Question
We get excited about governance whenever there is a crisis. One consequence of that is the public seems to have a poor opinion of corporate officers and directors. For example, there are calls by government officials to hold the officers and directors of Silicon Valley Bank accountable although it is not clear exactly what they did wrong.
Is one of the legitimate goals of corporate governance to bolster (or restore) public confidence in corporations? How should that affect lawyers and policymakers’ work on corporate governance?
Your work has been described as defending the board centric model of corporate governance. If the public has a low opinion of boards and their members, does that affect your model in any way?
Answer
At the risk of seeming unduly flippant, the public also has a very low opinion of the President, Congress, the news media, and so on. But we muddle along with them.
In my book, Corporate Governance after the Financial Crisis, I discuss how the Sarbanes-Oxley Act responded to the crisis caused by the bursting of the tech bubble, the scandals at Enron et al., and how the Dodd-Frank Act responded to the 2007 financial crisis.
In both cases, a powerful interest group coalition centered on activist institutional investors hijacked the legislative process so as to achieve longstanding policy goals essentially unrelated to the causes or consequences of either crisis. Without exception, the Acts’ provisions lacked strong empirical or theoretical justification. To the contrary, there were theoretical and empirical reasons to believe that each would be at best bootless and most would be affirmatively bad public policy. Finally, each eroded the system of competitive federalism that is the unique genius of American corporate law by displacing state regulation with federal law. Unfortunately, this has become a recurring pattern whenever the federal government is moved to action by a new economic crisis.
In sum, the federal role in corporate governance appears to be a case of what Robert Higgs identified as the ratchet effect.[1] Higgs demonstrated that wars and other major crises typically trigger a dramatic growth in the size of government, accompanied by higher taxes, greater regulation, and loss of civil liberties. Once the crisis ends, government may shrink somewhat in size and power, but rarely back to pre-crisis levels. Just as a ratchet wrench works only in one direction, the size and scope of government tends to move in only one direction—upwards—because the interest groups that favored the changes now have an incentive to preserve the new status quo, as do the bureaucrats who gained new powers and prestige. Hence, each crisis has the effect of ratcheting up the long-term size and scope of government.
We now observe the same pattern in corporate governance. As we have seen, the federal government rarely intrudes in this sphere except when there is a crisis. At that point, policy entrepreneurs favoring federalization of corporate governance spring into action, hijacking the legislative response to the crisis to advance their agenda. Although there may be some subsequent retreat, such as Dodd-Frank’s § 404 relief for small issuers, the trend is towards ever more federal regulation.
[1] See Robert Higgs, Crisis and Leviathan: Critical Episodes in the Growth of American Government 150-56 (1987) (describing the “ratchet effect” by which Congress increases not only the scale but also the scope of the federal government on a permanent basis).
