I'm going to be on a panel on "Rethinking Shareholder Value and the Purpose of the Firm" here at UCLA on Thursday:
Join UCLA School of Law, The Aspen Institute and top thinkers in business and law to explore what priorities are legally demanded of corporations, rethink what is meant by "creating shareholder value," and ask "What really is the purpose of the firm?"
Panelists include Professor Stephen Bainbridge, UCLA School of Law; Professor Henry Hansmann, Yale Law; and Roger Martin, Dean, Rotman School of Business, University of Toronto. The panel will be moderated by Professor Lynn Stout, UCLA School of Law.
The organizer sent around several questions to stimulate our thinking, including the following:
The number of publicly-listed US firms has declined from nearly 9,000 in 1997 to only about 5,000 today. What’s more, many of the firms that do go public (LinkedIn, Google, Zynga) have dual-class shares. Do these two data points suggest that the public corporation is a less attractive way to do business? If so, why?
Here's what I came up with in reply:
I addressed the first prong of this question at some length in my paper, Corporate Governance and U.S. Capital Market Competitiveness (October 22, 2010), which is available at SSRN: http://ssrn.com/abstract=1696303.
During the first half of the last decade, evidence accumulated that the U.S. capital markets were becoming less competitive relative to their major competitors. The evidence reviewed herein confirms that it was not corporate governance as such that was the problem, but rather corporate governance regulation. In particular, attention focused on such issues as the massive growth in corporate and securities litigation risk and the increasing complexity and cost of the U.S. regulatory scheme.
Tentative efforts towards deregulation largely fell by the wayside in the wake of the financial crisis of 2007-2008. Instead, massive new regulations came into being, especially in the Dodd Frank Act. The competitive position of U.S. capital markets, however, continues to decline.
My essay argues that litigation and regulatory reform remain essential if U.S. capital markets are to retain their leadership position. Unfortunately, the article concludes that federal corporate governance regulation follows a ratchet effect, in which the regulatory scheme becomes more complex with each financial crisis. If so, significant reform may be difficult to achieve.
There are three major reasons why federal intervention in corporate governance tends to be ill conceived. First, federal bubble laws tend to be enacted in a climate of political pressure that does not facilitate careful analysis of costs and benefits. Second, federal bubble laws tend to be driven by populist anti-corporate emotions. Finally, the content of federal bubble laws is often derived from prepackaged proposals advocated by policy entrepreneurs skeptical of corporations and markets.
In her critique of SOX, Roberta Romano proposed that these problems could be addressed in several ways: "The straightforward policy implication of this chasm between Congress’s action and the learning bearing on it is that the mandates should be rescinded. The easiest mechanism for operationalizing such a policy change would be to make the SOX mandates optional, i.e., statutory default rules that firms could choose whether to adopt. An alternative and more far-reaching approach, which has the advantage of a greater likelihood of producing the default rules preferred by a majority of investors and issuers, would be to remove corporate governance provisions completely from federal law and remit those matters to the states. Finally, a more general implication concerns emergency legislation. It would be prudent for Congress, when legislating in crisis situations, to include statutory safeguards that would facilitate the correction of mismatched proposals by requiring, as in a sunset provision, revisiting the issue when more considered deliberation would be possible."
In adopting Dodd-Frank, Congress ignored that advice. As a result, Dodd-Frank suffers from the same three flaws as its predecessors.
The federal role in corporate governance thus appears to be a case of what Robert Higgs identified as the ratchet effect. Higgs demonstrated that wars and other major crises typically trigger a dramatic growth in the size of government, accompanied by higher taxes, greater regulation, and loss of civil liberties. Once the crisis ends, government may shrink somewhat in size and power, but rarely back to pre-crisis levels. Just as a ratchet wrench works only in one direction, the size and scope of government tends to move in only one direction—upwards—because the interest groups that favored the changes now have an incentive to preserve the new status quo, as do the bureaucrats who gained new powers and prestige. Hence, each crisis has the effect of ratcheting up the long-term size and scope of government.
We now observe the same pattern in corporate governance. As we have seen, the federal government rarely intrudes in this sphere except when there is a crisis. At that point, policy entrepreneurs favoring federalization of corporate governance spring into action, hijacking the legislative response to the crisis to advance their agenda. Although there may be some subsequent retreat, such as Dodd-Frank’s § 404 relief for small reporting companies, the overall trend has been for each major financial crisis of the last century to result in an expansion of the federal role. The unfortunate conclusion thus seems to be that there is no cure insight for the corporate governance aspects of the American Illness.
