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Smith's Dystopian Perspective on CSR

Gordon Smith has a very fine new paper, The Dystopian Potential of Corporate Law. Here's the abstract:

The community of corporate law scholars in the United States is fragmented. One group, heavily influenced by economic analysis of corporations, is exploring the merits of increasing shareholder power vis-à-vis directors. Another group, animated by concern for social justice, is challenging the traditional, shareholder-centric view of corporate law, arguing instead for a model of “stakeholder governance.”

I guess I'm a group of one, but while my director primacy model assumes that shareholder wealth maximization is the proper decision making norm for corporate governance, as argued in The Case for Limited Shareholder Voting Rights, I also contend that "that the director primacy-based system of U.S. corporate governance has served investors and society well. This record of success occurred not in spite of the separation of ownership and control, but because of that separation." Anyway, back to Gordon's abstract

The current disagreement within corporate law is as fundamental as in any area of law, and the debate is more heated than at any time since the New Deal. This paper is part of a debate on the audacious question, “Can Corporate Law Save the World?” In the first part of the debate, Professor Kent Greenfield builds on his book, THE FAILURE OF CORPORATE LAW: FUNDAMENTAL FLAWS AND PROGRESSIVE POSSIBILITIES, offering a provocative critique of the status quo and arguing that “corporate law matters” to issues like the environment, human rights, and the “labor question.”

In response, Professor Smith contends that corporate law does not matter in the way Professor Greenfield claims. “Corporate law” is the set of rules that defines the decision making structure of corporations, and reformers like Professor Greenfield have only two options for changing corporate decision making: changing the decision maker or changing the decision rule. More specifically, he focuses on board composition and shareholder primacy. Professor Smith argues that changes in corporate law cannot eradicate poverty or materially change existing distributions of wealth, except by impairing the creation of wealth. Changes in corporate law will not clean the environment. And changes in corporate law will not solve the labor question. Indeed, the only changes in corporate law that will have a substantial effect on such issues are changes that make the world worse, not better.

Gordon explains that:

I invoked Edward Bellamy's famous utopian novel, Looking Backward, which was written in 1887. (If you teach corporate law and you haven't read Looking Backward, you should put it on your summer reading list. You can find it online here or here.) Looking Backward presents a horrifying vision:

Early in the last century the evolution was completed by the final consolidation of the entire capital of the nation. The industry and commerce of the country, ceasing to be conducted by a set of irresponsible corporations and syndicates of private persons at their caprice and for their profit, were entrusted to a single syndicate representing the people, to be conducted for the common interest for the common profit. The nation, that is to say, organized as the one great business corporation in which all other corporations were absorbed; it became the one capitalist in the place of all other capitalists, the sole employer, the final monopoly in which all previous and lesser monopolies were swallowed up, a monopoly in the profits and economies of which all citizens shared.

My argument is that Kent's proposals for reforms are motivated by the same impulses that motivated Bellamy, and the results of implementing those proposals ... well, I think you can see why I used the word "dystopian."

Ribstein comments:

Like Gordon, I believe that less accountability is likely to lead, not to some utopian prospect of "socially responsible" firms, but to higher agency costs and less social wealth.

Ditto.

The Difference Between RLBOs and Quick Flips

Deal Journal reported that:

The public shareholders in leveraged buyouts are starting to fight back.

The latest battleground is a Texas court, where buyout firms Silver Lake Partners and TPG, (formerly Texas Pacific Group) — which are trying to buy Sabre Holdings — agreed to share some of the spoils with the public shareholders they are buying the travel-reservations provider from if they quickly turn around and sell it. Read about what we’ll call a quick-flip tax at our friends over at the LBO Wire here.

Shareholders — and some directors — of publicly traded companies are fed up watching private-equity firms get all the glory and the cash. Deals like the $1.1 billion dividend loan Blackstone took out last week against Travelport, the Sabre rival it bought last year, are sparking unrest from public shareholders there, who want a slice of the pie. It’s also making image-conscious directors less eager to sell out, which makes the buyout firms’ hunt for targets all the more challenging.

And then they further reported that:

Now comes a story today from our colleagues over at the LBO Wire newsletter from Dow Jones Newswires that quotes Joseph Bartlett (left), a private-equity attorney at Fish & Richardson PC: “People are going to be alarmed that this sets a precedent.”

But what caught our eye wasn’t the scare quote, but the following. He goes on to say that these are relatively painless concessions, and he recommends that PE firms suck it up and accept these kinds of terms if “it would quiet the concerns and public alarm that they’re taking value away from shareholders without paying for it.”

Harvard Business School's Working Knowledge column offers a Q&A with Josh Lerner, in which he draws an important distinction between quick-flips and reverse leveraged buyouts:

Studying almost 500 private equity-led IPOs over a 22-year period, Lerner and co-researcher Jerry Cao conclude that reverse leveraged buyouts in general outperformed other IPOs and the market as a whole. Quick flips, however, are another story. Key concepts include:

• RLBOs have outperformed other types of IPOs, perhaps because private equity groups prepare their portfolio companies to perform as public companies.
• RLBOs have performed well across many market cycles.
• The most successful performances were associated with larger RLBOs, as well as offerings by larger groups.

...In essence, RLBOs are the offering of new shares in a company or part of a company that had been taken private in an initial leveraged buyout. Usually, buyout specialists will hold their portfolio firms for several years, working with existing management as well as bringing in new managers to improve the firm, Lerner says. After a number of years, the buyout team sells its stakes in these firms.

Critics complain that buyout firms suck out profits rather than improve the firms they acquire, making these companies weakened goods when the IPO is launched. IPO investors suffer when these crippled companies fail in the market.

But when Lerner and Cao started analyzing the actual performance numbers, they saw that conventional wisdom had it wrong. "Reverse LBOs appear to consistently outperform other IPOs and the stock market as a whole. The positive returns appear to be economically and statistically meaningful. Moreover, there is no evidence of a deterioration of returns over time, despite the growth of the buyout market: RLBOs performed strongly in the late 1980s, the mid-1990s, and the 2000s."

... Not all RLBOs are golden. So-called quick-flips—when a private equity firm sells off an investment within a year after acquisition—are underperformers compared to other IPOs and the market at large. The analysis found flips underperformed the S&P 500 by 5 percent in the following three years.

Lerner believes that problems with quick flips occur because of the short period that private equity groups have to work with these firms. "While I cannot prove this, my suspicion is that in many cases, the groups are less effective in reshaping the processes and systems of these companies, stemming largely from the fact that they have worked with management for so much shorter a period. It is as if you took your dog to obedience school for one lesson, and expected him to do all sorts of tricks!"

In other words, including a quick-flip tax provision in the LBO deal may not only be good PR but also may promote efficiency.

The Tort Law System's Drag on the Economy

The Pacific Research Institute's McQuillan and Abramyan published an important op-ed in today's W$J:

Based on our estimates, and applying the best available scholarly research, we believe America's tort system imposes a total cost on the U.S. economy of $865 billion per year. This constitutes an annual "tort tax" of $9,827 on a family of four. It is equivalent to the total annual output of all six New England states, or the yearly sales of the entire U.S. restaurant industry.

PRI has set up a website with the study and background materials.

2008 US News Rankings Leaked. UCLA # 15

Dave Hoffman has what purports to be a leaked copy of the US News top 100 law schools. UCLA comes in # 15, ahead of crosstown rival USC (tied with Vanderbilt for 16). Orin Kerr also offers what purports to be the "top 35" from the forthcoming US News ranking. A fast skim suggests they're from the same list. Meanwhile, Chapman law professor Tom Bell suggests UCLA is gaming our reporting of employment statistics. (HT: Leit er) Harumph! I believe it was Groucho Marx who observed "I'd horsewhip him if I had a horse"!

Judicial Objectivity and Elite Values

Brian Tamanaha has an interesting post on judicial objectivity/activism, in which he quotes at some length from a 1948 law review article by George Braden. One of Braden's comments jumped out at me:

Every constitutional question involves a weighing of competing values. Some of these values are held by virtually everyone, others by fewer people. Supreme Court justices likewise hold values. The more widely held are the values in society, the more likely the Supreme Court will hold them; the more controversial the values, the more likely the Supreme Court is to divide over them.

Assume arguendo Braden's right that making constitutional law requires weighing values, although I don't really believe that (see my Groping Towards a Conservative Theory of Judicial Review. My point here is that Braden's wrong about it being more likely that SCOTUS members will hold those values that are most widely held in society. Instead, I would argue, that SCOTUS members are most likely to hold the values of social elites.

And so we come to Christopher Lasch, who wrote that:

[T]he new elites, the professional classes in particular, regard the masses with mingled scorn and apprehension. In the United States, ?Middle America??a term that has both geographical and social implications?has come to symbolize everything that stands in the way of progress: ?family values,? mindless patriotism, religious fundamentalism, racism, homophobia, retrograde views of women. (The Revolt of the Elites: And the Betrayal of Democracy at 28.)

Given the prevalence of religious faith in America, Lasch's comments about elite attitudes toward religion are particularly telling:

A skeptical, iconoclastic state of mind is one of the distinguishing characteristics of the knowledge classes. ... The elites? attitude to religion ranges from indifference to active hostility. (Id. at 215.)

Not surprisingly, when it comes to the culture wars, for example, the SCOTUS swing votes (e.g., O'Connor and Kennedy) have consistently come down on the same side as elite opinion. To be sure, the Greenhouse Effect plays a role, but the cultural divide between ordinary Americans and SCOTUS members may be even more important.

Director Independence

There is a very fine new paper by Donald Clarke on director independence, Three Concepts of the Independent Director:

Abstract: Despite the surprisingly shaky support in empirical research for the value of independent directors, their desirability seems to be taken for granted in policy-making circles. Yet important elements of the concept of and rationale for independent directors remain curiously obscure and unexamined. As a result, the empirical findings we do have may be misapplied, and judicial gap- filling may be harder than imagined when legislative intent cannot be divined or is contradictory.

This article attempts to unpack the concept broadly understood by the term independent director and to distinguish among its various concrete manifestations. In particular, I discuss the critical differences between independent, outside, and disinterested directors, arguing that these manifestations serve different purposes and should not be confused with each other. This discussion is illustrated with examples from United States state and federal laws as well as stock exchange regulations, and supplemented with comparative reference to the United Kingdom, Germany, and Japan, with a brief mention of Chinese practice as well. I also argue that the whole purpose of having independent directors is surprisingly undertheorized, leading to inconsistent rules, in particular regarding the effect of director shareholding, both across countries and within the United States.

While we're on this topic, I also want to highly commend to your attention The Fetishization of Independence by Usha Rodrigues.

Abstract: According to conventional wisdom, a supermajority independent board of directors is the ideal corporate governance structure. Debate nevertheless continues: empirical evidence suggests that independent boards do not improve firm performance. Independence proponents respond that past studies reflect a flawed definition of independence.

Remarkably, neither side in the independence debate has looked to Delaware, the preeminent state source for corporate law. Comparing Delaware's notions of independence with those of Sarbanes-Oxley and its attendant reforms reveals two fundamentally different conceptions of independence. Sarbanes-Oxley equates independence with outsider status: an independent director is one who lacks financial ties to the corporation and is not a close relative of management. Delaware's approach to independence, in contrast, is situational. As different conflicts arise in different contexts, the focus of concern - the influence from which we wish to insulate directors - varies as well.

There are at least two lessons for corporate reformers. First, the definition of independence should be refined to address the conflict at hand. For example, if the area of concern is executive compensation, the question is not merely whether the director lacks financial ties to the corporation and familial ties to corporate executives, but also whether the director lacks financial ties to the executives being compensated. Current independence rules overlook this obvious hole. Second, and more fundamentally, independent directors are useful only in situations where a conflict exists. An independent director - a part-timer whose contact with the corporation is necessarily limited - is not inherently better suited to further the interests of shareholders than is an inside director. Current rules thus over-rely on independence, transforming an essentially negative quality - lack of ties to the corporation - into an end in itself, and thereby fetishizing independence.

They are both on to something here.

Sauce, Meet Ms. Goose, Esq.

The WSJ blog reports:

Bryan Cave sponsored a ?shoe event? in Manhattan recently for its female lawyers and female clients, described in great detail in a WSJ column yesterday. Earlier this month, Skadden Arps hosted its ninth annual Skadden Women?s retreat at the Ritz Carlton in Naples, Fla., attended by some 60 women partners and 135 women clients. The same weekend, Akin Gump held a similar event in Washington, D.C., for all of its female attorneys.

These types of women-only networking events are proliferating. ?There are spa retreats, conferences at resorts, evenings at art galleries and cooking demonstrations, all organized by women who want to network and socialize with clients in their own way ? at least some of the time,? writes the WSJ.

These confabs raise some complicated issues. What about the male clients of female lawyers? And the female lawyers of male clients? Some women think these events perpetuates stereotypes. And some men wonder, ?With all the equality women have achieved, why do they continue to have these separate events??

One also wonders how loud the howls from the bar and media would be if somebody reintroduced men-only events - maybe a dinner [update: a dinner and smoker at an all-male dining club] with red meat, foie gras, and red wine, passing of the port after dinner and smoking of cigars - for men "who want to network and socialize with clients in their own way ? at least some of the time"? Deafening would be my guess. Sauce. Gander. Goose.

From Priest Abuse to Legal Abuse

The Roman Catholic Diocese of San Diego recently declared bankruptcy, becoming the fifth and largest American diocese to initiate a bankruptcy proceeding in the face of massive tort lawsuits arising out of priest sex abuse allegations.

No person of good will denies that true victims of priest sex abuse deserve compensation for any physical or mental injuries they may have suffered. Likewise, no person of good will denies that priests proven to have abused their position deserve to be punished to the fullest extent of the law, as do bishops who may have protected such priests from criminal or civil action.

Yet, the victims and their lawyers aren't going after just the priestly abusers and their enablers in the hierarchy. Instead, they're going after the deep pockets by suing the dioceses in which the priests served. Typically, the diocese is sued directly for negligent hiring or supervision of priests; more rarely, the plaintiff may seek to hold the diocese vicariously liable for a priest's sexual misconduct.

Courts have consistently held that the First Amendment guarantee of free exercise of religion is not implicated in such suits. Yet, priest sex abuse litigation unquestionably implicates the ability of ordinary Catholics to exercise their religion.

In a diocese such as San Diego, there are hundreds of parishes, schools, orphanages, homeless shelters, hospitals, nursing homes, and so on, each ministering to numerous worshippers and even non-Church members. When the diocese faces mass tort liability, the assets and property of many parishes and other ministries that had no connection with any incident priest sex abuse are thus made available to satisfy the claims of sex abuse plaintiffs. Inevitably, execution of a judgment against such assets would impede, if not destroy, the ability of these ministries to serve the needs of their congregants. Indeed, the mere threat of liability might do so. As Edward Gaffney and Philip Sorensen have observed, "Both church and society will suffer if the continuation of ministries prompted by compassion—ministries often involving risks—is stopped short by the nervous calculation of legal liabilities."

In turn, the impact of such liability—or even the risk of such liability—on parishioners inevitably redounds against the Church. If parishioners come to believe that donations to their local parish, which they expect to be used in the main for the benefit of the local church and its ministries, are being siphoned off to pay diocesan claims and legal bills, their attitude towards giving to the support of the parish will inevitably sour. In turn, this is likely to impact the morale and effectiveness of the parish priest and other local church workers, whose morale may already be in doubt due to the threat to their retirement and health benefits. As Mark Chopko explains, "Religious entities, to a greater extent than their secular entities, rely on the unbridled goodwill of volunteers to make their operations run."

Put simply, the parties with an interest in priest sex abuse litigation are not just the victims and their abusers. All American Catholics are stakeholders in this litigation. The risk that abuse litigation poses to the financial viability of the Church and, as such, the implications of such litigation for the values that inform the First Amendment's guarantee of freedom of religion must be taken into account when secular courts assess the claims of the competing interests.

HLS Bulletin on Bebchuk

Lucian Bebchuk gets a well-deserved write up in the Harvard Law Bulletin, in which the author observes:

Bebchuk?s calls for [corporate governance] reform have struck a nerve, and he has no shortage of critics. Last year, for example, the Harvard Law Review published responses by Vice Chancellor Leo E. Strine Jr. of the Delaware Court of Chancery and UCLA?s Stephen Bainbridge to Bebchuk?s arguments for a greater shareholder role in governance arrangements.

Indeed, with all due deference to Prof. Bebchuk, I remain concinced that if his agenda for issues of federalism and corporate governance were to succeed, American business and the American economy would be the loser.

As I've noted before, Lucian's views on competitive federalism have been criticized by yours truly in The Creeping Federalization of Corporate Law, as well as by Steven Choi and Andrew Guzman, Jonathan Macey, and Robert a Romano. Lynn Stout and I have criticized Bebchuk's arguments for shareholder primacy in takeovers, as has student commentator Kevin Turner. Leo Strine and I criticized Bebchuk's proposals for shareholder empowerment, as have Martin Lipton and Mark Gordon. Core, Guay, and Thomas criticized Bebchuk's work on executive compensation, as have Jeff Gordon and I.

More on the Tax Aspects of the Blackstone IPO

Vic Fleischer offers a very detailed analysis of the "aggressive" tax aspects of the Blackstone IPO.

Fleischer on Blackstone

Vic Fleischer offers a very interesting analysis of the 40 Act and tax code aspects of the Blackstone IPO. Bottom Line?

For the structure to work, then, what Blackstone does has to be active services for 40 Act purposes (we're an asset management/advisory firm, not a pass-through who lets you invest in a pool of securities) but passive for tax purposes.  I'm not saying the structure doesn't work - quirks in the rules often allow this sort of regulatory arbitrage -- just that it seems a little aggressive.  I don't think I've ever seen an entity go public with such uncertain tax treatment.

Caremark and Stone v Ritter

I'm about to teach Stone v. Ritter for the first time. By the time we get there, my students will have already read Caremark. As I read Caremark, it is a case about whether "unconsidered inaction" on the part of the board of directors gives rise to liability under the duty of care. In Stone v. Ritter, however, the Delaware Supreme Court seems to have transformed the Caremark standard of review into one arising under the obligation of good faith. In turn, good faith is subsumed into loyalty. This is odd.

The doctrinal and remedial aspects of the duty of loyalty have little relevance to Caremark claims. First, the relevant factual issues go not to fairness but to negligence and errors of judgment. Instead, these are precisely the sorts of issues the duty of care was designed to address. Second, the duty of loyalty’s remedies, such as a constructive trust or rescissory damages make no sense in this context. The goal of such remedies in loyalty cases is to ensure that the wrongdoer retains neither its ill-gotten gains nor their tainted fruits. In cases like Stone, however, an award of rescissory damages would have the effect of ordering the defendant directors to return a benefit that they never received. By definition there are no ill-gotten gains to be recouped.

But here's what's really bothering me as I get ready to go teach this mess. In Stone, the court stated that:

We hold that Caremark articulates the necessary conditions predicate for director oversight liability: (a) the directors utterly failed to implement any reporting or information system or controls; or (b) having implemented such a system or controls, consciously failed to monitor or oversee its operations thus disabling themselves from being informed of risks or problems requiring their attention. In either case, imposition of liability requires a showing that the directors knew that they were not discharging their fiduciary obligations.

If I'm right that the Caremark "duties" are about "unconsidered inaction," the clearest cases for Caremark-based liability would be where “there was an unconsidered failure of the board to act in circumstances in which due attention would, arguably, have prevented the loss.”

This is so, Caremark clearly suggests, because the business judgment rule has no application where the board failed to exercise business judgment. The paradigm case for director liability thus was a board, such as the defendant board in Caremark itself, which over a sustained period of time simply failed to even consider whether a law compliance program was necessary.

Yet, by requiring “a showing that the directors knew that they were not discharging their fiduciary obligations,” the Stone court seemingly would allow such a board to escape liability. Right? Would a clueless board that just sort of drifted along for years with unconsidered inaction escape liability? Is ignorance really bliss?

Delaware Supreme Court to Tackle Fiduciary Duties in Zone of Insolvency

Francis Pileggi offers Mark Saltzburg's summary of a speech by Delaware Supreme Court Chief Justice Myron Steele, in which Steele notes:

... that the Delaware Supreme Court had just heard argument in the Trenwick America Litigation Trust litigation that may result in a decision on whether creditors may bring a cause of action for violation of fiduciary duty where a company deepens its insolvency in a way that further damages creditors after any residual interest of shareholders is out of the picture. Typically, fiduciary duties are only owed by directors to shareholders and not to creditors. Steele noted, however, that in an earlier decision by former Delaware Court of Chancery Chancellor William Allen in the Credit Lyonnais case, the court commented that directors may owe creditors a fiduciary duty where a company is in the vicinity of insolvency.

One hopes that Steele doesn't let the Supreme Court make the same mistake Allen made in Credit Lyonnais. As I explained in Much Ado about Little? Directors' Fiduciary Duties in the Vicinity of Insolvency:

Where the contract between a corporation and one of its creditors is silent on some question, should the law invoke fiduciary duties as a gap filler? In general, the law has declined to do so. There is some precedent, however, for the proposition that directors of a corporation owe fiduciary duties to bondholders and other creditors once the firm is in the vicinity of insolvency.

Courts embracing the zone of insolvency doctrine have characterized the duties of directors as running to the corporate entity rather than any individual constituency. This approach is incoherent in practice and insupportable in theory. Courts should focus on whether the board has an obligation to give sole concern to the interests of a specific constituency of the corporation.

Concern that shareholders will gamble with the creditors' money is the principal argument for imposing a duty on the board running to creditors when the corporation is in the vicinity of insolvency. On close examination, however, this argument proves unpersuasive. It is director and manager opportunism, rather than strategic behavior by shareholders that is the real concern. Because bondholders and other creditors are better able to protect themselves against that risk than are shareholders, there is no justification for imposing such a duty.

This article also argues that the zone debate is much ado about very little. The only cases in which the zone of insolvency debate matters are those to which the business judgment rule does not apply, shareholder and creditor interests conflict, and a recovery could go to directly to those who have standing to sue. In those cases, as this Article explains, there is a strong policy argument that creditors should be limited to whatever rights the contract provides or might be inferred from the implied covenant of good faith.

Vice Chancellor Strine was kind enough to consider my argument (which he called "incisive" -ahem!) in the Chancery Court opinion.

Reports of the Demise of the Public Firm Greatly Exaggerated

Holman Jenkins offers some enlightening thoughts on the future of public versus private firms:

Look upon Blackstone's prospectus, if one is ever issued, as a self-rebuttal to Blackstone co-founder Stephen Schwarzman's comment: "The public markets are overrated." ... Mr. Schwarzman has offered two observations, perfectly separable. One is that government regulation, shareholder lawsuits and political mau-mauing have made the bureaucratic and legal overhead of being a public company prohibitive in relation to the benefits.

Yup. Costs attend going public as well as benefits, and the costs likely have been rising since Enron and WorldCom. But regulation is driven by headlines, and headlines about the power of private equity now are making Washington hungry to regulate and tax the private equity firms more punitively. So it goes: Wealth holders are constantly on the hunt for new legal and financial structures to preserve their wealth from predatorial government, and government is never far behind.

Second, and more dubious, or at least more subjective, is Mr. Schwarzman's complaint that the public market's obsession with quarterly profits works against intelligent management of companies for the long term.

Here we come to the real crux. Complaints about short-termism always issue from managers, who naturally prefer freedom from second-guessing and nitpicking. But the shoe rapidly shifts to the other foot when an owner-manager wants to retreat to a more passive role. Then the second- guessing of public investors becomes a blessing not a curse. Few of us, after all, are prepared to extend to our agents the trust and confidence that we extend to ourselves in caring for our precious money.

And the benefits of a public share price only begin with the opportunity and incentive for all the smartest money in the world to inform itself about a company and its prospects and cast a weighted vote in the stock market. Constant feedback from well-informed investors is also a form of competitive intelligence, providing a signal when management's strategies aren't working, its assumptions need revisiting or new developments in the marketplace warrant its attention.

A public share price also allows no ambiguity internally about a company's overarching purpose, no difficulty in communicating its agenda and challenges up and down the chain of command, nor any uncertainty about what constitutes success and failure. And a public listing offers a transparent, easily understood mechanism to attract talent to a growing operation like Blackstone in the form of stock options. Stock options allow risks to be shared with recruits, without the arbitrariness or unreliability of promised bonuses and profit sharing after the fact.

Most of all, a public listing provides the incentive and means for well-informed outsiders to intervene and force a change in direction when a company is off track.

These benefits have tended to be downgraded in the recent enthusiasm for escaping from the public markets. While Mr. Schwarzman runs Blackstone, he (like anyone) undoubtedly prefers to be free of outside monitoring by busybody investors and analysts and financial journalists. Someday, though, he will hand off to a successor whom he will prefer not to trust quite so much. One onlooker, Christopher Bower, chairman of Pacific Corporate Group, was aptly quoted in Saturday's Journal about why a public listing becomes attractive at this point to Blackstone's founders: "They can use this to further institutionalize their business and make sure Blackstone is around 100 years from now, versus relying on any one personality."

If the public firm is likely to survive, as I also believe, I suppose it remains to be decided whether it will be in the form of a corporation or a "public uncorporation." My guess is the former. Even if it's true that publicly traded LLCs or partnerships have efficiency advantages over the corporate form, a debatable proposition but not one I propose to debate today, path dependence, herd behavior, and other incentives towards inertia likely will continue to bias choices of form towards the corporation at least in the near term. With 15 or so years left before I retire, I'm reasonably confident that I'll still be teaching mainly corporate law when I call it quits.

Associates: Hire or Sweat?

The W$J's Law Blog reports that most big law firms plan to hire more associates in the coming year:

“It’s all about firms trying to build up leverage,” says DiPietro, referring to the ratio of associates to partners. ...

Instead of hiring fleets of new associates, can’t law firms just ask their existing worker-bees to put in a few more hours every month? DiPietro says that associates are, on average, billing more hours then they were several years ago, but that they’re not at the the levels seen from 1998-2000. “I don’t know why that is,” he says, “if it’s a ‘Gen Y’ thing or what. But the ranks of associates are swelling because the firms aren’t getting them to work” as hard as they’d like.

Talk to us associates — what do you think is better for firms, and for yourselves: that firms hire more associates (thus making partnership more competitive), or task their current fleet with billing more hours (and thus making everyday life a bit more brutal)?

It's not obvious (at least to me) which option makes more sense for either firms or associates.

Like many other service firms, law firms use promotion tournaments as a mechanism for reducing agency costs through comparative performance evaluation. In a promotion tournament, the principal ranks its agents by their performance relative to one another. The best performing agents are promoted to positions with higher pay and/or status. In law firms, associates thus are ranked and the best performers are promoted to partner at the end of an evaluation period.

For law firms, the promotion-to-partner tournament solves two agency cost problems at a single stroke. On the one hand, the firm makes investments in its associates' human capital -- i.e., skills and client relationships -- during their apprenticeship. The firm will want to discourage associates from leaving the firm before it has fully amortized those investments. On the other hand, the firm must also deter shirking by associates. The firm gives associates incentive both to remain for the optimal period and to maximize their productivity during that period by holding what someone (I've lost the citation) called "a tournament in which all the associates in a particular entering class compete and the firm awards the prize of partnership to the top X percent of the contestants."

The prize of promotion to a more secure and higher status position, plus the accompanying increase in compensation, gives lawyers an incentive to remain at the firm. Conversely, the threat of losing the tournament deters shirking.

Hiring more associates means that a given junior lawyer's chance of winning the tournament decline. Unless the effect of adding additional leverage is to increase the value of the prize by an off-setting amount, hiring more associates therefore means the present value of the prize decreases for each associate and each associate therefore has less incentive to refrain from shirking and less incentive to remain at the firm.

Conversely, demanding more from the worker bees increases the current costs incurred by the associates competing in the tournament. Again, the net present value of the prize therefore decreases. Again, the prize has less of an incentive effect with respect to both shirking and retention.