ProfessorBainbridge.com

Director Primacy

I've been asked to contribute an essay on my director primacy model to a forthcoming anthology of recent work in corporate law theory. In this essay, entitled simply Director Primacy, I therefore recapitulate the core themes that have motivated my work in the field for the last decade. In particular, however, I also use this opportunity to respond to some leading criticisms of the model.

Abstract: Since its inception, corporate law has separated ownership and control. Shareholders nominally own the corporation, but they are entitled to exercise almost nonce of the control rights normally associated with ownership or property. Instead, control of the corporation is vested by statute in the board of directors.

This essay is premised on the assumption that corporate law tends towards efficient solutions. Accordingly, the question raised by the separation of ownership and control is why such separation has proven to have tremendous survival value.

The director primacy model was developed to provide just such a rationale. Grounded in Kenneth Arrow’s work on how organizations make decisions, this essay argues that shareholders lack both the information and the incentives necessary to make sound decisions. Overcoming the collective action problems that prevent meaningful involvement by the shareholders, moreover, would be difficult and costly. Under these conditions, Arrow predicts, it is “cheaper and more efficient to transmit all the pieces of information once to a central place” and to have the central office “make the collective decision and transmit it rather than retransmit all the information on which the decision is based.” The board of directors serves as the requisite central office.

Keywords: Corporate governance, shareholder primacy, shareholder activism, board centric, board of directors, shareholders

JEL Classifications: K22

You can download the essay from SSRN here. For a complete account of director primacy, however, you ought to buy the book too:

Redirecting State Takeover Laws at Proxy Contests

As noted yesterday, I agree with JW Verret that one effect of the pending federal Wall Street reform legislation likely will be to encourage Delaware lawyers now need to turn their attention to thinking up "structural defenses could viably protect against hostile proxy fights while at once surviving: (i) Delaware law’s strictures under Blasius, Chesapeake, Amylin, and other opinions vigorously protecting the shareholder franchise and shareholder rights, (ii) Exchange listing requirements, and (iii) SEC proxy rules."

Back in the 1980s, the so-called merger mania of the period induced states to regulate takeovers even though the federal Williams Act dominated the field. It's at least possible that states will react to the new federal legislation's corporate governance provisions by extending their takeover laws to also regulate proxy contests. If so, the analysis in my article Redirecting State Takeover Laws at Proxy Contests will be relevant--although it would need to be updated to consider the preemptive impact of the new law.

Here's the abstract of my article:

During the 1980s, many states adopted statutes intended to regulate corporate takeovers. The Supreme Court validated one of these statutes, The Indiana Control Shares Acquisition Statute, in CTS Corp. v. Dynamics Corp., 481 U.S. 69 (1987), against both preemption and commerce clauses challenges. Since CTS, state takeover laws have routinely withstood constitutional scrutiny, even though it is generally acknowledged that, by erecting new barriers to hostile tender offerors, they make tender offers less attractive.

At the time this article was published (1992), proxy contests were becoming an increasingly important component of hostile takeover battles. Today, of course, proxy contests and various other forms of shareholder activism have become a common feature of the corporate governance scene.

This article considered whether state laws designed to regulate proxy contests would withstand constitutional scrutiny. It surveys whether such laws would be preempted by the federal proxy rules or the Williams Act’s tender offer regulations. It also briefly touches upon the Commerce Clause aspects of any such challenge. The article concludes that state regulation of proxy contests should withstand constitutional challenge.

You can download the article by clicking the title link above.

The analysis would need to updated to account for the new federal financial services reform legislation because that legislation includes many provisions that impact the corporate governance of Main Street firms as well as Wall Streeters. As Larry Ribstein explains, we are experiencing federal preemption by a 1000 cuts:

Although none of the provisions ... is individually earth-shaking, they cumulatively touch many major aspects of corporate governance formerly left to contract and state law. This bill thus clearly adds to the framework for federal takeover of internal governance that SOX established. The overall effect is that it will be increasingly difficult to demark an area left exclusively for state law. This leaves little “firebreak” to protect against judicial incursions in the spaces not yet covered by explicit federal provisions. This could ultimately profoundly affect the relationship between federal and state law regarding business associations.

A generation ago the Supreme Court could say that “no principle of corporation law and practice is more firmly established than a State’s authority to regulate domestic corporations, including the authority to define the voting rights of shareholders.” CTS Corp. v. Dynamics Corp. of America, 481 U.S. 69, 89 (1987).

Erin O’Hara and I have argued that this separation between federal and state spheres does and should affect the scope of implied preemption of state law by federal statutes. Thus, when the Court held that state securities actions were preempted by the Securities Litigation Uniform Standards Act, it emphasized “[t]he magnitude of the federal interest in protecting the integrity and efficient operation of the market for nationally traded securities.” Merrill Lynch, Pierce, Fenner & Smith, Inc. v. Dabit, 547 U.S. 71, 78 (2006). See also my article on Dabit. However, we noted that “[m]any federal ‘securities’ laws reach deep into the kind of internal governance issues covered by the [internal affairs doctrine].” Thus, corporate internal affairs are only “relatively safe from federal preemption” and internal affairs is not “a constitutional boundary, as shown by the continuing forward march of federal corporation law.”

Under the Dodd bill, the forward march picks up the pace.

The process I called The Creeping Federalization of Corporate Law thus continues to accelerate. As I explained back in 2003:

The collapse of Enron and WorldCom, along with only slightly less high profile scandals at numerous other U.S. corporations, has reinvigorated the debate over state regulation of corporate governance. Post-Enron, politicians and pundits called for federal regulation not just of the securities markets but also of internal corporate governance. As Congress and market regulators began implementing some of those ideas, there has been a creeping - but steady - federalization of corporate governance law. The NYSE'S new listing standards regulating director independence is one example of that phenomenon. Other examples appeared to little public debate in the sweeping Sarbanes-Oxley legislation. Taken individually, each of Sarbanes-Oxley's provisions constitutes a significant preemption of state corporate law. Taken together, they constitute the most dramatic expansion of federal regulatory power over corporate governance since the New Deal.

No one seriously doubts that Congress has the power under the Commerce Clause to create a federal law of corporations if it chooses. The question of who gets to regulate public corporations thus is not one of constitutional law but rather of prudence and federalism. In this essay, I advance both economic and non-economic arguments against federal preemption of state corporation law. 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, exit is no longer an option and an essential check on excessive regulation is lost.

Sadly, the Dodd bill just makes things worse. Much worse.

Delaware's Future

I am increasingly convinced that the future of corporate governance is not the system of competitive federalism--i.e., state competition for charters--that has made US corporate law so successful. Instead, I am afraid it will be a struggle to keep the federal government from steadily encroaching on corporate governance to the point that we might as well adopt a federal corporations law.

JW Verret has done yeoman service in Congressional testimony trying to defend state regulation of corporate governance, so his ruminations on the Senate financial reform bill and the prospects for the upcoming conference between House and Senate are worth considering.

JW starts by reminding us that those of us on the side of the angels did win one victory:

Though Senator Carper wasn’t able, in the end, to get the proxy access provisions out of the Dodd Bill, which I think were the most troubling, we did eliminate another of Senator Schumer’s ideas. (The corporate governance provisions of the Dodd bill were taken from Sen. Schumer’s “Shareholder Bill of Rights.”) The initial draft of the Dodd Bill included a restriction prohibiting any publicly traded company from having a staggered board. I suspect we have the good work of Senator Carper and Congressman Castle’s offices to thank for their continued work against that provision. The option to have a staggered board is part of the Delaware brand’s advantage. Nearly 80% of Boards and their shareholders used to embrace the staggered election approach, since then some (but not most) companies’ shareholders have pushed, and been successful, in changing to annual elections under existing rules, a development which Delaware’s freedom-of-contract philosophy embraces. Now roughly 50% of publicly traded firms have staggered boards. I should add…this, like most corporate governance changes, is not exclusively a Delaware issue…as Delaware is home to only 50% of publicly traded companies and 60% of the Fortune 500.

When I testified in the Senate against the corporate governance provisions of this bill, I remember when Senator Corker quipped: “We’re a staggered body. The folks in the other house aren’t staggered, and we’ve all seen the crazy ideas they often send our way.” I also appreciated Senator Johanns of Nebraska when he observed, after one of my defenses of Delaware in testimony (quickly becoming my night gig) “When I was Governor of Nebraska, I tried to take on Delaware. And you know what I found out? That was going to be pretty hard, because Delaware sure was doing something right.” (See Bainbridge on the misguided efforts of the upper midwest to challenge Delaware).

He then goes on to suggest that Delaware lawyers now need to turn their attention to thinking up "structural defenses could viably protect against hostile proxy fights while at once surviving: (i) Delaware law’s strictures under Blasius, Chesapeake, Amylin, and other opinions vigorously protecting the shareholder franchise and shareholder rights, (ii) Exchange listing requirements, and (iii) SEC proxy rules." He does so because he believes that:

The new battleground will be defenses to proxy fights. We’ve already seen this issue discussed briefly, though not fully adjudicated, in the Amlyin case, which reviewed a contractual provision in debt covenants, the so-called “proxy put” that would accelerate debt upon the election of hostile directors not approved by the Board’s nominating committee. Gordon Smith weighed in here and Francis Pileggi discussed the case here.

Though Vice Chancellor Lamb did not expressly rule the provision violated Delaware law, in dicta he came fairly close. He noted that the provision seemed like it could prevent any contested elections, which would present a public policy dilemma. I wonder if he would have felt the same if, long before the actual proxy fight, the shareholders approved of the proxy put covenants?

Back in the early 1990s, I wrote an article on Redirecting State Takeover Laws at Proxy Contests, 1992 Wisconsin Law Review 1071, in which I predicted that proxy contests would become more important and that as a result states would extend their anti-takeover laws to them. I then reviewed the constitutional obstacles to states doing so, concluding that some state regulation would be permissible. It might be worth updating that analysis assuming the Dodd bill passes. In the meanwhile, I'll get the article up to SSRN ASAP.

Update: The article has been posted and is further discussed here.

The Intellectual Incoherence of the Senate Financial Reform Bill

Craig Pirrong summarizes the broad case against the Dodd bill and then focuses on two aspects I had not previously noticed:

Last week the Senate passed the financial “reform” legislation, which now goes to a conference committee that will produce a bill that combines the Senate bill with that passed by the House months ago. ...

The Senate bill is best measured in pounds rather than pages. (Pounds of what I’ll leave to your imagination.) It is comprehensive, and from what I can tell, it is comprehensively wretched. Stephen Bainbridge, whose opinion I respect a good deal, strenuously objects to the nationalization of corporate governance embedded in some of the bill’s language. The infamous Lincoln swaps provision, which I’ve written about, is a horror. It is some kind of sick joke to remake the entire derivatives market–and the banking sector–with a transparently populist ploy heaved up by a rather undistinguished senator (but I repeat myself) from Arkansas in a desperate attempt to stave off a primary challenge. ... The clearing mandate is also a disaster in waiting.

Rather than deconstruct the whole abortion, I’ll focus on a couple of (relatively minor, in the scheme of things) features that illustrate its intellectual incoherence. The first relates to market manipulation. ... Another poster child for the intellectual bankruptcy of the Senate bill is its provision to empower the CFTC to extend position limits to OTC energy derivatives.

It's a good and important analysis. Go read the whole thing.

Short Sale Bans Don't Work

A new paper confirms what anyone of sense already knew; i.e., that bans on short selling are counter-productive:

In September 2008, the U.S. Securities and Exchange Commission (SEC) surprised the investment community by adopting an emergency order that temporarily banned most short sales in nearly 1,000 financial stocks. In this paper, we study changes in stock prices, the rate of short sales, the aggressiveness of short sellers, and various liquidity measures before, during, and after the shorting ban. We match banned stocks to a control group of non-banned stocks in order to identify these effects. Shorting activity drops by about 65%. Stocks subject to the ban suffered a severe degradation in market quality, as measured by spreads, price impacts, and intraday volatility. Prices of stocks subject to the ban increase sharply, but it is difficult to assign this effect to the ban because the Troubled Asset Relief Program (TARP) and other initiatives were announced the same day. In fact, we find no positive share price effects in stocks that were added to the ban list later, suggesting that the ban may not have provided much of an artificial price boost.

Yet, German and Austrian regulators are considering expanding their bans on short sales.

Tax Cuts as a National Security Matter

Bruce Bartlett opines (HT: Sullivan):

Republicans primarily concerned about national security ought to be in the forefront of efforts to raise revenues to reduce deficits, free up domestic saving for domestic investment, and reduce the importation of foreign saving and the trade deficit. But so far they are not. They remain loyal to the Republican obsession with tax cuts and a refusal to raise taxes in any way for any reason. However, I think my national security-minded friends are soon going to discover that massive defense budget cuts will necessarily be a big part of the price that will be paid for not raising revenues.

I, for one, would be happy to see my taxes go up to pay for national security. The trouble is that I don't trust the Democrats (or very many of the Republicans) to use new tax revenues to address national security problems. Indeed, thisis the basic problem with Bartlett's recurrent demands that conservatives role over and let his new Democrat friends jack up taxes. As far as I can tell (and I'll email him to ask), he has nowhere explained what would prevent the Democrats from using new tax revenues to pay for favors for their key interest group supporters or prevent the Republicans from doing so if they get back in power.

Given a choice between spending $100 billion on defense of shoring up public sector union pension funds, what does Bartlett think his Democratic buddies would do? Given a choice between spending $100 billion on the troops and $100 billion on an unnecessary war of choice, what does Bartlett think the neoconservatives would do?

It's sort of like the old joke about an economist stranded on a desert island, whose punch line "assume a can opener." Bartlett's critique of his old friends would have a lot more traction if he could explain why we should assume a sudden outbreak of good government.

Until I see proof the beast has reformed, I say starve the [expletive deleted].

Update: Barlett amended his post to say: "Stephen Bainbridge apparently thinks gutting the defense budget is preferable to raising taxes by a single penny." How he gets that from this post is beyond me.

To be clear, however, my point is not that deficit reduction and other sensible budgetary policies can be achieved only through cutting spending. (Just as Bartlett presumably thinks we need spending cuts as well as tax increases.)

On a bipartisan basis, our rulers have spent us into a position in which taxes probably will have to go up at least for a while. But agreeing to tax increases ought to be done only in return for a package of fundamental reforms. We need entitlement reforms (including raising the retirement age), budgetary reforms (bans on ear marks, a line item veto, and a balanced budget amendment), political reforms (real restrictions on gerrymandering), and the like. Letting the powers that be have higher taxes without those other reforms will not solve the problem. All it does is make for a bigger candy store to which we've given the keys to the children.

Put simply, absent real reforms, I don't want anybody in Washington or Sacramento getting their grubby hands on any more of my money because I don't trust them to spend it wisely. My guess is that a lot of Bartlett's new friends on the left, for example, would be quite content to raise taxes and massively cut defense. So the either/or he presents strikes me as a false choice. 

Unfortunately, I'm afraid we probably need to wait until things get bad enough that politicians on all sides will be forced to agree to fundamental reforms to avoid going the way of Greece.

Ranking Faculty Quality

Brian Leiter posts:

Is it through scholarly impact/citation studies (like this one)?  Or reputational surveys (such as here or here)?  Or SSRN downloads (e.g., here)?  Or is there no reliable way to gauge this?  Take the poll.

UPDATE:  A comment from a reader leads me to realize that I should emphasize that you should please interpret the categories broadly:  so, e.g., "scholarly impact/citation studies" doesn't commit one to my way of doing them--it could include impact/citation studies that used different databases, that included books, Google scholar, etc.  Similarly, a reputational survey needn't mean the way US News does them, but could include a survey in which experts are asked to evaluate recent work by colleagues and give their assessment of it.

The core problem is to separate out three levels of metrics: those that measure the quality of an individual article (an article level metric), those that measure the quality of an individual scholar (individual level metrics), and those that measure the quality of a law school as a whole (an institutional level metric). It's not self-evident to me that metrics useful at one level tell us anything about the other levels. 

Let's start by thinking about individual faculty members. Most measures of a scholar's quality are based on some form of article level metric. Ranking citation counts simply adds up all the citations to all the scholar's articles. SSRN download rankings do the same with respect to an author's cumulative SSRN postings. These article level metrics are all problematic:

• They reward longevity and prolificacy. An older author with 100 articles that have each been cited 10 times will have a higher cite count than an author who has published 1 article that has been cited 900 times. Yet, might on not fairly argue that the latter is the more influential?
• They reward monumental stupidity: An article so dumb that a host of people decide to take shots at it. Conversely, they can also reward massive mediocrity. Although I suspect this is less true in law than in some disciplines, I suspect it is still possible to increase one's stats by publishing a dull but comprehensive literature review or non-analytical treatise that becomes a standard citation for some set of propositions of the sort for which law review editors insist upon a supporting citation no matter how obvious it may be.
• They disregard immediacy: An article that is being downloaded 500 times in the first year of its publication is probably more influential than article that's been downloaded 500 times over 20 years.
• They disregard the half-life of article citation rates, which might be a very useful proxy for influence.
• They disregard the quality of the citation. An article that gets cited by the Supreme Court as providing the basis for a decision would be a lot more impressive (at least to me) than an article that cited 500 times by fourth tier authors in fourth tier law reviews.
• They usually rely on one database, typically a legally oriented one, which limits measurement of interdisciplinary impact.
• I'm not aware of any that measure impact on judicial opinions, which strikes me as the really relevant question. (Sadly, it will strike all too many of my fellow law professors as irrelevant or even counting against one.)
• They don't make any use of new media (blog references?) or social networking.

We then compound the problem by assuming that simply adding up an aggregate of some article level metric tells us something useful about the reputation of the scholar. (Not that I would ever stop me from blogging about measures by which I do well.) Why doing so should tell us very much is not immediately apparent. In particular, I see no reason to think that the errors introduced by article level metrics are sufficiently randomized that they cancel one another out when aggregated.

In sum, what we need is a faculty member quality metric that transcends aggregates of article level metrics.

Turning to ranking law schools by the quality of their faculty as a group, most database-based metrics are really just a summation of the aggregate article level metrics of the entire faculty. All cites by all articles to all faculty members, for example. Again, one wonders why such indices should be revelatory. In particular, I again see no reason to think that the errors introduced by article level metrics are sufficiently randomized that they cancel one another out when aggregated at two successive levels.

US News' reputation score avoids that problem by creating an institution level metric. But the flaws in that metric are well documented. The answer, however, is to come up with a better institution level metric than relying on an aggregate of article level metrics.

I'm not sure what the right solution would be. We could try adapting a multi-factor index, such as a variant of the faculty scholarly productivity index, but it would have to be highly refined to be useful for law. The FPSI relies on factors that simply don't apply to law, such as peer-reviewed journals (we all know that issue), research awards (few in law), and federal grant awards (ditto).

Or we could let a thousand flowers bloom. Folks who want to measure faculty quality should use a bunch of different metrics, report them all, and let users make of the results what they will.

Cited in Delaware

In his recent Verifone Holdings, Inc., decision, Delaware Vice Chancellor Leo Strine cired my book Corporation Law for the proposition that:

The Delaware Supreme Court has noted the need for courts to temper the incentives for plaintiffs' counsel to be immoderate in the pursuit of their own interests:

The jurisprudence of Aronson and its progeny is designed to create a balanced environment which will: (1) on the one hand, deter costly, baseless suits by creating a screening mechanism to eliminate claims where there is only a suspicion expressed solely in conclusory terms; and (2) on the other hand, permit suit by a stockholder who is able to articulate particularized facts showing that there is a reasonable doubt either that (a) a majority of the board is independent for purposes of responding to the demand, or (b) the underlying transaction is protected by the business judgment rule.

Grimes, 673 A.2d at 1216-17 (citations omitted). The wide spread concerns about potential misuse of the derivative suit have been well summarized:

The courts have recognized that “derivative actions brought by minority stockholders could, if unconstrained, undermine the basic principle of corporate governance that the decisions of a corporation-including the decision to initiate litigation-should be made by the board of directors or the majority of shareholders.” Likewise, “it has long been recognized,” the derivative action is susceptible to abuse in cases where derivative claims are filed “more with a view to obtaining a settlement resulting in fees to the plaintiff's attorney than to righting a wrong to the corporation (the so-called ‘strike suit’).... Prerequisites to the commencement of derivative litigation and other special rules governing derivative litigation have developed in order “to filter such cases at an early stage more finely” than is the case in other types of litigation and “prevent abuse of this remedy.”

DENNIS J. BLOCK, NANCY E. BARTON & STEPHEN A. RADIN, THE BUSINESS JUDGMENT RULE: FIDUCIARY DUTIES OF CORPORATE DIRECTORS 1384-85 (5th ed.1998) (citations omitted); see also STEPHEN M. BAINBRIDGE, CORPORATION LAW AND ECONOMICS 365-68 (2002) (noting that “[m]any of the rules governing derivative litigation are best understood as a response to ... abuses” arising from the incentive for plaintiffs attorneys to bring non-meritorious lawsuits or to prematurely settle meritorious lawsuits).

The Senate Financial Reform Bill's Governance Provisions

Annette Nazareth offers a detailed and descriptive list of the many provisions of the Dodd bill that "would federalize significant governance and executive compensation matters that have historically been a matter of state law. The bill would affect all US public companies and would especially be felt by midcap and smaller companies that have until now generally not been the target of governance activists." Very useful.

Democratic Governance, Accountability, and Efficiency

I've just ordered Dino Falaschetti's book Democratic Governance and Economic Performance: How Accountability Can Go Too Far in Politics, Law, and Business. The introduction has been posted to SSRN (download here) and is summarized by the following abstract:

Conventional wisdom warns that unaccountable political and business agents can enrich a few at the expense of many. But logically extending this wisdom implies that associated principals – voters, consumers, shareholders – will favor themselves over the greater good when ‘rules of the game’ instead create too much accountability. Democratic Governance and Economic Performance rigorously develops this hypothesis, and finds statistical evidence and case study illustrations that democratic institutions at various governance levels (e.g., federal, state, corporation) have facilitated opportunistic gains for electoral, consumer, and shareholder principals. To be sure, this conclusion does not dismiss the potential for democratic governance to productively reduce agency costs. Rather, it suggests that policy makers, lawyers, and managers can improve governance by weighing the agency benefits of increased accountability against the distributional costs of favoring principal stakeholders over more general economic opportunities. Carefully considering the fundamentals that give rise to this tradeoff should interest students and scholars working at the intersection of social science and the law, and can help professionals improve their own performance in policy, legal, and business settings.

Readers familiar with my work on director primacy know that I contend that a similar tradeoff between authority and accountability is the central problem of corporate governance. They also know that I believe the current emphasis on shareholder democracy errs too much on the side of accountability. So I suspect Falaschetti's work and mine will be relevant one to another. As I work on my new book on corporate governance after the financial crises, I suspect I'll find much useful in his work.

Blaming Short Sellers

Michael Schouten:

The German Securities Exchange Commission, the Bafin, announced on Monday that it temporarily prohibits naked shorting and uncovered CDS in government bonds of euro zone countries to counter excess volatility. It also prohibits uncovered short-selling transactions in the shares of a number of companies from the financial sector (read the full press release here).

The latter measure is remarkable in light of a recent empirical study of short selling bans in response to the financial crisis by Alessandro Beber and Marco Pagano, which finds that find that bans (i) were detrimental for liquidity, especially for stocks with small market capitalization, high volatility and no listed options; (ii) slowed down price discovery, especially in bear market phases, and (iii) failed to support stock prices, except possibly for U.S. financial stocks (the study is available here).

Indeed, a strategist of Deutsche Bank (which, incidentally, is one of the companies whose shares are subject to the ban) was quoted as saying that "What we've learnt repeatedly in this crisis [is] that every action has an equal and opposite reaction ... If the authorities prevent free market activities in some areas, the risk is that the pressure moves somewhere else."

Combine the law of unintended consequences with the profit motive and you get regulatory arbitrage. Personally, I'd rather trust markets than governments and the german action is one more data point in favor of that view.

Where's Biden?

Dealbook reports that:

Fresh off a Senate vote to overhaul financial regulations, the Obama administration on Friday immediately began trying to influence the process for combining the Senate and House bills, pressing for tough provisions in the face of a final onslaught of Wall Street lobbying ....

Which prompts the question: Where's Joe Biden during all this? As a former senator from Delaware, Biden presumably understands the importance of the state role in corporate governance. So he presumably gets that the say on pay, proxy access, majority vote, and other corporate governance provisions in the senate bill are very bad ideas. Why isn't he working to get them out of the final product?

Senate Passes Finance Bill

The Senate has passed its financial reform legislation. I'll let others address the financial services aspect of the bill. Instead, I'll simply note that the pernicious corporate governance provisions in the bill remain intact. (I discuss the multitude of problems with these proposals at length in a series of posts grouped in the Wall Street Reform archive.)

According to a comparison chart in today's WSJ, the equivalent House bill lacks the corporate governance provisions. Unfortunately, I suspect that these are just the sort of provisions that will emerge intact from a conference committee.

Limiting CEO Pay to that of the President

When asked how he justified making more money than then-President of the United States Herbert Hoover, Babe Ruth famously quipped that "What the hell has Hoover got to do with it? Besides, I had a better year than he did."

I frequently remind my corporation law students of that story when we talk about shareholder proposals under SEC Rule 14a-8 aimed at executive compensation. Why? Because shareholder gadflies love to offer proposals caping CEO pay at the level of (or some low multiple of) the salary of the US President. Here, for example, is an oldie but a goodie submitted to Bell South in 1995:

Resolved: The shareholders of BellSouth recommend that the Board of Directors institute a salary and compensation ceiling such that as to future employment contracts, no senior executive or director of the Company receive combined salary and other compensation which is more than two times the salary provided to the President of the United States," that is, no more than $ 400,000.

Reasons: There is no corporation which exceeds the size and complexity of the United States government of which the President is the chief executive officer. Even most government agencies exceed the size as measured by personnel and budget, of most private corporations. The President of the United States receives a salary of $ 200,000; even agency heads and members of Congress are paid only somewhat more than $ 100,000. The recommended ceiling is sufficient to motivate any person to do his best.

The duties of the President of the United States are not comparable to those of senior executive officers or directors (the President has a much more demanding job). While the President has many valuable compensations which may exceed those of company executives, we use the salary of the President only as a reference point for shareholders to consider as they evaluate this resolution.

These proposals are so popular with a certain subset of shareholder activists that there is an extensive body of SEC no action letters dealing with the question of whether a proposal capping CEO pay at 2 times that of the US President is excludible on grounds that is duplicative of a competing proposal to cap the CEO's pay at three times that figure.

It's always struck me as a great prank to play on CEOs. (Not that I endorse using the shareholder proposal rule to play pranks. That would be wrong. Very, very wrong.)

The Role of the Business Judgment Rule When There is no Board Decision

At TDT, the wonderful Dutch corporate blog, Bastiaan Assink writes:

... the following question from Maarten Mussche landed in my inbox.

I have a question, Professor Assink. If I see it correctly, the rationale behing the business judgment rule is to allow directors to make risk neutral business decisions. In inquiry proceedings the investigated mismanagement doesn't always concern a business decision. It could be about e.g. internal struggles that cause a decision deadlock or about disobeying the interests of minority shareholders. There's no business judgment in play in those cases, no risk of giving directors an incentive to be inefficiently cautious. General application of the bjr to the judicial verdict about corporate mismangement in enquiry proceedings (as you and Prof. Maarten Kroeze seem to propose in your column) is therefore imho undesirable. Key is that a business decision is concerned. Do you agree?

Good question. The short and simple but true answer is that, without a business decision under attack, there is no reason to apply the business judgment rule. For this reason, a Dutch BJR would not automatically apply throughout the right of inquiry, something sceptics have difficulty to grapple. It's role would actually be relatively modest, as quite some cases don't involve an attack of management business decisions. This doesn't take away the case for introduction of a Dutch BJR though, let me be clear on that.

Well, yes, but....