ProfessorBainbridge.com

Parveen Gupta and Tim Leech on Board Oversight of Risk Management

Gupta and Leech argue for enhanced board attention to risk management. It's an interesting and detailed post, which I urge you to read. I am deeply skeptical, however, of their calls for greater regulatory attention to the issue. As I have written elsewhere (Stephen M. Bainbridge, Caremark and Enterprise Risk Management, 34 J. Corp. L. 967, 982-83 (2009)):

Just because a firm has the ability to reduce risk does not mean that it should. As the firm's residual claimants, shareholders do not get a return on their investment until all *983 other claims on the corporation have been satisfied.¹⁴¹ All else equal, shareholders therefore prefer high return projects.¹⁴² Because risk and return are directly proportional, however, implementing that preference necessarily entails choosing risky projects.¹⁴³

Even though conventional finance theory assumes shareholders are risk averse,¹⁴⁴ rational shareholders will still have a high tolerance for risky corporate projects. First, the basic corporate law principle of limited liability substantially insulates shareholders from the risks of corporate activity.¹⁴⁵ The limited liability principle holds that shareholders of a corporation may not be held personally liable for debts incurred or torts committed by the firm.¹⁴⁶ Because shareholders thus do not put their personal assets at jeopardy, other than the amount initially invested, they effectively externalize some portion of the business' total risk exposure to creditors.

Accordingly, as Chancellor Allen explained in Gagliardi v. Trifoods International, Inc.,¹⁴⁷ shareholders will want managers and directors to take risk:

Shareholders can diversify the risks of their corporate investments. Thus, it is in their economic interest for the corporation to accept in rank order all positive net present value investment projects available to the corporation, starting with the highest risk adjusted rate of return first. Shareholders don't want (or shouldn't rationally want) directors to be risk averse. Shareholders' investment interests, across the full range of their diversifiable equity investments, will be maximized if corporate directors and managers honestly assess risk and reward and accept for the corporation the highest risk adjusted returns available that are above the firm's cost of capital.^{148 ,,,,}

Just as the business judgment rule insulates risk taking from judicial review, so [In re Caremark Int'l Inc. Derivative Litg., 698 A.2d 959 (Del. Ch. 1996)] should insulate risk management from judicial review.

Risk management necessarily overlaps with risk taking because the former entails making choices about how to select the optimal level of risk to maximize firm value.151 Recall that there are only four basic ways of managing risk: avoiding it by avoiding risky activities, transferring it through insurance or hedging, mitigating it, and accepting it as unavoidable.152 All of these overlap with risk taking. Operational risk management, for example, frequently entails making decisions about whether to engage in risky lines of business and, more generally, determining whether specific risks can be justified on a cost-benefit analysis basis.153 As a result, it is becoming increasingly “difficult to draw a line between corporate governance and risk management.”154

The fuzzy line between risk-taking and risk management is nicely illustrated by how corporations use derivatives. On the one hand, they can be used to hedge risk. On the other hand, they can be used as speculative investments. In many cases, they can be used as both simultaneously.

As Chancellor Chandler correctly recognized in Citigroup, Caremark claims premised on risk management failures thus uniquely implicate the core concerns animating the business judgment rule in a way typical Caremark claims do not.155 Chancellor Chandler seemingly understood that risk management cannot be easily disentangled from risk taking, because it described plaintiffs' claim as “asking the Court to conclude . . . that the directors failed to see the extent of Citigroup's business risk and therefore made a ‘wrong’ business decision by allowing Citigroup to be exposed to the subprime mortgage market.”156 He declined to do so, explaining that “this kind of judicial second guessing is what the business judgment rule was designed to prevent, and even if a complaint is framed under a Caremark theory, this Court will not abandon such bedrock principles of Delaware fiduciary duty law.”157

It seems to me that regulators need to be cautious in this area for precisely the same reasons former Chancellor Chandler rightfully was cautious in Citigroup.

Heminway on law reviews asking faculty at other schools for reads on articles

Joan Heminway notes a growing phenomenon:

Last month, a colleague of mine received a request from a law review (one unaffiliated with her or our institution) to perform a peer review of an article that the law review was considering for publication.  The period for the requested review was short--about a week--and arrived with no prior notice two weeks before classes started.  No compensation was offered.  

Apparently, these kinds of requests for peer review have become more common, particularly among the elite law school primary law reviews.  I understand them to be a laudable attempt to improve the quality of the articles selected for publication, since law students typically are not knowledgeable or experienced enough to consistently make good judgments in that regard.  This is, in that way, an interesting development, and given its value, I guess I could live with the burden of providing these peer reviews on some level--as long as my email inbox is not clogged with requests--especially at critical junctures in the academic year.

But I would suggest that the law journals intent on getting peer review of submissions collectively build a process that incorporates this kind of review more consistently in the ordinary course of their article review processes, rather than as a last-minute surprise request of an expert faculty member.  This would take some effort, but law review editors-in-chief have engaged in collective action in the past to some effect.  They can do it again.

Personally, I am not a fan. 

Chicago Law Review Chutzpah - ProfessorBainbridge.com   Aug 5, 2011 ... I got an email from the University of Chicago law review yesterday, which I'm going to quote in pertinent part: I'm writing to you today on behalf ... www.professorbainbridge.com/.../chicago-law-review-chutzpah.html

Congratulations to my UCLAW colleague Russell Korobkin

Ted Sichelman at USD has compiled a list of the Top 25 Contracts Law Review Articles published in the last 25 years in terms of academic citations.  For those of you who haven’t otherwise been following the charts, Russell Korobkin of the UCLA School of Law alone clocks in with a remarkable three articles in the Top 25: Bounded Rationality at #5,  Status Quo Bias at #8, and, nertia and Preference in Contract Negotiation at #16.  Wow.

Link is at:  http://blogs.law.harvard.edu/nplblog/2015/09/10/top-25-most-cited-contract-law-articles-published-in-the-last-25-years-ted-sichelman/ .  

Mumm Napa Brut Prestige Sparkling Wine (Napa Valley) NV w/ Warm Duck Salad

Despite suffering from a twisted ankle and a scraped knee (don't ask), I manned up and made Ina Garten's Warm Duck Salad for dinner tonight.

Although the picture has a red wine in it, it turned out that that bottle of the 2008 Beaux Frères Pinot Noir Beaux Frères Vineyard was seriously flawed.

So I dumped it and opened the Mumm sparking wine. Lovely soft yellow color with tons of very fine bubbles. Powerful bouquet suggesting freshly baked bread, buttered toast, apples, and Meyer lemon. Ditto on the palate. Medium bodied. Good length to the finish. Grade: 90

Walter Olson on the Kim Davis Case

I got an email from Walter Olson of the Cato Institute, who passed along links to his work on the Kim Davis controversy. I thought they would be of interest to many of my readers, so I'm happy to pass it along:

The Kim Davis story has focused public attention on the issue of religious accommodation, especially in the workplace, and I have written four (!) new pieces on that subject two of them just out today. 

 

First,  if you haven't seen it, here's my Cato post from last Friday on the Kim Davis case itself:

 

http://www.cato.org/blog/kim-davis-case

 

I've got two pieces out today taking off in various directions from the Kentucky controversy. The longer one, just out at Newsweek, is an extended critique of the misnamed First Amendment Defense Act (FADA), a social-conservative priority that purports to shield believers in traditional marriage from any government discrimination whatsoever. It has been endorsed by Ted Cruz, Marco Rubio, and (incredibly) the RNC. Examine its provisions closely and you'll find it's really bad: 

 

http://www.newsweek.com/gay-marriage-and-religious-rights-say-nada-fada-370860

 

Also today at Politico Europe, my piece on why the EEOC case of a Muslim flight attendant who doesn't want to serve alcohol ("scruples about screwpulls") does not legally have much in common with the Kim Davis case. 

 

 

"Here’s the thing: The EEOC has *already* sided with Muslim employees who wish to avoid handling alcohol....If Charee Stanley or a future counterpart someday wins the right to bob and weave through the passenger cabin, handing out only beverages that meet with her spiritual approval, she’ll have this record of Congressional posturing to thank."

 

http://www.politico.eu/article/the-culture-wars-reach-new-heights/

Oman on "Kim Davis, Religious Accommodations, and Agency Law": Why Kim Davis Should Resign

Nate Oman offered up a thoughtful analysis of the Kim Davis controversy, which draws on "old fashioned agency law." When I first read it, I think it is pretty persuasive, but now I want to push the edge of the envelope a bit.

Here's the gist:

Kim Davis says that she has sincere religious objections to same-sex marriage, objections that keep her from issuing marriage licenses as county clerk.  Superficially, this sounds like a claim for a religious accommodation.  Agency law, however, explains why it is not.  In refusing to issue marriage licenses, Kim Davis is acting as the agent of Rowan County.  As an agent, her actions are the the actions of the county.  Indeed, the county, like any other juridical person, can only act through its agents.  The problem, however, is that Rowan County, as a legal person, has no religious beliefs.  Indeed, the Establishment Clause would, on my view, prohibit the county from having religious beliefs. Rowan County cannot claim a religious exemption without a violent change in our basic constitutional structure.  The county must comply with the Supreme Court's interpretation of 14th amendment and issue marriage licenses to same-sex couples.  In refusing to issue marriage licenses, Davis was both purporting to act as the agent of Rowan County and exceeding the scope of her authority as an agent.  She cannot do this.  In acting as an agent, she is the fiduciary of the county and must exercise that authority only on behalf of the county.  The county as a legal person simply cannot have the religious scruples that Davis has.

 

Now consider a hypothetical employee in the Rowan County Clerk's office with religious objections to same-sex marriage who asks that she be excused from issuing licenses to same-sex couples, requesting that a colleague without such religious scruples prepare and issue those documents.  This employee would also be an agent of Rowan county, and thus her actions could potentially become the actions of the county.  Unlike Kim Davis, however, this hypothetical employee is not seeking to act as an agent or exercise any authority on behalf of the county.  Rather, the hypothetical employee is seeking to disclaim authority.  She is asking that in this case she not be treated as an agent of the county.  This would be a request that the county accommodate her religious scruples, and it is very different than what Kim Davis is claiming. 

 

There are, of course, all sorts of arguments about whether or not my hypothetical county employee should be provided with such an accommodation and whether there is any mechanism under current law by which she might claim an accommodation.  My point is only that her case is fundamentally different than the case of Kim Davis.  Davis wishes to act as an agent of the county and exercise authority on its behalf.  My hypothetical employee, on the other hand, is trying to avoid acting as an agent and is disclaiming authority.  In short, it is the structure of agency law that illuminates the fundamental difference between religious accommodations and what Kim Davis is trying to do.

But consider another hypothetical. During the Holocaust the signature of Klaus--an agent of the German government--is required on transfer documents before the individuals in question can be sent to a concentration camp. Due to his religious scruples, Klaus refuses to sign. Isn't that exactly how Oman sets up the Davis case:

In refusing to [sign the papers], [Klaus] was both purporting to act as the agent of [the German government] and exceeding the scope of [his] authority as an agent.  [His] cannot do this.  In acting as an agent, [his] is the fiduciary of the county and must exercise that authority only on behalf of the [country].  The [country] as a legal person simply cannot have the religious scruples that [Klaus] has.

Now before you get on your high horse and start writing letters to the dean and chancellor of my university, let me be clear: I am NOT comparing same sex marriage and the Holocaust. Such a comparison would be ludicrous, offensive, and asinine. Which probably won't stop some lunatic left-wing blogger from claiming that's what I'm doing. But I ask you to try reading the whole post with an open mind.

I am simply trying to tee up the question of whether agency law in fact does the work Oman claims. Oman is basically saying that there is no conscientious objector exception to the agent's duty to obey the principal. And that is the point I want to explore. I chose the Klaus example precisely because it is the strongest case I can imagine for saying that there should be a conscientious objector exception to the agent's duty to obey the principal.

If Oman (or the reader) thinks Klaus should get a conscientious objector pass on violating agency law, then it seems to me he must show that Klaus' situation differs in kind and not just degree from Davis'. 

One possible way of doing so would be to focus on the wording of the agent's duty to obey as set out in the Restatement (Third) of Agency:

An agent has a duty to comply with all lawful instructions received from the principal and persons designated by the principal concerning the agent's actions on behalf of the principal.

Oman might argue that the orders given Davis to issue same sex marriage licenses were lawful and that she therefore had a duty to obey them. If so, I would agree. The Supreme Court has ruled, government action denying same sex marriage is unconstitutional, and therefore the orders given Davis were lawful instructions she has a duty to obey.

But then Oman must argue that the instructions given Klaus were unlawful. Assume that the laws in question were validly adopted under German law. Does their presumed invalidity under international human rights law excuse Klaus? Assume the answer to that is no, so that the question of whether Klaus gets a conscientious objector pass on obeying a lawful order is fairly presented by the hypothetical.

I think the problem here is that I (at least) intuitively want to give Klaus a conscientious objector pass. But that gets me into the difference in king versus degree problem.

The way of avoiding the whole difference in kind versus degree problem would be to acknowledge that there is no conscientious objector exception to the agent's duty to obey a lawful order period. Even for evil laws like the one Klaus must enforce.

In that case, the answer is clear, if Klaus' religious scruples preclude him from obeying a lawful order he should resign. And so should Davis. The right thing for her to do is either to issue the licenses or quit.

(Like Oman, I pass on the question of whether the county should accommodate her scruples by having somebody else issue the licenses.)

How Professors Bebchuk and Jackson are aiding and abetting Hillary Clinton's attack on GOP funding

As we know:

Lucian Bebchuk is Professor of Law, Economics, and Finance at Harvard Law School. Robert J. Jackson, Jr. is Professor of Law at Columbia Law School. Bebchuk and Jackson served as co-chairs of the Committee on Disclosure of Corporate Political Spending, which filed a rulemaking petition requesting that the SEC require all public companies to disclose their political spending.

Now put that fact together with this report from the LA Times:

Hillary Rodham Clinton knows her plan to stop big businesses from secretly funneling tranches of cash into politics may not fly with the Supreme Court and Congress, so she has a backup plan: publicly shame the companies.

Clinton is embracing one of the few effective tactics for loosening the grip on big money in politics. The plan she announced Tuesday to force publicly traded companies to disclose all political giving comes as a growing chorus of academics and activists are finding new ways to expose companies that hide their political maneuvering. ...

"This orchestrated 'disclosure' campaign by opponents of the business community is meant to intimidate corporations from participating in important policy debates, either directly or through trade associations and organizations such as the U.S. Chamber," chamber spokeswoman Blair Latoff Holmes said in an email.

Those joining the chamber in pushing back against the proposal say at the very least, it is not a matter that should be decided by financial regulators.

"Supporters of this say they want what is best for shareholders, but there is lots of information at firms that shareholders do not have access to," said David Primo, a professor of political science and business administration at the University of Rochester in New York. "Shareholders cannot micromanage every decision a CEO or their team makes."

So one continues to wonder why Professors Bebchuk and Jackson are providing academic cover for HRC and the left's plan to defund the right?

Full Disclosure: I vote Republican. I contribute Republican. But I would think Bebchuk and Jackson's proposal is a horrible idea despite my political affiliations, because it runs directly counter to the director primacy model of corporate governance that I espouse. My political views just fuel that fire. (Admittedly, they make that fire quite hot!)

Cheffins on "Corporate Governance Since the Managerial Capitalism Era"

Interesting post from Brian Cheffins on the rise of corporate governance:

The term “corporate governance”, while now ubiquitous, was largely unknown in the U.S. until the 1970s and the rest of world until the 1990s. There has been little research done on why corporate governance rose to prominence when it did. Conceivably the lack of analysis could be because nothing more was going on than the adoption of a handy catch phrase encompassing already familiar topics and themes. In fact, the new terminology was accompanied by a reconfiguration of governance arrangements in U.S. public companies. These important changes coincided with and were related to the demise of a “managerial capitalism” era that reached its apex in the U.S. during the 1950s and 1960s. In my paper “Corporate Governance Since the Managerial Capitalism Era”, available at http://ssrn.com/abstract=2618480 and forthcoming in the Business History Review, I consider how and why corporate governance moved to the forefront in the manner it did as well as identify the implications for executives, directors and shareholders of public companies.

Go read the whole thing.

Corporate political spending gets even more partisan

Lucian Bebchuk and Robert Jackson are celebrating--as if it were good news--Hillary Clinton's endorsement of their proposed "SEC rulemaking that would require public companies to disclose their political spending to their shareholders." As usual, they fail to acknowledge the highly partisan nature of the proposed rule making, the reasons it is supported exclusively by Democrats (and a tiny handful of Wall Street RINOs), or the way the proposal would drag the SEC further into the cesspool of Washington politics. Why this persistent radio silence?

For a more rebuttal of Bebchuk and Jackson on the political issue, see Jim Copland's "Reply to Bebchuk and Jackson":

Professors Lucian Bebchuk and Robert Jackson argue that the Securities and Exchange Commission (SEC) should engage in rulemaking to consider rules mandating new corporate political-spending disclosures, but their rationale is inconsistent with the agency’s statutory purpose of protecting investors, improv- ing market efficiency, and facilitating capital formation. Corporations’ political expenditures are tiny in relation to corporate budgets and clearly immaterial, in and of themselves, to investors’ financial interests. Bebchuk and Jackson’s argu- ment that corporate political spending is more related to agency costs than to corporate leaders’ legitimate desire to ameliorate the potential adverse impacts of government action on businesses’ earnings, and that such agency costs could helpfully be reduced by further disclosures, is highly speculative. Instead, evi- dence strongly suggests that special-interest groups with viewpoints adverse to corporate interests have attempted to leverage existing disclosures to chill cor- porate political participation. Finally, shareholder proposals involving corpo- rate political spending and political-spending disclosure have been overwhelmingly sponsored by some of these same special-interest groups and universally rejected by shareholders at large, when opposed by boards of directors. 

See also Bradley A. Smith and Dickerson, Allen, The Non-Expert Agency: Using the SEC to Regulate Partisan Politics (March 26, 2013). Forthcoming, 3 Harv. Bus. L. Rev. (2013). Available at SSRN: http://ssrn.com/abstract=2239987:

Abstract: Over the past 15 years advocates of campaign finance reform, frustrated by the structure and design of the Federal Election Commission, have attempted to offload the duties of campaign finance regulation to other federal agencies, most notably the Internal Revenue Service but also the Federal Communications Commission and, most recently, the Securities Exchange Commission. 

We respond specifically to Professors Lucian A. Bebchuk & Robert J. Jackson, Jr., Shining Light on Corporate Political Spending, 101 Geo. L. J. 923 (2013), who urge the SEC to adopt compulsory disclosure rules to govern corporate political activity. We argue that whatever the theoretical merits of this position, the reality is that the current pressure on the SEC to take adopt new compulsory disclosure laws is a direct result of a desire to use the SEC to regulate not corporate governance or the world of investment and trading, but campaign finance. As a result, we suggest that any rules adopted are likely to be ill-advised and co-opted in the enforcement process. At the core of the theory of the independent agency is that it will develop a unique technical competence and will operate within that sphere of expertise. Pressure on the SEC (or other agencies) to regulate campaign finance takes these agencies out of their area of professional expertise and competence, and is thus likely to result in bad law, damage to institutional reputation, and a distraction from the agency’s core mission.

Smith and Dickerson refrain from getting into the "theoretical merits" of the issue, but let's not give Bebchuk and Jackson a free ride on that subject. Instead we turn to Michael Guttentag's On Requiring Public Companies to Disclose Political Spending (May 16, 2014). Columbia Business Law Review No. 3, 593 (2014); Loyola-LA Legal Studies Paper No. 2014-25. Available at SSRN: http://ssrn.com/abstract=2438078:

Abstract: Mandatory disclosure is a central feature of securities regulation in the United States, yet there is little agreement regarding precisely how the Securities and Exchange Commission (“SEC”) should determine what public companies are required to disclose. The current debate about whether the SEC should require the disclosure of political spending by public companies is but one example of this lack of consensus.

In this Article I first answer the more general question of how to evaluate any proposed public company mandatory disclosure requirement. I then apply this new evaluation method to the specific question of whether public companies should be required to disclose political spending. This analysis shows, based, in part, on previously unpublished empirical findings, that the evidence does not support requiring public companies to disclose political spending.

Just to drive the point home: "the evidence does not support requiring public companies to disclose political spending."

In sum, this is a highly political rule making proposal that would have profound partisan implications. The people who support it intend to use it to defund the right. If the SEC were to adopt it, the Democrats should add Bebchuk and Jackson to their Hall of Fame.

Will Dole go federal?

Ann Lipton raises an interesting question, which she analyzes in depth:

The Delaware Chancery Court recently issued its opinion in the Dole Food Stockholder litigation (.pdf), and it’s a doozy.

The précis, as has been reported extensively, is that according to the court, Dole’s Chair, CEO, and 40% controlling shareholder David Murdock conspired with C. Michael Carter, another Dole officer, to make Dole look less profitable than it actually was, so that Murdock could buy out the public stockholders at a bargain price.

The opinion is well worth reading if only for the entertainment value – the machinations involved, and the court’s commentary, make for a riveting tale – but I can’t help but read this and wonder, can we expect to see a follow on Section 10(b) complaint?  And what would that look like?

 

Silver Oak (Napa Valley) 2002

I've been disappointed with a lot of recent Silver Oak wines, but this 2002 Napa Valley was delicious. At age 13, it's still a surprisingly deep ruby shading into purple at the core. Almost no sediment to speak of. The bouquet is appealing, suggesting currants, blackberries, and mocha java. The flavor associations on the palate follow the nose. Smooth and silky, but there's enough structure to suggest it should age well for at least 5 or more years. Next bottle in 2016 and last in 2018? Grade: 91

Pine Ridge Cabernet Sauvignon Stags Leap District (Napa Valley) 2002

At age 13, this Pine Ridge Cabernet was still remarkably youthful in appearance, aroma, and taste. It's a blend of 86% Cabernet Sauvignon, 6% Petit Verdot, 5% Malbec and 3% Cabernet Franc, with a whopping (but nevertheless reasonably well integrated) 14.7% alcohol. Deep garnet/ruby. A fairly strong bouquet of cassis,  kirsch, blueberry, blackberry, with a dash of spice. Full bodied, with a long, slightly hot finish tailing off into sour cherries. After 30 minutes in the decanter, there was still a potent core of tannin but they were silky and did not impede the wine from offering drinking pleasure now. I suspect it would age well for another 7-10 years, but (sadly) this was my last bottle. Grade: 90

Chateau Gloria (St Julien) 2005

Deep ruby color, having thrown a modest amount of sediment. Modest bouquet of leather, pencil shavings, prunes, and blackberry. Medium-bodied with a disappointingly short finish. Drinking well now and should hold for a few more years, but probably not going to get a lot better. Good match for lamb. Grade: 88

Foxen Pinot Noir Melville Vineyard (Sta. Rita Hills) 2011

Lovely ruby color. No sediment to speak of yet. Intense aromas of cherry, tea, and smoke. On the palate, there is firm structure and a meaty quality. Should continue to improve for a  few more years, but (sadly) this was my last bottle. Good match for grilled duck breast. Grade: 91

Ridge Ponzo Vineyard Zinfandel (Russian River Valley) 2008

This beautiful example of cool climate Zinfandel was a perfect match for a strip steak and fries as I start my Labor Day weekend. It's a blend of 98% Zinfandel and 2% Petite Sirah. I'd love to ask Paul Draper what he thought the dash of Petite Sirah added (or maybe he just had a little left over?). Deep ruby color, having thrown a very modest amount of sediment. Ideal with about 45 minutes in the decanter. On the nose and palate, it called to mind cherries, blackberries, and Chambord, as well as Cabernet-like notes of cassis, tobacco, leather, and mocha java. Delicious. Might improve for a while but is hard to resist now. Grade: 90.