all provocative and insightful; you can download them here.

Dual-class stock

The Google IPO highlighted the recurring issue of whether ordinary investors are harmed by dual-class stock capital structures in which one class of stock (typically held by insiders) has supervoting rights. A paper by economists Andrew Metrick, Paul Gompers, and Joy Ishii (available at Knowledge@Wharton, which is free but requires registration) finds that:

Company values improved as insider ownership rose, with the effect reaching a peak when insider ownership reached 33%, based on their share of “cash flow” such as dividends. As insider ownership grew from zero to 33%, Tobin’s Q grew by about 15%. “As the fraction of cash flow ownership increases, the incentives of management become more closely aligned with those of outside shareholders and thus lead to better decisions (from outside shareholders’ perspective) and higher valuations,” Metrick and his colleagues write. The effect levels off as ownership exceeds 33%, probably because of the wealth effect. Insiders become so rich they have dwindling interest in accumulating more and prefer corporate strategies that emphasize safety over performance.

Growth in insiders’ voting power had the opposite effect as growth in economic stakes. Tobin’s Q declined as insider’s voting power grew, with the loss bottoming out as their voting control reached 45% of the votes available to be cast. As voting power grew from zero to 45%, Tobin’s Q fell by 25%. “This is consistent with the entrenchment effect of voting ownership, i.e., the more control that the insiders have, the more they can pursue strategies that are at the expense of outside shareholders,” the authors write.

Does this mean that we should ban dual class stock? I have argued against doing so. As the abstract to my article The Short Life and Resurrection of SEC Rule 19c-4 explains:

In the 1980s, many corporations adopted disparate voting rights plans (also known as dual class stock plans) to concentrate voting control in the hands of incumbent managers and their allies. At most adopting firms, such plans were intended mainly to deter unsolicited takeover bids. Incumbent managers who cannot be outvoted, after all, cannot be ousted. In 1988, the Securities and Exchange Commission adopted rule 19c-4 pursuant to a claim of regulatory authority under Section 19(c) of the Securities Exchange Act of 1934. Rule 19c-4 purported to amend the listing standards of the self-regulatory organizations (i.e., the major stock exchanges and NASDAQ) so as to prohibit most forms of dual class stock. The United States Court of Appeals for the District of Columbia Circuit, however, subsequently invalidated rule 19c-4 as exceeding the scope of the SEC's delegated authority. This article reviews the history of dual class stock and stock exchange listing standards affecting it. The article then demonstrates that the D.C. Circuit was correct in concluding that the SEC lacked authority to adopt rule 19c-4. Finally, the article proposed an alternative exchange listing standard that responded to the conflict of interest inherent when management proposes a dual class stock recapitalization.

Domaine Chandon Chardonnay (Carneros) 2002

Very tart, suggesting green apples, citrus, and almonds. They exercised a very light hand with the oak, which suggests they were using Chablis as their model. If so, it worked, as this wine makes an unusually appropriate match for seafood dishes (unlike so much overly oaked California Chardonnay). Grade: B++

Corporate Social Responsibility

Last week's Economist observed:

Companies at every opportunity now pay elaborate obeisance to the principles of corporate social responsibility. They have CSR officers, CSR consultants, CSR departments, and CSR initiatives coming out of their ears.

Not surprisingly, the Economist isn’t convinced that that’s a good thing; and neither am I. My most direct analysis of the problem can be found in my article In Defense of the Shareholder Wealth Maximization Norm, which argues that the principle of shareholder wealth maximization is both a valid positive account of corporate law and also a legitimate normative proposition. Why? Well, it's a long article that makes a lot of arguments, but the Economist's conclusion is not a bad summary:

All things considered, there is much to be said for leaving social and economic policy to governments. They, at least, are accountable to voters. Managers lack the time for such endeavours, or should do. Lately they have found it a struggle even to discharge their obligations to shareholders, the people who are paying their wages. If they want to make the world a better place—a commendable aim, to be sure—let them concentrate for the time being on that.

I've got to give a talk on this subject to a conference on Friday, so I'll have more later.

Bebchuk and Fried on Executive Compensation

My review of Bebchuk and Fried's Pay Without Performance is now available on SSRN (download it here). Here's the abstract:

Pay Without Performance: The Unfulfilled Promise of Executive Compensation by Harvard law professor Lucian Bebchuk and UC Berkeley law professor Jesse Fried is an important contribution to the literature on executive compensation. Bebchuk and Fried's positive account of executive compensation is entirely managerialist; i.e., they argue that top management of public corporations so thoroughly control the board of directors that the former are able to extract compensation packages from the latter far in excess of that which would obtain under arms'-length bargaining. In this review essay, I argue that Bebchuk and Fried overstate the extent to which management controls the compensation process. I also argue that they have not made a convincing case for the reforms to corporate governance they propose.

What does HP Need?

Larry Ribstein opines:

When last I wrote about HP I responded to Prof Bainbridge?s suggestion that it looked like the board-shakeup at HP taking away some Fiorina power was a sign of hope that boards were asserting themselves. I was skeptical about the board?s ability to manage its way out of a CEO?s mistakes and thought we need stronger medicine.

Eisinger in today's W$J supports that with a harsher story on HP, calling the Compaq takeover a failed deal whose value is about to be written off. Eisinger says the solution is to split off the printer business, which is worth the same as the whole company. While the board took the cosmetic ?baby step? of realigning Fiorina?s responsibility, it took ?two large strides backward? when it combined its printer business with its pc unit. Instead, it needs to sell the printer business.

Larry may be right about the need for "stronger medicine," but I'm still not persuaded by the idea that what we all need to do is to shift from corporations to partnerships. But more on that later.

Tort Reform Could Work

Or so one infers from the WSJ($)'s report on tort reform in Ireland:

A new arbitration body in Dublin now reviews personal and employers' liability claims -- including motor, workplace, and other accidents but not medical malpractice cases -- before they get to court. This initial process is a lawyer-free zone. Attorneys are not permitted to handle the claim for plaintiffs, who deal directly with the panel, known as the Personal Injury Assessment Board. (Plaintiffs can hire a lawyer for consultation, however).

The panel's role is striking, given that Ireland is one of the most densely lawyered nations, with one attorney for every 369 people. That outstrips even the U.S., which has one lawyer per 421 people, according to the U.S. Bureau of Labor Statistics.

But the no-lawyers mandate isn't the only change. Guidelines on award amounts aim to stem inflation in payouts. Legal costs cannot be added to settlements -- plaintiffs pay lawyers from any money they receive. Law firms are banned from advertising a promise that plaintiffs don't incur any costs if their case isn't won. Another law requires plaintiffs to make claims under affidavit, and imposes sentences for false evidence of up to 10 years in prison or a ?100,000 ($130,000) fine.

And the payoff?

The number of personal injury claims dropped 20% in Ireland last year, according to the Irish Law Society. Liability insurance rates for government and private employers have also dropped substantially, down about 40% last year alone, according to the Central Statistics Office. Auto insurance premiums are back at 1999 levels.

Leder on Executive Comp

Michelle Leder of Footnoted.org has a rather silly take on executive compensation over at Slate. Leder notes that companies are increasingly using non-performance-based bonuses to compensate top executives and speculates that this trend is a response to Sarbanes-Oxley's ban on executive loans. Why do I call it silly? Several reasons:

1. Leder implies that there is something inherently wrong about doing an end-run around a legal prohibition. To which I reply: Since when? If the law prohibits me from doing something one way, but allows me to do it another, why shouldn't I do so? There is no moral or legal obligation for me to try to divine the spirit of the law - especially a law like SOX that was rushed into the books so that Congress could create the appearance of concern and action.
2. Leder says: "these new payoffs are a tribute to the enduring creativity of American corporate executives. No matter how the law changes, they still manage to find a way to overpay themselves." But she has no evidence - none, nada, zilch - that the executives in question were overpaid. Indeed, while she rolls out the ubiquitous Lucian Bebchuk (the Harvard law prof who wrote Pay Without Performance and never met an executive pay package he didn't think couldn't be explained as an exercise of managerial power), even Lucian contents himself with suggesting that these bonuses "may or may not be justified."
3. Her claim that non-performance-based bonuses are a substitute for the banned loans is supported by reference to one - that's right 1!- company's SEC filings.

Close only counts in horseshoes and hand grenades, but this column doesn't even come close. It's a waste of pixels (brought to you by the same folks who are doing such a good job with the Bushism of the Day).