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Delaware VC Travis Laster Responds to Trump AG William Barr's Critique of Woke Delaware Corporate Law

In a WSJ op-ed last week former Trump AG William Barr (and attorney Jonathan Berry) argue that Delaware courts' "flirtation with ESG is jeopardizing its status as a preferred destination for corporate headquarters." I commented on that article in an earlier post. Over the weekend, Delaware Vice Chancellor Travis Laster also critiqued Barr's article.

I'm a fan of VC Laster's writing style, which has a certain flair. So I was amused by the zinger with which he opened:

There are many legal topics where AG Barr has vast knowledge and experience. On those subjects, his opinion should carry weight. His column demonstrates that Delaware law is not one of them.

Turning to Laster's substantive argument, he opens by saying that:

First, Delaware is not a stakeholder state. It has a board-centric model in which fiduciary duties run to the corporation for the ultimate benefit of the stockholders. That’s why Robert T. Miller, an Iowa law professor with impeccable conservative bona fides, recently authored an article titled Delaware Law Requires Directors to Manage the Corporation for the Benefit of its Stockholders and the Absurdity of Denying It. It's a good place to start.

As a point of personal privilege, I would prefer to characterize Delaware corporate law as a system of director primacy but I concede that director primacy is board-centric, so let's move on.

I would also note in passing that Robert Miller's article is a must read on this topic. As another matter of personal privilege, however, I would also suggest checking out my book The Profit Motive: Defending Shareholder Value Maximization, which has an extensive treatment of the state of Delaware law on this point.

Back to VC Laster, Barr had complained that:

... former Delaware Supreme Court Justice Tamika Montgomery-Reeves, who in 2021 declared that state law allows directors “to consider interests of broader constituents,” such as “stakeholders other than stockholders.” President Biden named her to the federal appellate bench in 2022.

Laster responds:

Judge Montgomery-Reeves was right when she said in 2021 that Delaware law allows directors “to consider interests of broader constituents,” such as “stakeholders other than stockholders.” ... But when the board makes its decision, the directors must believe in good faith that the path chosen will promote the value of the corporation for the long-term benefit of its stockholders.

A quibble: There are two sets of cases in which directors who consider non-shareholder interests in making decisions face a serious risk of liability. First, confessional cases; i.e., those in which the board of directors basically says "we're putting stakeholder interests ahead of those of shareholders and our shareholders can lump it." As I discuss in The Profit Motive, the classic confessional case was the Michigan Supreme Court's decision in Dodge v. Ford Motor Co., which was embraced sub silentio by the Delaware Chancery Court in eBay Domestic Holdings, Inc. v. Newmark. In effect, confessional cases are those in which the board has effectively admitted that they are acting in bad faith.

Second, although Laster doesn't mention it, Delaware law is clear that there is one set of circumstances in which Delaware courts forbid directors from taking stakeholder interests into account. As I explain in The Profit Motive (at p. 60):

In the course of the [Revlon] opinion, the Delaware Supreme Court [held that] once the board enters Revlon-land [i.e., enters into a transaction that will result in a change of control], any “concern for non-stockholder interests is inappropriate.” In other words, getting the best possible deal for the shareholders—regardless of the potential impact on other corporate constituencies—must be the board’s sole focus.

Back to VC Laster. who minimizes concerns about Caremark:

All Caremark requires is that directors make a good faith judgment regarding an information system to make them aware of potential threats to the corporation, then respond in good faith to information about threats.

Here I must part ways with the Vice Chancellor, albeit with respect. As I have said many times, albeit to no avail, Caremark was wrong from the outset and its progeny have mostly made things worse. In particular, note VC Laster's reference to "threats to the corporation." Therein lies the nub of the problem: What kinds of threats? Although VC Laster suggests that Caremark is most relevant to decisions about law compliance, he acknowledges that "directors could breach their duties if they knowingly fail to respond to other types of risks," while positing that "it would be a much tougher case." As I explain in my article, Don’t Compound the Caremark Mistake by Extending it to ESG Oversight:

Although Caremark has been applied almost exclusively with respect to law and accounting compliance, the original Caremark decision contemplated applying the oversight duty to the corporation’s “business performance.” Accordingly, there is no doctrinal reason that Caremark claims should not lie in cases in which the corporation suffered losses, not due to a failure to comply with applicable laws, but rather due to lax risk management.

The question thus arises as to whether Caremark should be extended to board failures to exercise oversight with respect to environmental, social, and governance (ESG) factors. Obviously, where existing legislation or regulations impose compliance obligations in ESG-related areas, such as human resources, the environment, or worker safety, Caremark already applies. As such, boards must “ensure that compliance and monitoring systems are in place” to oversee corporate compliance with those laws.

Many ESG issues are not yet the subject to legal requirements, however. The question addressed in this Article is whether the board’s Caremark obligations should be extended to encompass oversight of corporate performance with such issues. In other words, should the board face potential liability not just for failing to ensure that the company has adequate reporting and monitoring systems in place to ensure compliance with ESG-related legal requirements, but also to monitor ESG risks in areas where corporate compliance would be voluntary or aspirational.

Admittedly, I have indulged in a fun bit of hyperbole by repeatedly comparing Caremark to The Chicken Heart, which was an episode of Arch Oboler's 1930s radio show Lights Out. The risk that Caremark will continue to expand into areas like ESG compliance, however, still strikes me as a very valid concern.

Having said that, however, I must note that Chancellor McCormick is not alarmed by recent developments suggesting that Caremark cases are becoming more frequent and easier to win. I also note Larry Cunningham's comments about a panel discussion on which he and Chancellor McCormick participated, which he thinks suggests concerns are the growth of Caremark are overstated. Larry concludes that "The real danger today is from Washington not Wilmington," a point with which I am fully in accord.

In sum, I agree with VC Laster's first two points. As for Barr's concern that "Caremark [is] a vector for “social-responsibility topics,” I tend to come down more on AG Barr's side. As I explained in my article, Don’t Compound the Caremark Mistake by Extending it to ESG Oversight , Caremark has the potential to convert aspirational goals into legal mandates. As such, extending Caremark to the ESG context would effectively create a legal mandate that directors try to balance profit against environmental and social issues. As such, it would work an important change in Delaware’s law of corporate purpose.

Former Trump AG William Barr thinks Delaware's Caremark Doctrine is a Serious Policy Error That's Going to Erode Delaware's Dominance. He's half right.

Former Trump Attorney General William Barr (and attorney Jonathan Berry) are now trying to save Delaware from itself. From the WSJ:

Delaware is falling in line with other blue states in embracing ESG, which rejects shareholder value as corporate law’s lodestar. Meanwhile, red states are developing potentially attractive alternatives. …

The watchword is Delaware’s Caremark doctrine, which makes executives liable for failures in risk management. Once reserved for outright corporate crime, this notable exception to Delaware’s signature deference to executives has demonstrated expansive potential. Two former Delaware Supreme Court justices have stated that, under the doctrine, ESG issues should become more than optional social-responsibility topics. They should be “risks” that boards are required to oversee. The influential former Delaware Supreme Court Chief Justice Leo Strine has coauthored several papers—including one titled “Caremark and ESG: Perfect Together”—addressing how the doctrine invites companies to undertake ESG initiatives.

… Delaware’s weakness presents an opportunity for red states that oppose ESG. This year Texas elected to set up its own designated business court. Georgia, Utah and Wyoming recently did the same.

At this point, I pause to ask readers unfamiliar with Caremark to skip over to an earlier post: After Boeing, Caremark is no longer "the most difficult theory in corporation law upon which a plaintiff might hope to win a judgment". It will provide necessary background on Caremark's growth.  I also refer the reader to my post summarizing my recent writing on corporate purpose, ESG, corporate social responsibility, and stakeholder theory.

I want to come at this issue from three perspectives. First, will the Delaware courts expand Caremark to encompass ESG issues? I confess to a certain amount of concern on this score; so much so that I wrote a law review article, Don’t Compound the Caremark Mistake by Extending it to ESG Oversight, arguing that Caremark should not be extended to board failures to exercise oversight with respect to environmental, social, and governance (ESG) factors. What follows briefly summarizes the main arguments in that article.

In Caremark and its progeny, Delaware courts mandated that company boards establish effective legal compliance systems. Originally, Caremark was largely focused on legal and accounting compliance, but it also considered overseeing a company's overall business performance. Thus, Caremark-related claims could potentially arise not only from legal non-compliance but also from inadequate risk management.

Several experts have suggested that Caremark's scope should include board oversight failures in environmental, social, and governance (ESG) matters. Prominent legal figures, including former Delaware Chief Justice Norman Veasey and former Justice Randy Holland, have suggested that board responsibilities should cover monitoring programs in areas like ESG. SEC Commissioner Allison Herren Lee also argues that directors’ fiduciary duties encompass ESG risk oversight.

Caremark is already applicable in areas where ESG-related compliance is legally required, such as human resources, environmental protection, and worker safety. However, many ESG issues are not legally mandated yet. The debate, as discussed in my article, centers on whether Caremark duties should also cover voluntary or aspirational ESG performance oversight.

Extending Caremark in this way would be highly problematic. First, the original Caremark ruling was a serious error whose premise rested on the case’s procedural uniqueness and the resulting leeway it gave Chancellor Allen to misinterpret (deliberately) Delaware Supreme Court precedents. Second, subsequent decisions have altered the foundational fiduciary duty from care to loyalty, leading to an unwarranted expansion of Caremark liability. Although actual liability risk remains low, the perceived risk might prompt directors to take excessive measures.

Furthermore, applying Caremark to ESG matters risks distorting Delaware's established corporate purpose laws by pushing director duties into areas of social responsibility not directly tied to corporate profits. This extension might inadvertently encourage companies to adopt socially responsible practices not mandated by political processes, effectively blurring the lines between corporate and governmental roles.

In sum, the combined issues – the original Caremark decision's flaws, the shift in fiduciary duty from care to loyalty, and its potential extension to non-mandatory areas – could undermine the protections provided by the business judgment rule. Expanding Caremark to ESG matters threatens Delaware's board-centric corporate governance model and could lead to a scenario where adherence to externally set “best practices” becomes the primary defense against loyalty duty lawsuits.

In sum, I share Barr and Berry’s concern that Delaware courts are expanding Caremark far beyond its original boundaries and that doing so is a serious policy error.

Second, I note in passing Carr and Berry’s comment on my friend former Delaware Supreme Court Chief Justice Leo Strine. It is true that Strine’s recent scholarship has been pro-ESG (or, as he renamed it, EESG by adding Employees to the list). Yet, one of the many reasons I respect Strine is his ability to draw a sharp difference between what he thinks the law ought to be and what he knows the law is. In a 2015 article, Strine more broadly addressed claims by Stout and numerous progressive corporate law scholars “that directors may subordinate what they believe is best for stockholder welfare to other interests, such as those of the company’s workers or society generally.” In assessing that claim, the Chief Justice minced no words; to the contrary, he hurled multiple verbal grenades into the debate:

• “These well-meaning commentators, of course, ignore certain structural features of corporation law . . ..”
• “Indeed, these commentators essentially argue that Delaware judges do not understand the very law they are applying, and the Delaware General Assembly does not understand the law it has created.”
• “It is not only hollow but also injurious to social welfare to declare that directors can and should do the right thing by promoting interests other than stockholder interests.”

Perhaps most damningly, however Strine essentially accused the commentators – whom he called out by name in lengthy string cites – of misrepresenting the law, arguing that they “pretend that directors do not have to make stockholder welfare the sole end of corporate governance, within the limits of their legal discretion, under the law of the most important American jurisdiction – Delaware.” It is about as damning a dismissal of academic arguments as one encounters.

Third, where I part ways with Barr and Berry is in their theory that the Caremark error will lead to Delaware losing incorporations to red states (or, for that matter, any state). So many states have tried to knock Delaware off its throne. None have succeeded.

I explored the reasons for Delaware’s success in Why the North Dakota Publicly Traded Corporations Act Will Fail. In that short essay, I commented on the North Dakota Publicly Traded Corporations Act. North Dakota hoped that the Act will empower it to compete with Delaware in the market for corporate charters. In my view, North Dakota was doomed to failure. If state chartering competition is a race to the bottom, managers will prefer Delaware to North Dakota because the former facilitates the extraction of private rents. If state competition is a race to the top, investors will prefer the director primacy approach taken by Delaware to the shareholder primacy one adopted by North Dakota. Either way, North Dakota was bound to lose. And it has.

Obviously, Delaware makes mistakes. But for the most part Delaware manages to retain pride of place. On major reason is that Delaware's legislature acts quickly to adopt developments in other states that prove successful. "The Delaware legislature pays close attention to keeping the GCL [i.e., the Delaware General Corporation Law]up-to-date and efficient. It has a longstanding relationship with the Corporate Law Section of the Delaware Bar Association, which frequently recommends, reviews, and drafts revisions to the GCL. William F. Griffin, The Delaware Alternative, CLHBU MA-CLE 10-1 (2015).

As Wilmington attorney Black noted, … Delaware's system is not easily emulated. “There are elements unique to Delaware that would be very hard to replicate, particularly in big states,” he says. Delaware benefits from having a unique combination of an enabling corporation statute, a legislature that keeps the statute up to date and that has developed a long and trusting relationship with the corporate bar, and judges who come from among the best and brightest attorneys in the state, he says. “

Donald F. Parsons Jr. & Joseph R. Slights III, The History of Delaware's Business Courts: Their Rise to Preeminence, 17 Bus. L. Today 21, 25 (March/April 2008).

In sum, if a state starts to make gains, the Delaware legislature will just copy that state’s approach--probably with improvements--and remain dominant by virtue of the unique combination of identified by Parsons and Slights.

Business Law Books Podcast

It's a great list, on which I am proud to be included. https://t.co/V0xQAoP6b1

— Steve Bainbridge (@PrawfBainbridge) November 24, 2023

"Is Undisclosed Jiu-Jitusu Securities Fraud?"

Today's Money Stuff email from Matt Levine informs us that:

1. Every bad thing that happens to a public company is also securities fraud.
2. Getting beaten up is bad.
3. Mark Zuckerberg getting beat up is probably bad for Meta Platforms Inc. “If Mr. Zuckerberg were to become unavailable for any reason,” says Meta in its securities filings, “there could be a material adverse impact on our operations.” For instance if he got beat up real bad.
4. Therefore Mark Zuckerberg getting beaten up is securities fraud.

He notes that a Bloomberg reporter wrote that:

Meta’s Mark Zuckerberg has become increasingly obsessed with formal mixed martial arts fighting, and is training for a competitive fight next year. But the chief executive officer faced a major setback: He tore his ACL in training and underwent surgery to repair it. ...

there is a serious consideration here about whether Meta Platforms Inc.’s co-founder, CEO and controlling shareholder has a duty to disclose his MMA activities to investors, particularly if formal contests are in his future. What if it’s worse next time? Zuckerberg posted about his surgery on Instagram, and there was no filing or company statement.

“It’s a question of materiality,” said Bryan Westhoff, an attorney at Polsinelli PC. “Is it material to a reasonable investor to know what the executives are doing? Is there danger and uniqueness to it? MMA is something that most of us don’t do."

Really? "A serious consideration"? Seriously?

Back to Levine:

The corollary to “everything is securities fraud” is that everything is also insider trading, and there are obvious applications here. What if you show up at a Brazilian jiu-jitsu tournament to find that you are fighting Mark Zuckerberg? If you knock him out, can you run to your Robinhood account and short Meta stock before the ambulance gets there? (Can you short the stock before the match if you just know that you’re huge and will knock him out? Do you then fight dirty?) Brazilian jiu-jitsu tournaments now have a unique ability to create material nonpublic information about Meta stock; what if someone uses it?

There is noting new under the sun, of course. To the contrary, there has been occasional academic speculation about when a CEO's health becomes a matter for discloure to investors. Before diving into that topic, however, let us pause to recall that a Friends episode presciently deal with this precise topic:

Back to the law. My friend Joan Heminway wrote about this back in 2007. Joan MacLeod Heminway, Personal Facts About Executive Officers: A Proposal for Tailored Disclosures to Encourage Reasonable Investor Behavior, 42 Wake Forest L. Rev. 749 (2007).

Joan argued that:

Personal facts about an executive may be important to a reasonable investor or have a significant impact on available public information because they may indicate the possibility that the corporation will be without the executive's services either temporarily or permanently. ... Investors may find an executive's unavailability especially important in making an investment decision as to a corporation's securities if the executive has a unique expertise or specialized skill critical to the corporation's successful operations.

Joan further argued that executives and companies are likely to err on the side of non-disclosure, not least because of privacy concerns.

She made two proposals: 

First, the SEC should establish baseline mandatory corporate disclosures of executives' personal facts in the 1933 Act registration statements and the 1934 Act periodic reports (Form 10-K or Form 10-Q). These mandatory disclosures would establish, at the outset of public company status or an individual's service as an executive and on a periodic basis during the executive's term of office,186 the corporate significance of the executive's service and other attributes (e.g., name-as-the-brand or other elements of iconic status)--importance to operations, financial condition or results of operations, or other aspects of firm value.

My problem with this proposal is that no CEO is going to want the company to disclose that s/he is not essential. 

Next, the SEC should provide specific guidance on event-based and transaction-triggered corporate disclosures of executives' personal facts in current reports (on Form 8-K) under the 1934 Act. These disclosures would be prompted only when a personal fact impacts a specific executive's articulated importance to the company, as identified in the corporation's baseline disclosures about the executive (as the same are updated from time to time) and could be simply implemented as an addition to the items required to be reported on Form 8-K.

My problem with this proposal is how one defines "impacts." Should Zuckerberg have to disclose his MMA involvement even before he loses time to an injury? Should a CEO have to disclose their chronically high cholesterol? That s/he bought a McLaren and take it on high speed track meets every weekend? After all, a disclosure mandate that only kicks in after the CEO dies by slamming the McLaren into a flaming crash at 200 mph is too little too late.

I would also recommend Tom C. W. Lin, Undressing the Ceo: Disclosing Private, Material Matters of Public Company Executives, 11 U. Pa. J. Bus. L. 383 (2009), to the interested reader.  Tom proposed:

a model approach that would first require principle-based disclosure by senior executives of material private information to their board of directors or appropriate committee. Second, the approach requires that such disclosure be made available to the investing public within the current federal securities framework after the board independent of the disclosing executive determines that such disclosure is material and should be disclosed. ...

Examples of the type of information that should be disclosed about senior executives are diagnoses of a fatal illness, certain threatened criminal investigations, and certain meaningful outside investments.

But there remains a serious line drawing problem.

Personally, I have long been rather dubious of requiring disclosure of matters relating to a CEO's personal life. Between privacy concerns and the difficulty of drawing lines between what should and should not be disclosed, the game is not worth the candle.

Corporate Governance Q&A at the Lowell Milken Institute’s Mini-Conference on Corporate Governance, Tax Law and Nonprofit Law

The Lowell Milken Institute for Business Law and Policy at the UCLA School of Law today celebrated ten years of training the next generation of leaders in business law with a mini-conference for alumni, practitioners, business executives and students. I was honored to be asked to serve on a panel with Kimberly Simpson, Chief Operating Officer and General Counsel, National Association of Corporate Directors, in which we were asked and answered a bunch of questions about corporate governance. In a series of posts below, I revise and extend my remarks:

What are major issues/challenges boards are facing in the next year or two?

What do we mean by the term “corporate governance”?

Do you think corporate culture has any role to play in effective governance?

What is the relationship between defining the corporation’s purpose and establishing principles of corporate governance?

Do you still support outsourcing the board?

How can lawyers get on boards of directors?

How should we respond to crises in corporate governance?

Caremark and the Board's Duty of Oversight

What do each of you see as the major challenges facing boards beyond the economy?

Corporate Governance Panel Question: What are major issues/challenges boards are facing in the next year or two?

Question

What are major issues/challenges boards are facing in the next year or two? They seem to be facing numerous difficult issues including:

• Political issues, e.g. Disney and Florida; crisis in the Middle East
• Marketing issues, e.g. Budweiser marketing campaign involving a transgender influencer
• More “mundane” issues: AI, cybersecurity, lots of questions about the future of regulatory regimes, role of institutional investors on corporate boards.

Answer

1. Cybersecurity. As the frequency and complexity of cyber threats continues to grow, boards are coming under increasing pressure from regulators and litigation (such as Caremark claims) to ensure cybersecurity. Accordingly, board members need to make safeguarding their organization's digital assets and customer data a top priority. This entails consistently assessing and enhancing cybersecurity strategies, allocating resources to establish resilient systems, providing comprehensive training for employees, and ensuring adherence to data protection regulations.
2. Risk management: Cybersecurity is a sufficiently important risk to deserve its own category. But the general problem of risk management remains an important part of what boards must do. Board-level systems designed to monitor and oversee mission-critical functions play a crucial role in showcasing the board's fulfillment of its Caremark duties. This was evident last year when the Delaware Court of Chancery allowed a Caremark duty-of-oversight claim to advance against Boeing Company directors. The court's decision was based on allegations of insufficient board involvement in safety matters and the absence of a dedicated committee with direct oversight responsibilities. Nevertheless, it's worth noting that two subsequent cases, Hamrock and SolarWinds, have underscored the necessity of establishing bad faith rather than merely proving gross negligence for a Caremark claim to succeed.
3. Shareholder activism. The ongoing fluctuations in equity values, characterized by both volatility and a general decline, have brought vulnerabilities to the forefront for many companies while also opening up opportunities for activist investors. This trend is expected to continue into the coming year. What particularly piques my interest is the potential impact of the recent SEC rule mandating the use of universal proxy cards in director election proxy battles. This innovation is poised to streamline the proxy contest process, reducing the costs and efforts associated with activists nominating and seeking proxies for board member elections. Consequently, this change may shift the focus in proxy battles towards assessing the track records and skill sets of individual directors, as opposed to evaluating the overall performance of the company or board as a whole. With the introduction of universal proxy cards, shareholders will gain the ability to selectively choose individual directors from both the company's and the activist's competing slates.
4. Political risks. Boards need to pay attention both to how the corporation engages with politics and how politics affects the corporation. As to the former, activists are paying attention to issues like corporate political spending. As for the latter, the runup to the 2024 presidential election will require boards to assess possible changes in the presidency, Congress, and the membership of the SEC.

Corporate Governance Panel Question: What do we mean by the term “corporate governance”?

Question

Some commentators suggest that the modern iteration of corporate governance in the United States began in the 1970s.[1] So, in 2023, what do we mean by the term “corporate governance”?

Does it just mean the set of legal rules and norms addressing the conduct of directors and officers of a corporation? Does it necessarily include mechanisms of regulatory oversight such as those applied to public companies and certain industries such as banking and certain functions such as privacy? Does it necessarily include criminal laws? Is it more than that?

And, if it is more than just the legal rules and norms addressing the conduct of directors and officers of a corporation, how should we make regulators more effective at enforcing corporate governance norms? Are there other regulatory agencies, federal or state, that should have a direct role in corporate governance?

What about member organizations like the NACD? What should its role be in developing norms for directors? Are organizations like the NACD potentially more effective because they explain the role of the board in terms that non-lawyers can understand?

Answer

I like this question a lot. But I will use it as a jumping off point for flagging the importance of non-legal aspects of corporate governance; specifically, best practices. In 1982, Thomas Peters and Robert H. Waterman expanded upon Xerox's practical approach in their influential book, "In Search of Excellence: Lessons from America's Best-Run Companies." Their work brought the concept of best-practices research and implementation into the mainstream of American organizations. The authors conducted a comprehensive study, analyzing sixty-two American companies spanning various industries, and identified eight attributes that they believed epitomized the excellence of America's most innovative entities. With over three million copies sold and a long stint on bestseller lists, Peters and Waterman succeeded in popularizing the adoption of best practices as a strategy for gaining a competitive edge by emulating the most effective strategies of competitors.

As the number of success stories multiplied and the popularity of best practices soared, three primary styles of benchmarking emerged: competitive benchmarking, cooperative benchmarking, and collaborative benchmarking. Competitive benchmarking involves gathering information from competitors to establish a benchmark. This approach entails measuring your functions, processes, activities, products, or services against those of your competitors and continually improving them to attain best-in-class status. Cooperative benchmarking necessitates a company seeking improvement in a particular activity to reach out to a best-in-class firm and request knowledge-sharing with the benchmarking team. Collaborative benchmarking, on the other hand, involves companies coming together to exchange information about an activity with the aim of enhancing their internal processes based on the acquired insights. Ideally, as more companies adopt best practices and engage in cooperative knowledge-sharing, the resulting impact will be widespread, fostering further innovation.

Despite facing its share of critics, the best-practices methodology undeniably remains a common and highly regarded practice among many modern organizations. Most large corporations now engage in at least one form of benchmarking to develop and implement best practices.

The NACD has played an important role in developing and promulgating best practices. The NACD’s Corporate Governance Guidelines, for example, incorporate both legal rules and norms of best practice.

But given the emphasis in your question on the role of regulatory agencies, it would be worth having a discussion of whether the United States should follow the lead of the United Kingdom in having a regulatory body that develops best practice codes.

The UK Corporate Governance Code acknowledges that effective corporate governance cannot be achieved through a one-size-fits-all approach, recognizing that different companies may require different methods. Consequently, it allows for flexibility and permits companies to deviate from the Code, provided they offer a rationale for their non-compliance.

In their annual reports, companies are expected to disclose whether they have: a) fully adhered to all aspects of the Code's Provisions throughout the entire financial year; or b) departed from any of the Code's Provisions (either for the entire financial year or a portion thereof), specifying the Provisions they have not followed and indicating where in the report the explanation can be located.

It's crucial to note that the Code serves as a framework for best practices rather than a strict set of rules. It comprises adaptable requirements. In instances where a company has justified non-compliance with a Provision, it falls upon investors to assess whether the explanation is satisfactory and demonstrates how deviating from the Code benefits the company. In cases where explanations are deemed inadequate, investors are encouraged to engage with the companies and hold directors accountable, with the aim of enhancing governance practices and reporting standards.

 

[1] See e.g., https://www.thecorporategovernanceinstitute.com/insights/lexicon/why-does-corporate-governance-matter-a-look-back-at-history/

Corporate Governance Panel Question: Do you think corporate culture has any role to play in effective governance?

Question

We often speak of a "corporate culture" in the context of corporate governance. What is meant by that? Do you think corporate culture has any role to play in effective governance?

The NACD tries to mold corporate culture through its education programs and Kimberly you have written about that and participated in those programs. What do you think are effective drivers in creating an optimal corporate culture in the boardroom and the C-Suite?

Answer

Corporate cultures are very real. Indeed, I would argue that dysfunctional corporate cultures lie at the root of many corporate business failures and violations of the law.

The interesting issue implied by your question is whether boards of directors have much influence over corporate cultures. Personally, while I agree with those who would argue that “tone from the top” is crucial for creating effective and ethical corporate cultures, I suspect that the “top” for this purpose is the C-suite—especially the CEO—rather than the board of directors. They are the folks the employees of the company will look to for guidance, rather than the board. The board does not interact with most employees even in times of crisis. It is the CEO and the other members of the C-suite who are in the office daily, setting the desired tone.

The board’s role in this regard thus is primarily one of monitoring the CEO and the C-suite to ensure that they are setting the proper tone at the top. The ABA Corporate Director’s Guidebook explains:

The CEO and senior management must take the leadership role to promote integrity, honesty, and ethical conduct throughout the organization. The board's role is to assess the CEO's commitment and efforts in this area, support and encourage appropriate values (including through policies and incentives), and provide oversight of the programs and procedures that management implements to support behaviors and identify issues that may arise (including reporting mechanisms). This board role includes directing the CEO and other members of the senior management team to establish the proper “tone at the top” by setting clear expectations for the corporation's ethical behavior and conduct of its business in compliance with law.[1]

 

[1] The Corporate Laws Committee, ABA Section of Business Law, Corporate Director's Guidebook-Sixth Edition, 66 Bus. Law. 975, 987 (2011).

Corporate Governance Panel Question: What is the relationship between defining the corporation’s purpose and establishing principles of corporate governance?

Question

What is the relationship between defining the corporation’s purpose and establishing principles of corporate governance? U.S. society is in the middle of a debate over the proper purpose of the corporation. Do we need to settle that debate in order to decide what is good governance?

On this point, recently the NACD did a survey of which practices directors expect to see more of and less of in the years ahead.  40% of respondents say that in the future it will be less acceptable to focus on shareholders at the expense of other stakeholders. About 62% said that boards will widen their definition of success to include the societal impact of operations.

Answer

There’s a lot going on in this question. It’s really about half a dozen questions rolled into one.

I will start by asking whether the ends of corporate governance can be separated from the means of corporate governance. Put another way, why is board centric governance a feature of shareholder capitalism? Would it also be a feature of stakeholder capitalism? I think (emphasis on the word think) the answer is yes.

But even if a board of directors would exist in corporate system premised on stakeholder capitalism, what would be the role of the board in such a system? At present,  in our system of shareholder capitalism, the board’s role is primarily monitoring. Its service and managerial roles are of minor importance. Would that change in a stakeholder capitalist system? Margaret Blair and Lynn Stout argue the board should function as mediating hierarchs, which would seem to imply an emphasis on managerial decision making.

By the way, as for the NACD survey, it is a fundamental tenet of my book The Profit Motive: Defending Shareholder Value Maximization that what directors and CEOs say is of far less importance than what they do. Most boardroom and C-suite ESG talk is greenwashing.

Corporate Governance Panel Question: Do you still support outsourcing the board?

Question

In 2018, Stephen, with his co-author University of Chicago Law Professor Todd Henderson, published a book entitled Outsourcing the Board: How Board Service Providers Can Improve Corporate Governance. The argument in the book was that after decades of trying, those who advocate for better corporate governance have failed to find ways to implement it as evidenced by corporate scandal after corporate scandal. Professors Bainbridge and Henderson proposed to replace a board of diverse individuals with special service organizations with the subject matter expertise and experience to serve as the board. Are there other changes that could improve corporate governance?

Answer

Short answer: Adopt our proposal. We would not mandate that all boards adopt the board service provider model in which a single outside entity replaces the board, but we think it should be an available option.

Long answer: Read the book.

Corporate Governance Panel Question: How can lawyers get on boards of directors?

Question

Many in our audience are lawyers. Often lawyers want to become members of the board. What does it take for a lawyer to become a member of a board? What are some paths and resources for lawyers interested in becoming a member?

Answer

I wish I knew. As someone for whom the board of directors is his principal academic interest, I’d love to get the experience of actually serving on a board. But nobody’s asked.

Corporate Governance Panel Question: How should we respond to crises in corporate governance?

Question

We get excited about governance whenever there is a crisis. One consequence of that is the public seems to have a poor opinion of corporate officers and directors. For example, there are calls by government officials to hold the officers and directors of Silicon Valley Bank accountable although it is not clear exactly what they did wrong.

Is one of the legitimate goals of corporate governance to bolster (or restore) public confidence in corporations? How should that affect lawyers and policymakers’ work on corporate governance?

Your work has been described as defending the board centric model of corporate governance. If the public has a low opinion of boards and their members, does that affect your model in any way?

Answer

At the risk of seeming unduly flippant, the public also has a very low opinion of the President, Congress, the news media, and so on. But we muddle along with them.

In my book, Corporate Governance after the Financial Crisis, I discuss how the Sarbanes-Oxley Act responded to the crisis caused by the bursting of the tech bubble, the scandals at Enron et al., and how the Dodd-Frank Act responded to the 2007 financial crisis.

In both cases, a powerful interest group coalition centered on activist institutional investors hijacked the legislative process so as to achieve longstanding policy goals essentially unrelated to the causes or consequences of either crisis. Without exception, the Acts’ provisions lacked strong empirical or theoretical justification. To the contrary, there were theoretical and empirical reasons to believe that each would be at best bootless and most would be affirmatively bad public policy. Finally, each eroded the system of competitive federalism that is the unique genius of American corporate law by displacing state regulation with federal law. Unfortunately, this has become a recurring pattern whenever the federal government is moved to action by a new economic crisis.

In sum, the federal role in corporate governance appears to be a case of what Robert Higgs identified as the ratchet effect.^[1] 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 issuers, the trend is towards ever more federal regulation.

[1] See Robert Higgs, Crisis and Leviathan: Critical Episodes in the Growth of American Government 150-56 (1987) (describing the “ratchet effect” by which Congress increases not only the scale but also the scope of the federal government on a permanent basis).