Christine Hunt suspects not. I concur.
Keith Paul Bishop notes:
In Jones v. H. F. Ahmanson & Co., 1 Cal. 3d 93 (1969), the California Supreme Court famously held:
Majority shareholders may not use their power to control corporate activities to benefit themselves alone or in a manner detrimental to the minority. Any use to which they put the corporation or their power to control the corporation must benefit all shareholders proportionately and must not conflict with the proper conduct of the corporation’s business.
Id. at 108. The Nevada Supreme Court has not explicitly adopted Jones, but has recognized the possibility that minority stockholders may be able to pursue a breach of fiduciary duty claim against the majority stockholders. Cohen v. Mirage Resorts, Inc., 119 Nev. 1, 11 (2003).
In Jones v. H.F. Ahmanson & Co., 460 P.2d 464 (Cal. 1969), the California supreme court, per Chief Justice Traynor, limited the ability of controlling shareholders to create a market for their shares without providing comparable liquidity for the minority.
The United Savings and Loan Association of California was a closely held financial institution. The defendants owned about 85 percent of United’s shares. Defendants wished to create a public market for their shares, a task that could have been accomplished using any of several methods, most of which would have created a market for all shareholders’ stock. Instead of adopting any of those options, however, the defendants set up a holding company, to which they transferred their shares. The holding company then conducted a public offering of its stock, which created a secondary trading market for that stock. The 15 percent of United’s stock that was not owned by the holding company was thus left without a viable secondary market.
The California supreme court held that when no active trading market for the corporation’s shares exists, the controlling shareholders may not use their power over the corporation to promote a marketing scheme that benefits themselves alone to the exclusion and detriment of the minority.
It once seemed likely that Ahmanson would become an important precedent, perhaps precluding a wide range of transactions including sales of control blocks at a premium. At least outside California, that has not happened. See Nixon v. Blackwell, 626 A.2d 1366 (Del.1993); Toner v. Baltimore Envelope Co., 498 A.2d 642 (Md. 1985); Delahoussaye v. Newhard, 785 S.W.2d 609 (Mo. App. 1990).
Even in California, there seems to be something of a trend towards limiting Ahmanson to its unique facts and procedural posture. See, e.g., Miles, Inc. v. Scripps Clinic and Research Foundation, 810 F. Supp. 1091 (S.D. Cal. 1993) (“The Jones case did give the narrow circumstance in which a fiduciary duty may be imposed: when a majority shareholder usurps a corporate opportunity from or otherwise harms the minority shareholder.”); Kirschner Bros. Oil Co., Inc. v. The Natomas Co., 229 Cal. Rptr. 899 (Cal. App. 1986) (noting that Ahmanson’s sweeping dicta must be “carefully related” to the facts before a violation can be found; hence, plaintiffs must explain with “specificity what they . . . might have been entitled to that they did not receive”). But see Stephenson v. Drever, 16 Cal. 4th 1167, 1178, 947 P.2d 1301, 1307 (1997) (calling Jones a "leading case").
If Ahmanson is to remain on the books, a debatable proposition, it should be so limited. The case was decided on appeal from the trial court’s grant of a motion to dismiss. Interpreting the facts most favorably for the plaintiffs, the defendants went out of their way to deprive the minority shareholders of a market for their shares, reduced the dividend in order to deprive the minority shareholders of any economic return, at least in the short run, and displayed their true objective by offering a low price for the minority shares. In short, this is just a run of the mill squeezeout case. Unfortunately, there is much broader dicta in the opinion—and it is that dicta for which the case is frequently cited.
I am delighted to announce that you can now pre-order Limited Liability: A Legal and Economic Analysis, which I had the honor of co-writing with my dear friend Professor Todd Henderson of the University of Chicago Law School. Here's the blurb:
The modern corporation has become central to our society. The key feature of the corporation that makes it such an attractive form of human collaboration is its limited liability. This book explores how allowing those who form the corporation to limit their downside risk and personal liability to only the amount they invest allows for more risks to be taken at a lower cost.
This comprehensive economic analysis of the policy debate surrounding the laws governing limited liability examines limited it not only in an American context, but internationally, as the authors consider issues of limited liability in Britain, Europe and Asia. Stephen Bainbridge and M. Todd Henderson begin with an exploration of the history and theory of limited liability, delve into an extended analysis of corporate veil piercing and related doctrines, and conclude with thoughts on possible future reforms. Limited liability in unincorporated entities, reverse veil piercing and enterprise liability are also addressed.
This comprehensive book will be of great interest to students and scholars of corporate law. The book will also be an invaluable resource for judges and practitioners.
And here are some reviews:
This book does a wonderful job of bringing sharp and clear analysis to a breathtakingly complex and poorly understood area of law. In particular, the book is distinctive for its careful treatment of the inefficiencies generated by current confusion and apparent subjectivity of the law in many states. Also of interest is the book's thoughtful economic analysis of the various ways that parent companies and other controlling investors react to the confused state of the law.' --Jonathan Macey, Yale University
'Professors Bainbridge and Henderson have made an outstanding contribution to the literature on limited liability. There is something valuable for everyone in this book, which provides not only a clear and comprehensive exposition of the doctrine and theory of limited liability, but also with a cogent and clever solution to limited liability's deeply troubled exception, veil-piercing. This is an important book in one of the most important areas of business law, and is a tremendous, versatile resource for attorneys, entrepreneurs, students and scholars alike.' --Peter Oh, University of Pittsburgh
'Bainbridge and Henderson have given us one of the most important books on one of the most important contemporary legal issues, the liability of individual and corporate shareholders for corporate debts. There is no issue in corporate law more subject to uncertainty and no issue more likely to be litigated. No single book has ever attempted, much less carried off, the complete historical, international, economic and legal theoretical exegesis of limited liability, which these two authors do with range, depth, confidence and even a bit of panache. This monograph, of crucial interest both to scholars and practitioners, will become an instant classic and an immediate authority.' --Stephen B. Presser, Northwestern University and the author ofPiercing the Corporate Veil
Including one by yours truly:
Economics of Corporate Law (Economic Approaches to Law series)
Edited by Claire A. Hill, Professor and James L. Krusemark Chair in Law and Brett H. McDonnell, Professor and Dorsey & Whitney Chair in Law, University of Minnesota Law School
Scholarly analysis of corporate law in the United States has come to be dominated by an economic approach. Professor Hill and Professor McDonnell here draw together seminal articles which represent major milestones along the road that economics has traveled in coming to play this central role in corporate law scholarship. The focus is on the analysis of corporate law, drawing mainly upon legal scholarship and particularly on US scholarship, which is the originator of the application of modern economic analysis to corporate law and has had much influence in other countries.
Claire A. Hill and Brett McDonnell
PART I ECONOMICS OF THE FIRM
1. Ronald Coase (1937), ‘The Nature of the Firm’, Economica, 4, 386–405
2. Michael C. Jensen and William H. Meckling (1976), ‘Theory of the Firm: Managerial Behavior, Agency Costs and Ownership Structure’, Journal of Financial Economics, 3 (4), October, 305–60
3. Oliver Williamson (1984), ‘Corporate Governance’, Yale Law Journal, 93 (7), June, 1197–230
PART II THE BOARD AND PURPOSE
4. A.A. Berle, Jr. (1931), ‘Corporate Powers as Powers in Trust’, Harvard Law Review, XLIV (7), May, 1049–74
5. E. Merrick Dodd, Jr. (1932), ‘For Whom are Corporate Managers Trustees?’, Harvard Law Review, XLV (7), May, 1145–63
6. Stephen M. Bainbridge (2003), ‘Director Primacy: The Means and Ends of Corporate Governance’, Northwestern University Law Review, 97 (2), 547–606
7. Margaret M. Blair and Lynn A. Stout (1999), ‘A Team Production Theory of Corporate Law’, Virginia Law Review, 85 (2), March, 247–328
8. Sanjai Bhagat and Bernard Black (1999), ‘The Uncertain Relationship Between Board Composition and Firm Performance’, Business Lawyer, 54 (3), May, 921–63
9. Donald C. Langevoort (2001), ‘The Human Nature of Corporate Boards: Law, Norms, and the Unintended Consequences of Independence and Accountability’, Georgetown Law Journal, 89, 797–832
PART III STATE COMPETITION
10. William L. Cary (1974), ‘Federalism and Corporate Law: Reflections Upon Delaware’, Yale Law Journal, 83 (4), March, 663–705
11. Ralph K. Winter, Jr. (1977), ‘State Law, Shareholder Protection, and the Theory of the Corporation’, Journal of Legal Studies, 6 (2), June, 251–92
12. Roberta Romano (1985), ‘Law as a Product: Some Pieces of the Incorporation Puzzle’, Journal of Law, Economics, and Organization, 1 (2), Fall, 225–83
13. Bernard S. Black (1990), ‘Is Corporate Law Trivial?: A Political and Economic Analysis’, Northwestern University Law Review, 84 (2), 542–97
14. Robert Daines (2001), ‘Does Delaware Law Improve Firm Value?’, Journal of Financial Economics, 62 (3), December, 525–58
15. Ehud Kamar (1998), ‘A Regulatory Competition Theory of Indeterminacy in Corporate Law’, Columbia Law Review, 98 (8), December, 1908–59
16. Mark J. Roe (2003), ‘Delaware’s Competition’, Harvard Law Review, 117 (2), December, 588–646
An introduction to both volumes by the editors appears in Volume I
PART 1 TAKEOVERS AND TAKEOVER DEFENCES
1. Henry G. Manne (1965), ‘Mergers and the Market for Corporate Control’, Journal of Political Economy, 73 (2), April, 110–20
2. Frank H. Easterbrook and Daniel R. Fischel (1981), ‘The Proper Role of a Target’s Management in Responding to a Tender Offer’, Harvard Law Review, 94 (6), April, 1161–204
3. Ronald J. Gilson and Reinier Kraakman (1989), ‘Delaware’s Intermediate Standard for Defensive Tactics: Is There Substance to Proportionality Review?’, Business Lawyer, 44 (2), February, 247–74
4. Jeffrey N. Gordon (1997), ‘”Just Say Never?” Poison Pills, Deadhand Pills, and Shareholder-Adopted Bylaws: An Essay for Warren Buffett’, Cardozo Law Review, 19 (1–2), September–November, 511–52
5. Lucian Arye Bebchuk, John C. Coates IV and Guhan Subramanian (2002), ‘The Powerful Antitakeover Force of Staggered Boards: Theory, Evidence, and Policy’, Stanford Law Review, 54 (5), May, 887–951
PART II SHAREHOLDER SUITS AND OTHER AGENCY MECHANISMS
6. Janet Cooper Alexander (1991), ‘Do the Merits Matter? A Study of Settlements in Securities Class Actions’, Stanford Law Review, 43 (3), February, 497–598
7. Melvin Aron Eisenberg (1993), ‘The Divergence of Standards of Conduct and Standards of Review in Corporate Law’, Fordham Law Review, 62 (3), 437–68
8. Edward B. Rock (1997), ‘Saints and Sinners: How Does Delaware Corporate Law Work?’, UCLA Law Review, 44, 1009–107
9. Bernard Black, Brian Cheffins and Michael Klausner (2006), ‘Outside Director Liability’, Stanford Law Review, 58 (4), February, 1055–159
10. Lucian Arye Bebchuk, Jesse M. Fried and David I. Walker (2002), ‘Managerial Power and Rent Extraction in the Design of Executive Compensation’, University of Chicago Law Review, 69, 751–846
11. John C. Coffee, Jr. (2002), ‘Understanding Enron: “It’s About the Gatekeepers, Stupid”’, Business Lawyer, 57 (4), August, 1403–420
12. Tom Baker and Sean J. Griffith (2006), ‘The Missing Monitor in Corporate Governance: The Directors’ and Officers’ Liability Insurer’, Georgetown Law Journal, 95, 1795–842
PART III OTHER PERSPECTIVES
13. Mark J. Roe (1991), ‘A Political Theory of American Corporate Finance’, Columbia Law Review, 91, 10–67
14. Henry Hansmann and Reinier Kraakman (2001), ‘The End of History for Corporate Law’, Georgetown Law Journal, 89 (2), June, 439–68
15. Henry Hansmann and Reinier Kraakman (2000), ‘The Essential Role of Organizational Law’, Yale Law Journal, 110 (3), December, 387–440
There's a very important new paper out by Rauterberg and Talley, which reports:
For centuries, the duty of loyalty has been the hallowed centerpiece of fiduciary obligation, widely considered one of the few “mandatory” rules of corporate law. That view, however, is no longer true. Beginning in 2000, Delaware dramatically departed from tradition by granting incorporated entities a statutory right to waive a crucial part of the duty of loyalty: the corporate opportunities doctrine. Other states have since followed Delaware’s lead, similarly permitting firms to execute “corporate opportunity waivers.” Surprisingly, more than fifteen years into this reform experiment, no empirical study has attempted to measure either the corporate response to these reforms, or to evaluate the implications of that response.
This Article presents the first broad empirical investigation of the area. Contrary to conventional wisdom, we find that hundreds of public corporations have adopted waivers – often with capacious scope and reach. We thus establish a central empirical fact that is an important baseline for further discussion: public corporations have an enormous appetite for contracting out of the duty of loyalty when freed to do so. Our analysis further sheds light on the high-stakes normative debate around the relationship between fiduciary principles and freedom of contract. What types of corporations choose to contract around default rules? When they do so, do such measures tend to bolster or thwart shareholder welfare? We develop an efficient contracting approach to explain why corporations – and their shareholders – might favor tailoring the duty of loyalty, and provide empirical evidence that Delaware’s experiment has generally been a success.
There's been a lot of griping at Harvard Law School recently about political correctness, multiculturalism, and the usual left-liberal causes. Now Harvard Magazine notes that some are trying to extend the activist heat to Harvard's status as a giant of corporate lawyer training:
There’s an inherent tension in HLS’s role as an institution devoted to advancing justice and public welfare, and its role as an elite professional school. Much as undergraduates from institutions like Harvard flock to high-paying business jobs, HLS graduates are drawn in vast numbers to corporate-interest law firms, almost exclusively representing wealthy clients. Of HLS’s class of 2015, more than 60 percent took jobs at private firms or in business. The vast majority of them work at firms of more than 500 lawyers in New York, Washington, San Francisco, and Boston. The class of 2015 had a median starting salary of $160,000, the standard offer for first-year associates—higher than the $130,000 median starting salary for Harvard Business School graduates.
Ralph Nader, LL.B. ’58, a long-time critic of HLS’s pipeline to corporate law, argues that last year’s activism missed an opportunity to question the prominence of corporate law or ask questions about students’ debt to society after graduation. Asked about how well HLS is meeting its stated mission of advancing justice and the well-being of society, Nader seemed surprised by the question: “Well, largely they’re training corporate lawyers,” he says plainly. Early last fall, he gave a talk on campus in which he asked, “What is the purpose of the Harvard Law School?” and urged students to allow their moral and civic conscience, and not the hiring demands of corporate firms, to answer that question. “Harvard Law,” he said then, “is not an institution that provokes any kind of consternation or fear among the power structure.”
The school’s administration points out that it offers a wealth of resources for public interest—and indeed students interested in public service have at their disposal a full office devoted to public-interest advising; generous loan forgiveness; and funding for legal-aid work after graduation. But between the well-established path to corporate law and the demands of a just society, HLS takes no position on where its graduates ought to work, and struggles to articulate a role for itself in a broader justice system. Career options are framed as a matter of personal choice or market demand rather than public need, reflected in the recruiting structure that accommodates corporate law. How pervasive should corporate law be at a top law school? What do Harvard graduates owe to the public? These are questions Harvard hasn’t answered—but the controversies of the last year, and the ones sure to come, suggest that perhaps it needs to.
If the leadership of HLS have a spine (dubious) they'll answer such complaints with a resounding defense of corporate law as public interest law.
I addressed this point in my essay Reflections on Twenty Years of Law Teaching: Remarks at the Rutter Award Ceremony (April 2008), which is available at http://ssrn.com/abstract=1122577. In it, I wrote that:
Legal education pervasively sends law students the message that corporate lawyering is a less moral and socially desirable career path than so-called “public interest” lawyering. The corporate world is viewed as essentially corrupting and alienating, while true self-actualization is possible only in a Legal Aid office.
Our students get these messages not only in law school, of course, but also in the media. Films like “A Civil Action” or “Erin Brockovich” illustrate the general ill repute in which corporations—and corporate lawyers—are held, at least here in Hollywood.
In my teaching, I have chosen to unabashedly embrace a competing view. I tell my students about Nicholas Murray Butler, president of Columbia University and winner of the Nobel Peace Prize, who wrote that: “The limited liability corporation is the greatest single discovery of modern times. Even steam and electricity are less important than the limited liability company.”
I tell them about journalists John Micklethwait and Adrian Wooldridge, whose magnificent history, The Company, contends that the corporation is “the basis of the prosperity of the West and the best hope for the future of the rest of the world.” ...
And so I put it to my students this way: You want to help make society a better place? You want to eliminate poverty? Become a corporate lawyer. Help businesses grow, so that they can create jobs and provide goods and services that make people’s lives better.
Alison Frankel reports that:
There were two big takeaways from a new Cornerstone Research study of shareholder suits challenging big M&A announcements. First, Cornerstone confirmed what other analysts have previously reported: Plaintiffs’ lawyers are filing fewer cases in the wake of a 2015 crackdown on disclosure-only settlements by Delaware’s Chancery Court. The drop-off is dramatic (assuming that, like me, you accept the premise that the filing rate of shareholder M&A suits is the stuff of drama). At the 2013 peak of shareholder M&A litigation, plaintiffs’ lawyers sued to challenge 94 percent of announced deals valued at more than $100 million. In the first half of 2016, the rate was down to 64 percent – lower than we’ve seen since 2009.
Cornerstone’s second big finding is that when plaintiffs’ lawyers do sue over M&A transactions, they are much more likely to file cases outside of Delaware. In the first three quarters of 2015 – before Chancery Court judges began rejecting settlements that granted defendants broad releases in exchange for immaterial additional proxy disclosures – shareholders sued in Delaware in 61 percent of the M&A deals that prompted litigation. After the crackdown, only 26 percent of the deal challenges were filed in Delaware. Even when the acquired company is incorporated in Delaware, shareholders’ lawyers sued in Chancery Court in only 36 percent of all cases, compared to 74 percent in 2015.
As Frankel points out, this raises a key question:
In Delaware, plaintiffs’ lawyers know they can’t collect six-figure fees for bringing unwarranted deal challenges and defendants know they can’t buy global releases for the low, low price of a few hundred thousand bucks in fees to shareholders’ counsel. But will other judges countenance those agreements?
Fordham law professor Sean Griffith is worried that they will. As you may recall, Griffith is one of the academics who stirred the debate over disclosure-only settlements, co-authoring the 2015 paper, “Confronting the Peppercorn Settlement in Merger Litigation.” He then pledged to put his theories into practice. Griffith bought shares of recently acquired companies in order to object to disclosure-only settlements in shareholder class actions challenging the transactions. He made a splash last summer as an objector in a Delaware case involving Riverbed Technologies. (Griffith’s objection didn’t squelch the Riverbed settlement but provoked an opinion expressing skepticism about the viability of future disclosure-only settlements; the judge nevertheless awarded the professor’s lawyer only $10,000 in fees because he was worried about encouraging meritless objections.)
Now Griffith is busy warning courts outside of Delaware about disclosure-only settlements.
One answer is forum selection bylaws. I'm surprised they aren't almost universal by now.
Regular readers may recall that I recently gave short critiques of several corporate governance proposals put forward by UK Prime Minister Theresa May: pay ratio disclosure, mandatory say on pay, and worker representation on boards.
Our friend JW Verret has now published a commentary on May's proposals:
It appears May seeks to supplant conservative principle with political expediency and more socialist ideology. Her proposals will replace the discipline of the market with the cronyism of special interest governance. Thatcher's government drew a firm distinction with her Conservative Party platform, built on the values of free enterprise and the unforgivable business discipline of market competition. The Iron Lady knew what she believed, and she governed from those beliefs.
Prime Minister May's speech provides a road map that merges some conservative rhetoric with a series of top priorities for liberals and the Labour Party. A Conservative Party platform cannot survive however with such a cafeteria approach to principal.
Go read the whole thing.
A few days ago I posted that:
Thirteen (an auspicious or suspicious number?) top CEOs published a joint statement on what they called Commonsense Corporate Governance Principles as a full page ad in today's Wall Street Journal (and perhaps elsewhere). It was reprinted by CNBC here.
These principles have gotten considerable press, but I was skeptical:
So what do we have? A mixed bag, it seems. Some feel good platitudes. Some commonsense. And some pure bunkum.
In the NY Times DealBook, attorney Michael W. Peregrine comments on the principles that:
Sensible they may be, but they are not, as some academics suggest, mere platitudes.
I assume I'm "some academics." So let's see what arguments Mr. Peregrine brings to the fray:
His first argument is an appeal to authority:
The principles were prepared by a diverse group of 12 prominent corporate executives and other financial leaders, including the chief executives of JPMorgan Chase, Berkshire Hathaway, General Electric, General Motors and Verizon as well as those of BlackRock, Vanguard and other institutional investors and financial services companies. It is an all-star lineup that should command broad boardroom attention.
The trouble, of course, is that appeal to authority is a logical fallacy. Even assuming the authors are authorities on corporate governance (which, given the shoddy governance at some of their own companies is hardly an assumption worth making), that doesn't mean their recommendations are necessarily true or valid:
An argument from authority (Latin: argumentum ad verecundiam), also called an appeal to authority, is a logical fallacy that argues that a position is true or more likely to be true because an authority or authorities agree with it.
Carl Sagan wrote of arguments from authority:
"One of the great commandments of science is, 'Mistrust arguments from authority.'...Too many such arguments have proved too painfully wrong. Authorities must prove their contentions like everybody else."
Here's his next claim:
... the principles appear premised on the crucial, if understated, connection between effective corporate governance and economic prosperity.
But where is the evidence for this connection? None is cited. In fact, "The link between corporate governance and economic growth is tenuous." Brett H. McDonnell, Professor Bainbridge and the Arrowian Moment: A Review of the New Corporate Governance in Theory and Practice, 34 Del. J. Corp. L. 139, 183 (2009). See also Bruce E. Aronson, Reconsidering the Importance of Law in Japanese Corporate Governance: Evidence from the Daiwa Bank Shareholder Derivative Case, 36 Cornell Int'l L.J. 11, 54 (2003) (stating that "there is no clear evidence linking corporate governance with economic performance"); John W. Cioffi, 52 Am. J. Comp. L. 770, 773 (2004) (stating that "the evidence shows a very complex and variable impact of corporate governance regimes on economic performance at the levels of the firm and the national economy").
As one proceeds through Pergrine's article one finds several paragraphs containing no citation of evidence but rather simply descriptions of the proposals embedded in glowing approbation.
And then one comes to this claim:
... the principles are likely to add fuel to growing efforts to support — if not mandate — diversity standards for governance. These are, individually and collectively, unique contributions.
There are two argumentative moves buried in that text: (1) the efforts to support diversity on boards is good and (2) therefore the principles must also be good. The trouble is that even the SEC can't define what we mean when we talk about board diversity (see this post) and there is no consensus that the business case has been made for board diversity. See Lissa L. Broome, John M. Conley, Kimberly D. Krawiec, Dangerous Categories: Narratives of Corporate Board Diversity, 89 N.C. L. Rev. 759, 765 (2011) (stating that "the empirical literature on corporate board diversity also yields largely inconclusive results").
Peregrine makes a similar move in the next paragraph.
But the principles also reflect some missed opportunities — important governance topics that arguably deserve note. ... They do not address the growing movement toward assuring the general counsel a prominent position within the senior leadership team, or acknowledge the oft-referenced role of the general counsel as “lawyer-statesman.”
Granted, there has been some movement towards this conception of the general counsel's role. There is the implicit, or so it seems, this is a good thing. But where is the evidence? If one digs into the literature, one finds important cautionary lessons, such as that advanced by my friend and colleague Sung Hui Kim, who argues that:
[One can] understand why inside lawyers acquiesce in fraud by combining insights from decades of social scientific research on the causes of unethical behavior with known facts about inside lawyers' roles inside the corporation. Combining these insights and facts allows us to construct and analyze the “ethical ecology” of inside counsel. As I argued, this ethical ecology emerges from the *1871 multiple roles that inside lawyers inhabit. These roles, in turn, unleash psychological pressures that strongly affect the actions and choices of inside lawyers. In simplified terms, inside counsel act as “mere employees” subject to obedience pressures, as “faithful agents” subject to alignment pressures, and as “team players” subject to conformity pressures.
And then the rest of the article consists of descriptions buried in adulatory commentary.
In sum, what Peregrine offers is mostly platitudes about platitudes.
A friend and longtime blog reader sent along this response to the preceding post:
I actually disagree that Trulia is working, at least for certain values of working. I think they key number is on page 3: while only 64% of M&A deals were litigated, of those litigated involving Delaware corporations, only 36% were litigated in Delaware (as opposed to 74% in 2015). So cases are leaving Delaware, but I’m not certain the overall decline is long-term.
My prediction? This number reverses (or at least the decline slows) in 2H 2016 as plaintiffs recognize that they can still get fees in 47 other jurisdictions.
Of course, I agree with you on fee-shifting bylaws. If some state does want to compete with Delaware, that’s the “killer app.”
Point taken. Indeed, well taken. But a solution--at least for Delaware corporations lies to hand--exclusive forum bylaws.
An exclusive forum bylaw is designed to prevent multi-forum litigation by forcing all cases challenging the same deal to be filed in the Delaware Chancery Court. Such bylaws have routinely been upheld and enforced. The Delaware Chancery Court upheld them in a case involving Chevron. The Oregon Supreme Court upheld them in a 2015 case involving TriQuint Semiconductor. Courts in California, New York, Illinois, Ohio, Texas, and Louisiana have done likewise.
Today while there apparently have been no precise counts, hundreds of corporations have adopted such bylaws. As happened recently at Tesla, moreover, it has become routine for companies about to enter an acquisition to do so.
Critics argue that these bylaws funnel litigation into Delaware courts that are biased in favor of corporate management. In my view, that’s too simplistic. To be sure, there have been some recent decisions in Delaware that disfavored plaintiffs. The Trulia decision, for example, effectively banned so-called disclosure-only settlements and thus made it harder for plaintiff lawyers to make a quick buck off suits with dubious merit.
On the other hand, consider the Dell appraisal proceeding case in which Vice Chancellor Laster determined that the fair value of Dell Inc.’s common stock at the time of its sale, by means of a merger, to Michael Dell and Silver Lake Partners was $17.62 per share – approximately 28% more than the final merger consideration of $13.75. While acknowledging Dell’s special committee and its advisors did “many praiseworthy things,” – the Vice Chancellor found that the sale process did not result in a fair value for the Company.
So exclusive forum bylaws are not necessarily litigation killers, but taken together with Trulia they should help prune some of the less meritorious litigation.
The good news on the litigation front comes from Cornerstone, which reports that:
For the first time since 2009, the percentage of M&A deals valued over $100 million and challenged by shareholder litigation dropped below 90 percent in 2015 and so far in 2016, according to a new report released today by Cornerstone Research. The report, Shareholder Litigation Involving Acquisitions of Public Companies—Review of 2015 and 1H 2016 M&A Litigation, found that 64 percent of M&A deals faced litigation in the first six months of 2016. There were 47 M&A deals with associated lawsuits during the first half of the year.
Over the first three quarters of 2015, plaintiffs challenged mergers and acquisitions in the Delaware Court of Chancery 61 percent of the time. In the fourth quarter of 2015 and the first two quarters of 2016 combined, M&A-related litigation was filed in Delaware for only 26 percent of challenged deals.
Of course, Delaware could have made an even greater impact on reining in spurious litigation if they had not banned fee shifting bylaws. Yes. it still rankles. And, yes, I still think it was a mistake: See Bainbridge, Stephen M., Fee Shifting: Delaware's Self-Inflicted Wound (2015). 40 Delaware Journal of Corporate Law 851 (2016); UCLA School of Law, Law-Econ Research Paper No. 15-10. Available at SSRN: http://ssrn.com/abstract=2624750
In her principal speech during her recent successful campaign to become the United Kingdom's new Prime Minister, Theresa May said a lot of things that as a corporate governance thinker I have very serious doubts about. In this post, I look at her proposal for greater CEO pay disclosure:
I want to see more transparency, including the full disclosure of bonus targets and the publication of “pay multiple” data: that is, the ratio between the CEO’s pay and the average company worker’s pay.
The US adopted such a requirement in the 2010 Dodd-Frank legislation, of course. It was a dumb idea back then and it's still a dumb idea.
I discussed this Dodd-Frank requirement in my my book Corporate Governance after the Financial Crisis, where I argued that:
The rules are unlikely to provide investors with meaningful information. Instead, they are intended to shame corporations by highlighting the disparity between CEO and shop floor employee pay.
I further explained that:
This requirement is going to be hugely burdensome:
[It] means that for every employee, the company would have to calculate his or her salary, bonus, stock awards, option awards, nonequity incentive plan compensation, change in pension value and nonqualified deferred compensation earnings, and all other compensation (e.g., perquisites). This information would undoubtedly be extremely time-consuming to collect and analyze, making it virtually impossible for a company with thousands of employees to comply with this section of the Act.
In sum, this was another pointless and useless but incredibly costly regulation of the sort that Washington has been loading on business on a bipartisan basis ever since George Bush decided to cave and sign Sarbanes-Oxley into law. Why the UK would want to go down that road is simply beyond me.
In her principal speech during her recent successful campaign to become the United Kingdom's new Prime Minister, Theresa May said a lot of things that as a corporate governance thinker I have very serious doubts about. Ion this post, I look at her views on say on pay:
So as part of the changes I want to make to corporate governance, I want to make shareholder votes on corporate pay not just advisory but binding.
<SARCASM>What a good idea. After all, the nonbinding say on pay rules have worked so well.</SARCASM>
From my book Corporate Governance after the Financial Crisis:
Professor Jeffrey Gordon argues that the U.K. experience with say on pay makes a mandatory vote a “dubious choice.” First, because individualized review of compensation schemes at the 10,000-odd U.S. reporting companies will be prohibitively expensive, activist institutional investors will probably insist on a narrow range of compensation programs that will force companies into something close to a one size fits all model. Second, because many institutional investors rely on proxy advisory firms, a very small number of gatekeepers will wield undue influence over compensation. This likely outcome seriously undercuts the case for say on pay. Proponents of say on pay claim it will help make management more accountable, but they ignore the probability that say on pay really will shift power from boards of directors not to shareholders but to advisory firms like RiskMetrics. There is good reason to think that boards are more accountable than those firms. “The most important proxy advisor, RiskMetrics, already faces conflict issues in its dual role of both advising and rating firms on corporate governance that will be greatly magnified when it begins to rate firms on their compensation plans.” Ironically, the only constraint on RiskMetrics’ conflict is the market—i.e., the possibility that they will lose credibility and therefore customers—the very force most shareholder power proponents claim does not work when it comes to holding management accountable.
In her principal speech during her recent successful campaign to become the United Kingdom's new Prime Minister, Theresa May said a lot of things that as a corporate governance thinker I have very serious doubts about. Let's start with her proposal to put consumers and employees on corporate boards of directors.
And I want to see changes in the way that big business is governed. The people who run big businesses are supposed to be accountable to outsiders, to non-executive directors, who are supposed to ask the difficult questions, think about the long-term and defend the interests of shareholders. In practice, they are drawn from the same, narrow social and professional circles as the executive team and – as we have seen time and time again – the scrutiny they provide is just not good enough. So if I’m Prime Minister, we’re going to change that system – and we’re going to have not just consumers represented on company boards, but employees as well.
Presumably, she has something along the lines of the German codetermination model in mind. And that's a really bad idea.
Is it curious that only shareholders get the vote? What about all of the corporation’s other constituencies, such as employees, creditors, customers, suppliers, etc.? Why do they not get a voice in, say, the election of directors? The traditional answer is that shareholders own the corporation. Ownership typically connotes control, of course. Consequently, despite the separation of ownership and control characteristic of public corporations, shareholders’ ownership of the corporation might be deemed to vest them with unique control rights. Recall that the nexus of contracts theory of the firm demonstrates that shareholders do not in fact “own” the corporation in any meaningful sense. By throwing the concept of ownership out the window, however, the contractarian model eliminates the obvious answer to our starting question—why are only shareholders given voting rights?
Our answer to that question relies on the analysis of organizational decisionmaking economist Kenneth Arrow set out in The Limits of Organization. Recall that Arrow identified two basic modes of decisionmaking: consensus and authority. Consensus requires that each member of the organization have identical information and interests so that preferences can be aggregated at low cost. In contrast, authority-based decisionmaking structures arise where group members have different interests and information.
The analysis that follows proceeds in three steps. First, why do corporations not rely on consensus-based decisionmaking? In answering that question, we begin by imagining an employee-owned firm with many thousands of employee-shareholders. (Employees are used solely for purposes of illustration—the analysis would extend to any other corporate constituency.) After demonstrating that Arrow’s conditions cannot be satisfied in such a firm, we then turn to the more complex public firm in which employees and shareholders constitute separate constituencies to demonstrate that Arrow’s conditions are even less likely to be met in this type of firm. Second, why do corporations not permit multiple constituencies to elect directors? Finally, why are shareholders the favored constituency?
A. The necessity of authority
Assume an employee-owned corporation with 5,000 employee-shareholders. Could such a firm function as a participatory democracy? Not if we hoped that each participant would make informed decisions. As a practical matter, of course, our employee-shareholders are not going to have access to the same sorts of information. Assuming at least some employees serve in managerial and supervisory roles, they will tend to have broader perspectives, with more general business information, while line workers will tend to have more specific information about particular aspects of the shop floor.
These information asymmetries will prove intractable. A rational decisionmaker expends effort to make informed decisions only if the expected benefits of doing so outweigh its costs. In a firm of the sort at bar, gathering information will be very costly. Efficient participatory democracy requires all decisionmakers to have equal information, which requires that each decisionmaker have a communication channel to every other decisionmaker. As the number of decisionmakers increases, the number of communication channels within the firm increases as the square of the number of decisionmakers. Bounded rationality makes it doubtful that anyone in a firm of any substantial size could process the vast number of resulting information flows. Even if they were willing to try, moreover, members of such a firm could not credibly bind themselves to reveal information accurately and honestly or to follow prescribed decisionmaking rules. Under such conditions, Arrow’s model predicts that the firm will tend towards authority-based decisionmaking. Accordingly, the corporation’s employer-owners will prefer to irrevocably delegate decisionmaking authority to some central agency, such as a board of directors.
Now introduce the complication of separating capital and labor. Nothing about such a change economizes on the decisionmaking costs outlined above. Instead, as described below, labor and capital can have quite different interests, which increases decisionmaking costs by introducing the risk of opportunism. In particular, capital and labor may behave strategically by withholding information from one another.
Again, begin by assuming an employee-owned firm with 5,000 employee shareholders. Is it reasonable to expect the similarity of interest required for consensus to function in such a firm? Surely not. In some cases, employees would differ about the best way in which to achieve a common goal. In others, individual employees will be disparately affected by a proposed course of action. Although the problems created by divergent interests within the employee block are not insurmountable, such differences at least raise the cost of using consensus-based decisionmaking structures in employee-owned firms.
The existence of such divergent interests within the employee group is confirmed by the empirical evidence. Labor-managed firms tend to remain small, carefully screen members, limit the franchise to relatively homogeneous groups, and use agenda controls to prevent cycling and other public choice problems. All of these characteristics are consistent with an attempt to minimize the likelihood and effect of divergent interests.
Now again complicate the analysis by separating capital and labor. Although employee and shareholder interests are often congruent, they can conflict. Consider, for example, the down-sizing phenomenon. Corporate restructurings typically result in substantial reductions in force, reduced job security, longer work weeks, more stress, and diminished morale. From the shareholders’ perspective, however, the market typically rewards restructurings with substantial stock price increases. The divergence of interest suggested by this example looms large as a bar to the use of consensus in capitalist firms.
B. The inefficiency of multiple constituencies
The analysis to this point merely demonstrates that corporate decision making must be made on a representative, rather than on a participatory, basis. As yet, nothing in the analysis dictates the U.S. model in which only shareholders elect directors. One could plausibly imagine a board of directors on which multiple constituencies are represented. Indeed, imagination is not required, because the supervisory board component of German codetermination provides a real world example of just such a board. Empirical evidence, however, suggests that codetermination does not lead to efficiency or productivity gains.
Why not? In Arrow’s terminology, the board of directors serves as a consensus-based decisionmaking body at the top of an authority-based structure. Recall that for consensus to function, however, two conditions must be met: equivalent interests and information. Neither condition can be met when employee representatives are on the board.
The two factors are closely related, of course. Indeed, it is the potential divergence of shareholder and employee interests that ensures employee representatives will be deprived of the information necessary for them to function. Because of the board’s position at the apex of the corporate hierarchy, employee representatives are inevitably exposed to a far greater amount of information about the firm than is normally provided to employees. As the European experience with codetermination teaches, this can result in corporate information leaking to the work force as a whole or even to outsiders. In the Netherlands, for example, the obligation of works council representatives to respect the confidentiality of firm information “has not always been kept, causing serious concerns among management which is required . . . to provide extensive ‘sensitive’ information to the councils.”
Given that providing board level information to employee representatives appears clearly contrary to shareholder interests, we would expect managers loyal to shareholder interests to withhold information from the board of directors in order to deny it to employee representatives, which would seriously undermine the board’s ability to carry out its essential corporate governance roles. This prediction is borne out by the German experience with codetermination. German managers sometimes deprive the supervisory board of information, because they do not want the supervisory board’s employee members to learn it. Alternatively, the board’s real work may be done in committees or de facto rump caucuses from which employee representatives are excluded. As a result, while codetermination raises the costs of decisionmaking, it may not have much effect on substantive decisionmaking.
Although Arrow’s equality of information criterion is important, in this context the critical element is the divergence of shareholder and employee interests. The interests of shareholders will inevitably differ as amongst themselves, as do those of employees, but individual constituents of the corporation nevertheless are more likely to share interests with members of the same constituency than with members of another constituency. Allowing board representation for employees thus tends only to compound the problem that gives rise to an authority-based hierarchical decisionmaking structure by bringing the differing interests of employees and shareholders directly into the board room. The resulting conflicts of interest inevitably impede consensus-based decisionmaking within the board. Worker representatives on corporate boards tend to prefer greater labor advocacy than do traditional directors, no doubt in large part because workers evaluate their representatives on the basis of labor advocacy, which also results in role conflicts. The problem with codetermination thus is not only that the conflict of employee and shareholder interests impedes the achievement of consensus, but also that it may result in a substantial increase in agency costs.
Although it is sometimes asserted that employee representation would benefit the board by promoting “discussion and consideration of alternative perspectives and arguments,” the preceding analysis suggests that any such benefits would come at high cost. In addition, there is reason to doubt whether those benefits are very significant. Workers will be indifferent to most corporate decisions that do not bear directly on working conditions and benefits. All of which tends to suggest that employee representatives add little except increased labor advocacy to the board.
C. Why only shareholders?
The analysis thus far demonstrates that public corporation decisionmaking must be conducted on a representative rather than participatory basis. It further demonstrates that only one constituency should be allowed to elect the board of directors. The remaining question is why shareholders are the chosen constituency, rather than employees. Answering that question is the task of this section.
The standard law and economics explanation for vesting voting rights in shareholders is that shareholders are the only corporate constituent with a residual, unfixed, ex post claim on corporate assets and earnings. In contrast, the employees’ claim is prior and largely fixed ex ante through agreed‑upon compensation schedules. This distinction has two implications of present import. First, as noted above, employee interests are too parochial to justify board representation. In contrast, shareholders have the strongest economic incentive to care about the size of the residual claim, which means that they have the greatest incentive to elect directors committed to maximizing firm profitability. Second, the nature of the employees’ claim on the firm creates incentives to shirk. Vesting control rights in the employees would increase their incentive to shirk. In turn, the prospect of employee shirking lowers the value of the shareholders’ residual claim.
At this point, it is useful to once again invoke the hypothetical bargain methodology. If the corporation’s various constituencies could bargain over voting rights, to which constituency would they assign those rights? In light of their status as residual claimants and the adverse effects of employee representation, shareholders doubtless would bargain for control rights, so as to ensure a corporate decisionmaking system emphasizing monitoring mechanisms designed to prevent shirking by employees, and employees would be willing to concede such rights to shareholders.
Granted, collective action problems preclude the shareholders from exercising meaningful day-to-day or even year-to-year control over managerial decisions. Unlike the employees’ claim, however, the shareholders’ claim on the corporation is freely transferable. As such, if management fails to maximize the shareholders’ residual claim, an outsider can profit by purchasing a majority of the shares and voting out the incumbent board of directors. Accordingly, vesting the right to vote solely in the hands of the firm’s shareholders is what makes possible the market for corporate control and thus helps to minimize shirking. As the residual claimants, shareholders thus would bargain for sole voting control, in order to ensure that the value of their claim is maximized. In turn, because all corporate constituents have an ex ante interest in minimizing shirking by managers and other agents, the firm’s employees have an incentive to agree to such rules. The employees’ lack of control rights thus can be seen as a way in which they bond their promise not to shirk. Their lack of control rights not only precludes them from double-dipping, but also facilitates disciplining employees who shirk. Accordingly, it is not surprising that the default rules of the standard form contract provided by all corporate statutes vest voting rights solely in the hands of common shareholders.
To be sure, the vote allows shareholders to allocate some risk to prior claimants. If a firm is in financial straits, directors and managers faithful to shareholder interests could protect the value of the shareholders’ residual claim by, for example, financial and/or workforce restructurings that eliminate prior claimants. All of which raises the question of why employees do not get the vote to protect themselves against this risk. The answer is two-fold. First, as we have seen, multiple constituencies are inefficient. Second, as addressed below, employees have significant protections that do not rely on voting.
Suppose a firm behaves opportunistically towards it employees. What protections do the employees have? Some are protected by job mobility. The value of continued dealings with an employer to an employee whose work involves solely general human capital does not depend on the value of the firm because neither the employee nor the firm have an incentive to preserve such an employment relationships. If the employee’s general human capital suffices for him to do his job at Firm A, it presumably would suffice for him to do a similar job at Firm B. Such an employee resembles an independent contractor who can shift from firm to firm at low cost to either employee or employer. Mobility thus may be a sufficient defense against opportunistic conduct with respect to such employees, because they can quit and be replaced without productive loss to either employee or employer. Put another way, because there are no appropriable quasi-rents in this category of employment relationships, rent seeking by management is not a concern.
Corporate employees who make firm-specific investments in human capital arguably need greater protection against employer opportunism, but such protections need not include board representation. Indeed, various specialized governance structures have arisen to protect such workers. Among these are severance pay, grievance procedures, promotion ladders, collective bargaining, and the like.
In contrast, shareholders are poorly positioned to develop the kinds of specialized governance structures that protect employee interests. Unlike employees, whose relationship to the firm is subject to periodic renegotiation, shareholders have an indefinite relationship that is rarely renegotiated, if ever. The dispersed nature of stockownership also makes bilateral negotiation of specialized safeguards difficult. The board of directors thus is an essential governance mechanism for protecting shareholder interests.
If the foregoing analysis is correct, why do we nevertheless sometimes observe employee representation? An explanation consistent with our analysis lies close at hand. In the United States, employee representation on the board is typically found in firms that have undergone concessionary bargaining with unions. Concessionary bargaining, on average, results in increased share values of eight to ten percent. The stock market apparently views union concessions as substantially improving the value of the residual claim, presumably by making firm failure less likely. While the firm’s employees also benefit from a reduction in the firm’s riskiness, they are likely to demand a quid pro quo for their contribution to shareholder wealth. One consideration given by shareholders (through management) may be greater access to information, sometimes through board representation. Put another way, board of director representation is a way of maximizing access to information and bonding its accuracy. The employee representatives will be able to verify that the original information about the firm’s precarious financial situation was accurate. Employee representatives on the board also are well-positioned to determine whether the firm’s prospects have improved sufficiently to justify an attempt to reverse prior concessions through a new round of bargaining.