ProfessorBainbridge.com

New article by yours truly

Stephen M. Bainbridge, "The New Investor Cliffhanger" uclalawreview.org/?p=4584

— UCLA Law Review (@UCLALawReview) May 22, 2013

How American Corporate and Securities Law Drives Business Offshore

The American Illness: Essays on the Rule of Law is a new book from Yale University Press edited by Frank Buckley. Amazon's description informs that:

This provocative book brings together twenty-plus contributors from the fields of law, economics, and international relations to look at whether the U.S. legal system is contributing to the country’s long postwar decline. The book provides a comprehensive overview of the interactions between economics and the law—in such areas as corruption, business regulation, and federalism—and explains how our system works differently from the one in most countries, with contradictory and hard to understand business regulations, tort laws that vary from state to state, and surprising judicial interpretations of clearly written contracts. This imposes far heavier litigation costs on American companies and hampers economic growth.

Yale's site offers up these blurbs:

"Buckley has assembled essays by many, perhaps most, of the best economic and legal scholars in the Anglo-American world to consider seriously the ways in which the American legal system burdens our citizens and our economy and puts us at an international competitive disadvantage. The "rule of law" we so earnestly commend to other countries is clearly in need of serious reform at home. The rigor of these historical, economic, and comparative studies, and the logic of the framework within which Buckley presents them, make a compelling case for law reform scaled to our needs for the 21st Century."—Judge Douglas H. Ginsburg, U.S. Court of Appeals and NYU Law School

"This book presents strong evidence of American hyper-litigiousness and the social costs it creates. The editor has assembled an impressive array of authors, who attack these issues with rich empirical evidence."—Eugene Kontorovich, Northwestern University School of Law

"This authoritative collection of essays draws a vivid portrait of a legal system that is out of control. The Rule of Law in America has become a kind of Frankenstein’s monster, bashing indiscriminately both good and bad conduct without proportion or self-awareness. These vivid essays let the facts drive you to this unavoidable conclusion: American law is indeed “exceptional”—but no longer in a way that supports either freedom or regulatory protection."—Philip K. Howard, author of The Death of Common Sense and Chair of Common Good  

I was privileged to be one of those asked to contribute an essay to the project. My offering is entitled "How American Corporate and Securities Law Drives Business Offshore," a preview of which is available here.

I've been reading the other essays in the volume and each is a gem. Collectively, they are essential reading for anyone interested in how law is choking our economy and society.

Resolving the "should hedge funds be able to pay their stooges on corporate boards of directors" kerfuffle by private ordering

Steve Davidoff reports that:

Responding to hedge funds’ efforts to give incentives to nominees to company boards, the law firm Wachtell, Lipton, Rosen & Katz in essence came over the top on Thursday in a memo distributed to clients. Signed by the leading deal lawyer Martin Lipton and seven other Wachtell partners, the memo proposes that company boards consider adopting a bylaw prohibiting shareholder activists from compensating director nominees. Excluded from this prohibition are out-of-pocket expenses and payments for indemnification.

Wachtell’s proposal takes square aim at a topic I recently wrote about: the payment by hedge funds of large amounts of incentive compensation to director nominees. The issue has come to light because of two recent activist situations. Paul Singer’s Elliott Management has nominated five directors to the 14-member board of Hess while Barry Rosenstein’s Jana Partners recently lost a contest to elect five directors to Agrium’s 12-member board. In both cases, the hedge funds’ director nominees were provided with incentive compensation linked to the performance of the companies’ shares that had the potential to pay them millions of dollars.

Since then a mini-debate has broken out online among law professors over whether these payments are legal or appropriate. Wachtell, which has done battle before with academics over their views in support of shareholders, is now citing two academics who are on its side.

The first is John C. Coffee Jr., the Columbia Law School professor, who stated that these “third-party bonuses create the wrong incentives, fragment the board and imply a shift toward both the short-term and higher risk.”

Meanwhile, Professor Stephen Bainbridge of the UCLA School of Law has written extensively on this subject and summed up his feelings by stating that “if this nonsense is not illegal, it ought to be.”

On the other side, several equally well-respected academics have signed off on these arrangements, even allowing themselves to be quoted in Elliot’s materials. In this corner we have Professor Randall Thomas of Vanderbilt Law School who said this approach made sense because it “lends itself to allowing these nominees, if elected, to focus on independent decision-making and fulfilling their fiduciary obligations on behalf of shareholders.” Another professor quoted in the materials is Larry Cunningham of George Washington University Law School who later argued that all of this “is intended to align the interests of those directors with those of the company’s shareholders.”

Director Primacy at the Lowell Milken Institute

Herewith the text of remarks I gave yesterday to a gathering at UCLAW's Lowell Milken Institute:

In the US, corporate governance traditionally has been board-centric. Section 141(a) of the Delaware General Corporation Law commands that “The business and affairs of every corporation organized under this chapter shall be managed by or under the direction of a board of directors, except as may be otherwise provided in this chapter or in its certificate of incorporation.” The drafters of the Model Business Corporation Act tell us that the corporation code of every state but one have some such formulation. I call this the director primacy model of corporate governance. Other call it the board-centric model. In retrospect, if I had it to do over again, I would too.

Why is director primacy almost universally enshrined in corporate statutes? Why not shareholder primacy, in which management power is vested in the shareholders, who own the corporation? Alternatively, why not managerialism, in which management authority is vested in the Chief Executive Officer (CEO) or an executive committee of top management?

Those are the questions to which the bulk of my scholarship has been devoted for the last 15 years or so.

I set out not to reform the statutory allocation of power, but simply to understand it. As it turned out, however, the analysis ended up having strong normative implications.

In particular, I’ve spent a considerable amount of time debating the merits of shareholder activism. As you likely know, shareholder activists have already achieved considerable results. Majority voting, say on pay, board declassifications, proxy expense reimbursement, and proxy access bylaws are just the most prominent legal changes they have affected.

Demands from the investor community for further shareholder empowerment, moreover, remain unrelenting. As such, the “most important trend in corporate governance today … is the move toward ‘shareholder empowerment.’” Iman Anabtawi & Lynn Stout, Fiduciary Duties for Activist Shareholders, 60 Stan. L. Rev. 1255, 1255 (2008).

The most important question in corporate governance today thus is finding the endpoint of the shareholder empowerment movement. Is there a balance that is both politically feasible and theoretically sound?

I am pleased to report that The Lowell Milken Institute has authorized me to organize a conference at UCLA Law in April 2014 that will bring together prominent corporate law scholars to discuss the central question of corporate governance; i.e., “who decides?” The focus will be on the changing dynamics in both law and practice that have significantly empowered shareholders.

I plan to invite scholars working in all three of the major models of corporate governance currently in widespread use in the corporate legal literature; namely, director primacy, team production, and shareholder primacy.

Director primacy is the model I have developed over the last ten years or so. It attempts to both explain and defend the broad grant of authority to boards of directors that is at the heart of American corporate law. It argues that this grant of authority is essential to ameliorating the informational demands a large corporation faces. The grant of authority, however, creates the potential for abuse of that authority, creating a need for accountability mechanisms to limit such abuses. The tradeoff between authority and accountability is at the heart of corporate law. I propose that a presumption should generally favor authority, and therefore I oppose most proposals to increase shareholder power.

Director primacy has been well received as a model of corporate governance. And I have been recognized as “the leading proponent of the director primacy view,” to quote J.W. Verret, Treasury, Inc.: How the Bailout Reshapes Corporate Theory and Practice, 27 Yale J. on Reg. 283, 321 (2010).

To be sure, director primacy has its critics. Some see it as normatively unattractive, while others see it as lacking descriptive power. A leading competitor to director primacy is the team production theory of Margaret Blair and Lynn Stout. Like director primacy, team production theory defends the broad grant of authority to boards. However, it draws upon a different theoretical framework in doing so. Although team production theorists agree with me on the desirability of granting significant authority to boards, they disagree on the proper ultimate aims of the board in exercising that authority. I believe boards should focus on maximizing the value of the corporation for shareholders. Team production theorists believe boards should focus on maximizing the net value created for all corporate constituents collectively.

More importantly, director primacy is strongly opposed by those scholars who adhere to shareholder primacy, with Lucian Bebchuk as the most prominent example. Shareholder primacy theorists contend not only that shareholders are the principals on whose behalf corporate governance is organized, but also that shareholders do (and should) exercise ultimate control of the corporate enterprise. Hence, for example, shareholder primacy assumes shareholder voting rights that are both exclusive and strong.

The debate between these models is widely recognized as having considerable importance for our understanding of corporate law and governance. Faith Stevelman, for example, notes that “[t]he competing claims of ‘shareholder primacy’ and ‘director primacy. go back to the early beginnings of corporate law.” Faith Stevelman, Globalization and Corporate Social Responsibility: Challenges for the Academy, Future Lawyers, and Corporate Law, 53 N.Y. L. Sch. L. Rev. 817, 841 (2008/2009).

The choice between shareholder and director primacy is most obvious relevant to proposals to empower shareholders, such as say on pay, proxy access, and majority voting. At present, as Gordon Smith notes, “[d]espite the recent moves facilitating shareholder empowerment with respect to director elections, both Delaware and the SEC continue to rely on ‘director primacy’ as a foundational principle of corporate governance.” D. Gordon Smith, Private Ordering With Shareholder Bylaws, 80 Fordham L. Rev. 125, 170 (2011). As advocates of shareholder empowerment continue to press their claims with respect to other legal issues, however, the pressure on Delaware and the SEC to chose between shareholder and director primacy will become even more intense.

The conference therefore will be devoted to using these models to explore the ongoing question of shareholder empowerment.

In the mail: Research Handbook on Insider Trading

Today's mail brought an advance copy of the Research Handbook on Insider Trading, edited by yours truly.

In most capital markets, insider trading is the most common violation of securities law. It is also the most well known, inspiring countless movie plots and attracting scholars with a broad range of backgrounds and interests, from pure legal doctrine to empirical analysis to complex economic theory. This volume brings together original cutting-edge research in these and other areas written by leading experts in insider trading law and economics.

The Handbook begins with a section devoted to legal issues surrounding the US's ban on insider trading, which is one of the oldest and most energetically enforced in the world. Using this section as a foundation, contributors go on to discuss several specific court cases as well as important developments in empirical research on the subject. The Handbook concludes with a section devoted to international perspectives, providing insight into insider trading laws in China, Japan, Australia, New Zealand, the United Kingdom and the European Union.

This timely and comprehensive volume will appeal to students and professors of law and economics, as well as scholars, researchers and practitioners with an interest in insider trading.

Table of Contents (below the fold)

We are cited in Delaware

Delaware Vice Chancellor Laster cited my article Incorporating State Law Fiduciary Duties into the Federal Insider Trading Prohibition, 52 Wash. & Lee L. Rev. 1189 (1995), at pp. 31-32 and 33 of his opinion in IN RE WAYPORT, INC. LITIGATION, a very interesting opinion dealing with the state law of insider trading. More later.
   

My Corporate Governance After the Financial Crisis is reviewed

In the Texas Law Review by Holly J. Gregory and Rebecca C. Grapsas. They open by stating that:

Professor Stephen M. Bainbridge’s Corporate Governance After the Financial Crisis presents a cogent discussion of the congressional and regulatory reaction to two significant economic crises within the past decade and the unprecedented federal expansion into the traditional state bulwark of corporate law that resulted. Much has been written about corporate governance and the federal reaction to these crises in the aftermath of the Sarbanes-Oxley Act of 2002 (the Sarbanes-Oxley Act or Sarbanes-Oxley) and the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (the Dodd-Frank Act or Dodd-Frank). For those trying to understand the state of corporate governance regulation today and the key debates and tensions that are at work, Bainbridge’s book is a must read, along with Lynn Stout’s The Shareholder Value Myth, and—to balance things out with a broader perspective about how crises drive governance regulation and change—Ira Millstein’s and Paul MacAvoy’s book, The Recurring Crisis in Corporate Governance. Indeed, when the next crisis comes along, but before the federal legislators and regulators pick up their pens, these should all be required reading to help avoid further federal imposition of “quack corporate governance” as Bainbridge—borrowing from Professor Roberta Romano—colorfully terms the recent federal efforts. 

How I Rank

Third among the 25 corporate law professors whose work has been most often downloaded from SSRN.

Sixth among the top 50 law professors of all genres.

Thanks to Larry Cunningham for putting the lists together.

Academics on corporate boards boost performance ... so why aren't I on a board?

Francis, Bill, Hasan, Iftekhar and Wu, Qiang, Professors in the Boardroom and their Impact on Corporate Governance and Firm Performance (February 28, 2013). Available at SSRN: http://ssrn.com/abstract=2226411:

Directors from academia served on the boards of more than one third of S&P 1,500 firms over the 1998-2006 period. This paper investigates the effects of academic directors on corporate governance and firm performance. We find that companies with directors from academia are associated with higher performance. In addition, we find that professors without administrative jobs drive the positive relation between academic directors and firm performance. We also show that professors’ educational backgrounds affect the identified relationship. For example, academic directors with business-related degrees have the most positive impacts on firm performance among all the academic fields considered in our regressions. Furthermore, we show that academic directors play an important governance role through their monitoring and advising functions. Specifically, we find that the presence of academic directors is associated with higher acquisition performance, higher number of patents, higher stock price informativeness, lower discretionary accruals, lower CEO compensation, and higher CEO turnover-performance sensitivity. Overall, our results provide supportive evidence that academic directors are effective monitors and valuable advisors, and that firms benefit from academic directors.

CEO’s of large firms interested in increasing their profits should click here

Leo Strine throws yours truly a cite

A keen-eyed reader of both Delaware corporate opinions and PB.com spotted a cite to yours truly in a recent opinion by Delaware Chancellor Leo Strine:

For their part, the incumbent board argues that the standard of review is the plain vanilla business judgment rule, which requires that their decision be approved if it can be attributed to any rational business purpose. Thus, the incumbent board argues for something as close to non-review as our law contemplates.79 

79. See generally Stephen M. Bainbridge, The Business Judgment Rule as Abstention Doctrine, 57 Vand. L. Rev. 83 (2004) (arguing that, under the business judgment rule, courts refrain from reviewing directors’ decisions). 

Thanks to them both. For those without Lexis or Westlaw access, you can read a working draft of the article in question at SSRN:

Abstract: The business judgment rule is corporate law's central doctrine, pervasively affecting the roles of directors, officers, and controlling shareholders. Increasingly, moreover, versions of the business judgment rule are found in the law governing the other types of business organizations, ranging from such common forms as the general partnership to such unusual ones as the reciprocal insurance exchange. Yet, curiously, there is relatively little agreement as to either the theoretical underpinnings of or policy justification for the rule. This gap in our understanding has important doctrinal implications. As this paper demonstrates, a string of recent decisions by the Delaware supreme court based on a misconception of the business judgment rule's role in corporate governance has taken the law in a highly undesirable direction. 

Two conceptions of the business judgment rule compete in the case law. One views the business judgment rule as a standard of liability under which courts undertake some objective review of the merits of board decisions. This view is increasingly widely accepted, especially by some members of the Delaware supreme court. The other conception treats the rule not as a standard of review but as a doctrine of abstention, pursuant to which courts simply decline to review board decisions. The distinction between these conceptions matters a great deal. Under the former, for example, it is far more likely that claims against the board of directors will survive through the summary judgment phase of litigation, which at the very least raises the settlement value of shareholder litigation and even can have outcome-determinative effects. 

Like many recent corporate law developments, the standard of review conception of the business judgment rule is based on a shareholder primacy-based theory of the corporation. This article extends the author's recent work on a competing theory of the firm, known as director primacy, pursuant to which the board of directors is viewed as the nexus of the set of contracts that makes up the firm. In this model, the defining tension of corporate law is that between authority and accountability. Because one cannot make directors more accountable without infringing on their exercise of authority, courts must be reluctant to review the director decisions absent evidence of the sort of self-dealing that raises very serious accountability concerns. In this article, the author argues that only the abstention version of the business judgment rule properly operationalizes this approach.

Bainbridge, Stephen M., The Business Judgment Rule as Abstention Doctrine (July 29, 2003). UCLA, School of Law, Law and Econ. Research Paper No. 03-18. Available at SSRN: http://ssrn.com/abstract=429260

Attention corporate law professors needing an article idea

The Michigan Law Review has announced that:

The Michigan Law Review publishes an Annual Survey of Books dedicated to book reviews. Book reviews are not included in any other issue of the Michigan Law Review. The Survey includes reviews of books published in the current year and the past two years. So, for example, the 2014 Survey, which will be published in April 2014, will include reviews of books published in 2012, 2013, and 2014.

The 2014 Survey of Books is currently accepting submissions for the 2014 Review. The Book Review Office welcomes unsolicited submissions. Proposal guidelines can be downloaded here.

My book Corporate Governance after the Financial Crisis was published in 2012. Just sayin'.

 

News on "Reforming LIBOR: Wheatley versus the Alternatives"

From SSRN:

Dear Stephen Mark Bainbridge:

Your paper, "REFORMING LIBOR: WHEATLEY VERSUS THE ALTERNATIVES", was recently listed on SSRN's Top Ten download list for: Corporate Governance & Law eJournal. ...

Corporate Governance & Law eJournal Top Ten.

Click the following link(s) to view all the papers in:

Corporate Governance & Law eJournal All Papers.

Also, I have posted a revised version of the paper to SSRN that you can download here.

Abstract:  The London Interbank Offered Rate (LIBOR) is the trimmed average interest rate for interbank loans by a panel of leading London banks. LIBOR is the most widely used benchmark rate. An estimated $350 trillion in financial products are based on the LIBOR rate.

In late June 2012, a major scandal broke when Barclays PLC — one of the panel banks whose rates went into calculating LIBOR — agreed to pay $453 million in fines to UK and US regulators to settle allegations that Barclays had attempted to manipulate the LIBOR rate. The probe by multiple national regulators around the world quickly spread to include several other global banks.

In response, the United Kingdom’s Chancellor of the Exchequer charged a commission led by Martin Wheatley with conducting an independent review of the setting and usage of LIBOR. In September 2012, Wheatley released a report proposing a comprehensive 10-point reform plan. In October, the UK Government announced that it accepted “the recommendations of Martin Wheatley’s independent review of LIBOR in full.”

Even though Wheatley’s recommendations likely will have been implemented by the time this article appears in print, they are still deserving of analysis. First, changes and amendments may be necessary to further improve the process, perhaps including some of those suggested in this Article. Second, while LIBOR is one of the most important benchmark rates, it is not the only such rate. Some of these other benchmarks are already under scrutiny. Assessing the merits of various LIBOR reforms therefore may be helpful as regulators evaluate whether these other benchmark rates require similar reform.

In light of LIBOR’s systemic importance as a global interest rate benchmark and the compelling evidence of rate manipulation by panel banks, reforming LIBOR was both a political and economic incentive.

This Article explores a number of alternatives that were available to the UK government. The Article concludes that leaving the problem to market forces had failed and, moreover, was politically unfeasible. Switching to a government-supplied alternative benchmark was both impractical and unwise as a policy matter, as was installing a government agency as a replacement for BBA as the LIBOR administrator. Although vesting the LIBOR administrator with sufficiently strong intellectual property rights to ensure an adequate stream of licensing fees to provide adequate incentives for the administrator and panel banks is an important part of a reform package, but — contrary to what some commentators have suggested — is not viable as a stand-alone reform.

In contrast to the alternatives, the Wheatley Review provides a comprehensive reform package that has proven politically attractive and seems likely to significantly enhance LIBOR’s credibility and attractiveness as a interest rate benchmark. To be sure, the Wheatley regime is not perfect. To the contrary, this Article suggests a number of ways in which it can be expanded and improved. Over all, however, the analysis of the Wheatley Review herein strongly suggests that it will prove a viable starting point as a blueprint for reforming LIBOR and other interest rate benchmarks.

Keywords: London Interbank Offering Rate, LIBOR, benchmark, intellectual property, property rights, banks, financial reform

Bainbridge, Stephen M., Reforming LIBOR: Wheatley versus the Alternatives (January 31, 2013). NYU Journal of Law & Business, Vol. 9, No. 2, 2013; UCLA School of Law, Law-Econ Research Paper No. 13-02. Available at SSRN: http://ssrn.com/abstract=2209970.

It'll be the lead article in the next issue of the NYU Journal of Law & Business.

 

Reforming LIBOR cracks top ten lists

From SSRN.com:

Your paper, "REFORMING LIBOR: WHEATLEY VERSUS THE ALTERNATIVES", was recently listed on SSRN's Top Ten download list for: Corporate Governance: Arrangements & Laws eJournal, European Economics: Microeconomics & Industrial Organization eJournal and Regulation of Financial Institutions eJournal.

You may view the abstract and download statistics at: http://ssrn.com/abstract=2209970.

Top Ten Lists are updated on a daily basis. Click the following link(s) to view the Top Ten list for:

Corporate Governance: Arrangements & Laws eJournal Top Ten

European Economics: Microeconomics & Industrial Organization eJournal Top Ten 

Regulation of Financial Institutions eJournal Top Ten.

SEC Commissioner Gallagher slams federalization of corporate governance, citing yours truly

SEC Commissioner Daniel Gallagher recently gave a great speech on the problems posed by the creeping federalization of corporate law, in which he noted that:

Although the stated purpose of Sarbanes-Oxley was to help protect investors, if you were to ask executives and boards of directors today who they believed were the biggest beneficiaries of the passage of the Act, many would answer that it was accountants, foreign markets, and lawyers that truly benefited.  One example relates to compliance with Section 404 of Sarbanes Oxley, which the Commission estimated would cost on average roughly $91,000 a year to implement.⁵  Section 404 of Sarbanes-Oxley (in conjunction with the related PCAOB Auditing Standard 2) caused a fury when the associated costs of compliance ended up being substantially higher than anticipated by policymakers.  Most of the costs related to auditors, who were perhaps overly cautious in the wake of the failure of Arthur Andersen.  Or maybe they simply found Section 404 compliance to be a lucrative new revenue source. ...

Proxies today are remarkably different than they were twenty, ten or even five years ago.  Disclosure requirements have made them increasingly longer, more technical and more difficult to read. I have no doubt that many – indeed, most - retail investors find it too time consuming and daunting to attempt to dissect the issues they must vote on. This phenomenon is paralleled by the rise of proxy advisory firms and the increasing willingness of investment advisers to large institutional investors to rely on such firms to do this work for them.    

In addition to raising the vital question of whether advisers are fulfilling their fiduciary duties when they rely on recommendations from proxy advisory firms – a question I don’t have time to address today but one to which I hope you all give serious thought – this shift by institutional investors has resulted in increased influence by proxy advisory firms over investors and the companies in which they invest.  The Dodd-Frank mandated say-on-pay requirement has only increased this influence.  As Professor Stephen Bainbridge wrote in his article Quack Federal Corporate Governance Round II, the proponents of say-on-pay ignore “the probability that say-on-pay really will shift power from boards of directors not to shareholders but to advisory firms[.]”⁷

5 Stephen M. Bainbridge, Dodd-Frank: Quack Federal Corporate Governance Round II, 95 Minn. L. Rev. 1779, 1781 (2011). ...

7 Bainbridge supra note 5 at 1811.

Do go read the whole thing. It's concise and clear. Also, of course, I hope you'll read Dodd-Frank: Quack Federal Corporate Governance Round II. 

 

Attention Law Review Articles Editors: Have I Still Got a Deal for You

I have just posted to SSRN my latest article, Reforming LIBOR: Wheatley versus the Alternatives, which I will be sending out to the law reviews via Scholastica and Expresso next week. But that's such an annoying process. So here's my offer: If your law review is in the W&L Top Thirty  or Concurring Opinion's Top 25 or Expresso's Top 30, your journal is current in its publication schedule, you are willing to offer me a lead article slot, and promise to edit with a very light hand, I will accept your offer on the spot. I won't use your offer to try to ratchet my way up the list. I won't make you wait. First qualifying offer gets the article. Period.

I've already received one non-qualifying offer. But I'm waiting for a qualified offer.

Look at what you're getting if you accept my offer. I've been cited in 2160 articles on Westlaw's JLR database. I'm the # 6 author on SSRN's law datatbase when ranked by total all-time downloads. I've been named to Directorship magazine's list of the 100 most influential people in the field of corporate governance three times in the last 5 years. In 2007, I was #14 on Brian Leiter's list of the most cited business law faculty and was the only person under 50 on the list. So odds are that your cite count will soar.

Note to regular readers: For obvious reasons, I am taking advantage of TypePad's "feature this post" option to keep this post at the top of the blog for the next week or so. Scroll down for new stuff.