In a series of articles that culminated in my book, The New Corporate Governance in Theory and Practice, I developed a theory of corporate governance I call director primacy.
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.
My work 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.
In contrast to most other legal academics, who focus exclusively on the problem of accountability, my work therefore argues that a fully specified account of corporate law must also incorporate the value of authority—i.e., the need to develop a set of rules and procedures that provides the most efficient decision-making system. At the core of the director primacy model therefore lies the normative claim that the virtues of authority, in terms of corporate decision-making efficiency, can be ensured only by respecting the board’s decision-making authority.
The problem is that achieving an appropriate mix between authority and accountability is a daunting task. Ultimately, authority and accountability cannot be reconciled. At some point, greater accountability necessarily makes the decision-making process less efficient, while highly efficient decision-making structures necessarily entail non-reviewable discretion.
This is so because the power to review is the power to decide. As Arrow observed: “If every decision of A is to be reviewed by B, then all we have really is a shift in the locus of authority from A to B and hence no solution to the original problem.” Shareholder oversight of board decisions—whether through the vote or in courts—would effect just such a shift. It contemplates outside review of management decisions, with shareholders or judges stepping in to make corrections and changes when management performance falters. If it were easy for shareholders to obtain such reviews, directors might be more accountable, but the board’s power of fiat would become merely advisory, rather than authoritative. The efficient separation of ownership and control that makes the modern corporation possible thus is inconsistent with routine shareholder review of board decisions.
The predictive power of director primacy is demonstrated in the host of legal doctrines and governance structures that resolve the tension between authority and accountability in the favor of the former. Because only shareholders are entitled to elect directors, for example, boards of public corporations are insulated from pressure by non-shareholder corporate constituencies, such as employees or creditors. At the same time, the diffuse nature of U.S. stockownership and regulatory impediments to investor activism insulate directors from shareholder pressure. As such, the board has virtually unconstrained freedom to exercise business judgment.
Other commenators have observed the close fit betwen my work and Delaware corporate jurisprudence:
“Although ‘Delaware has not explicitly embraced director primacy,’ the relevant statutory provisions and the [cases] have largely intimated that directors retain authority and need not passively allow either exogenous events or shareholder action to determine corporate decision-making.” Harry G. Hutchison, Director Primacy And Corporate Governance: Shareholder Voting Rights Captured By The Accountability/Authority Paradigm, 36 Loy. U. Chi. L.J. 1111, 1194 (2005).
"Delaware jurisprudence favors director primacy in terms of the definitive decisionmaking power, while simultaneously requiring directors to be ultimately concerned with the shareholders’ interest. ... The Delaware jurisprudence, while not explicitly affirming ‘director primacy,’ does implicitly leave the directors to make decisions with shareholders expressing their views only in specific and limited situations.” Kevin L. Turner, Settling The Debate: A Response To Professor Bebchuk’s Proposed Reform Of Hostile Takeover Defenses, 57 Ala. L. Rev. 907, 927-28 (2006).
A recent article in Corporate Board Member, however, suggests that Delaware courts are wandering away from the true gospel of director primacy in favor of the false prophets of shareholder primacy:
[Delaware's Court of] Chancery has been taking its lumps from ... critics who see a creeping erosion of its support for corporate prerogatives. The leading advocate for this position is Carney, a senior scholar who has written a standard textbook on M&A law. In 2008, he published a 94-page polemic entitled “The Mystery of Delaware Law’s Continuing Success,” arguing that: “The dominant phenomena present in recent Delaware judicial decisions are a loss of the courts’ faith in the good faith of directors and a significant erosion of the deference formerly granted under the business judgment rule.” He suggested firms would do better these days incorporating in one of the many states whose law is based on the Model Business Corporation Act, a generic code drawn up by the American Bar Association.
Chandler shot back a 36-page response maintaining that Carney “cherry-picked data to provide a superficially plausible characterization” of Delaware law. He then took to the road, debating Carney live at Emory and other law schools. Carney stuck to his guns, but gained personal respect for the chancellor. “He’s a lovely man,” he comments.
Yet more measured observers than Carney also observe a subtle tilt in Chancery’s rulings away from defending management and board dictat. A decision last year by Vice Chancellor Travis Laster, the court’s newest member, increased minority shareholder rights in tender offers and other actions, such as “freeze-out” consolidations of corporate subsidiaries.
Chandler himself has delivered two “anti-management” judgments in recent years that were overturned by the Supreme Court, suggesting he is gently pushing the juridical envelope for shareholders. Last October he found that a would-be acquirer, Air Products and Chemicals Inc., could use a shareholder resolution to shift the annual meeting of its target, Airgas Inc., with the aim of ousting a staggered board that opposed the purchase. Chandler reached a potentially more incendiary decision in late 2008 in the case of Lyondell Chemical Corp., whose board had approved an acquisition by European competitor Basell AF. He refused to dismiss a shareholder suit that sought personal damages from the directors on the grounds that they pushed through the unsolicited deal in just seven days without exploring the market for rival bids. The Supreme Court saw it differently and granted summary judgment for the defense. “The Court of Chancery has become more attuned to the complaints of shareholders,” one Delaware lawyer observes. "I don’t know whether the Supreme Court has.”
I have to finish my book Corporate Governance After the Crises for Oxkford, writie a book on the role and place of employees in corporate governance for Edward Elgar, and edit an anthology on insider trading for Elgar. I've also got to write an article on insider trading for that anthology and another article on the corporation sole for a symposium. All of which should keep me occupied until 2014 or thereabouts. In the interim, however, I plan on continuing to monitor the Delaware case law. If I detect a continued retreat from director primacy, a project taking them to task will go to the top of the pile.
