ProfessorBainbridge.com

Religiosity Enhances the Quality of Management Earnings Forecasts

There's a new paper linked on SSRN: Chourou, Lamia and Luo, He-san and Zhong, Ligang, Does Religiosity Enhance the Quality of Management Earnings Forecasts? (July-August 2020). Journal of Business Finance & Accounting, Vol. 47, Issue 7-8, pp. 910-948, 2020, Available at SSRN: https://ssrn.com/abstract=3700039 or http://dx.doi.org/10.1111/jbfa.12446

Abstract: This study investigates whether firms located in areas with higher levels of religiosity disclose higher‐quality management earnings forecasts than do other firms. Using a US sample of 4,655 firm‐year observations over the period 2001 to 2014, we find that firms headquartered in counties with higher proportions of religious adherents issue earnings forecasts that are less optimistically biased and that the effect of religiosity is concentrated in firms with weak monitoring mechanisms. We also find that religiosity mitigates pessimistic bias in management earnings forecasts, but only for those issued by firms operating in low litigation industries. This result suggests that when the litigation risk is high, both ethicality and risk aversion are at work and their competing effects likely offset each other. Additionally, we document that forecasts issued by firms in more religious areas trigger stronger stock price reactions than those issued by other firms and that the effect is limited to forecasts containing optimistic bias. Overall, our results show that religiosity enhances the quality of management earnings forecasts, but the effect varies based on different conditions.

Unfortunately, they're charging $42 to download it, so I'm just taking the abstract's word for it.

Does Van Gorkom's requirement of an informed decision survive Corwin? I'm stumped.

Assume the following:

1. The board of directors is approached by a private equity fund-backed management buyout group.
2. The board approves the transaction but, in doing so, was grossly negligent in failing to inform themselves of all information reasonably available to them.
3. The board then puts the proposal to a vote of the shareholders. The shareholder vote is uncoerced. The proposal is approved by a substantial majority of the disinterested shareholders.
   1. But the proxy statement did not disclose that the directors had been grossly negligent in failing to inform themselves of all information reasonably available to them.
4. Has the shareholder vote satisfied Corwin?
   1. See Stroud v. Grace, 606 A.2d 75, 84 n.1 (Del. 1992) ("We recognize the long-standing principle that to comport with its fiduciary duty to disclose all relevant material facts, a board is not required to engage in “self-flagellation” and draw legal conclusions implicating itself in a breach of fiduciary duty from surrounding facts and circumstances prior to a formal adjudication of the matter. Nonetheless, when a board allegedly breaches its fiduciary duties, we will not uphold shareholder ratification unless the board discloses all material facts relevant to the issue at hand.").

Assuming Corwin applies, is there any room left for rebutting the business judgment rule by showing that the directors failed to satisfy the informed decision requirement laid out by Van Gorkom? Or is that requirement a dead letter?

On the basis of Leo Strine's decision in Singh v. Attenborough, 137 A.3d 151 (Del. 2016), I think the answer to the former is no:

We affirm the judgment of the Court of Chancery solely on the basis of its decision on reargument of October 29, 2015, finding that a fully informed, uncoerced vote of the disinterested stockholders invoked the business judgment rule standard of review. But, we note that the reargument opinion's decision to consider post-closing whether the plaintiffs stated a claim for the breach of the duty of care after invoking the business judgment rule was erroneous. Absent a stockholder vote and absent an exculpatory charter provision, the damages liability standard for an independent director or other disinterested fiduciary for breach of the duty of care is gross negligence, even if the transaction was a change-of-control transaction.Therefore, employing this same standard after an informed, uncoerced vote of the disinterested stockholders would give no standard-of-review-shifting effect to the vote. When the business judgment rule standard of review is invoked because of a vote, dismissal is typically the result. That is because the vestigial waste exception has long had little real-world relevance, because it has been understood that stockholders would be unlikely to approve a transaction that is wasteful.

On the other hand, I take it that Robert Miller disagrees:

Even after Corwin, in the absence of a Section 102(b)(7) provision in the corporate charter, a plaintiff-stockholder may argue post-closing that the stockholder vote was not fully informed, and if the plaintiff succeeds on this score, the directors would be liable in monetary damages for any breaches of their duty of care, including under Revlon. In the presence of a Section 102(b)(7) provision, the plaintiff-stockholder has to argue that any material misstatement or omission in the disclosure resulted from a breach of the board's duty of loyalty--a claim that, in a third-party transaction in which the directors were not otherwise interested--is very unlikely to succeed. See Larkin v. Shah, C.A. No. 10918-VCS, 2016 WL 4485447, at *20 (Del. Ch. Aug. 25, 2016). The upshot is that, even after Corwin, Section 102(b)(7) remains very important in insulating directors from post-closing actions for damages in merger cases.

Robert T. Miller, Smith v. Van Gorkom and the Kobayashi Maru: The Place of the Trans Union Case in the Development of Delaware Corporate Law, 9 Wm. & Mary Bus. L. Rev. 65, 219 n.676 (2017). But note that his article pre-dated Singh.

I welcome comments, but prefer not to get speculation. Cites preferred.

Update: We got a great response from Robert Miller. Here.

I'm proposing to make remote teaching a permanent option for my law school

I just sent the powers that be at my law school the following message:

I’m finding that I really enjoy teaching remotely. Let me explain why:

1. As you know, many of my classes—especially Business Associations—have to be taught in our largest classrooms, where I have to boom to be heard in the back and where my eyesight—even with glasses—prevents me from seeing the back few rows as more than blurs.
1. Remotely, I can speak normally and can see student faces more easily.
2. Because I use a Mac at home and the office, switching to the classroom Windows machines has always been a headache.
1. Using a Mac to teach from has made my life much easier.
2. Using a Mac at home has also allowed me to be much more spontaneous. I routinely pause the lecture to pull things off the internet or open files from DropBox. My greatly diminished Windows skills make that much harder on the classroom screens.
3. I find I am more experimental. I am using PollEverywhere, with I think success. But I’m also incorporating more videos and so on to see what works.
4. I’m more available to students. I send out Doddle polls to find out when they want me to hold office hours in a week. I meet with them individually via Zoom even in the evening.
5. I have the flexibility of recording a class for asynchronous viewing in even of a crisis.
6. My attendance has been very good. 20-22 out of 24.
1. I credit that in part to the greater intimacy that online learning seems to promote.
7. I get a TON of student questions via chat. Students are much more willing to ask a question via private chat than to raise their hand in a classroom, especially because I have a policy of not naming the student who sent the question.
8. I’m even attending more faculty meetings since they went to remote.
9. My carbon footprint is lower. I’ve only driven my car 4 times since March.

What I propose is that the administration give serious thought to giving faculty an option to teach remotely on a permanent basis. In my case, for example, Helen and I are about 90% sure that we will not retire in California. Currently, my plan is to retire mid-2025, when I am Social Security eligible. But remote teaching would make it possible for Helen and I to move now and for me to continue teaching well past 2025. Plus, as you know, I am not a morning person and constantly request afternoon classes. But if I were on the East Coast, I could get up late, teach a class at 1 PM and it would still be 10 am in Los Angeles. 

Recommended Reading: Roe and Shapira's "The Power of the Narrative in Corporate Lawmaking"

A new paper by Mark Roe and Roy Shapira makes some very valuable contributions to the debate over short-termism and, more important, to the way we understand corporate and securities law debates:

This Article explores the role of narrative power. Some ideas are better at being popular than others. The concept of pernicious stock market short-termism has three strong qualities that make its narrative power formidable: (1) connotation — the words themselves tell us what is good (reliable long-term commitment) and what is not (unreliable short-termism); (2) category confusion — disparate types of corporate misbehavior, such as environmental degradation and employee mistreatment, are mislabeled as being truly and primarily short-termism phenomena emanating from truncated corporate time horizons (when they in fact emanate from other misalignments), thereby making us view short-termism as even more rampant and pernicious than it is; and (3) confirmation — the idea is regularly repeated, because it is easy to communicate, and often boosted by powerful agenda-setters who benefit from its repetition.

The Article then highlights the real-world implications of narrative power — powerful narratives can be more certain than the underlying evidence, thereby leading policymakers astray.

Roe, Mark J. and Shapira, Roy, The Power of the Narrative in Corporate Lawmaking (August 24, 2020). Available at SSRN: https://ssrn.com/abstract=3703882 or http://dx.doi.org/10.2139/ssrn.3703882

There is no such thing as shareholder democracy to reclaim

There's a new paper out, Back to the Future? Reclaiming Shareholder Democracy Through Virtual Annual Meetings (August 26, 2020), by Yaron Nili and Megan Shaner, which argues that:

From demanding greater executive accountability to lobbying for social and environmental policies, shareholders today influence how managers run American corporations. In theory, shareholders exert that influence through the annual meeting: a forum where any shareholder, large or small, can speak their mind, engage with the corporation’s directors and managers, and influence each other. But today’s annual meetings, where a widely diffused group of owners often vote by proxy, are largely pro forma: only handful of shareholders attend the meeting and voting results are largely determined prior to the meeting. In many cases, this leaves Main Street investors’ voice unspoken for.

But modern technology has the potential to resurrect the annual meeting as the deliberative convocation and touchstone of shareholder democracy it once was. COVID-19 has forced most American corporations to hold their annual meetings virtually. Virtual meetings allow shareholders to attend meetings at a low cost, holding the promise of re-engaging retail shareholders in corporate governance. If structured properly, virtual meetings can reinvigorate the annual meeting, reviving shareholder democracy while maintaining the efficiency benefits of proxy voting.

It's a well written and researched paper, but I don't believe either that there ever was such a thing as shareholder democracy or that we should try to create shareholder democracy. (To be clear, I'm talking here about public corporations, not close corporation).

As to the former, the separation of control and the concomitant limitation of shareholder participation in corporate decision making is not new:

According to Berle and Means's version of economic history, dispersed ownership arose as a consequence of the development of large capital-intensive industrial corporations during the late nineteenth century. These firms required investments far larger than a single entrepreneur or family could provide, which could be obtained only by attracting funds from many investors. Because small investors needed diversification, even very wealthy individuals limited the amount they would put at risk in any particular firm, further fragmenting share ownership. The modern separation of ownership and control was the direct result of these forces, or so the story goes.

Professor Walter Werner aptly referred to Berle and Means's account as the “erosion doctrine.” According to their version of history, there was a time when the corporation behaved as it was supposed to:

The shareholders who owned the corporation controlled it. They elected a board of directors to whom they delegated management powers, but they retained residual control, uniting control and ownership. In the nation's early years the states created corporations sparingly and regulated them strictly. The first corporations, run by their proprietors and constrained by law, exercised state-granted privileges to further the public interest. The states then curtailed regulation . . . and this Eden ended. The corporation expanded into a huge concentrate of resources. Its operation vitally affected society, but it was run by managers who were accountable only to themselves and could blink at obligations to shareholders and society. The erosion doctrine, however, rested on a false account of the history of corporations. Werner explained that economic separation of ownership and control in fact was a feature of American corporations almost from the beginning of the nation:

Banks, and the other public-issue corporations of the [antebellum] period, contained the essential elements of big corporations today: a tripartite internal government structure, a share market that dispersed shareholdings and divided ownership and control, and tendencies to centralize management in full-time administrators and to diminish participation of outside directors in management.

In contrast to Berle and Means's account, which rested on technological changes during the nineteenth century, this alternative account rests on the early development of secondary trading markets. Such markets existed in New York and Philadelphia by the beginning of the nineteenth century. The resulting liquidity of corporate stock made it an especially attractive investment, which in turn made selling stock to the public an attractive financing mechanism. Stocks were purchased by a diversified and dispersed clientele, including both institutions and individuals. The national taste for speculation also played a part in the early growth of the secondary trading markets and, in turn, to dispersal of stock ownership. As a result of these economic forces, ownership and control separated not at the end of the nineteenth century, but at its beginning.

If this version of history is correct, [and it is] there never was a time in which unity of control and ownership was a central feature of U.S. corporations. To the contrary, it appears that ownership and control separated at a very early date.

Stephen M. Bainbridge, The Case for Limited Shareholder Voting Rights, 53 UCLA L. Rev. 601, 620–21 (2006). 

As to the second point, I have long argued that:

While notions of shareholder democracy permit powerful rhetoric, corporations are not New England town meetings. Put another way, we need not value corporate democracy simply because we value political democracy.

Stephen M. Bainbridge, Unocal at 20: Director Primacy in Corporate Takeovers, 31 Del. J. Corp. L. 769, 812 (2006).

More recently, I have argued that:

Who decides what products a company should sell, what prices it should charge, and so on? Is it the board of directors, the top management team, or the shareholders? In large corporations, of course, the traditional answer is the top management team operating under the supervision of the board. As for the shareholders, they traditionally have had no role in these sort of operational decisions.

This allocation of decision-making power follows from the basic principle that public corporations are not shareholder democracies. Although shareholders nominally own the corporation, they possess very few control rights normally associated with ownership. Instead, corporate law assigns virtually plenary decision-making authority to the board of directors and the subordinate managers to whom the board properly delegates authority.

This allocation of authority is essential if the corporation is to be run efficiently. Just as a large city cannot be run as a New England town meeting, a large corporation is a poor candidate for direct democracy. There simply are too many widely dispersed shareholders who have varying degrees of information about the company, differing goals and investment time horizons, and competing ideas about optimal business practices for their preferences to be aggregated efficiently. Accordingly, state corporate law traditionally has given primary decision-making authority to the board and the managers to whom the board properly delegates authority. As the Delaware General Corporation Law puts it, the “business and affairs” of a corporation “shall be managed by or under the direction of a board of directors.”

Stephen M. Bainbridge, Revitalizing SEC Rule 14a-8's Ordinary Business Exclusion: Preventing Shareholder Micromanagement by Proposal, 85 Fordham L. Rev. 705, 707–08 (2016).

My longest and most detailed argument against policies designed to promote shareholder democracy is contained in Chapter 1 of my book The New Corporate Governance in Theory and Practice. In Chapter 5, I return to the case against shareholder democracy by exploring and rejecting proposals designed to promote shareholder activism.

In sum, there was no Golden Age of shareholder democracy. There simply is nothing there to reclaim. And that's a very good thing.

Under California law, shareholder inspection rights are not an internal affair

Keith Paul Bishop writes:

In this recent post, UCLA Law School Professor Stephen Bainbridge discusses Vice Chancellor  J. Travis Laster's recent ruling that "[s]tockholder inspection rights are a core matter of internal corporate affairs."  2020 Del. Ch. LEXIS 264.  He notes that he has "long understood (and taught) that shareholder inspection rights are a rare exception to the internal affairs doctrine".  ...

I would add that the California Court of Appeal is in agreement with Professor Bainbridge's understanding and teaching.  In Valtz v. Penta Investment Corp., 139 Cal. App. 3d 803, 807 (1983), the Court held that Section 1600 (governing the right to inspect the shareholder records):

"However, even assuming the validity of this internal affairs doctrine, Penta's argument fails because section 1600 does not address an internal affair; the inspection of shareholder lists is a right incidental to the ownership of stock, affects the relationship between corporation and shareholder, and is thus subject to regulation by statute where the corporation does business."

See my article, California Court of Appeal Applies California Inspection Rights to Delaware Corporation, 17 CEB California Business Law Reporter 168 (1996).

More evidence that the Business Roundtable statement on corporate purpose was just green washing

In the prior post, I discussed the new paper studying "the CEO compensation decisions of large publicly traded companies in the U.S. following the spread of COVID-19 to see how many elected to modify CEO pay and how many left it unchanged. " Batish, Amit and Gordon, Andrew and Larcker, David F. and Tayan, Brian and Watts, Edward and Yu, Courtney, Sharing the Pain: How Did Boards Adjust CEO Pay in Response to COVID-19? (September 1, 2020). Rock Center for Corporate Governance at Stanford University Closer Look Series: Topics, Issues and Controversies in Corporate Governance No. CGRP-86, Available at SSRN: https://ssrn.com/abstract=3682766.

To be sure, the study focused on companies listed in the Russell 3000 index, which includes--but is not limited to--the companies whose CEOs signed the Business Roundtable statement on corporate purpose of which I have written much. One finding jumped out at me:

Following COVID-19, fewer than 20 percent of public companies elected to make changes to their executive and director compensation programs.

Moreover, those who did make changes reduced CEO pay by only about 8 percent.

COVID-19 has adversely impacted corporate stakeholders in numerous and dramatic ways. As the authors note, cutting the CEO's salary would have sent a "signal to shareholders, employees, and stakeholders that corporate leadership intended to share their economic burden." If the Business Roundtable statement on corporate purpose accurately stated what corporations are really doing, presumably companies would have been eager to send such a signal. Granted, companies that cut CEO salaries were more likely to layoff employees, suggesting that such firms may have sought to send such a signal. On the other hand, companies that cut CEO salaries also "were among the hardest hit in terms of stock price performance." So one could also interpret the pay cuts as a signal to their shareholders. In either case, the key takeaway remains that over 80% of Russell 3000 companies made no changes to their CEO pay in response to a debilitating crisis, which does not speak well of their desire to benefit stakeholders.

Looks like ESG ratings are of minimal utility, if any

A new paper studies "the CEO compensation decisions of large publicly traded companies in the U.S. following the spread of COVID-19 to see how many elected to modify CEO pay and how many left it unchanged. " Batish, Amit and Gordon, Andrew and Larcker, David F. and Tayan, Brian and Watts, Edward and Yu, Courtney, Sharing the Pain: How Did Boards Adjust CEO Pay in Response to COVID-19? (September 1, 2020). Rock Center for Corporate Governance at Stanford University Closer Look Series: Topics, Issues and Controversies in Corporate Governance No. CGRP-86, Available at SSRN: https://ssrn.com/abstract=3682766.

First, they found that only 502 companies in the Russell 3000 index (17%) adjusted their CEO's pay in the first 6 months of 2020. 

Surprisingly, CEO/director pay actions appear to have little relation to ESG (environmental, social, and governance) ratings for our sample of companies. Using ratings from Sustainalytics, we found that the median ESG rating of companies taking CEO/director pay actions was not significantly different from the median rating of companies that left pay unchanged (38 versus 34, respectively, with a rating of 1 indicating low ESG risk and a rating of 100 indicating high ESG risk ...).

To explore this further, we regressed the probability of observing a CEO/director pay action on ESG rating, controlling for stock-price performance and industry. We found that an increase in ESG risk is associated with a higher probability of CEO/directors taking a pay reduction. That is, companies with better ESG scores are less likely to make compensation changes, even when economic performance is held constant. This finding is unexpected. We would expect CEOs and directors of companies that truly value ESG to be more (not less) likely to reduce their pay during times of economic stress, but this is not what we found. This suggests either that firms with better ESG scores are less likely to reduce pay or that ESG scores do not accurately predict compensation actions (an element of social behavior or “S”).

They further explain:

The concept of ESG (environmental, social, and governance) centers on the fact that companies that truly embrace their stakeholders and invest in their needs have lower risk and higher performance. These companies are expected to suffer less economic loss in a downturn, and also to “do the right thing” by their employees.However, we found no observable difference in the ESG scores of companies that voluntarily reduced CEO/director pay and those that did not—despite differences in performance. Nor did we find a difference in ESG scores based on whether or not they chose to lay off employees. What does this say about our ability to accurately measure ESG? Are companies with more favorable ESG scores actually “better” companies from a stakeholder perspective?

A Delaware business corporation cannot opt out of the shareholder wealth maximization norm in its certificate of incorporation

I am going back and forth with a friend and fellow Business Associations teacher as to whether it is possible for a Delaware business corporation to opt out of the shareholder wealth maximization norm in its certificate of incorporation. As you may have already guessed from the title of this post, I am quite sure that the answer is a resounding no.

(I note, in passing, that the fact that I am helping my friend even though s/he uses the wrong BA casebook, speaks volumes. Don't you think?)

My analysis starts with Sterling v. Mayflower Hotel Corp, 93 A.2d 107, 118 (Del. 1952), which held that “the stockholders of a Delaware corporation may by contract embody in the charter a provision departing from the rules of the common law, provided that it does not transgress a statutory enactment or a public policy settled by the common law or implicit in the General Corporation Law itself.” That command must be read in conjunction with Chancellor Chandler's eBay opinion, which held that:

Jim and Craig opted to form craigslist, Inc. as a for-profit Delaware corporation and voluntarily accepted millions of dollars from eBay as part of a transaction whereby eBay became a stockholder. Having chosen a for-profit corporate form, the craigslist directors are bound by the fiduciary duties and standards that accompany that form. Those standards include acting to promote the value of the corporation for the benefit of its stockholders. The “Inc.” after the company name has to mean at least that.

eBay Dom. Holdings, Inc. v. Newmark, 16 A.3d 1, 34 (Del. Ch. 2010) (emphasis in the original). If that is not a clear statement that shareholder wealth maximization is "a public policy settled by the common law" I don't know what it is.

I would next move on to Siegman v. Tri-Star Pictures, Inc., CIV. A. 9477, 1989 WL 48746, at *8 (Del. Ch. May 5, 1989), which held that an amendment to the articles that “would eliminate or limit the liability of Tri-Star directors for breach of their fiduciary duty of loyalty” is “proscribed by § 102(b)(7).” 

I note that the Tri-Star case forced the legislature to adopt DGCL 122(17) to allow provisions in the articles that renounce specified corporate opportunities. But 122(17) does not speak to the duties at issue under eBay et al.

Accordingly. “there is substantial reason to doubt whether the Delaware Secretary of State would accept for filing a certificate of incorporation (other than for a benefit corporation) that included an expressly non-profit-maximizing mission.” David B. Guenther, The Strange Case of the Missing Doctrine and the "Odd Exercise" of Ebay: Why Exactly Must Corporations Maximize Profits to Shareholders?, 12 Va. L. & Bus. Rev. 427, 484 (2018).

Professor Guenther goes on to opine that:

Chancellor Chandler's language in eBay suggests that a non-profit-maximizing purpose may be invalid per se, regardless of whether shareholders have approved such purpose or embodied it in the corporate charter. The rights plan struck down in eBay, it must be recalled, had previously been approved by 71.6% - a supermajority - of craigslist's shareholders. If eBay is good law, whether shareholders of a Delaware for-profit corporation can simply “opt out” in the corporate charter from eBay's mandate to maximize profits appears unsettled in Delaware law.

Id. at 485.

Likewise, Larry Hammermesh and Jack Jacobs (who know a thing or two about Delaware law) opine that “we maintain that for an investor who has not expressly manifested a contrary preference, the purpose of the Delaware business corporation is maximization of the wealth of its stockholders. We further maintain that this is at  least the default rule, and earnestly doubt that this rule could be changed even in the certificate of incorporation of a traditional corporation.” Lawrence A. Hamermesh & Jack B. Jacobs, Lyman Johnson's Invaluable Contribution to Delaware Corporate Jurisprudence, 74 Wash. & Lee L. Rev. 909, 933–34 (2017).

Additionally, as Joan Heminway has pointed out:

Professor Stephen Bainbridge's academic work in analyzing anti-takeover devices and non-shareholder constituency statutes also casts doubt on the validity of private ordering that displaces the shareholder wealth maximization norm,⁶⁶ a norm that he argues is both the law and circumstantially compelled as an essential attribute of the for-profit corporation.⁶⁷ Specifically, Professor Bainbridge opines on the potential invalidity of “shark repellents”--in effect, charter-based rejections of the shareholder wealth maximization norm in response to unsolicited business combinations--as a form of private ordering involving a significant alteration of the directors' fiduciary duties.

[S]tate law arguably does not permit corporate organic documents to redefine the directors' fiduciary duties. In general, a charter amendment may not derogate from common law rules if doing so conflicts with some settled public policy. In light of the well-settled shareholder wealth maximization policy, nonmonetary factors charter amendments therefore appear vulnerable.

Joan MacLeod Heminway, Shareholder Wealth Maximization As A Function of Statutes, Decisional Law, and Organic Documents, 74 Wash. & Lee L. Rev. 939, 962 (2017).

She kindly cites: Stephen M. Bainbridge, Interpreting Non-Shareholder Constituency Statutes, 19 PEPP. L. REV. 971, 985 (1992) (questioning whether the law permits private ordering in derogation of director fiduciary duties and other common law rules); Stephen M. Bainbridge, Director Primacy: The Means and Ends of Corporate Governance, 97 NW. U. L. REV. 547, 575-77 (2003) (“[S]hareholder wealth maximization is not only the law, but also is a basic feature of corporate ideology.”).

All of which seems to me to be reinforced by Delaware’s adoption of the public benefit corporation option. If somebody wants a Delaware corporation that has a purpose other than shareholder wealth maximization, they have to go the B Corp route.

In which sometime guest poster J.W. Verret and I debate the relative merits of the MBCA and the ALI

1. There is no ALI Restatement of the Law of Corporate Governance (yet). There is only a set of Principles of Corporate Governance.
2. The MBCA is actually the law in about 35 states. None that matter, but still.

— Steve Bainbridge (@PrawfBainbridge) October 8, 2020

The American Law Institute is going to try writing a Restatement of Corporate Governance. Again. Oh joy.

It somehow escaped my attention that the American Law Institute is going to try writing a Restatement of the Law of Corporate Governance. Because they did such a good job the first time?

My article Independent Directors and the ALI Corporate Governance Project, 61 Geo. Wash. L. Rev. 1034 (1992), explored the hash the ALI made of the project the first time they tried.

The first attempt foundered. It was ultimately downgraded from a Restatement to a set of Principles, which have proven almost completely irrelevant to the development of corporate law in the intervening decades. Put bluntly, it has been almost entirely without influence.

The Project floundered because of the competing interests of the various voting blocks within the ALI.  The ALI prides itself on being, in the words of its then-President, “analytical and impartial.”  In fact, however, the process by which the project took shape most closely resembled the rough-and-tumble politics of a state legislature.

Two voting groups within the ALI—academics within the law and economics school and corporate practitioners—strongly resisted much of the Project. Law and economics scholars tended to oppose mandatory rules, be skeptical of the utility of independent directors, and resist attempts to expand the scope of judicial review of management actions. Between the steady barrage of critical academic commentary they directed at the Project and their growing strength within the ALI, their influence gradually began to be felt.  For example, Tentative Draft No. 2 strongly rejected the notion that market forces alone will result in the creation of effective monitoring systems.  In contrast, the Final Draft significantly softened and scaled back the discussion of market forces.

While resistance from the law and economics community undoubtedly played an important part in shaping the Project’s final form, the critical opposition ultimately came from corporate practitioners. Many corporate practitioners undoubtedly perceived legitimate policy objections to the Project, but there was another force at work: self-interest. In the long run, a lawyer’s self-interest points towards expansive judicial review.  Rational members of the plaintiff’s bar prefer rules throwing open the courthouse doors. So too should rational litigators within the corporate bar, given that defending lawsuits is almost as profitable as bringing them in the first instance. Even transactional lawyers have a strong interest in frequent judicial review of their client’s conduct, given that it is the threat of litigation that makes transactional lawyers necessary to those clients. Because most observers believed that the Project would significantly increase the amount of corporate litigation, long-run self-interest thus should have led practitioners to support the Project.

Short-run self-interest, however, cut the other way.  Many senior corporate executives strongly opposed the Project.  Nor did they fail to make the corporate bar aware of their views.  Indeed, it was alleged “that corporations were hiring members of the ALI to represent their interests in that body’s deliberations and that they were removing their legal business from law firms with partners who were sympathetic to the ALI’s pro-litigation outlook.”  If so, short-run self-interest argued for keeping one’s clients happy by voting as those clients wished.

The ALI’s leadership apparently believed that much of the opposition to the Project within the Institute arose from this source. Prior to the 1992 annual meeting, for example, President Perkins wrote that it was “critical that our final deliberations not be subject to the charge of a skewed representation, weighted toward any particular interest group.”  That he felt it necessary to further warn the membership not to vote unless they had “the stomach for voting in a way that an important client might not like”  strongly suggests that at least some members did not leave their clients’ interests at the door.

To understand the practicing bar’s opposition to the Project we thus must first understand the business community’s opposition. Again, much of the opposition undoubtedly proceeded from legitimate policy concerns. Many executives were concerned that the derivative suit rules, for example, would increase the number of strike suits, resulting in greater costs.  Others thought the ALI should be restating existing law, rather than making new law.  Some objected to the lack of flexibility in the Project’s various provisions.  Still others thought the Project’s drafters misunderstood the corporate enterprise.  In view of the ALI’s prestige and the widespread acceptance earlier restatements had received from courts, the business community undoubtedly feared that what it saw as policy missteps would quickly become law. 

Here too, however, self-interest no doubt also played a part. Unlike most ALI projects, the corporate governance project directly affected the prerogatives and pocketbooks of senior corporate managers. Despite all the denials and qualifications offered by the Project’s proponents, increasing management accountability—and thus management’s liability exposure—was the Project’s central goal

Not surprisingly, much of the business community’s opposition centered on the Project’s liability provisions.  Early drafts of the Project’s substantive provisions would have significantly increased the likelihood of personal liability on the part of an officer or director. Given the significantly greater risk of personal liability if those drafts had been adopted, self-interest is the most plausible explanation for the vehemence of the business community’s opposition. In turn, their opposition was reflected in the positions taken by many within the ALI.

In the face of this opposition, the Project’s drafters steadily backed down. The compromises ultimately reached generally reduced the likelihood of director and officer liability. In particular, the procedures governing derivative suits gradually moved towards the Delaware position.  The substantive provisions, including those governing interested director transactions, were likewise modified.  Perhaps as a mere incidental by-product these changes also generally introduced a greater degree of judicial deference to decisions made by independent directors.

Maybe the new Project will go more smoothly.

Maybe.

I have a sneaking feeling, however, that the new project will be the gift that keeps on giving law review article topics and that I’m going to spend much of the final years of my career takings shots at the drafts to come.

Pardon me for a moment while I get grumpy about the ESG/CSR literature

I'm reading a draft law review article corporate social responsibility. It exemplifies a recurring problem I have with the CSR/ESG crowd. They assume that there is a single way of viewing corporate social responsibility; namely, the perspective of limousine liberals. The CSR/ESG crowd never considers that somebody who adheres to, e.g., Catholic social teaching might have very different social priorities than either the Davos crowd or the Occupy Wall Street crowd.

Press accounts of the Supreme Court's oral argument in Carney v. Adams, re Delaware's political balance requirement

Long time readers may recall that I wrote a WLF backgrounder on Carney v. Adams, a case challenging Delaware's requirement of a politically balanced judiciary:

Delaware’s state constitution imposes two unique requirements on the state judiciary that differentiates its courts from those of all other states. Under the bare majority rule, no more than half of the total number of the members of the state Supreme and Superior courts and the Chancery Court can be from the same political party (50 percent plus one if there is an odd number of judges). Under the major party rule, those judges must be from a “major” political party.

James R. Adams is a Delaware lawyer who has been frustrated in his search for a Delaware judicial position because he is a political independent. Adams sued Delaware Governor Carney in federal court seeking to have the Delaware provisions declared unconstitutional. Delaware argued that Adams lacked standing and, in the alternative, that the judicial-selection provisions fell within the policymaker exception to the First Amendment’s ban on conditioning state government positions on membership in a specific political party. The district court ruled for Adams on both grounds.

On appeal, the Third Circuit held that Adams had sufficiently pled Article III standing. As to the merits, the Third Circuit addressed solely the major party rule. The court nevertheless struck down both it and the bare majority rule on grounds that the latter was not severable from the former.

I argued that the Supreme Court should reverse.

The Supreme Court heard oral argument in the case yesterday. 

Bloomberg reports that:

The U.S. Supreme Court seemed likely to reinstate Delaware rules requiring a politically balanced state judiciary, which the state argues are responsible for the “First” state’s outsized role in American corporate law.

... the majority of justices during oral argument Oct. 5 signaled they didn’t seem to think the rules unconstitutionally prohibited Independent and third parties from judicial service on Delaware state courts.

Amy Howe at SCOTUSblog reports that the Court may not reach the merits. Delaware counsel argued that Adams lacked standing, but several justices pushed back strongly on that issue. 

... the justices seemed even more concerned about the broader effect that a ruling for Adams might have on other governments around the country. Alito asked Finger whether it would be any different if a governor indicated that he would never appoint someone from the opposing political party as a judge; Finger responded that it would not. Although Finger stressed that a ruling for his client would “not necessarily” have any effect on other partisan-balance rules elsewhere, it is not clear whether the justices shared his view.

Delaware Business Times is something of an outlier, speculating that law is in trouble:

In the first case of their 2020-21 term, the U.S. Supreme Court justices wasted no time needling counsel representing the state of Delaware in a case that could change the decades-old rules under which the state’s top judges are appointed.

The case, Carney v. Adams, will be closely watched by corporate America, as it impacts courts where litigation is heard for more than a million incorporated businesses, impacting shareholders, executives and more. At question is whether a state can dictate that judges be selected from major political parties and whether it can legally divide judgeships amid parties.

Tuch on Information Fiduciaries

I'm a big fan of Andrew Tuch's work on fiduciary law. His new article is quite interesting:

Abstract Countless high-profile abuses of user data by leading technology companies have raised a basic question: should firms that traffic in user data be held legally responsible to their users as “information fiduciaries”? Privacy legislation to impose fiduciary duties of care, confidentiality and loyalty on data collectors enjoys bipartisan support but faces strong opposition from scholars. First, critics argue that the information fiduciary concept flies in the face of fundamental corporate law principles that require firms to prioritize shareholder interests over those of users. Second, it is said that the overwhelming self-interest of digital companies makes fiduciary loyalty impossible as a practical matter from the outset.

This essay finds neither objection convincing. The first objection rests on a mischaracterization of corporate law, which in reality would require compliance with user-regarding fiduciary obligations—the opposite of what critics fear. The second objection fails to convince because fiduciary law has proven itself adaptable enough to survive such challenges in other settings, such as in the asset management industry. The second objection nevertheless reveals a need for greater specificity of the fiduciary duties that would be imposed under the information fiduciary model, but even then it is unlikely that either objection would undermine the model.

Tuch, Andrew F., A General Defense of Information Fiduciaries (September 12, 2020). Washington University in St. Louis Legal Studies Research Paper No. 20-09-01, Available at SSRN: https://ssrn.com/abstract=3696946.

One of Tuch's arguments is that it is possible for Facebook (to cite one example) to owe fiduciary duties to its users, while Facebook's directors owe duties to Facebook's shareholders. This seems obviously correct. It is a basic tenet of the corporate social responsibility debate, for example, that directors' duty to maximize shareholder fiduciary duties does not require and, arguably, (see below) does not allow directors to cause the corporation to break the law.

Second, he argues that "Never in Delaware law are shareholders’ interests equated with the corporation’s immediate profitability to the exclusion of long-term interests ...."  Accordingly, because care for users will often be consistent with the long term interest of the shareholders, directors who protect user interests at the cost of short term profits will rarely (if ever) be held liable for breaching the duty of shareholder wealth maximization (citing, inter alia, yours truly). 

Third, he argues that Delaware "case law indicates clearly that directors must act 'within the law.'" Well, yes, but. It is my longstanding view that "fiduciary obligation and the duty to act lawfully make a bad fit." See also my post Can directors of corporations be held liable to shareholders when the corporation breaks the law. 

My main concern with suggesting that Facebook and its ilk should be treated as fiduciaries of their users is that fiduciary duties, by virtue of their inherent ambiguity, are a blunt instrument as a regulatory tool. Stephen M. Bainbridge, Director Primacy: The Means and Ends of Corporate Governance, 97 Nw. U.L. Rev. 547, 591 (2003). Consider, for example, the famously vague language of Meinhard v. Salmon:

In discussing the problem with a broad conception of fiduciary duty, under which the fiduciary has “a duty to act in the best interests of the beneficiary,” Lionel Smith explains that “the indeterminacy of such a duty is such that any lawyer would agree that this cannot be its correct formulation.”

Stephen M. Bainbridge, Must Salmon Love Meinhard? Agape and Partnership Fiduciary Duties, 17 Green Bag 2d 257, 265 (2014).

 

Anyway, be sure to check it out.

Are shareholder inspection rights subject to the internal affairs doctrine?

I have long understood (and taught) that shareholder inspection rights are a rare exception to the internal affairs doctrine. In our casebook, for example, we include Crane Co. v. Anaconda Co., 346 N.E.2d 507 (N.Y. 1976), in which the court applied New York law to determine whether a shareholder (that was incorporated in Illinois) was eligible to examine the stockholder list of a company incorporated in Montana. Plaintiff relied on NY BCL sec. 1315, which permits NY courts to order inspection of books and records of companies incorporated in other states.

In Juul Labs, Inc. v. Grove, CV 2020-0005-JTL, 2020 WL 4691916 (Del. Ch. Aug. 13, 2020), however, the Delaware Chancery Court held that "[s]tockholder inspection rights are a core matter of internal corporate affairs."

This is a critical holding, because the internal affairs doctrine has important constitutional implications:

“[T]he internal affairs doctrine raises important Constitutional concerns—namely, under the Fourteenth Amendment Due Process Clause, the Full Faith and Credit Clause, and the Commerce Clause.” Salzberg v. Sciabacucchi, 227 A.3d 102, 136 (Del. 2020). The Due Process Clause of the Fourteenth Amendment is implicated by the need for directors and officers “to know what law will be applied to their actions” and by the stockholders' “right to know by what standards of accountability they may hold those managing the corporation's business and affairs.” McDermott Inc. v. Lewis, 531 A.2d 206, 216–17 (Del. 1987). The Full Faith and Credit Clause “commands application of the internal affairs doctrine except in the rarecircumstance where national policy is outweighed by a significant interest of the forum state in the corporation and its shareholders.” Id. at 218 (emphasis in original) (footnote omitted). Under the Commerce Clause, a non-chartering state “ ‘has no interest in regulating the internal affairs of foreign corporations.’ ” Id. at 217. ...

The statute at issue in Juul was a California law substantially similar to New York's section 1315. As the court explained:

California is not alone in granting rights to access the books and records of foreign corporations that do business in the state. If other states could define the terms by which stockholders can inspect books and records, then a Delaware corporation could be subjected to different provisions and standards in jurisdictions around the country. Under constitutional principles outlined by the Supreme Court of the United States and under Delaware Supreme Court precedent, stockholder inspection rights are a matter of internal affairs. Grove's rights as a stockholder are governed by Delaware law, not by California law.

If widely accepted, Juul’s application of the internal affairs doctrine to shareholder inspection rights thus calls into question the constitutional validity of statutes like those of New York and California that attempt to treat shareholder inspection rights as being an exception to the internal affairs doctrine.

Juul stands in opposition to prior law that treats access to stockholder lists as a well-established exception to the internal affairs doctrine as a matter of both corporate law and conflicts of law. The Restatement (Second) of Conflict of Laws, for example, provides:

The right of a shareholder to inspect the books of a corporation poses special problems. This is an issue which can practicably be determined differently in different states. This is also an issue which, if decided differently in different states, will not seriously undermine the policy favoring uniform treatment for all shareholders of a corporation. For these reasons, a court will apply to a foreign corporation doing substantial business in the state a local statute providing for the inspection of books by a shareholder if in the court’s opinion the statute embodies an important policy.

Restatement (Second) of Conflict of Laws § 304, comment d (1971). See also Annot., 19 A.L.R.3d 869, 889-91 (1968) (noting that states have traditionally exercised authority to require disclosure of stockholder lists of foreign corporations doing business within their borders).

Although the Juul court did not directly speak to the Restatement commentary, it did address the argument that having multiple states regulating shareholder inspection rights of the same corporation would not be problematic:

An important public policy served by the internal affairs doctrine is to ensure the uniform treatment of directors, officers, and stockholders across jurisdictions. “Uniform treatment of directors, officers and shareholders is an important objective which can only be attained by having the rights and liabilities of those persons with respect to the corporation governed by a single law.” Restatement (Second) of Conflict of Laws § 302, cmt. e. “A State has an interest in promoting stable relationships among parties involved in the corporations it charters, as well as in ensuring that investors in such corporations have an effective voice in corporate affairs.” CTS Corp., 481 U.S. at 91, 107 S.Ct. 1637. Having the law of the state of incorporation govern a corporation's internal affairs “prevent[s] corporations from being subjected to inconsistent legal standards” and “provide[s] certainty and predictability,” thus “protect[ing] the justified expectations of the parties with interests in the corporation.” VantagePoint, 871 A.2d at 1112–13.

...

California's balancing of the competing interests between stockholders and the corporation differs from Delaware's. And California is not alone in granting rights to access the books and records of foreign corporations that do business in the state. If other states could define the terms by which stockholders can inspect books and records, then a Delaware corporation could be subjected to different provisions and standards in jurisdictions around the country.

Update: Our friend Francis Pileggi has an excellent post discussing the case, including treatment of its analysis of the exclusive forum clause.