ProfessorBainbridge.com

What she said

Althouse:

"The treatment of workers by American corporations has been worse — far more treacherous — than most of the population realizes."

"... Many of those workers were cashiered for no reason other than outright greed by corporate managers. And that cruel, irresponsible, shortsighted policy has resulted in widespread human suffering and is doing great harm to the economy."

Anguishes Bob Herbert in a column called "A Sin and a Shame." How is it a sin — greed! — or treachery for a business to operate efficiently by laying off employees when there is less work to be done? Herbert does say that there was a disproportion between the number of people who were laid off and the decrease in the amount of work that needed to be done. That is, the workers who kept their jobs became more productive. But what is the evil in that?

Using Board Qualifications to Defang Proxy Access

JW Verret has been considering whether state law-based defenses could be erected that would minimize the effect of the likely adoption by the SEC of a proxy access rule. In one post, he observed that:

Proxy access was one of the major corporate governance reforms included in the Dodd-Frank Act, and we can expect that Boards of Directors will be anxious to implement defenses against insurgent shareholder campaigns as a result.  This paper considers what defenses would be strategically useful, and then analyzes whether they will survive review in Delaware, federal courts, the SEC and the stock exchanges.  It follows my previous academic work and testimony on proxy access.

In my first post on this topic I mentioned the possibility of using lower poison pill triggers to prevent shareholders from obtaining a sufficient ownership stake to meet the minimum holding requirements to actually nominate candidates onto the corporate proxy.  A second defense I want to mention could be even more powerful and is more likely to survive review in both Delaware and the federal courts.

The Delaware General Corporation Law gives the board and the shareholders the co-extensive authority to adopt bylaws setting the qualification requirements necessary to become a director.  There is very little case law interpreting this provision, other than the general rule from Schnell v. Chris-Craft that powers granted to the corporation may not be used in an inequitable manner.  Qualification requirements based on experience, education, and other background-like variables would likely survive scrutiny, particularly where they are adopted well in advance of a threatened proxy fight.

The key element in such a bylaw would be that the Board would serve as the ultimate interpreter of the provisions.  For example, a qualification provision could require directors to have 20 years of experience at a comparable company in the same line of business.

I have a slightly different proposal, albeit one also based on board qualifications.

My friend Charles Elson has long advocated that directors should be paid in stock rather than cash. he has also advocated board qualification rules requiring that directors own a very substantial amount of stock in the corporation on whose board they serve. In a 2004 Wake Forest law review article, for example, Elson wrote that:

Commitment to the organization by a director is demonstrated in two respects-- time and ownership. The time requirement is obvious. The more time effectively devoted to one's directorship, the more complete a job one will do. Ownership, though, is particularly critical. The Council urged meaningful equity ownership by independent directors both in the form of direct stock purchases by directors and equity-based compensation. While director independence promotes objectivity, a requirement that board members maintain equity ownership in the corporation gives the directors an incentive to exercise their objectivity effectively. When management appoints the board of directors, and these directors have no stake in the corporate enterprise other than their board seats, the directors simply have no pecuniary incentive to actively monitor management. When directors shirk their duty to monitor management, stockholder interests are left unprotected. The most effective incentive for directors to address their responsibilities to the shareholders is to make them stockholders as well. By becoming equity holders, the outside directors assume a personal stake in the success or failure of the enterprise.

An ISS report further notes that Elson proposes a minimum of $100,000 stock ownership, while others support a similar figure:

How much director ownership is enough? The majority of director ownership requirements are expressed as a multiple of annual retainer, typically five times retainer to be acquired within five years of election to the board, though some guidelines may be expressed as a number of shares or a dollar amount of stock.[12] Among companies using the latter, median ownership requirements are 3,500 shares (where expressed as a number of shares) or $180,000 (where expressed as a dollar value). For Elson, the amount should be personally meaningful. "It ought to be enough so that if you lose it you get sick." His own rule is to buy $100,000 of company stock when he joins a board. Directors should also be discouraged from selling stock while on the board, which sends a bad signal to shareholders. Few companies, however, have stock retention policies for directors.

Requiring directors to invest, say, $250,000 in the company would shrink the pool of candidates able and willing to make use of the proxy access machinery. It also would align the interests of those who do get nominated and elected via proxy access with those of the shareholders as a whole.

Tort law run amok

Walter Olson:

A product liability action filed in San Francisco alleges that “defendants failed to warn the plaintiff that playing with a sharp sword displayed in its store would result in the plaintiff slicing his hand when he attempted to place it back in its sheath.”

More ADA Absurdities

Ted Frank has details on what looks to be an absurd ADA suit.

Epstein on Liberal Bias in Law Schools

U Chicago law prof Richard Epstein:

There is no question that if law professors were arrayed on a one-dimensional liberal to conservative line, the majority would be toward the liberal end. The interesting questions are two.

First, just what would the distribution look like? This is hard to gauge without some detailed work, but on average I would say that there are more left-wing democrats than center-left democrats. I define the difference as follows. The former are those who have sympathy for programs of redistribution on such key areas as education and health care, but are by and large supportive of market institutions on the production side of the line. There is an effort to make good on the earlier social democratic tradition. The left democrats are in favor of a larger public sector and are deeply suspicious of markets more or less across the board. To put the point most vividly, the center left group is uncomfortable that Obama is too far to the left. The left liberal group is uncomfortable that he is too far to the right. There is a lot of difference there.

On the conservative side there is also a break of a different order, between social conservatives and libertarians. There are some people who are both, but neither group is represented in large numbers. I have not done any empirical work, but my own sense is that a larger fraction of the right of center law professors are active in scholarship than on the left, which changes the public discourse.

Second, there is one factor that mutes these differences in many instances. Law is a profession, and you have to know such things as the civil rules of procedure and corporations. The subject matter requires technical knowledge. There are right and wrong answers. The gap therefore among law professors may be large on such questions as do we believe in constitutional originalism. But by the same token, the technical and professional anchor tends to bring the two sides closer together, for the great benefit of the profession. That is perhaps why it is often hard to figure out where academics stand on the political spectrum from reading their legal writings.

More on shareholder wealth maximization

Larry Ribstein's got a nice follow on post to the earlier discussion.

Sunshine is the best disinfectant, unless you're the SEC

We all knew there was a lot of bad stuff buried in the 2300-odd pages of Dodd Frank, but this is really outrageous:

Under a little-noticed provision of the recently passed financial-reform legislation, the Securities and Exchange Commission no longer has to comply with virtually all requests for information releases from the public, including those filed under the Freedom of Information Act.

The law, signed last week by President Obama, exempts the SEC from disclosing records or information derived from "surveillance, risk assessments, or other regulatory and oversight activities." Given that the SEC is a regulatory body, the provision covers almost every action by the agency, lawyers say. Congress and federal agencies can request information, but the public cannot.

That argument comes despite the President saying that one of the cornerstones of the sweeping new legislation was more transparent financial markets. Indeed, in touting the new law, Obama specifically said it would “increase transparency in financial dealings." ...

If the SEC’s interpretation stands, Mintz, who represents FOX Business Network, predicted “the next time there is a Bernie Madoff failure the American public will not be able to obtain the SEC documents that describe the failure,” referring to the shamed broker whose Ponzi scheme cost investors billions.

Konczal on McArdle on Warren

Megan McArdle offered up a long blog post criticizing Elizabeth Warren's scholarship. This prompted liberal economics blogger Mike Konczal to respond, inter alia, that:

Given that Warren is considered “the leading authority in the country on bankruptcy law,” being called a hack by McArdle, of all people, is something.

If you follow Konczal's link, you'll discover that the authority he cites is an unattributed publisher's blurb for one of Warren's books. It's pure PR puffery. Not evidence.

Is Liz Warren the leading authority in the country on bankruptcy? No. If you take citations as the best metric, she's way behind Bob Scott in Brian Leiter's latest survey.

Is Liz Warren a leading authority? Sure. By Leiter's count, she's tied for third. 

But citing an anonymous PR blurb for even that more modest proposition would be just stupid.

Why are proponents of shareholder activism so thin skinned?

JW Verret had the temerity to post about ways in which companies could defend against proxy contests, which annoyed self-appointed shareholder activist and spokesperson James McRitchie, "who writes at Corpgov.net and works with the large institutional investors like the AFL-CIO and the California State Pension Fund that lobbied for proxy access":

I wonder if Professor Verret also offers advice on how to circumvent tax codes, the Occupational Safety and Health Act, or the Americans With Disabilities Act. Harvard must be pleased to have such a distinguished scholar. Hopefully, most companies will seek to work with their shareowners but I suppose there will always be companies like Apache that may find Verret’s strategies appealing. No, I’m not adding these posts to our Links page. Hopefully, they will fall under the category of fantasy.

I've spent the better part of my career crossing swords with these folks and I find them a remarkably thin skinned bunch. Call them "self-appointed" or "gad flies" or "water carriers for left liberal organizations like unions" and they get all offended.

Anyway, let's dissect McRitchie's effort to cloak proxy access in immunity from criticism. Notice the rhetorical sleight of hand he uses. First he tees up three laws he thinks everybody loves: taxes, OSHA, and the ADA. (It says a lot about the mindset of McRitchie and his ilk that he thinks these are such wonderful laws, BTW. Considering how much those laws cost shareholders every year, there's a real inconsistency between his status as self-appointed shareholder advocate and his invocation of them as golden calfs of the law.) Then he implies that any attempt to mitigate the impact of those laws is evil. Then he sneaks proxy access into the protected circle of laws that no right thinking person would try to avoid.

But what's wrong with giving people advise about how to circumvent the tax code? After all, as famed Judge Learned Hand opined, "any one may so arrange his affairs that his taxes shall be as low as possible." If they get a lawyer's help in doing so, who cares?

As for giving people advice on circumventing the Americans with Disabilities Act, why not? David Frum recently observed that the ADA was "a generous idea turned into a litigation morass." His comment was prompted by Walter Olson's devastating 20th birthday salute to the Act., in which he observed that:

One reason for the law’s immunity from criticism is that it is defended as a matter of identity politics: if you’re against it, then you must be against the people it protects. So it is treated as rude, not merely provocative, to bring up the failure of the original ADA premise that the new law would “pay for itself” by increasing the labor force participation of the disabled (the rate declined instead). Or to question the law’s “all for one, one for all” extension of the disability label to cover alcoholics, the mentally ill, and the mentally retarded, groups whose problems have historically been seen as quite different from those of the blind, deaf or paraplegic. Or to mention the money-driven ADA “filing mills” in California, Florida and other states under which complainants roam the land filing hundreds of similar complaints against local businesses which their lawyers then convert into assembly-line cash settlements.

McRitchie none too subtly tried to cloak proxy access in the same immunity from criticism that he think the ADA deserves. Clever, but unpersuasive. Proxy access is a bad idea and will make a lousy law, as Verret opines:

Enabling large institutional investors like CalPers and the AFL-CIO will result in politicization of the shareholder voting process. Groups like Corpgov.net and Nell Minow’s Corporate Library hide behind fluffy notions like the “triple bottom line” to justify pushing companies toward vague objectives like sustainability or stakeholder accountability in order to support their ideas that companies should make decisions about health care coverage or wages without a view to profitability. Those groups have never been able to effectively respond to Bainbridge’s argument that the profit motive is the only viable accountability mechanism for corporate boards.

So kudos to Verret. Any day one riles up the self-appointed shareholder spokesperson crowd is a good day.

Al Franken, shareholder wealth maximization, and the business judgment rule

Todd Henderson:

In a recent speech at the Netroots Nation, Senator Al Franken tried to frighten the crowd by trotting out the corporate bogeyman that greedily makes decisions without regard to anything other than profit. Franken told them: “it is literally malfeasance for a corporation not to do everything it legally can to maximize its profits.” Individuals across the political spectrum share this common canard. Those on the right, like Milton Friedman, argue that the shareholder-wealth-maximization requirement prohibits firms from acting in ways that benefit, say, local communities or the environment, at the expense of the bottom line. Those on the left, like Franken, argue that the duty to shareholders makes corporations untrustworthy and dangerous. They are both wrong.

While the duty to maximize shareholder value may be a useful shorthand for a corporate manager to think about how to act on a day to day basis, this is not legally required or enforceable. The only constraint on board decision making is a pair of duties – the “duty of care” and the “duty of loyalty.” The duty of care requires boards to be well informed and to make deliberate decisions after careful consideration of the issues. Importantly, board members are entitled to rely on experts and corporate officers for their information, can easily comply with duty of care obligations by spending shareholder money on lawyers and process, and, in any event, are routinely indemnified against damages for any breaches of this duty. The duty of loyalty self evidently requires board members to put the interests of the corporation ahead of their own personal interest.

Under this legal regime, it is not malfeasance for boards or corporate chiefs to make decisions that do not maximize shareholder value. Boards are protected by the so-called “business judgment rule” from claims that their decisions were the wrong ones. The business judgment rule protects corporate decisions unless the plaintiffs can show a breach of one of the two duties. In other words, unless there is a plausible story the board’s decision was woefully uninformed or was tainted by self interest, a shareholder challenge to a corporate decision will fail.

The business judgment rule means that decisions that turn out badly for firms are protected. This encourages risk taking and avoids the hindsight bias of litigation in cases where well-meaning and rational decisions do not maximize shareholder value. It also gives boards wiggle room to take more than just profit into consideration when setting corporate policy. As such, firms can tailor their decisions to the demands of the marketplace. One company might believe that employees, customers, and shareholders (the three big constituencies of any firm) prefer a decision to keep open a more expensive factory in Michigan, while another company might believe these stakeholders prefer a decision to move its manufacturing base to Mexico. Both are lawful.

I agree. Indeed, I've made this point in my own writing on corporate social responsibility. See, e.g., The Bishops and the Corporate Stakeholder Debate. As I explain therein, however, while the business judgment rule has the effect of giving directors latitude to make decisions that deviate from the shareholder wealth maximization norm, that is not the purpose of the rule.

The fact that corporate law does not intend to promote corporate social responsibility, but rather merely allows it to exist behind the shield of the business judgment rule becomes significant in -- and is confirmed by -- cases where the business judgment rule does not apply. See, e.g., Revlon, Inc. v. MacAndrews & Forbes Holdings, Inc., a takeover case in which the target's board based some of their decisions out of a concern for the interests of creditors rather than shareholders and got spanked for it:

The original threat posed by Pantry Pride-the break-up of the company-had become a reality which even the directors embraced. Selective dealing to fend off a hostile but determined bidder was no longer a proper objective. Instead, obtaining the highest price for the benefit of the stockholders should have been the central theme guiding director action. Thus, the Revlon board could not make the requisite showing of good faith by preferring the noteholders and ignoring its duty of loyalty to the shareholders. The rights of the former already were fixed by contract. . . . The noteholders required no further protection, and when the Revlon board entered into an auction-ending lock-up agreement with Forstmann on the basis of impermissible considerations at the expense of the shareholders, the directors breached their primary duty of loyalty.

The Revlon board argued that it acted in good faith in protecting the noteholders because Unocal permits consideration of other corporate constituencies. Although such considerations may be permissible, there are fundamental limitations upon that prerogative. A board may have regard for various constituencies in discharging its responsibilities, provided there are rationally related benefits accruing to the stockholders. . . . However, such concern for non-stockholder interests is inappropriate when an auction among active bidders is in progress, and the object no longer is to protect or maintain the corporate enterprise but to sell it to the highest bidder.

Because the business judgment rule did not apply, the directors "breached their primary duty of loyalty" by failing to obtain "the highest price for the benefit of the stockholders." Corporate social responsibility be damned.

Now let us consider a different case. Imagine a board of directors presented with a pure zero sum decision. Anything they do is going to hurt somebody.The choice is stark: They can do X, which not only increases shareholder wealth, but also increases the total wealth of all internal stakeholders (such as employees and creditors). I make that qualification for reasons that will become apparent in a moment. Unfortunately, X will have a very serious negative impact on society. Or they can do Y, which produces a substantial social benefit, while significantly reducing the value of the enterprise and having a deleterious effect on shareholder wealth. In these days of systemically important firms that are too big to fail, such a hypothetical seems more plausible than one might imagine. The Board chooses option Y.

In In re Walt Disney Co. Deriv. Litig., 906 A.2d at 67 n.111, the Delaware Supreme Court held that:

A failure to act in good faith may be shown, for instance, where the fiduciary intentionally acts with a purpose other than that of advancing the best interests of the corporation, where the fiduciary acts with the intent to violate applicable positive law, or where the fiduciary intentionally fails to act in the face of a known duty to act, demonstrating a conscious disregard for his duties. There may be other examples of bad faith yet to be proven or alleged, but these three are the most salient.

This is significant, of course, because the business judgment rule does not protect a failure to act in good faith.

As I've set up my hypothetical, hasn't the board of directors "intentionally act[ed] with a purpose other than that of advancing the best interests of the corporation"? Notice that good faith/bad faith is premised on failing to act in the best interests of the entity rather than the shareholders. That's why I set up the problem in such a way that the entity was harmed, not just the shareholders. I should note, however, that I find this distinction highly pernicious. The issue ought not to be the interests of the entity; it ought to be the interests of the shareholders. See my article Much Ado about Little? Directors' Fiduciary Duties in the Vicinity of Insolvency.

As far as I know, nobody has addressed the question of whether the emergent doctrine of good faith could be deployed to constrain director discretion to pursue corporate social responsibility. It might be worth doing, however. Speaking as someone who is deeply skeptical of both the corporate social responsibility agenda (see here) AND the doctrine of good faith as it has emerged in Delaware (see here), I'm feeling highly conflicted.

Unfortunately, my research agenda is set for the next couple of years -- I'm up to my neck with book contracts -- so I offer this project up gratis. (Well, not quite. I do expect lots and lots of cites.)

Are Nonprofit CEOs Paid too Much?

According to the NY Times, some legislators think so:

A provision in New Jersey’s recently passed budget, for example, includes a limit on what nonprofit groups can pay their chief executives if they are providing social services under state contracts. The cap, based on a formula that also applies to for-profits providing such services on behalf of the state, is part of a broader effort by Gov. Chris Christie to rein in salaries on state workers. ...

“Many donors feel that paying the leader of a charity a six-figure salary is outrageous,” said Ken Berger, the group’s president.

So what do we know about executive compensation at nonprofits?

On the one hand, you might think that "people who work for nonprofits are inherently altruistic and unconcerned with pay." But you would be wrong. Even among religious nonprofits, where presumably non-monetary incentives ought to be most prominent (money being the root of all evil and all that), we see non-profits using pay for performance compensation schemes.

On the other hand, you might think that "the principal-agent problem" should be worse in the nonprofit sector, since they are less subject to market forces and there is, by definition, no ownership constituency to monitor the performance of agents. If so, you would be right.

There is evidence that "nonprofit executive compensation is not significantly related to CEO performance, as measured either by improved fund-raising results or better administrative efficiency." Worse yet, "CEO compensation is significantly higher in organizations where free cash flows is present, as measured by commercial revenues, liquid assets and investment portfolios."

The latter point is especially significant, because agency cost theory teaches that it is not money--but free cash flow--that is the root of all evil. Free cash flow exists when a firm has earnings in excess of that required to fund all available investments that have positive net present values. Experience teaches that managers are likely to waste free cash flows on such things as high compensation, perks, and empire-building. Which is consistent with the evidence about which nonprofits tend to have higher CEO compensation.

The question is: What is the appropriate response? Here the story conflates several issues: (1) Should there be caps on the amount of compensation a nonprofit can give executives? Because the evidence seems clear that pay is an important element in recruitment and retention of nonprofit executives, capping nonprofits would disadvantage those that must compete with the for profit sector for employees. Hospitals spring to mind as an example. Ditto money management outfits like TIAA-CREF or university endowments.

(2) Should government contract out services to nonprofits with high paid CEOs? Put another way, should government contracts be conditioned on a cap on nonprofit executive compensation? James Joyner observes:

First, it’s quite debatable whether these public-private partnerships ought exist at at. I don’t have a firm position on the issue. Second, if they do, then it makes sense to evaluate them on a cost-benefit basis. And I’m not sure why that would be done on a line-item basis. Either Boys & Girls Clubs of America is providing whatever service the government wants provided at a level of cost and efficiency that outcompetes other potential bidders or it doesn’t. A high CEO salary should make them less competitive than outfits paying lower salaries, all things being equal. But if they still come out on top even with that drag, what’s the problem?

Sounds right to me.

Caremark claims premised on violations of federal law

Caremark claims are a parasitic form of shareholder litigation. As the case usually develops, the corporation is caught by the government committing some sort of regulatory crime or accounting transgression. The corporation pays a fine to resolve the matter.

Some plaintiff's attorney then free rides on the government case, filing suit against the company's directors for failing to have adequate oversight and monitoring systems in place. The claim is that the company would not have committed the underlying violation if such programs had been in place.

A new Washington Legal Foundation research paper looks at the particular issues posed when Caremark claims are based on corporate violations of federal law. Here's the summary:

A developing phenomenon in corporate litigation, known as ”Caremark claims,” threatens corporate directors with state-law fiduciary duty to monitor lawsuits based upon the corporation’s actual, or merely alleged, violations of federal law. Arising out of a Delaware Chancery Court ruling in In re Caremark, courts have accepted that fiduciary claims may be brought against corporate directors if they failed to monitor or act in good faith to protect against corporate malfeasance. Over time, plaintiffs have brought fiduciary claims against corporate directors even when the corporations are not proven guilty of violations of federal regulations or statutes. Caremark claims demand scrutiny and in the vast majority of situations, judicial rebuke, for three reasons.

First, the conflation of state-law civil liability claims with federal criminal violations and accusations is inappropriate and subverts Congressional intent. The collision between state and federal law leads to questions of preemption. Even in situations where the motivation for the state corporate law duty of loyalty and for a federal law, such as the Foreign Corrupt Practices Act, are similar, courts have properly rejected derivative shareholder lawsuits.

Second, accurately measuring the harms which alleged wrongdoing caused to a business is difficult at best, and encourages plaintiffs’ lawyers to manipulate Caremark claims and invites dangerous judicial speculation. Further complicating the measurement of damages, corporations often gain a net monetary benefit as a result of actual violations of federal law.

Third, federalized Caremark claims based solely upon announcements of federal investigations or indictments undermine important protections for corporate directors. Delaware and other states adopt such laws to ensure that qualified professionals are willing to serve on corporate boards. The plaintiffs’ bar, for instance, could bring a state lawsuit based upon unsubstantiated allegations or the commencement of federal law investigations, and could file suit again upon the completion of a federal investigation if it leads to a settlement.

In order to prevent Caremark-style derivative lawsuits from becoming vehicles for abusive litigation and violations of legislative intent, courts must closely scrutinize such claims, particularly when no court has found the defendant’s corporation guilty of any violations of federal law.

I'm not convinced by the arguments that federal law-based Caremark claims are a unique problem. The over deterrence argument is true, but applies to any situation in which both a corporate entity and its directors face liability under different theories of law arising out of the same transaction. OTOH, their argument about the practical conflict between Caremark and the Federal Corrupt Pratices Act has some merit.

In any case, as I discuss in my article, Caremark and Enterprise Risk Management, Delaware courts are doing a pretty good job of limiting Caremark claims to the handful of truly meritorious settings.

Macey's Corporate Governance: Promises Kept, Promises Broken

Michael Sirkin reviews Jonathan Macey's new book, Corporate Governance: Promises Kept, Promises Broken:

Macey’s controlling idea is that corporate governance is about promises. He evaluates the institutions and mechanisms of corporate governance according to the degree to which they facilitate the making and keeping of promises by corporations to investors. He chooses the “Promise Premise” instead of the more traditional nexus-of-contracts premise because “the idea of promise captures the primordial fact that trust rather than reliance on the prospect of enforcement is the focal point of a successful system of corporate governance.” As Macey’s analysis reveals, investors rely largely on trust and reputational capital when they participate in the capital markets, and even those mechanisms that are designed to offer some degree of enforcement power fall short.

Macey’s “Promise Premise” works as the governing theme because it is intuitively appealing and allows for private ordering. Intuitively, it seems fair that there is no one-size-fits-all set of metrics with which to evaluate corporate performance. On a basic level, consider two companies, “Income” and “Growth.” Income consistently pays dividends, operates in a stable industry with a sustainable capital structure, and attracts risk-averse investors. Growth, meanwhile, retains its earnings, operates in emerging markets and developing industries and with high leverage, and attracts risk-hungry investors. If in twenty years, Income has continued paying its quarterly dividend and retained its stable position in its stable industry, and Growth has survived some investments that didn’t pay off and hit it big in emerging markets, sending its volatile share price temporarily skyrocketing, which company has been more successful? Both companies have been successful by doing what they set out to do. But which company has been more effectively governed? We won’t know if we look to board and management turnover, leverage, and share price whose management has performed better over the time period. But applying Macey’s Promise Premise, we can evaluate the governance approaches of any company by measuring the degree to which they facilitate the keeping of the promises the company has made to its investors. This approach therefore allows for useful governance comparisons between two companies that may have completely different agendas. ...

acey evaluates all the major institutions and mechanisms of corporate governance according to his Promise Premise described above. He comes down in favor of market-based institutions such as the markets for corporate control and initial public offerings. As compared with markets, Macey is far less confident in people, whether they be managers, directors, regulators, judges, or legislatures. On an individual level, Macey places little faith in a person’s ability to overcome decision-making biases. On a group level, as with legislatures and boards of directors, effective governance is lacking because of capture. ...

On the whole, Macey studies thirteen different institutions or mechanisms of corporate governance. He deems five of them effective (the market for corporate control, the IPO market, insider trading and short selling, hedge funds, and banks and other fixed claimants), but notes that none of them are encouraged in our legislative and regulatory environment. He deems the remaining eight ineffective (the SEC and stock exchanges, boards of directors, the accounting industry, litigation, whistle-blowing, shareholder voting, credit rating agencies, and stock market analyst) and notes that they are encouraged. Macey offers political and path-dependence explanations to resolve this paradox in some of the book’s chapters.

Overall, the book is detailed, thorough, and easy to read and follow. Macey’s great strength as a writer lies in his ability to move effortlessly between levels of abstraction; he’ll talk on the highest theoretical level about the effectiveness of boards of directors and then support his ideas with discussions of individual case studies on the effectiveness of boards of directors. Macey’s thoughts are obviously well-considered and thoroughly researched, and this book should be considered a must-read for anyone interested in the governance of U.S. companies. The book, or excerpts from it, would make a great companion to a corporations course because of its disagreements with the status quo.

Of course, if you really want to understand corporate governance, you'll also need my book.

Will Liz Warren be nominated/confirmed to head consumer financial agency? Does it Matter?

David Skeel lines up the pros and cons:

Reasons to pick Warren: 1) the liberal base: liberals will be outraged if the President picks someone else, which could further deflate the enthusiasm of his base, boding ill for the November elections; 2) She’s a true consumer advocate: if he cares at all about the new agency, it will be hard to pick anyone else; 3) when push comes to shove, it won’t be easy for Democratic senators to vote “no” on someone who has defined herself as a protector of middle class Americans. (Republicans won’t be the issue. My guess is that the three who voted for the financial reforms are possible yes’s, and the others will all be no’s.)

Reasons to pick someone else: 1) picking Warren could destroy the President’s relationship with the financial services industry (a relationship that is a lot better than people tend to think); this might not matter in November, but it could be a big problem as he raises money for 2012; 2) a vote for Warren would be a very difficult vote for moderate Democrats like Ben Nelson, who’ve already taken some tough votes this year; as a result, confirmability is a genuine issue; 3) Effect on markets and lending: Warren’s signature concerns, such as clamping down on further on credit card and mortgage loans, could scare the markets and prompt banks to further tighten their lending to consumers and small businesses.

David concludes that Warren will be nominated.

Meanwhile, David Zarig asks why Obama would "want someone relentlessly critical of the administration's economic policy, who goes to the media at the drop of a hat, in a position where she would be tough to fire?" And continues:

To say nothing of Megan McArdle's pointed observations about the relationship between evidence and argument in the ouevre? I think she was wrong about whether the administration was misusing the TARP money, too - they're going to get most of it back, except on the piece she supported, which was mortgage mod. 

The only way Washington politicians would hire someone to an economic post who isn't a team player and doesn't support their economic agenda is if they were absolutely forced to do so, which maybe they will be, given that I presume the unions are strongly behind her.  Still, it's not an elected office, it's an appointed one, and the Obama administration must like drama much more than previously understood, because that's what they would be getting with Warren.  She was a great secured transactions teacher - I can personally attest to that - and very, very smart.  By my lights, she probably deserves a job that she invented and fought for.  But I suspect that the people who keep telling us that don't really have the current regime's best interests at heart.

Liberal law professor Sandy Levinson writes that for himself and his fellow lefties that:

For many of us, this is an acid test as to whether the Obama Administration really does have backbone, except when Rahm Emanuel wants to curse liberals for not being sufficiently "understanding" of the need to capitulate, again and again, to self-proclaimed "realities." Some of the time, of course, Emanuel is absolutely right. But this isn't one of them. Both crass politics and the public interest make Elizabeth Warren the right person at the right time. If she is passed over, then "we" should insist that she be nominated to replace Ruth Bader Ginsburg, not least because it would really be wonderful to have someone on the Court who actually understands bankruptcy law and because, of course, it would be even more wonderful to have Elizabeth Warren construing the meaning of the various provisions of the 2300-page statute signed yesterday.

In the long run, I doubt very much whether the outcome of this fight will matter. Regardless of whether Warren is the agency's first chair or not, the odds are high that the agency will end up being captured by the banking and financial industries it is supposed to regulate.

IMF researcher Daniel Hardy explains that regulatory capture is "the possibility that the regulated institutions exercise excessive influence on the regulator. A captured regulator acts primarily in the interests of the regulatees, rather than in accordance with their putative mandate to promote the common good."

The seminal article by Stigler (1971) suggests that regulators are commonly subject to intense and effective pressure from regulated firms to modify regulations and their implementation to suit the interests of the latter (Laffont and Tirole, 1993, provide a useful overview). The regulated firms may exercise pressure at the political level, for example, by supplying politicians with one-sided evidence supporting their positions and attempting to gain their allegiance through campaign contributions. The regulated firms may exercise pressure and influence also at the level of the regulatory agency, for example, by implicitly offering agency staff lucrative employment opportunities in exchange for being cooperative, and generally inducing the regulators to identify with the regulated industry. Other interest groups may adopt similar tactics. As emphasized in Laffont and Tirole (1991) and Laffont (1999), regulatory capture is likely to be more effective when one interest group is highly concentrated and organized and has much at stake, and when the regulations are technically complex and asymmetric information is pervasive, so that outside verification is difficult. Most of the literature on regulatory capture is framed in terms of a regulated utility. Classic instances include a utility that lobbies for higher prices, a polluter that lobbies for higher emission limits, or a monopolist that lobbies for the retention of barriers to entry.

Hardy continues by arguing that "bank regulation may be especially susceptible to capture, and there is some evidence that capture has significantly influenced regulatory and supervisory decisions affecting banks and other financial institutions."

There is no reason to suppose that financial sector regulation is immune from capture, and features of financial markets may make the sector especially prone to it. Financial institutions’ vital interests are at stake in the formulation and implementation of regulations. The financial sector often contains a number of very large institutions, or is organized into powerful banking associations, which can afford lobbying efforts and well-prepared participation in public debate on regulatory measures. In contrast, other concerned interest groups, such as deposit holders, typically have more diffuse membership. Financial institutions tend also to be well connected to the political establishment and thus to have access to channels of influence. In the United States, for example, they are among the largest contributors to political campaigns.

As I said above, whether Warren gets the job or not won't matter ten years from now.

From Sword to Shield: The Transformation of the Corporate Income Tax, 1861 to Present

Samuel Brunson reviews my friend and UCLA law faculty colleague Steven Bank's book, From Sword to Shield: The Transformation of the Corporate Income Tax, 1861 to Present:

Steven A. Bank’s excellent From Sword to Shield: The Transformation of the Corporate Income Tax, 1861 to Present ... paints a picture of an undeliberate, though not-quite-accidental, tax, the design and underlying purpose of which changed regularly, and the consequences of which were poorly understood, even by the business interests that lobbied for legislation that would ultimately prove problematic for corporations and their shareholders. ...

From Sword to Shield is a fascinating read on several levels. It is, of course, a history of the corporate tax. And it offers a broad history the last 150 years or so of business in the United States. But it is also a history of the legislative sausage-making process: in tracing one legal regime for over a century, Professor Bank shows the interaction between the President, legislators, the Treasury Department, parties affected by the legislation, and even newspapers and public perception. The various sides’ discourse is thought-out, passionate, but measured. Every new iteration of the corporate income tax was a compromise, and sometimes the consequences were unexpected. As messy as the process was, though, it succeeded in producing a functional corporate income tax.

Which is to say, if you have any interest in tax, you need to read this book. And even if you don’t have any interest in tax, if you are interested in the legislative process or in economic history (or even on the impact of war on fiscal policy), this book is for you. Although the tax law has an unfortunate (and inaccurate) reputation for dryness, From Sword to Shield is anything but. The prose is accessible and compelling; the policy issues are well-explained and cogent. And the history will help give more depth and context as you listen to or participate in debates about the future of corporate taxation.