The WaPo reports that:
Key members of both parties said Wednesday that they are close to agreeing on the main elements of a bill to overhaul the nation's financial regulations, raising the prospect that the Senate could begin formal discussion of the landmark legislation early next week.I accept that Wall Street "reform" is a political necessity. What I don't understand is why the legislation includes one-size fits all corporate governance rules that will apply to every Main Street firm. Even if there's justification in the financial crisis for reforming Wall Street, there's no reason to drag Main Street into the morass.
Four provisions are especially pernicious:
- Say on Pay (sec. 951)
- Majority vote for election of directors (sec. 971)
- Proxy Access (sec. 972)
- Separation of Chairman of the Board and CEO (sec. 972)
Collectively, however, they have the hugely pernicious effect of substantially expanding the federal role in corporate governance. So in this post I want to focus on the federalism implications of the Dodd Bill.
My analysis here is a capsule summary of the detailed argument made in my essay The Creeping Federalization of Corporate Governance, to which I refer you for the definitive explanation (if I may say so myself) of why these sort of issues should be left to state law.
For over 200 years, corporate governance has been a matter for state law. Even the vast expansion of the federal role begun by the New Deal securities regulation laws left the internal affairs and governance of corporations to the states. …
… The state-based system of regulating corporate governance is one of the main strengths of the U.S. capital markets. Indeed, as Professor Roberta Romano famously claimed, state regulation and the resulting regulatory competition between jurisdictions it is the “genius of American corporate law.”
Because … “state regulation of corporate governance is regulation of entities whose very existence and attributes are a product of state law,” the Supreme Court has consistently reaffirmed that: “It ... is an accepted part of the business landscape in this country for states to create corporations, to prescribe their powers, and to define the rights that are acquired by purchasing their shares.” Indeed, the Supreme Court opines that “[n]o principle of corporation law and practice is more firmly established than a State’s authority to regulate domestic corporations.” …
The corporation is a creature of the state, “whose very existence and attributes are a product of state law.” States have an interest in overseeing the firms they create. States also have an interest in protecting the shareholders of their corporations. Finally, a state has a legitimate “interest in promoting stable relationships among parties involved in the corporations it charters, as well as in ensuring that investors in such corporations have an effective voice in corporate affairs.” In other words, state regulation not only protects shareholders, but also protects investor and entrepreneurial confidence in the fairness and effectiveness of the state corporation law.
According to the Supreme Court’s CTS decision, the country as a whole benefits from state regulation in this area, as well. As Justice Powell explained in that case, the markets that facilitate national and international participation in ownership of corporations are essential for providing capital not only for new enterprises but also for established companies that need to expand their businesses. This beneficial free market system depends at its core upon the fact that corporations generally are organized under, and governed by, the law of the state of their incorporation. This is so in large part because ousting the states from their traditional role as the primary regulators of corporate governance would eliminate a valuable opportunity for experimentation with alternative solutions to the many difficult regulatory problems that arise in corporate law. As Justice Brandeis pointed out many years ago, “It is one of the happy incidents of the federal system that a single courageous State may, if its citizens choose, serve as a laboratory; and try novel social and economic experiments without risk to the rest of country.” So long as state legislation is limited to regulation of firms incorporated within the state, as it generally is, there is no risk of conflicting rules applying to the same corporation. Experimentation thus does not result in confusion, but instead may lead to more efficient corporate law rules.
In contrast, the uniformity imposed by [the Dodd Bill] will preclude experimentation with differing modes of regulation. As such, there will be no opportunity for new and better regulatory ideas to be developed—no “laboratory” of federalism. Instead, we will be stuck with rules that may well be wrong from the outset and, in any case, may quickly become obsolete.
... Competitive federalism promotes liberty as well as shareholder wealth. When firms may freely select among multiple competing regulators, oppressive regulation becomes impractical. if one regulator overreaches, firms will exit its jurisdiction and move to one that is more laissez-faire. In contrast, when there is but a single regulator, such that exit by the regulated is no longer an option, an essential check on excessive regulation is lost.
Accordingly, the four key corporate governance provisions of the Dodd Bill should be stripped.
