ProfessorBainbridge.com

The business judgment rule is NOT a standard of review

Maybe my May talk to the Delaware bar ought to be about why the business judgment rule is not a standard of review. This seemingly perennial problem came up yet again in Vice Chancellor Laster's decision in Reis v. Hazellt Strip Castng Corp. It is an interesting case. Edward McNally explains that:

When a reverse stock split eliminates minority stockholders, they are entitled to be paid the "fair value" of their stock. This decision explains what that means.  In particular, it does not mean they get the same value as if their stock were subject to an appraisal.  While the valuation process is very similar, it is affected by the standard of review involved, particularly if the squeeze out was done unfairly and the intrinsic fairness standard applies.

The opinion is also an excellent review of the overall Delaware law on the standard of review for any transaction.

Well, no. It is the opinion's description of standards of review that draws my ire. Laster opines that:

Delaware has three tiers of review for evaluating director decision-making: the business judgment rule, enhanced scrutiny, and entire fairness. The business judgment rule is the default standard of review. It presumes that “in making a business decision the directors of a corporation acted on an informed basis, in good faith, and in the honest belief that the action taken was in the best interests of the company.” Aronson v. Lewis, 473 A.2d 805, 812 (Del. 1984). “[W]here the business judgment [rule] presumptions are applicable, the board’s decision will be upheld unless it cannot be attributed to any rational purpose.” In re Walt Disney Co. Deriv. Litig., 906 A.2d 27, 74 (Del. 2006) (internal quotation marks omitted).

I'm not at all sure Delaware law limits itself to three standards of review. But that's a question for another day. I am confident, however, that the business judgment rule--properly understood--is not a standard of review. It is an abstention doctrine. See my article The Business Judgment Rule as Abstention Doctrine, in which I explain that:

Obamacare hoisted on Obama's petard

From the Washington Times:

In ruling against President Obama‘s health care law, federal Judge Roger Vinson used Mr. Obama‘s own position from the 2008 campaign against him, when the then-Illinois senator argued there were other ways to achieve reform short of requiring every American to purchase insurance.

“I note that in 2008, then-Senator Obama supported a health care reform proposal that did not include an individual mandate because he was at that time strongly opposed to the idea, stating that, ‘If a mandate was the solution, we can try that to solve homelessness by mandating everybody to buy a house,’” Judge Vinson wrote in a footnote toward the end of his 78-page ruling Monday.

Judge Vinson, a federal judge in the northern district of Florida, struck down the entire health care law as unconstitutional on Monday, though he is allowing the Obama administration to continue to implement and enforce it while the government appeals his ruling.

The footnote was attached to the most critical part of Judge Vinson‘s ruling, in which he said the “principal dispute” in the case was not whether Congress has the power to tackle health care, but rather whether it has the power to compel individual citizens to purchase insurance.

I had forgotten that Obama himself once upon a time took seriously the broccoli hypothetical.

Ilya Somin recently explained precisely why the broccoli objection to Obamacare has teeth:

Opponents of the constitutionality of the individual mandate have emphasized that upholding the mandate would give Congress the power to mandate virtually anything, including forcing people to eat broccoli.... First, even if Congress would never actually enact the broccoli mandate, the fact that it could so under the same logic as the health insurance mandate highlights a logical flaw in the argument made by defenders of the latter. It strains credulity that a constitutional text that gives Congress the power to regulate interstate commerce gives it unlimited authority to force people to buy products they don’t want, even within the borders of a single state.

Somin then goes on to discuss why broccoli-like mandates are not infeasible as a political matter:

Congress need not admit that they’re intended to help powerful interest groups. They could instead be defended as efforts to stimulate the economy by helping a vital industry (the same justification as was used to justify government bailouts of the banks and auto industry). Forcing people to purchase broccoli or other food could be defended as a public health measure. Indeed, paternalists of both the “libertarian” and traditional varieties have successfully advocated numerous coercive regulations on precisely those kinds of grounds. There is no reason why they couldn’t use similar strategies to justify purchase mandates. An alliance between well-intentioned paternalists and industry interest groups is precisely the kind of “baptist-bootlegger” coalition that has often been successful in the past. Given widespread political ignorance, voters will often be hard-pressed to tell whether such proposals will really increase public health or not.

Glenn Reynolds interviews Benjamin H. Barton, whose book "The Lawyer-Judge Bias in the American Legal System" looks at the ways judges skew the law in ways that favor the legal profession.

Virtually all American judges are former lawyers. This book argues that these lawyer-judges instinctively favor the legal profession in their decisions and that this bias has far-reaching and deleterious effects on American law. There are many reasons for this bias, some obvious and some subtle. Fundamentally, it occurs because - regardless of political affiliation, race, or gender - every American judge shares a single characteristic: a career as a lawyer. This shared background results in the lawyer-judge bias. The book begins with a theoretical explanation of why judges naturally favor the interests of the legal profession and follows with case law examples from diverse areas, including legal ethics, criminal procedure, constitutional law, torts, evidence, and the business of law. The book closes with a case study of the Enron fiasco, an argument that the lawyer-judge bias has contributed to the overweening complexity of American law, and suggests some possible solutions.

More on action actresses

Tung Yin nominated Lucy Lawless, Angelina Jolie, Michelle Yeoh, and Summer Glau, as "best action actresses." In an earlier post, which you'll find below, I offered up Yvonne Strahovski, Linda Hamilton, and Uma Thurman as alternate candidates. Tung replied:

I don't watch "Chuck" so can't really comment on Ms. Strahovski's screen fighting prowess.

Don't watch Chuck? It's the best scripted show on TV. And you really don't want to mess with Strahovski's Sarah Walker:

And then Tung really went off the rails:

Uma Thurman was quite good in "Kill Bill" but . . . I dunno. I mean, Scarlett Johannsen beat up a bunch of guys in "Iron Man 2" but I'm not rushing to put her on my list of best action actresses.

I'm, sorry. The Bride doesn't just beat up a lot of people. She destroys them. Exhibit A: The NC-17 version of the fight with Gogo and the Crazy 88s. "Any more subordinates for me to kill?"

Exhibit B: Taking out Elle Driver after having been buried alive. "And in the very immediate future it will become my sword." "Bitch, you don't have a future."

I rest my case.

Executive Compensation: Less Focus on "Executive," More Focus on "Bank"

I'm broadly in agreement with Erik Gerding's take:

If we are justifying regulating compensation because of the crisis, it seems odd to sweep in non-financial firms. What, after all, does the pay of executives at Intel, Google, Boeing, or Exxon Mobil have to do with the financial crisis? Say-on-pay and other Dodd-Frank reforms that apply to a broad swath of non-financial firms need to be justified on their own merits and not with an invocation of crisis spirits.

On the other hand, financial firms are fundamentally different beasts. We cannot stop with the standard analysis of agency costs that applies to the compensation arrangements at generic companies. The capacity of financial firms to externalize the costs of their risk-taking on the credit markets and the economy as a whole argues for additional scrutiny. The principal Federal bank regulators made this point in June 2010 guidance on compensation policies at banks. They wrote, “Aligning the interests of shareholders and employees, however, is not always sufficient to protect the safety and soundness of a banking organization.” The regulators argued that the presence of a federal safety net meant that shareholders may not care enough about whether a bank’s compensation policies encourage excessive risk. This argument could be taken a step further as the failure of firms, like Lehman, that did not receive a federal lifeline still caused massive economic damage. Financial firms need to be treated differently. Moreover, the agency cost rubric for looking at compensation that applies to most firms – does compensation align management and shareholder interests – may produce perverse results if applied to financial firms. Leo Strine of the Delaware Court of Chancery makes a case that further aligning manager interests with those of shareholders might further encourage short-termism – including high-reward-today-high-risk-tomorrow investments. This argument becomes stronger when applied to financial institutions.

If much of Dodd-Frank’s compensation focus is thus too broad, much of it is also too narrow. The compensation of non-executives – from traders at a Bear Stearns trading desk to mortgage brokers earning six figure incomes at Countrywide – may explain more of the perverse risk-taking in the crisis than the pay of ceos at those firms. Indeed, many of the most prominent ceos pilloried after the crisis – Cayne, Mozilo, Fuld – actually lost a significant chunk of their personal fortunes as their firms foundered. (See Fahlenbrach & Stulz for a more rigorous analysis).

If compensation – executive and non-executive -- at financial institutions is more directly connected to the crisis, then banking regulation offers a better toolbox for addressing skewed incentives for taking excessive risk produced by bad compensation arrangements.

A, B, and C students

Usha Rodrigues quotes Larry Summer's quip about Harvard students and wonders about its application to law students:

From the WSJ: "The A, B and C alums at Harvard in fact could be broadly characterized thus, [Summers] said: The A students became academics, B students spent their time trying to get their children into the university as legacies, and the C students—the ones who had made the money—sat on the fund-raising committee."

This split may be true at Harvard.  Do you, dear readers, think it's true for law school?  My gut says no.  Clearly the A students are more likely to choose the ivory tower, but my sense is that many of them go on to make the big bucks in law firms, investment banks, etc.  The B students also often end up with large paychecks, but the C students are not as prosperous.  Am I wrong?

FWIW, I heard a verison of this for law students that went: A students become law professors, B students become successful lawyers, and C students become judges.

If you were a Delaware corporate lawyer, what topic would you want me to speak about?

I've been asked to give an hour talk on corporate law at a May seminar for the Delaware State Bar. I don't have to write an academic paper, but I will need to give them an outline to meet CLE requirements. In any case, job one is to find a topic.

I'd like it to be something new-ish. I don't think anybody wants to hear me rehash director primacy for the 3,000 time. Or explain yet again why the Delaware courts' hostility to precommitment devices is so illogical. Or try one more time to convince them that giving substance to good faith was a terrible idea and that subsuming it into loyalty was even worse.

On the other hand, it should not be so new (to me) as to require a ton of work. It also ought to be something practice-oriented, but not nuts and bolts stuff.

So let's take requests: If you were going to attend the talk (about which more details later), what would you want me to talk about?

The Very Active Activist Investors

In her informative post The Very Active Activist Investors, Michelle Harner reviews the state of play on investor activism. As I grapple with the problem of shareholder activism for my upcoming book (Corporate Governance After the Crises), one issue I'm beginning to focus special attention on is that of whether activism by hedge funds and their ilk differs in kind from that of union and state and local government pension funds. My criticism of shareholder activism has focused mainly on the latter. In Shareholder Activism in the Obama Era, for example, I argue that:

Activist investors pursue agendas not shared by and often in conflict with those of passive investors. Activism by investors undermines the role of the board of directors as a central decision-making body, thereby making corporate governance less effective. Finally, relying on activist institutional investors will not solve the principal-agent problem inherent in corporate governance but rather will merely shift the locus of that problem.

One question I'm trying to resolve is whether hedge fund operatives like Bill Ackman (currently having some considerable success at JC Penney) are chasing private rents or are engaged in conduct that benefits all shareholders. The other question I'm trying to answer is whether these guys are micromanaging target firms in a way that is inconsistent with director primacy.

The Corporation: A Thing of Power and Beauty

OTB blogger Alex Knapp channels Southern agrarianism:

“I hope we shall take warning from the example and crush in it’s birth the aristocracy of our monied corporations which dare already to challenge our government to a trial of strength and bid defiance to the laws of our country.”
– Thomas Jefferson, 1816

Unfortunately, we didn’t.

To which I replied in the comments:

Pish posh. When I teach corporate law, I tell my students about Nicholas Murray Butler, president of Columbia University and winner of the Nobel Peace Prize, who wrote that: “The limited liability corporation is the greatest single discovery of modern times. Even steam and electricity are less important than the limited liability company.”

I tell them about journalists John Micklethwait and Adrian Wooldridge, whose magnificent history, The Company, contends that the corporation is “the basis of the prosperity of the West and the best hope for the future of the rest of the world.”

And so I also tell them that the corporation has proven to be a powerful engine for focusing the efforts of individuals to maintain economic liberty. Because tyranny is far more likely to come from the public sector than the private, those who for selfish reasons strive to maintain both a democratic capitalist society and, of particular relevance to the present argument, a substantial sphere of economic liberty therein serve the public interest. As Michael Novak argues, private property and freedom of contract were “indispensable if private business corporations were to come into existence.” In turn, by providing centers of power separate from government, corporations give “liberty economic substance over and against the state.”

We should be eternally grateful that slave owning, miscegenating, Jacobin-leaning Jefferson failed to squelch the corporation.

BTW, the Southern agrarian strain of anti-corporation feeling is filed away as a future project.

The Financial Crisis Inquiry Commission's Report and Corporate Governance

The Financial Crisis Inquiry Commission's report repeatedly identifies corporate governance failures as a causal factor in the crisis of 2007-2008. At page 19, for example, the report opines that:

We conclude dramatic failures of corporate governance and risk management at many systemically important financial institutions were a key cause of this crisis.

It's probably the case that there were corporate governance breakdowns at some specific firms. Lehman and AIG spring to mind. On close examination, however, the evidence is hardly conclusive.

Yet, on close examination, the evidence turns up some very curious findings. First, the U.K.’s corporate governance regime is generally regarded as more shareholder empowering than is the U.S., which in the minds of many governance activists makes it superior. If governance failures were a key factor in the crisis, one thus would expect the U.K. to have been less susceptible than the U.S. Yet, the U.K. went through essentially the same financial crisis as the U.S. at about the same time. Accordingly, while governance practices “such as independent board chairs and ‘say on pay’ votes have been available to U.K. shareholders for years,” they apparently did “did little to prevent the crisis or mitigate its effects on the U.K. financial system.” Christopher M. Bruner, Corporate Governance in a Time of Crisis 25 (2010), http://ssrn.com/abstract=1617890.

Second, there is some evidence that corporate governance standards widely regarded as best practice were actually associated with poorer performance during the crisis. A study by USC business school professors Erkens, Hung, and Matos of 296 financial institutions in 30 countries found that board independence and high institutional investor ownership, which we’ll see in chapters that follow are usually assumed to be good practices, were associated with poor stock performance during the crisis. They further found that financial institutions with more independent boards were more likely to raise equity capital during the crisis, which ultimately resulted in a wealth transfer from shareholders to creditors. As for institutional ownership, higher levels thereof were associated with greater risk taking, which ultimately resulted in greater losses. David Erkens et al., Corporate Governance in the 2007-2008 Financial Crisis: Evidence from Financial Institutions Worldwide (Sept. 2010), http://ssrn.com/abstract=1397685.

A study by Beltratti and Stulz found no evidence that banks with higher scores on the Institutional Shareholder Services’ Corporate Governance Quotient performed better than lower-scoring firms. Beltratti and Stulz attributed the crisis to flawed bank capital structures, instead of corporate governance failures. Banks that relied on long-term sources of capital fared better than those that relied on short-term funding. Andrea Beltratti & Rene M. Stulz, Why did some banks perform better during the credit crisis? A Cross-Country Study of the Impact of Governance and Regulation (ECGI Finance Working Paper No. 254/2009), http://www.nber.org/papers/w15180.

We can draw a couple of important conclusions from this evidence. First, what constitutes good corporate governance depends on which constituency’s interests one is seeking to advance. Governance regimes that advantage shareholders may not be good for taxpayers. Yet, virtually all of the reforms mandated after the financial crises of the last decade were designed to empower shareholders. The risk thus is that the reforms may make the next crisis more likely and potentially more severe.

Second, one size does not fit all in corporate governance. The problems of Wall Street and Main Street are quite different and may require quite different solutions. Yet, the reforms of the last decade almost without exception are one size fits all mandates from which derogation by private ordering is not allowed.

The Irrelevance of Empirical Legal Scholarship

More from Josh Wright, who asserts that "the claim that I bemoan the irrelevance of ELS is misplaced."

Skeel on Dodd-Frank reviewed

David Skeel's wonderful new book The New Financial Deal: Understanding the Dodd-Frank Act and Its (Unintended) Consequences continues to garner positive reviews. This one is from corporate law professor Steven Bradford:

I just finished reading David Skeel’s new book on the Dodd-Frank Act, The New Financial Deal.  Skeel’s book is a very good introduction to the major provisions of the Dodd-Frank Act, including its regulation of major financial institutions and the new requirements relating to derivative clearinghouses and exchange trading of derivatives.  He has less to say about the corporate governance aspects of Dodd-Frank, but those provisions are, after all, a very minor part of the Act.  The discussion is straightforward and not laden with legal jargon, so this book is not only great for lawyers, but also for intelligent lay people wanting to know more about the Dodd-Frank edifice.

Skeel argues that Dodd-Frank, with its partnership between large financial institutions and government regulators, is a massive exercise in corporatism.  U.S. government corporatism didn’t begin in 2008, of course.  The recent government bailouts and government control of business corporations like GM continues a long-term trend that includes massive subsidies to ethanol and even the longstanding mortgage interest deduction. 

Recently, both liberals and conservatives have been criticizing corporatist polices.  This is an issue on which Tea Party conservatives and liberal populists could naturally coalesce, but I doubt it’s going to happen.  It’s hard to make common ground when you’re questioning each other’s character.

Skeel also argues that the discretion Dodd-Frank gives government regulators to intervene in business on an essentially ad hoc basis seriously undermines the rule of law.

Wallison's Dissent from the Majority Report of the Financial Crisis Inquiry Commission

Peter Wallison has published his Dissent from the Majority Report of the Financial Crisis Inquiry Commission. It's a must read for those of us interested in the financial crisis and Dodd-Frank. Money quote:

Like Congress and the Obama administration, the Commission's majority erred in assuming that it knew the causes of the financial crisis. Instead of pursuing a thorough study, the Commission's majority used its extensive statutory investigative authority to seek only the facts that supported its initial assumptions--that the crisis was caused by "deregulation" or lax regulation, greed and recklessness on Wall Street, predatory lending in the mortgage market, unregulated derivatives, and a financial system addicted to excessive risk taking. The Commission did not seriously investigate any other cause and did not effectively connect the factors it investigated to the financial crisis. The majority's report covers in detail many elements of the economy before the financial crisis that the authors did not like, but generally fails to show how practices that had gone on for many years suddenly caused a worldwide financial crisis. In the end, the majority's report turned out to be a just-so story about the financial crisis, rather than a report on what caused the financial crisis.

Litigators ruin pretty much everything

Plaintiff's lawyers take all the fun out of life and are a big reason the culture of personal responsibility is dying:

It's one of the simple, most wonderful pleasures of life: zooming down a snow-covered hill just fast enough for a touch of fear to quicken your pulse. Maybe it's a solo run. Maybe you're clinging to a loved one as you tear down the hill tandem. Surely, sledding is one of those things that makes it worth toughing it out and living in New Jersey when sunnier climes often beckon.

Unfortunately, it's getting tougher and tougher to find a place to do it. For the past two years on Ledger Live, we've taken viewers suggestions and hit the road in search of New Jersey's best sledding hills. But more and more, we found, the hills that have thrilled generations of sledders are now closed.

Lawsuits filed by injured sledders, it seems, have struck fear in the hearts of municipal and county government officials, prompting them to simply ban sledding at some of the state's erstwhile sledding meccas.

As a kid and young adult, I got racked up more times sledding than I care to remember. But it never would have occurred to me to sue anybody over it.

Remember: The only good lawyer is a transactional lawyer.

Howrey Schadenfreude

The Howrey law firm seems to be in big trouble:

When we last wrote about goings-on at Howrey, the once-strong law firm now experiencing troubled times, we mentioned the possibility of partner losses in the Chicago office. The firm pushed back on this, denying knowledge of any imminent defections in the Windy City.

It now seems, however, that additional partner departures may be on the horizon — in Chicago, and elsewhere too. As reported in Crain’s Chicago Business (via WSJ Law Blog), the Chi-town powerhouse of Winston & Strawn recently discussed a possible merger with Howrey — but then decided against that approach, opting instead to pick off specific groups and partners from Howrey.

The Howrey situation is starting to look a lot like what happened to Heller Ehrman. A well-respected firm with a widely admired culture encounters business difficulties. Key partners and groups start leaving for greener pastures or more stable platforms. A potential white knight emerges — Mayer Brown in Heller’s case, and Winston & Strawn in Howrey’s — but then decides to order a la carte from the menu of partners and practices, instead of going for the chef’s tasting menu.

Twenty-plus years ago, I was a second year law student at UVA in the midst of summer associate interviewing. I had an on-campus interview with Howrey. A few days later, two letters from Howrey showed up in my mailbox. One invited me up to DC for an call-back interview. The other was a rejection letter. Oddly, both were signed by the same partner. I called the partner to inquire, but only go to his secretary. I told her my inquiry--which letter should I act upon?--and she put me on hold. After consulting with her boss, I hope and assume, she got back on the line and told me it would not be necessary for me to come to DC. It still rankles. A bit.

So I'm going to dissent from admiring Howrey's culture and root for the vulture. A bit.