In a recent law review article (35 Seattle U. L. Rev. 1033), Matt Bodie compliments my director primacy theory for having "move[d] the ball significantly when it comes to our conceptions of the modern corporation" and for having "been influential in academic, practitioner, and judicial circles." He notes, however, that:
Bainbridge fails to flesh out his theory sufficiently to justify the near absolute control he provides to the board. He repeatedly relies on Arrow's contrast between consensus and authority to resolve any questions of power allocation in favor of stronger authority. This move--characterized by Brett McDonnell as Bainbridge's “Arrowian moment”--is the crux of his model. But as McDonnell points out, Arrow's description of the tradeoff between authority and accountability does not resolve all policy questions in favor of authority. Ultimately, Arrow's dichotomy--and by extension, the director primacy model--is “not able to tell us whether reform in favor of somewhat more accountability at the expense of some, but far from total, loss in authority is a good idea or not.”
I responded to the "Arrowian moment" critique in a paper entitled, simply enough, Director Primacy, which appears in Research Handbook on the Economics of Corporate Law
Critics of the director primacy model sometimes suggest that it overstates the importance of authority. Brett McDonnell (2009, 143), for example, argues that “Bainbridge moves very, very quickly from recognizing the tension between authority and accountability to arguing that we should presume a legal structure that favors authority over accountability, unless there are strong arguments against that presumption.” Apropos the discussion in the preceding section, however, I contend that the utility of director primacy is confirmed by its ability to explain one of the truly striking things about U.S. corporation law; namely, the extent to which the balance between authority and accountability in fact leans towards the former. As we’ve seen, for example, a host of rules serve to limit the power of shareholders vis-à-vis directors. As we’ve also just seen, the business judgment rule is designed precisely “to protect and promote the full and free exercise of the managerial power granted to Delaware directors.”[1]
In the closely related context of the procedural rules governing shareholder derivative litigation, the New York Court Appeals stated in Marx v. Akers that “By their very nature, shareholder derivative actions infringe upon the managerial discretion of corporate boards.... Consequently, we have historically been reluctant to permit shareholder derivative suits, noting that the power of courts to direct the management of a corporation’s affairs should be ‘exercised with restraint.’”[2] The Marx court further noted the need to strike “a balance between preserving the discretion of directors to manage a corporation without undue interference, through the demand requirement, and permitting shareholders to bring claims on behalf of the corporation when it is evident that directors will wrongfully refuse to bring such claims,” which is precisely the balance between authority and accountability the director primacy model predicts.
We observe similar rules seemingly designed to protect the board’s authority in statutory provisions, such as those governing transactions in which the directors are personally interested, including management buyouts, which involve a significant conflict of interest and therefore tend to get close judicial scrutiny, but which receive judicial deference in appropriate cases. (Bainbridge 1993, 1074-81) The same is true for the similar problem of target board of director resistance to unsolicited takeover bids. (Bainbridge 2008b)
On the other hand, I have never claimed that the board should have unfettered authority. In some cases, accountability concerns become some pronounced as to trump the general need for deference to the board’s authority. Once again, I turn to Arrow (1974, 78):
To maintain the value of authority, it would appear that [accountability] must be intermittent. This could be periodic; it could take the form of “management by exception,” in which authority and its decisions are reviewed only when performance is sufficiently degraded from expectations ....
Given the significant virtues of discretion, however, I continue to believe that one must not lightly interfere with the board’s decision-making authority in the name of accountability.
McDonnell (2008, 143) contends that this argument proves too much when applied to real world problems, however:
The argument that Bainbridge borrows from Arrow only tells us that there is a trade-off between authority and accountability, and that both have real value. It also tells us that it will generally be unwise to choose a structure that eliminates authority completely in favor of accountability, or vice versa. None of the major pro-accountability reform proposals currently in play, however, comes even close to eliminating board authority. In the world in which we live today, Arrow's argument is not able to tell us whether reform in favor of somewhat more accountability at the expense of some, but far from a total, loss in authority is a good idea or not.
... I have never denied that the argument McDonnell (2009, 143) calls my “Arrowian moment” doesn't do much more than establish a general presumption in favor of respecting director authority.[3] Each doctrinal problem must be carefully analyzed to determine where to strike the balance between authority and accountability. The necessary analysis typically requires one to go beyond the “Arrowian moment” to consider other policies. Hence, for example, my analysis of the business judgment rule acknowledged that:
Critics of the [Arrowian moment] likely would concede that judicial review shifts some power to decide to judges, but contend that that observation is normatively insufficient. To be sure, they might posit, centralized decision making is an essential feature of the corporation. Judicial review could serve as a redundant control on board decision making, however, without displacing the board as the primary decision maker. (Bainbridge 2008, 114)
To explain why the presumption in favor of authority prevails in this context, accordingly, I moved on to consider other policies, such as encouraging risk taking, preventing hindsight bias, and so on.
Similarly, I acknowledge that it’s not enough to point out that proposals to change the shareholder voting process would shift the balance towards accountability. One must go on to ask why such a shift is undesirable (or, preferably, to defend the presumption against such a shift). Hence, in Bainbridge (2008, chap. 5), for example, I went on to consider such questions as whether the shareholders would use the powers activists propose to give them, whether certain shareholders are more likely to do so than others, and whether those shareholders are likely to use their new powers to pursue private gains at the expense of other shareholders.
In sum, director primacy sets the stage. It defines the parameters within which the debate over particular issues takes place. It enables one to make broad predictions about the law and foundational critiques of legal rules that depart from those predictions. The fact that specific problems sometimes require additional fine tuning is hardly proof that the basic model is flawed.
Having made that concession, however, I must immediately recall, by way of analogy, recall Benjamin Cardozo’s famous dictum that the legal duties of a fiduciary should not be undermined by “the ‘disintegrating erosion’ of particular exceptions.”[4] Just so, if one believes that authority has survival value, one should protect the board of directors’ decision-making authority from the “disintegrating erosion” of reform.
This does not mean that one should always reject reforms that shift the balance towards accountability. It does, however, suggest one must pay attention to the cumulative impact of repeated reform proposals, lest one subject the board’s authority to the legal equivalent of death by a thousand cuts. It also suggests that there ought to be at least a presumption in favor of authority. In light of the huge advantages authority offers the corporate form, the burden of rebutting that presumption should be on those who wish to constrain the board’s authority.
[1] Smith v. Van Gorkom, 488 A.2d 858, 872 (Del. 1985).
[2] Mark v. Akers, 666 N.E.2d 1034, 1037 (N.Y. 1996) (quoting Gordon v. Elliman, 119 N.E.2d 331, 335 (N.Y. 1954)); see also Pogostin v. Rice, 480 A.2d 619, 624 (Del. 1984) (“[T]he derivative action impinges on the managerial freedom of directors ....”).
[3] As we have just seen, however, such a presumption has considerable explanatory value when one reviews the many corporate law doctrines that enshrine deference to boards. If one grants my starting hypothesis that corporate law tends towards efficient solutions, those doctrines are persuasive evidence for director primacy.
[4] Meinhard v. Salmon, 249 N.Y. 458, (N.Y. 1928).
