ProfessorBainbridge.com

What should companies maximize? A very brief comment on Hart and Zingales

Oliver Hart and Luigi Zingales have weighed in on an important question:

What is the appropriate objective function for a firm? We analyze this question for the case where shareholders are prosocial and externalities are not perfectly separable from production decisions. We argue that maximization of shareholder welfare is not the same as maximization of market value. We propose that company and asset managers should pursue policies consistent with the preferences of their investors. Voting by shareholders on corporate policy is one way to achieve this.

It is clearly not the law that company managers must "pursue policies consistent with the preferences of their investors." 

The value of a shareholder's investment, over time, rises or falls chiefly because of the skill, judgment and perhaps luck-for it is present in all human affairs-of the management and directors of the enterprise. When they exercise sound or brilliant judgment, shareholders are likely to profit; when they fail to do so, share values likely will fail to appreciate. In either event, the financial vitality of the corporation and the value of the company's shares is in the hands of the directors and managers of the firm. The corporation law does not operate on the theory that directors, in exercising their powers to manage the firm, are obligated to follow the wishes of a majority of shares. In fact, directors, not shareholders, are charged with the duty to manage the firm.

Paramount Commc'ns Inc. v. Time Inc., 1989 WL 79880, at *30 (Del. Ch. July 14, 1989), aff'd sub nom. Literary Partners, L.P. v. Time Inc., 565 A.2d 280 (Del. 1989), and aff'd, 565 A.2d 280 (Del. 1989), and aff'd sub nom. In re Time Inc. S'holder Litig., 565 A.2d 281 (Del. 1989).

Why is that the default rule rather than the one proposed by Hart and Zingales? Hart and Zingales discuss many of the standard tropes, many of which have been neaten to death on these pages and elsewhere. So let's take a different approach.

Let's start with the assumption that the current legal rule is the majoritarian default. Why?

I suspect it's less costly for firms to shareholders to learn about firm policies than for firms to try to gather information about shareholder preferences. 

Public companies exist in a fluid and constantly changing market. This is presumably one reason, for example, that shareholders get a say on pay every year (or two): As shareholder demographics shift, so may their preferences. Hart and Zingales' proposal thus would only work if shareholder preferences are stable and homogenous. Neither seems likely to be true, as my friend and colleague Iman Anabtawi has pointed out. Indeed, shareholder policy preferences can shift very rapidly when activist shareholders arrive on scene and demand sweeping changes in core policies.

Let's think of the stock market as a cafeteria. The investor can move down the line, selecting those companies that match their preferences and declining those that don't.

The Theory of the Firm in The Economist

Interesting essay does a nice job of summarizing the major contributions (except, oddly, director primacy).

The Chamber of Commerce's case for repealing/revising the shareholder proposal rule

Here

Shareholder Activism: I'm Really Disappointed in SEC Chairman Jay Clayton

Bloomberg Law reports that Jay Clayton recently told the US Chamber of Commerce that:

“We live in a democracy. We have a democratized public company system. That's good.”

Corporate governance is not supposed to be a democracy:

As Delaware’s Chancellor William Allen has observed, our “corporation law does not operate on the theory that directors, in exercising their powers to manage the firm, are obligated to follow the wishes of a majority of shares. In fact, directors, not shareholders, are charged with the duty to manage the firm.” Allen further recognized that the fact that many, “presumably most, shareholders” would have preferred the board to make a different decision “done does not . . . afford a basis to interfere with the effectuation of the board’s business judgment.” In short, corporations are not New England town meetings.

As I have explained elsewhere:

As my director primacy model of corporate governance explains, the corporation is a vehicle by which directors hire equity capital. Shareholders are entitled to use the vote to ensure that directors use their capital to pursue wealth maximization rather than personal self-interest, but shareholders have no right to set corporate policy or otherwise exercise the rights of ownership. As I explained in my article Director v. Shareholder Primacy in the Convergence Debate:

Large-scale investor involvement in corporate decisionmaking seems likely to disrupt the very mechanism that makes the public corporation practicable; namely, the centralization of essentially nonreviewable decisionmaking authority in the board of directors. The chief economic virtue of the public corporation is not that it permits the aggregation of large capital pools, as some have suggested, but rather that it provides a hierarchical decisionmaking structure well-suited to the problem of operating a large business enterprise with numerous employees, managers, shareholders, creditors, and other inputs. In such a firm, someone must be in charge: “Under conditions of widely dispersed information and the need for speed in decisions, authoritative control at the tactical level is essential for success.” While Roe argues that shareholder activism “differs, at least in form, from completely shifting authority from managers to” institutions, it is in fact a difference in form only. Shareholder activism necessarily contemplates that institutions will review management decisions, step in when management performance falters, and exercise voting control to effect a change in policy or personnel. For the reasons identified above, giving institutions this power of review differs little from giving them the power to make management decisions in the first place. Even though institutional investors probably would not micromanage portfolio corporations, vesting them with the power to review major decisions inevitably shifts some portion of the board’s authority to them.

As the paper further explains, corporate law therefore provides a whole host of devices that insulate directors from shareholder influence. The drive for shareholder democracy thus ... threatens to undermine the very structures that make corporations work.

All of which brings us to the case for pruning the shareholder proposal rule:

I made the case for pruning the rule in my article Revitalizing SEC Rule 14a-8's Ordinary Business Exemption: Preventing Shareholder Micromanagement by Proposal (March 29, 2016). UCLA School of Law, Law-Econ Research Paper No. 16-06. Available at SSRN: https://ssrn.com/abstract=2750153....

Update: A friend who knows the SEC very well sent this email in response to this post:

I saw your tweet about Clayton's Chamber remarks. I think there is a disconnect (at least I hope so) between your interpretation and what he meant. I read his comments to applaud the ability of the Everyman to invest in public companies. And separately, he had fantastic commentary on proxy advisory firms and 14a-8 (see below). I think he's our best hope for real reform in the governance space, and he can use allies like you.

 

https://www.thestreet.com/story/14243842/1/sec-s-clayton-takes-hard-line-on-activist-shareholder-proposal.html 

Recommended "Agape, Justice, and Law: How Might Christian Love Shape Law?"

I just bought Agape, Justice, and Law: How Might Christian Love Shape Law?, which was edited by friend Bob Cochran. Here's the basic blurb:

In a provocative essay, philosopher Jeffrie Murphy asks: 'what would law be like if we organized it around the value of Christian love, and if we thought about and criticized law in terms of that value?'. This book brings together leading scholars from a variety of disciplines to address that question. Scholars have given surprisingly little attention to assessing how the central Christian ethical category of love - agape - might impact the way we understand law. This book aims to fill that gap by investigating the relationship between agape and law in Scripture, theology, and jurisprudence, as well as applying these insights to contemporary debates in criminal law, tort law, elder law, immigration law, corporate law, intellectual property, and international relations. At a time when the discourse between Christian and other world views is more likely to be filled with hate than love, the implications of agape for law are crucial.

 Here's the TOC.

I was at a conference where a lot of these papers were presented. They were uniformly interesting and provocative.

More on Mandatory Arbitration Bylaw or Charter Provisions

An earlier post touched on the validity of mandatory arbitration clauses in corporate bylaws or articles of incorporation, noting Ann Lipton's skepticism about them.

It turns out that Kevin LaCroix has also been musing on this topic:

As Alison Frankel points out on here On the Case blog (here), mandatory arbitration of shareholder claims is not a new idea. Academics have been debating the possibility for decades. And as I noted in a post a few years ago, several courts did uphold the enforceability of one company’s bylaw provision requiring arbitration of shareholder claims.

Nevertheless, at least until now, the view has been that the SEC opposes provisions requiring shareholder claims to be arbitrated. The agency’s position has been a corporate charter provision mandating arbitration of shareholder claims would violate Section 29 of the ’34 Act, which voids any contractual provision that would seek to waive any right under the statute. As I noted in a post at the time (here), in 2012, the SEC advised the Carlyle Group, which planning an IPO, that owing to the mandatory shareholder claim arbitration provision in the company’s bylaws, the agency would not accelerate the firm’s registration statement. Carlyle ultimately withdrew the arbitration provision. ...

Though Piwowar seems to have invited companies planning IPOs to step forward with mandatory securities claim arbitration provisions, there may be some good reasons for companies to hold back until the situation is clarified. For starters, notwithstanding Piwowar’s comments, it is not entirely clear whether a securities claim arbitration provision would withstand scrutiny. Among other things, a court might conclude that, notwithstanding the SEC’s position, an arbitration provision is contrary to the prohibitions in Section 29.

There may be a more practical reason companies might hold back from adopting a securities claim arbitration provision, and that is concern about the market’s reaction. In her blog post, Frankel raised the question whether big institutional investors might balk at waiving their right to sue. Frankel quotes Columbia Law School Professor John Coffee as noting that a company’s adoption of an arbitration provision could have an impact on the company’s share price at the IPO. On the other hand, Frankel also quotes Michigan Law School Professor Adam Pritchard as suggesting that investors might pay more for shares of companies that could be able to avoid the expenses of securities class action lawsuits.

As Mr LaCroix points out, of course, the key question is what new SEC Chairman Jay Clayton thinks. A former SEC Commissioner once told me that SEC Chairs treat Commissioners like mushrooms: keep them in the dark and pour manure on them.

Anyway, go read the whole thing.

Trump Reportedly Plans to Renominate Hester Peirce to SEC. What about Lisa Fairfax?

Reuters reported last week that President Trump plans to renominate Hester Pierce to be an SEC Commissioner. That would leave one seat open, which by law would have to go to a Democrat. President Obama had nominated Pierce and (my friend) Lisa Fairfax. Their nominations got hung up on election year politics, but also (reportedly) because Senator Elizabeth Warren reportedly nixed Fairfax because Lisa refused to commit to voting in favor of disclosure of corporate political spending. I still think Fairfax is incredibly qualified for the job. Elizabeth Warren used to think so too.

I hope Trump sends Lisa's name back to the Senate and the Senator Warren does the right thing and supports her this time.

Pileggi on Fiduciary Duties in Limited Partnerships

Friend of the blog Francis Pileggi posts:

For my latest column in Directorship, the publication of the National Association of Corporate Directors, I discuss a recent Delaware Supreme Court decision that addresses fiduciary duties as modified in the context of a limited partnership agreement. The case of Brinckerhoff v. Enbridge Energy Company was previously highlighted on these pages, but the opinion remains required reading for any lawyer who needs to know the latest Delaware law regarding how fiduciary duties can be modified by agreement in non-corporate entities, and the interfacing of those modified duties with the implied covenant of good faith and fair dealing.

As always, his analysis greatly rewards reading.

Piercing the entity veil to reach officers

Keith Paul Bishop reports that a US District Court, applying California law, declined to pierce the veil of a LLC to reach the entity's President:

However, the Trust Funds present no evidence or even an allegation that Murphy is a member of Show Ready; they merely allege that he is the “President” of Show Ready. (Compl. ¶ 6.)  Thus, this statute [§ 17703.04] does not establish Murphy’s personal liability for Show Ready’s debts.

In our book, Limited Liability: A Legal and Economic Analysis, Todd Henderson and I discuss both the law governing LLC veil piercing and the policy arguments for and against (we come out against). We also discuss the much more limited law on piercing the corporate veil to reach corporate officers and directors rather than shareholders (which we're also against).

Which gives me an excuse to reprint this:

Josh Fershee on Director Primacy and Social Benefit Entities

Good stuff, which concludes:

My view of entity purpose remains committed to the principle of director primacy.  Director are obligated to run the entity for the benefit of the shareholders, but, absent fraud, illegality, or self-dealing, the directors decide what actions are for the benefit of shareholders.  Period, full stop.  

Ditto. (But you already knew that, didn't you?)

Might the SEC permit mandatory arbitration clauses in corporate charters?

Ann Lipton discusses:

So Michael Piwowar inspired a bit of heartburn in the plaintiffs’ bar this week when, during a speech to the Heritage Foundation, he encouraged corporations to add mandatory arbitration provisions in their charters prior to an IPO. This is a subject on which I’ve frequently posted, but since it’s in the news again I can’t let it go by without comment.

Mandatory arbitration is an idea that terrifies plaintiffs’ attorneys because arbitration clauses typically come with a class action waiver, and that could sound the death-knell for federal securities litigation.  Moreover, because the Supreme Court has interpreted the Federal Arbitration Act to bar most attempts at regulating contracts to arbitrate, see, e.g., AT&T Mobility LLC v. Concepcion, 563 U.S. 333 (2011), the fear is that once an arbitration clause makes it into the corporate governance documents, it’s pretty much game over.  The plaintiffs’ bar has long taken comfort in the fact that (at least until now) the SEC has taken the position that such provisions are impermissible, which is exactly why Piwowar's remarks raised concern.  Delaware, of course, recently amended its corporation law to prohibit the use of mandatory arbitration clauses in corporate charters and bylaws, see Del. Code tit. 8, § 115, but there’s some question as to whether the prohibition extends to federal securities claims, and, even if it does, whether Delaware’s law is preempted by the FAA.

She argues that such provisions are not viable:

But, as I explained in my article Manufactured Consent: The Problem of Arbitration Clauses in Corporate Charters and Bylaws, 104 Geo. L.J. 583 (2016) (and, to a lesser extent, my chapter Limiting Litigation Through Corporate Governance Documents, in Research Handbook on Representative Shareholder Litigation (Sean Griffith et al., eds., forthcoming 2017)) - and as I previously posted here, here, and here - I don’t think existing law permits charters and bylaws to regulate federal securities claims.  And even if charters and bylaws do extend that far, I do not believe the FAA applies.  To summarize briefly (you can consult older posts or Manufactured Consent for the long version):

First, corporate charters and bylaws only govern internal governance matters, i.e., the matters typically governed by the internal affairs doctrine.  This makes sense; corporate law is intended to govern stockholders’ relationship to the corporation in their capacity as stockholders.  It does not govern matters outside the role of the stockholder as a member of the corporate polity, such as personal torts.  Federal securities law may be closely related to corporate law, but it’s a different animal, and therefore outside the scope of the state-constructed corporate entity.

Second, though it is fashionable to describe charters and bylaws as “contractual,” I do not believe they are, at least not in the manner envisioned by the FAA.  Within the corporate form, shareholders are not treated as autonomous counterparties bargaining with directors over terms.  Thus, the preconditions for contract envisioned by the FAA jurisprudence are not present.

I have not studied the question in depth, but let me play devil's advocate anyway. First, if charters and bylaws are not contracts, why did Delaware need to amend its statute to disallow mandatory arbitration provisions. Second, so what if the FAA doesn't apply, isn't there also a common law on arbitration provisions? Third, courts have enforced mandatory arbitration clauses in the articles of entities such as an incorporated fraternal benefit association. Crosby v. Aid Ass'n for Lutherans, No. MC 00-11088, 2004 WL 2584847 (Minn. Dist. Ct. Oct. 21, 2004). 

Can the SEC unilaterally ignore Dodd-Frank rule making requirements?

When Dodd-Frank was passed, the Democrats had control of Congress, the White House, and the SEC. Despite that preponderance, Leviathan moved ever so slowly. As a result, seven years after Dodd-Frank became law there are a slew of rule making requirements imposed by the statute that remain unfulfilled.

Now, of course, the GOP controls the White House, Congress, and the SEC. The new Wall Street cops clearly have a deregulatory focus. But can they just ignore the Dodd-Frank requirements?

Bloomberg reports that the GOP is ignoring a number of Dodd-Frank regulatory mandates. Assuming Congress doesn't try twisting the SEC's arm, could a private party sue to compel the SEC to initiate the required rule making proceedings?

As I understand that law, the general rule is that "private parties have “no right to compel the agency to hold rulemaking proceedings."  Prof'l Drivers Council v. Bureau of Motor Carrier Safety, 706 F.2d 1216, 1223 (D.C.Cir.1983). See also WWHT, Inc. v. FCC, 656 F.2d 807, 818 (D.C.Cir.1981) (“It is only in the rarest and most compelling of circumstances that this court has acted to overturn an agency judgment not to institute rulemaking.”). 

On the other hand, at least one court has seen fit to grant an order compelling the SEC to initiate a rule making under Dodd-Frank:

Section 1504 of Dodd-Frank amends the Securities Exchange Act of 1934 to require “publicly traded oil, gas, and mining companies,” or “resource extraction issuers,” to disclose payments made to foreign governments or the federal government for the commercial development of oil, natural gas or minerals. D. 18 at 4. Under Dodd-Frank, these disclosures must be made in annual reports to the SEC. Id. Section 1504 requires the SEC to issue a rule implementing the new disclosure requirements. Id. Specifically, Section 1504 provides that:

Not later than 270 days after the date of enactment of the Dodd-Frank Wall Street Reform and Consumer Protection Act, the Commission shall issue final rules that require each resource extraction issuer to include in an annual report of the resource extraction issuer information relating to any payment made by the resource extraction issuer, a subsidiary of the resource extraction issuer, or an entity under the control of the resource extraction issuer to a foreign government or the Federal Government for the purpose of the commercial development of oil, natural gas, or minerals ....

*171 Id. (quoting 15 U.S.C. § 78m(q)(2)(A)) (emphasis omitted). As such, the SEC's statutory deadline for promulgating a final disclosure rule was April 17, 2011. Id. at 5.

Oxfam Am., Inc. v. United States Sec. & Exch. Comm'n, 126 F. Supp. 3d 168, 170–71 (D. Mass. 2015).

By the time the case got before the First Circuit, the SEC was in default by over a year even though it had gotten two 270 day periods to complete the rule.

The court held that because Congress had set a date-certain deadline for the issuance of the final regulation, the court had no discretion to delay the mandatory duty imposed. Accordingly, it issued an order compelling the SEC to act. See South Carolina v. United States, No. 1:16-CV-00391-JMC, 2017 WL 1053844, at *9 (D.S.C. Mar. 20, 2017) (holding that "a few courts have agreed with Forest Guardians' conclusion that when an agency action is “unlawfully withheld” under § 706(1), a reviewing court has no equitable discretion to deny an order compelling the action").

The key factor may be whether the statute in question contains both a rule making mandate AND a date-certain deadline by which the rule must be adopted. See  Cobell v. Norton, 240 F.3d 1081, 1096 (D.C. Cir. 2001) ("The D.C. Circuit, confronting a case in which an agency had unreasonably delayed an action under a statute that provided no deadline (rather than and [sic] agency that unlawfully withheld an action under a statute that imposed a deadline), explained that 'a finding that delay is unreasonable does not, alone, justify judicial intervention’”).

Richard Posner runs amok. Again.

Richard Posner, pp. 72-73 of his new book.
Actual quote says "of those states," refers back to "states of the deep South" in prev sentence. https://t.co/5braUI1rYK

— Ed Whelan (@EdWhelanEPPC) July 20, 2017

Fagor LUX Multi Cooker

I've wanted a pressure cooker for a long time but hadn't gotten around to getting one. When I finally decided to do so, I discovered the new wave of multi-cookers. In theory, they do it all: brown, sauce, simmer, slow cook, pressure cook, rice cooker, warm, etc. Research suggested that the Fagor LUX Multi Cooker was the one to get. It won the Cook's Illustrated test (albeit with a middling review), USA Today called it the one for the "organized home chef," and it won Good Housekeeping's test beating out the more popular Instant Pot:

It came up to pressure in less than 32 minutes (the fastest in our test), so even if you're busy, you can have a hearty meal on the table in under an hour. Then, using the quick-release mode, pressure drops in three minutes. Its Keep Warm function goes on automatically if you're running late, and the Lux, like only a few others, also works as a yogurt maker. It was one of the few models that excelled at making rice and was able to evenly brown a steak. When it's time for cleanup, you can pop the cooking insert in the dishwasher. Even with all the bells and whistles, this multi-cooker got top ratings in our ease-of-use tests, thanks to intuitive controls and a helpful manual.

So I bought the 6-quart model and used it to make various braises and stews. It works as advertised. When making a lamb stew, I spent more time on cutting vegetables and so on then the actual cooking required. I liked it so much I also bought the 4-quart model to make smaller meals, but I'll also use it to make (say) polenta while cooking braciola in the bigger one. In sum, highly recommended, especially for those with limited kitchen storage space. It really can replace multiple appliances and pots.

Some hints:

• The browning function is your friend. In addition to its main purpose of browning meat, I find it useful in sautéing vegetables. I start the veggies on brown and then switch to sauté after a few minutes. Giving them that jump start significantly speeds the process.
• I also use the brown function to reduce sauces as the simmer function doesn't get hot enough (according to my infrared temperature gun, simmer only brings the surface of a liquid up to about 185 °F or so).
• Use natural release for meats, as quick release seemed to toughen meat.
• The recommended Fagor accessory steamer basket is crap. Get the OXO one.
• The lack of a handle is a pain. Literally. I avoid it by using my grilling gloves to handle the cooking insert.

Bainbridge and Henderson on Limited Liability reviewed

Professor David Milman of the School of Law at the University of Lancaster reviewed Bainbridge & Henderson's Limited Liability: A Legal and Economic Analysis in vol. 28 of the International Company and Commercial Law Review (P. 243), writing that:

This new text represents scholarship in its finest form. Professors Bainbridge and Henderson provide, in succinct form, a masterly coverage of the central corporate law concept of limited liability. ...

This is a “must have” component for the personal library of any serious scholar of corporate law in the developed world. Students at all levels will benefit from the insights on offer. It could be read with interest by a range of policymakers. I would recommend it without any qualification.