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I wonder what this guy would make of Obama's Government Motors?

Shareholder Non-Activism at Exxon

Lisa Fairfax reports that:

Yesterday, Exxon shareholders voted against all eleven of the shareholders proposals on the company’s proxy statement. So it appears that the extra effort to reach out to mutual fund shareholders did not have the desired impact on the vote. In fact, the proposal to split the CEO and chair functions garnered only 29.5% of the vote, a ten percent decrease from last year. Moreover, despite the extra outreach by shareholders, Exxon’s annual meeting was notable because of the lack of protesters outside of the meeting place. So perhaps the meeting and its outcome reveal that the financial crisis has had an impact on shareholder activism, making shareholders more hesitant to rock the boat and less willing to support initiatives that may impinge on managers’ discretion or otherwise pressure them to divert resources on green initiatives, despite assertions that such initiatives could improve the financial bottom-line in the long term.

It just goes to show, perhaps, that shareholder activism is an expensive indulgence for people with too much time on their hands. Like other luxury items, it may disappear during bad times, even though certain people would have you believe that these sort of times are when it is needed most. 

In contrast, director primacy comes through in the clutch.

 

Update: AP reports that shareholder activism fizzled at Target too:

Target Corp.'s shareholders have re-elected the company's slate of directors, rejecting a hedge fund's alternate slate, according to preliminary vote totals.

William Ackman had sought for months to put up his own slate — including himself — to the Minneapolis-based retailer's board of directors. ...

Shareholders also sided with the company in approving a measure that sets the board's size at 12 members.

Yet, the SEC and the Congress doubtless will continue pressing for pro-activism "reforms."

Delaware Justice Jack Jacobs Interviewed

JW Verret interviews Delaware Supreme Court Justice Jack Jacobs, whose many prominent corporate law decisions have given him enormous influence in our field. (We are big Jacobs fans here at PB.com)

Some highlights:

Verret: You first joined the bench in 1985, which seems to have been a watershed period for takeover law in Delaware.  It must have been an exciting time to be on the Court of Chancery?

Justice Jacobs: It was a very exciting time, for many reasons. First, the takeover cases were at the very cutting edge of Delaware corporate law. Although we could not know it at the time, they ultimately transformed Delaware corporate jurisprudence and made merger and acquisitions law a new and important sub-specialty. It was very heady to be at the center of many of these widely publicized cases. Second, those cases presented unique intellectual challenges, not only because each new takeover dispute pushed the envelope of corporate law doctrine out one more notch, but also because it forced the judges to do their best to reconcile the rulings in each new case consistently with the doctrine developed up to that point. That was more easily said than done, and in many cases the process took years to complete. This new doctrine was a moving target that was being developed at warp speed, rather than at the tortoise’s pace which characterized corporate doctrinal development during decades before. Third, and relatedly, these cases forced the judiciary to examine several of the basic premises and underpinnings of corporate law.

Our need to shape this law into a fabric that was coherent led the Court of Chancery judges to become a very collegial group. Although each trial judge is free to decide a case as he or she deems appropriate, unencumbered by the views of colleagues, nonetheless, we found it institutionally useful and beneficial to attempt to puzzle out collectively (where possible) the difficult issues that we confronted individually, in circumstances where the decision of one judge in any particular takeover case could bind other judges in future cases. This practice also helped to avoid inconsistent adjudications and to strengthen that court as an institution.
   
Verret: What is so unique about Delaware's approach to corporate law?

Justice Jacobs: That is a subject to which corporate law academics have devoted much time and law review space. In my opinion, the quality that is most unique is its effort to reconcile, in each specific case, the requirements of law (specifically, transactional predictability and giving practical guidance to corporate fiduciaries) with the commands of equity (to arrive at results that are fair and make sense in the business world). That is often more easily said than done, but over time I believe we have been successful in doing that.

How Liberal is Sotomayor?

Walter Olson comments:

Her defenders (and less-severe critics) do make some interesting points about a judge whose friend, Yale lawprof Stephen Carter, calls her a "moderate, with liberal leanings" but not a "firebrand on a mission":

Alarms over Dabit v. Merrill Lynch notwithstanding, Paul Karlsgodt at Class Action Watch finds Sotomayor's rulings in class action and securities cases mostly unexceptional (more here). Jonathan Adler summarizes what he's found, good and bad.

Conservative California lawyer-blogger Patterico says the nominee, a former prosecutor, "appears to be OK on criminal law issues".

And at Volokh Conspiracy, libertarians David Bernstein and Ilya Somin have good words for rulings by the judge on public-employee discipline for off-job racist speech and seizure of the vehicles of persons charged with DUI.

The talk radio-types will get worked up, but it's going to be hard (based on what we know so far) to make the case that Sotomayor is so far out of the mainstream as to be unconfirmable.

 

Sonia Sotomayor and Business Law

Walter Olson comments on Barack OBama's nomination of Sonia Sotomayor to the Supreme Court:

Two 2006 cases present more problems for Sotomayor advocates, but they're on subject matter that could come off to the public as dry and remote: Merrill Lynch v. Dabit, where she held that state courts could entertain certain securities lawsuits notwithstanding the preemptive effect of federal law (reversed 8-0 by the high court), and Knight v. Commissioner, on the deductibility of certain trust fees, in which the court upheld her result but unanimously rejected her approach as one that (per Roberts) "flies in the face of the statutory language."

Issues of business law don't come across as Sotomayor's great passion one way or the other, so it's hard to know what all this portends for the high court's direction on business issues should she be confirmed. As Home Depot's ( HD - news - people ) Bernard Marcus and others have pointed out, for all of David Souter's predictable role on the court's liberal side in most high-profile cases, he in fact steered to middle-of-the-road, hard-to-characterize views on many issues of litigation, liability and procedure, either as a swing vote or as the author of opinions. (Two key issues to watch: what sort of constitutional restraints, if any, there are on punitive damages, and how much scrutiny judges should give to initial pleadings to determine whether a federal lawsuit ought to go forward.)

In a post at Point of Law, Olson reports:

Randy Maniloff at White and Williams finds that she's ruled mostly for insurers against policyholders (PDF) in coverage disputes -- not usually seen as the more "liberal" or empathy-driven way of doing things.

OTOH, the Business Law Professor observes:

I was reviewing Judge Sotomayer's record on business cases and the same word kept coming up, reversed.   There is little to be said of a consistent record learning one way or the other on the business cases except the high frequency of reversals by the Supreme Court whenever one of her cases goes up on appeal.  There is one case she wrote that I do not like at all and that is her opinion several years back giving the NYSE immunity from investor actions questioning the manipulative activities of NYSE floor brokers and specialists.  The NYSE has change enough to moot the opinion, but at the time it I found it poorly reasoned and of questionable policy to boot. 

RIP: John Cribbet

I am saddened to learn that my former University of Illinois colleague John Cribbet has passed away. The College of Law announcement informs us that:

Cribbet, chancellor of the Urbana campus from 1979-84, was a well-known legal scholar and pioneer in the field of property law. His books include the widely used "Cases and Materials on Property," a law textbook now in its eighth edition.
"John Cribbet transformed all that he touched - the university, the College of Law, and, most importantly, his students and colleagues," said Bruce P. Smith, the dean of the college and Guy Raymond Jones Faculty Scholar. "He was a legendary teacher and scholar in the field of property law. But he was also a terrific person.

I can confirm from personal experience that John was an amazing teacher (I sat in on several of his classes as a young teacher to see what the fuss was about and was blown away by his command of the classroom) and a wonderful colleague. He was a true gentlemen and scholar. (HT: Leiter)

Cuban's battle with SEC heating up

The Houston Chronicle relates:

The Dallas Mavericks are out of the NBA playoffs, and the spotlight is now following the team's controversial owner, Mark Cuban, to a different venue — federal court.
The insider trading suit filed against Cuban by the U.S. Securities and Exchange Commission last year is scheduled to receive its first hearing Tuesday when attorneys present oral arguments on a motion by the billionaire owner to have the case dismissed.
The hearing will provide yet another window to a case that has captured the attention of the country's legal minds, some of whom believe it represents an unprecedented step by the SEC....

"The basis on which they're going after Cuban hasn't been tried before," said Peter Henning, a law professor at Wayne State University in Detroit who formerly worked as an attorney in the SEC's enforcement division. "Whether the SEC is going to be able to stretch (its authority) that far certainly remains to be seen."
The SEC alleges that Cuban engaged in insider trading when he sold his shares in a Canadian Internet search engine company, Mamma.com Inc., after receiving confidential information that the company planned to sell additional shares through a private offering in 2004. Cuban was able to avoid more than $750,000 in losses by selling his shares, according to the SEC.
The government's case is based on the contention that, by violating an oral agreement to keep the sensitive information confidential, Cuban committed insider trading.
Cuban and his legal team, while not admitting that the facts detailed in the suit are true, say the government's premise is wrong. They say Cuban, whose shares represented a 6.3 percent stake in Mamma.com, was never an "insider" because he didn't have a fiduciary or similar duty in his relationship with the company.
Cuban's motion to have the case dismissed has sparked a series of pleadings and briefs in which he has attacked the government's position and the government has pushed back with equally sharp elbows.
The SEC argues that a confidential agreement is sufficient to establish a fiduciary relationship and derides Cuban's attempt to say it isn't so.
"Cuban's argument that a person can promise confidentiality and then deliberately and furtively break that promise by trading on the confidential information is shameless," the SEC stated in a memo opposing his motion to dismiss. "Cuban accepted a duty of trust and confidence to the source of the information and was therefore legally obligated to abstain from trading or first disclose his plan to trade."
Five respected law professors have filed a brief in support of Cuban's position. The professors — Alan Bromberg of Southern Methodist University in Dallas, Stephen Bainbridge of UCLA, Allen Ferrell of Harvard, Todd Henderson of the University of Chicago and Jonathan Macey of Yale — weren't compensated for signing off on the brief, according to the document.

The Prescient David Skeel

While doing some research on Google, I recently ran across a article on hedge funds by my friend U Penn bankruptcy law scholar David Skeel in the November 2005 (!) issue of Legal Affairs. Money quote:

Hedge fund misbehavior looks ominously like the edge of the next wave of financial scandals. While many top executives of Enron and WorldCom—and the investment bankers and accountants who advised them—have been punished or soon will be, the scandals they perpetrated never prompted a thorough rethinking of how American markets should work, and how best to preserve the markets' integrity. After 25 years of deregulation in financial, airline, and other industries, a high-velocity, service-oriented economy has given the wealthiest Americans more money than ever. They are pouring it into hedge funds, whose whiz-kid managers are guided by an overriding principle: Multiply the money, any way you can.

I’m not convinced that hedge funds deserve much of the blame for the current financial mess, but Skeel’s essay otherwise looks quite prescient in many respects.

Beneficial Corporations

In my corporate governance seminar this past semester, a couple of students wrote papers on the emerging phenomenon of so-called beneficial corporations (a.k.a. for benefit corporations). As Inc explained:

Public companies are legally obligated to maximize returns to shareholders, according to a widespread interpretation of corporate law. For private firms, it's more a matter of withstanding pressure from investors. Hannigan and Marx, for example, fear their social mission could be threatened if an investor changed his mind about Give Something Back's penchant for charity. They want to avoid the fate of ice cream maker Ben & Jerry's, which received a buyout offer from the Dutch conglomerate Unilever (NYSE:UL) in 2000. Founders Ben Cohen and Jerry Greenfield didn't want to sell, so Cohen assembled a group of investors to make a counteroffer. When they couldn't offer as much as Unilever, shareholders sued, and the company, then publicly traded, was forced to relent. In April 2000, Ben & Jerry's was acquired by Unilever for $326 million.

That's exactly the situation that B Lab, a new nonprofit organization, aims to prevent. The group is creating a new kind of company--the B Corporation. (The B stands for "beneficial.") It's less a legal designation than a certification system that will allow businesses to define themselves as socially responsible to consumers and investors. To become a certified B Corporation, a company must amend its articles of incorporation to say that managers must consider the interests of employees, the community, and the environment instead of worrying solely about shareholders. Those amendments, according to B Lab, will let entrepreneurs like Hannigan take on outside investors without worrying that their values will be compromised. "For us, this is a huge step forward," says Hannigan, whose company recently became one of about two dozen certified B Corporations.

I'm considering writing a law review article on this phenomenon and therefore have been doing some research on it. In the course of that research, I ran across a blog post by Geoffrey Manne on the Community Interest Company, which is a relatively new form of business organization in the UK. 

While there might be some benefit here in providing an off-the-rack form that could have been difficult to contract into otherwise (or not -- more on this in a later post), the form surely seems tailor made to deal with the CSR problem. (On which see here, here, here and here). If corporate directors want to maximize something other than shareholder interests, let them. But why not also make them (permit them to?) identify their organizations accordingly -- call it Whole Foods, CIC –- and subject them to dividend monitoring by regulators (and see how well that goes over).

Part of the stated purpose with the CIC is, in fact, branding, and this might be its real appeal: “The CIC legal form was specifically designed to provide a purpose-built legal framework and a ‘brand’ identity for social enterprises that want to adopt the limited company form.” It’s a way for “socially-conscious” corporations cheaply to identify their consciousness (and a way for the rest of us cheaply to avoid investing in them). (But I will note that some fascinating recent research by Anup Malani and Guy David has suggested that there may be less value in nonprofit branding than we might have thought, and the benefits of a CIC designation may be accordingly limited).

Larry Ribstein commented:

The CIC clarifies ... that the key csr question concerns the extent of managers’ control over the cash.  In a standard publicly held corporation, managers significantly control corporate cash subject only to shareholders’ fairly weak voting, selling and fiduciary rights.  In a CIC, the managers have even more control over the cash. 

... the main effect of opting into the CIC form is that the governing statute would then limit the extent to which the firm's governance ever could be changed through a takeover or similar device to restrict the manager’s control over the cash.

If US corporation law codes were more clearly understood to be enabling statutes, there is nothing the CIC buys you (other than the label) that could not be done via the articles of incorporation of a standard business corporation. The articles of an aspiring US CIC would include:

1. A nonshareholder constituency interest shark repellent. These provisions permit, and in some cases require, directors to consider a variety of nonprice factors in evaluating a proposed acquisition. A typical one allows directors to consider "the social, legal and economic effects of an offer upon employees, suppliers, customers and others having similar relationships with the corporation, and the communities in which the corporation conducts its business."
2. Restrictions on payment of dividends.
3. Strong takeover defenses. Perhaps a combination of a poison pill, a classified board, and a dual class capital structure in which management holds supervoting shares. Although changes to the articles require board approval, a belt-and-suspenders corporate social responsibility advocate would want to further protect these provisions by requiring some sort of supermajority vote to amend them.(All of these devices, by the way, are discussed at length in my book Mergers and Acquisitions.)

Unfortunately, it's not at all clear that US corporate law is sufficiently enabling to achieve this result. State law arguably does not permit corporate organic documents to redefine the directors' fiduciary duties. In general, a charter amendment may not derogate from common law rules if doing so conflicts with some settled public policy. In light of the well settled shareholder wealth maximization policy, nonmonetary factors charter amendments therefore appeared vulnerable. This problem seems especially significant for Delaware firms, as Delaware law became increasingly hostile to directorial consideration of nonshareholder interests in the takeover decisionmaking process.

The question of whether corporate law is sufficiently enabling strikes me as one of the two big issues. The other is how to give a B corp teeth.

Manne's Primer on Corporate Governance

Several years ago, famed law and economics scholar Henry Manne published a very fine essay on corporate governance in the WSJ($), which is perhaps even more timely today in light of Senator Schumer's proposed Shareholder Bill of Rights. 

Manne's essay begins with an analysis of proposals to increase disclosure of executive compensation and to enhance the power of shareholders, which are two key aspects of Schumer's bill, concluding:

Only in the make-believe world of SEC regulation could anything like the proxy fight be seen as a significant solution to the agency-cost problem of exorbitant salaries.

I agree, for the reasons detailed at length in my article The Case for Limited Shareholder Voting Rights.

Henry's proposed alternative solution to the ills of corporate governance will come as no surprise to those who know him; namely, a reinvigorated market for corporate control.

Henry writes:

... free markets do not tolerate economic inanities for long, even in the case of large, publicly held companies. Contrary to the popular liberal shibboleth, markets do not often fail on their own. It usually requires help from the government. In the late '50s and '60s, we witnessed the early development of the hostile tender offer -- the most powerful market tool ever devised for dealing with non-profit-maximizing managers in publicly held companies. It did not appear before this time for the simple reason that there were very few companies that had the wide diffusion of stock ownership prerequisite to hostile tender offers. Tax laws and a growing understanding of the virtues of share diversification changed all that, and hostile takeovers were not slow then in making their appearance.

But their appearance was, for incumbent managers, a terrifying thing: surprise offers for almost all outstanding shares at a huge premium over current market price -- and with little time for shareholders or the corporation to shop the offer, or for the incumbents to mount a counterattack or defense. The opportunity for affording such a premium, of course, was created by the low stock market value generated by the policies of the incumbent managers. There were no inefficiencies in the stock market that generated incorrectly low prices for these companies' shares.

... Until we return to something like the pre-Williams-Act market for corporate control, we shall continue to see egregious salaries, crazy option grants, and golden handshakes and parachutes. Disclosure as a solution to that problem is a bit like a New Orleans levee faced with Katrina. A return to the takeover law of the '60s would substantially solve the compensation problem without ungainly regulation, and it would also deliver us from vacuous and harmful notions of corporate social responsibility. All that is required is a little guts from Mr. Cox, confidence in free markets from the managers of large corporations, and some humility about economic regulation from the U.S. Congress.

I would quibble with Henry on a couple of points. First, I don't entirely share his faith in the efficiency of the stock market. As I detail in my book Mergers and Acquisitions (at 54-56): In standard economic theory, a control premium is not inconsistent with the efficient capital markets hypothesis. The pre bid market price represented the consensus of all market participants as to the present discounted value of the future dividend stream to be generated by the target—in light of all currently available public information. Put another way, the market price represents the market consensus as to the present value of the stream of future cash flows anticipated to be generated by present assets as used in the company's present business plans. A takeover bid represents new information. It may be information about the stream of future earnings due to changes in business plans or reallocation of assets. In any event, that pre bid market price will not have impounded the value of that information. To the extent the bidder has private information, moreover, the market will be unable to fully adjust the target's stock price.

Some commentators contend that the demand curves for stocks slope downwards and may even approximate unitary elasticity. If so, buying 50% of a company's stock would require a price increase of 50%. If so, little or no new wealth is created by takeovers. Instead, takeover premia are largely an artifact of supply and demand.

Put another way, the downward sloping demand curve hypothesis takeover premium implies that many investors have a reservation price higher than the pre-bid market price of the target corporation’s stock. Indeed, because investors with a reservation price below the prevailing market price should already have sold, most investors’ reservation price will be near or above the prevailing market price. Accordingly, a bidder must offer a control premium simply to induce those investors to sell. As to those investors, however, the portion of the control premium reflecting their reservation price really should not be considered new wealth.

Second, I find the notion that takeovers are driven by disciplinary concerns unpersausive. If there are alternative explanations of how takeovers create value, the market for corporate control loses some of its robustness as a policy engine. Put another way, awarding the lion's share of the gains to be had from a change of control to the bidder only makes sense if all gains from takeovers are created by bidders through the elimination of inept or corrupt target managers and none of the gains are attributable to the hard work of efficient target managers.

The empirical evidence suggests that takeovers produce gains for many reasons, of which the agency cost constraining function of the market for corporate control is but one. Studies of target corporation performance, for example, suggest that targets during the 1980s generally were decent economic performers. Second, studies of post takeover workforce changes find that managers are displaced in less than half of corporate takeovers. Third, as already noted, acquiring company shareholders frequently lose money from takeovers. If displacing inefficient managers was the principal motivation for takeovers, acquiring company shareholders should make money from takeovers. Finally, there is little convincing evidence that acquired firms are better managed after the acquisition than they were beforehand. In sum, displacement of inefficient managers is a plausible way in which takeovers create value, but it is hardly the only way—and it may not even be a particularly important way. (I cite these studies at pages 48-49 of my Mergers and Acquisitions text.)

Finally, there is a very strong argument for allowing incumbent target managers to at the very least compete to retain control. (I discuss this argument in my recent paper Unocal at 20: Director Primacy in Corporate Takeovers, which also makes a number of other arguments for granting target management a gatekeeping function in takeover fights.)

Michael Dooley has suggested that management resistance to unsolicited tender offers may not deserve the opprobrium to which it is usually subjected. Michael P. Dooley, Fundamentals of Corporation Law at 561-63. Observing that it would be naive to assume that takeovers displace only “bad” or “inefficient” managers, while acknowledging that blamelessness does not eliminate the managers’ conflict of interest, he suggests that “resistance may not deserve the opprobrium usually attached to self-dealing transactions.” Id. at 562.

Indeed, Dooley observes, it may often be shareholders rather than managers who act opportunistically in the takeover context. Id. Much of the knowledge a manager needs to do his job effectively is specific to the firm for which he works. As he invests more in firm specific knowledge, his performance improves, but it also becomes harder for him to go elsewhere. An implicit contract thus comes into existence between managers and shareholders. On the one hand, managers promise to become more productive by investing in firm specific human capital. They bond the performance of that promise by accepting long promotion ladders and compensation schemes that defer much of the return on their investment until the final years of their career. In return, shareholders promise job security. See Stephen M. Bainbridge, Interpreting Nonshareholder Constituency Statutes, 19 PEPPERDINE L. REV. 971, 1004-08 (1992).

Viewed in this light, the shareholders’ decision to terminate the managers’ employment by tendering to a hostile bidder “seems opportunistic and a breach of implicit understandings between the shareholders and their managers.” DOOLEY at 562. Shareholders can protect themselves from opportunistic managerial behavior by holding a fully diversified portfolio. By definition, a manager’s investment in firm specific human capital is not diversifiable. Shareholders’ ready ability to exit the firm by selling their stock also protects them. In contrast, the manager’s investment in firm specific human capital also makes it more difficult for him to exit the firm in response to opportunistic shareholder behavior. See John C. Coffee, Jr., Shareholders versus Managers: The Strain in the Corporate Web, 85 MICH. L. REV. 1, 73-81 (1986).

Dooley concedes that this analysis certainly helps explain the courts’ greater tolerance of conflicted interests in this context than in, say, garden variety interested director transactions. But he also argues that the possibility that the shareholders’ gains come at the expense of the managers does not justify permitting management to block unsolicited tender offers. Rather, he argues, the managers’ loss of implicit compensation appears to be a particularly dramatic form of transaction costs, which could be reduced by alternative explicit compensation arrangements, such as payments from shareholders to managers who lose their jobs following a takeover. It thus may be that courts tolerate management involvement in the takeover process not because they perceive management as having a right for management to defend its own tenure, but rather a right to compete with rival managerial teams for control of the corporation. By allowing management to compete with the hostile bidder for control, the courts provide an opportunity for management to protect its sunk cost in firm-specific human capital without adversely affecting shareholder interests. Indeed, allowing them to compete for control will often be in the shareholders’ best interests. There is strong empirical evidence that management-sponsored alternatives can produce substantial shareholder gains. See Michael C. Jensen, Agency Costs of Free Cashflow, Corporate Finance, and Takeovers, 76 AM. ECON. REV. 323, 324-26 (1986) (summarizing studies of shareholder gains from management-sponsored restructurings and buyouts). A firm’s managers obviously have significant informational advantages over the firm’s directors, shareholders, or outside bidders, which gives them a competitive advantage in putting together the highest valued alternative. Management may also be able to pay a higher price than would an outside bidder, because to a firm’s managers’ the company’s value includes not only its assets but also their sunk costs in firm specific human capital. Shareholders thus have good reason to want management to play a role in corporate takeovers, so long as that role is limited to providing a value maximizing alternative.

It is certainly true that any management response to an unsolicited tender offer, other than pure passivity, triggers a competition between two or more rival managerial teams for control of the corporation. The competition is obvious when an unsolicited tender offer is made to the shareholders of the target of a locked-up negotiated acquisition. But a competition also results when management defends against a standard hostile takeover bid by putting forward a management-endorsed white knight bid, a management-sponsored leveraged buyout proposal, a restructuring of the corporation’s control structure transferring effective voting control to management and its allies, a restructuring preserving management’s incumbency by making the target unpalatable to hostile bidders, or even merely a management statement urging shareholder to reject the bid. Revlon’s progeny appear to encourage this sort of competition, so long as it is conducted fairly, by making it clear that the board in conducting an auction must have a very good reason for skewing the auction in favor of one of the competing bidders. Paramount Communications Inc. v. QVC Network Inc., 637 A.2d 34, 45 (Del. 1993); Barkan v. Amsted Indus., Inc., 567 A.2d 1279, 1286 (Del. 1989); Mills Acquisition Co. v. Macmillan, Inc., 559 A.2d 1261, 1286-87 (Del. 1989).

Yet, to focus on competition between incumbent management and the outside bidder would obscure the critical role played by the board of directors. The Delaware courts have rejected formalistic and formulaic approaches to takeovers. Instead, they have adopted a case-by-case search for conflicted interests. Where the facts suggest that the directors have allowed self-interest to affect their decisions, they have lost, but where the directors pursued the shareholders’ interests, Delaware courts have deferred to their decisions, even where the court might not have made the same decision.

Arianna Huffington

On our way to DC.

arianna huffington 1
Originally uploaded by ProfessorBainbridge.com

Canon Digital Rebel XT Kit for Sale

Over on eBay, I'm selling my Canon Rebel XT DSLR:

This extensive set includes:

• Canon EOS Digital Rebel XT 8 MP Camera body
• EFS 18-55 MM zoom lens
• EFS 17-85 MM zoom lens with image stabilization w/ 67mm UV lens filter attached
• Ultrasonic 70-300 MM lens with image stabilization and 58 mm circular polarizer attached
• Lens case for 70-300 MM lens
• EFS 60 MM macro lens w/ 52 mm UV lens attached
• spare battery
• 3 lens hoods of assorted sizes
• Manuals for camera and macro lens included
• Assorted 58mm and 67mm lens filters
• Camera bag
• Tamrac rolling CyberPro Flyer camera kit carry on bag
• Charlotte K Lowrie's Canon EOS Digital Rebel Field Guide (250+ page guide)

Battery charger NOT included 

Bonus item:

• Canon Powershot SD950 IS w/ battery charger

Condition: All items used but in very good to excellent condition

The Many Roles of the Board of Directors

The SEC's proposed shareholder access rules are premised on the monitoring model of the board of directors. We see this, for example, in SEC Chairman Mary Shapiro's comments that:

The nation and the markets have recently experienced, and remain in the midst of, one of the most serious economic crises of the past century. This crisis has led many to raise serious questions and concerns about the accountability and responsiveness of some companies and boards of directors, to the interests of shareholders. These concerns have included questions about whether Boards are exercising appropriate oversight of management, whether Boards are appropriately focused on shareholder interests and whether Boards need to be more accountable for their decisions regarding such issues as compensation structures and risk management.

The trouble with this argument (or, more precisely, one of many problems with it) is that the monitoring model is a terribly incomplete understanding of the board's role.

In my article Why a Board?, I puzzled over the fact that corporation law expects the corporation to governed not by a single autocrat but by a committee acting by consensus. In the course of teasing out the rationale for this structure, I noted that boards have several different functions:

What then does the board produce and how does it produce it? First, and foremost, the board monitors and disciplines top management. Second, while boards rarely are involved in day-to-day operational decision making, most boards have at least some managerial functions. Broad policymaking is commonly a board prerogative, for example. Even more commonly, however, individual board members provide advice and guidance to top managers with respect to operational and/or policy decisions. Finally, the board provides access to a network of contacts that may be useful in gathering resources and/or obtaining business. Outside directors affiliated with financial institutions, for example, apparently facilitate the firm’s access to capital.

... At the core of the board’s service role is providing advice and counsel to the senior management team, especially the CEO. At the intersection of the board’s service and monitoring roles is the provision of alternative points of view. Put another way, most of what boards do requires the exercise of critical evaluative judgment, but not creativity. Even the board’s policymaking role entails judgment more than creativity, as the board is usually selecting between a range of options presented by subordinates. The board serves to constrain subordinates who have become wedded to their plans and ideas, rather than developing such plans in the first instance.

As an admittedly anecdotal example, consider the saga of RJR Nabisco’s efforts to develop a smokeless cigarette. As the story goes, management spent millions of dollars on the project. When the board was finally informed, many directors were reportedly angered by management’s failure to consult with them beforehand. Their anger was wholly justified, for the smokeless cigarette flopped. Those responsible resigned to avoid being fired. The corporation would have been better served if the board had been advised of the project early in its development. Those responsible seem to have been wedded to the project, a tendency the board might have been able to counteract.

I also noted that Congress in Sarbanes-Oxley and the stock exchanges in their corporate governance listing standards have been pushing for ever more independent boards of directors and to focus the board on its monitoring role. Although there is much that is commendable about greater board independence, a focus on the board's monitoring role can become counterproductive if it results in an adversarial relationship between the CEO and the board. In such a case, even if the board remains able to monitor effectively the CEO, the board's ability to fulfill its other roles may be compromised.

My argument found support in a paper by economists Renee Adams and Daniel Ferreira:

This paper analyzes the consequences of the board's dual role as an advisor as well as a monitor of management. As a result of this dual role, the CEO faces a trade-off in disclosing information to the board. On the one hand, if he reveals his information, he gets better advice. On the other hand, a more informed board will monitor him more intensively. Since an independent board is a tougher monitor, the CEO may be reluctant to share information with it. Thus, our model shows that management-friendly boards can be optimal. Using the insights from the model, we analyze the differences between a sole board system, such as in the United States, and the dual board system, as in various countries in Europe. We highlight several policy implications of our analysis.

The current shareholder access proposal reflects a moronic mindset on the part of its drafters that one size fits all. As someone with my, shall we say, "robust" physique can attest from long experience, that is always a lie. Even so, the SEC seems determined to further increase board independence, with no regard to the impact of the proposal on the board's other functions. 

Whatever incremental enhancement the proposal provides in board monitoring is likely to be swamped by the deleterious impact on the board's other functions.

Meetings and Dominance Rituals

Because I fancy myself something of a student of how groups make decisions, during meetings I devote much of my time not to the agenda but to observing how the group is behaving. As the owner of three dogs over the years, I'm also necessarily something of a student of pack behavior and dominance rituals. Lately, I've been thinking about how the two lines of inquiry overlap. After all, effective boards of director meetings presumably promote effective corporate governance.

It is well-established that persons of higher stature within the group tend to talk more than persons of lower stature. Where the group is a new one, and status relations are undefined, however, the competition for speaking time becomes a critical part of the larger competition for dominance within the group. In turn, this leads to filibustering, cross-talk, and other dysfunctional behaviors that may prevent the meeting from accomplishing anything substantive.

You can usually identify the would-be alpha dogs pretty easily. They will start talking and simply not stop. Typically both their volume and speaking speed will be high. They will not meet anyone in the eye for an extended period and will ignore "I want to talk" body language. Anything said by anyone else will be immediately woven back into the filibustering speaker's line of argument, including express disagreement or even non sequiturs.

There are several ways of managing this sort of competition. One is to define a group hierarchy pre-meeting, perhaps by establishing a chairman as a presiding officer, who becomes the alpha dog by definition. An effective chairman can keep control of the agenda and keep the meeting on course. Unfortunately, just as a weak-minded owner invites his/her dog to compete for dominance, an ineffectual chairman can actually make the situation worse by inviting nominal subordinates to compete for control.

Alternatively, you can believe that people are not pack animals and hope to set up an egalitarian, non-hierarchical, consensus-building atmosphere. Personally, I don't believe it is possible to do so. Humans are pack animals. We are hard-wired by evolution to establish dominance relationships, which is probably one reason we were able to so successfully domesticate dogs. Studies of chimpanzees, for example, find that "high-ranking females were shown to have significantly higher infant survival, faster maturing daughters, and more rapid production of young." Our ancestors thus got a significant reproductive and genetic reward for successfully competing for dominance.

Competition for dominance, moreover, is arguably socially beneficial. Once a clear dominance hierarchy (pecking order) is established, aggression within the group becomes less likely, because less dominant individuals will not incur the high costs of challenging more dominant individuals. The resulting social stability facilitates subsequent cooperation between group members.

Hence, for effective meetings, it likely will be best if the group has a dominance hierarchy imposed on it from the outside at the outset or collectively establishes one at the earliest opportunity, so as to minimize the amount of time spent on non-constructive dominance rituals. (The benefits of such competition, after all, follow mainly from the establishment of the hierarchy rather than the competition itself.)

(Or, you can do what I often do, which is to slip out the back door and go for a drive.)

If I'm right about the way dominance rituals affect group decision making in meetings, it suggests that one function of the board of directors is providing a set of status equals for top managers. We know, for example, that higher status group members are more inclined to propound initiatives and exercise greater influence over the group’s ultimate decision. As such, corporate law’s insistence on the superiority of the board to management begins to make sense. To the extent law shapes social norms, admittedly a contested proposition, corporate law may empower the board to constrain top management more effectively by creating a de jure status relationship favoring the board.

GM's Problems: Too Much CSR?

I recently ran across an old post by Dale Oesterle on the form of corporate social responsibility waged by GM:

There is a sizable group of academics that favor empowering boards of directors to favor constituencies other than shareholders (employees, suppliers, local citizens) in corporate decision making.  GM overpaid labor, buying peace for managers, at the expense of shareholder profit (and share price) for years.  Now GM's survivability is at stake; employees themselves would be better off it the GM board had been more careful of shareholder profits.  Railroads situation is similar to GM (they have special legislation that protects their unions). Compare GM's (or the railroad's) situation to that of Caterpillar's.  Caterpillar went through some tough strikes to hold the line on labor costs;  Caterpillar is now doing very well and is an international success story. The theory of shareholder primacy, rejected by many academics, is that in 9 cases out of 10, sustained shareholder profits are a surrogate for long-term gains for other constituencies -- when shareholders make money over-time, employees have good, stable jobs.  If we hold boards accountable for profits, all constituencies, over-time, also benefit.

Still timely today. And it makes you wonder about the merits of giving the UAW 55% of Chrysler.