ProfessorBainbridge.com

California Board of Directors Gender Quota Law has Negative Effect on Stock Price of Covered Companies

Keith Paul Bishop:

Three researchers (two at Clemson and one the University of Arizona) recently announcedthe results of their study of the impact of California's board gender quota law (SB 826) on publicly traded [sic] firms headquartered in California.  They found that these companies experienced "a large negative stock market reaction" when the law was signed last year by then Governor Jerry Brown.  See Acknowledging Potentially "Fatal" Flaws, Governor Signs Board Gender Quota Bill.

The researchers also examined the costs of the law, finding bad news for smaller firms:

"The costs of board expansion are negligible for the largest firms but substantial for the smallest".  

They also observe that small firms may have a more difficult time attracting female directors. The Wall Street Journal was quick to note the study, labeling it in an editorial published on Saturday a "board diversity tax".

Among Elizabeth Warren's many dubious policy proposals perhaps the most absurd is her revival of the concession theory of the corporation

Splendid analysis by Abdurrahman Kayıklık

Keith Paul Bishop on how the SEC's proposed Rule 14a-8 amendments interact with California corporate law

State Law And Shareholder Representatives

Did The SEC Misstate State Law In Proposing Changes To Shareholder Proposal Rule?

A case comment by yours truly on Tornetta v. Musk

New WLF Legal Pulse Featured Guest Expert column by @ProfBainbridge https://t.co/3Lz17mLWwz via @wlf

— Washington Legal Fdn (@WLF) October 30, 2019

Wachtell, Lipton's False Gospel of the Law of Corporate Social Responsibility and the Reasoning Behind It

A new Harvard post by famed lawyer Martin Lipton, founding partner of Wachtell, Lipton, Rosen & Katz, and fellow WLRK partner William Savitt contains an astonishing number of erroneous statements about the purpose of the corporation.To wit:

Nor does any rule of law mandate director obeisance to the ideology of share-price maximization. No statute anywhere enshrines or even endorses the objective of share-price maximization. Nor does case law require directors to manage the ongoing business and affairs of the corporation with the paramount goal of maximizing share price. Directors may be obligated to seek the highest price in the context of a corporate auction, and the market’s perception of a corporation’s future prospects, as reflected in the stock price, is no doubt a relevant factor in deciding how to manage the company to maximize its potential. But not even the most aggressive reading of precedent identifies share-price maximization as the polestar of director decision-making.

What part of Dodge v. Ford Motor Co. do Lipton and Savitt fail to understand:

There should be no confusion (of which there is evidence) of the duties which Mr. Ford conceives that he and the stockholders owe to the general public and the duties which in law he and his codirectors owe to protesting, minority stockholders. A business corporation is organized and carried on primarily for the profit of the stockholders. The powers of the directors are to be employed for that end. The discretion of directors is to be exercised in the choice of means to attain that end, and does not extend to a change in the end itself, to the reduction of profits, or to the nondistribution of profits among stockholders in order to devote them to other purposes. [Dodge v. Ford Motor Co., 170 N.W. 668, 684 (Mich. 1919).]

Or eBay?

The corporate form in which craigslist operates, however, is not an appropriate vehicle for purely philanthropic ends, at least not when there are other stockholders interested in realizing a return on their investment. 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).]

To be sure, those cases do not require short-term profit maximization at the expense of the long-term health of the business, but neither do they contemplate what Lipton and Savitt call "a cooperative exercise among a corporation’s shareholders, directors, managers, employees, business partners, and the communities in which the corporation operates."

Lipton and Savitt might try to explain these cases and their ilk away. Many lawyers and scholars have tried to do that before. And they were all wrong. That's not just my opinion, it's also the opinion Delaware Chief Justice Leo Strine:

... advocates for corporate social responsibility pretend that directors do not have to make stockholder welfare the sole end of corporate governance, within the limits of their legal discretion, under the law of the most important American jurisdiction--Delaware. [Leo E. Strine, Jr., The Dangers of Denial: The Need for A Clear-Eyed Understanding of the Power and Accountability Structure Established by the Delaware General Corporation Law, 50 Wake Forest L. Rev. 761 (2015).]

Let's just pause a moment to savor that word: "pretend," How wonderfully well put.

And, as Strine pointed out, he is not alone in so reading the case law:

[T]he finest corporate law judge of his era--and arguably the finest overall trial judge of his era--Chancellor William T. Allen ... dilated on the two major traditions in American corporate law. In that essay, Chancellor Allen gave his own reading of Dodge v. Ford Motor Co., where the Michigan Supreme Court observed that “[a] business corporation is organized and carried on primarily for the profit of the stockholders. The powers of the directors are to be employed for that end.” He explained:

Dodge v. Ford . . . reflects as pure an example as exists of the property conception of the corporation. In this conception, the corporation is seen as it is in its nineteenth century roots, as essentially a sort of limited liability partnership. The rights of creditors, employees and others are strictly limited to statutory, contractual, and common law rights. Once the directors have satisfied those legal obligations, they have fully satisfied all claims of these “constituencies.” This property view of the nature of corporations, and of the duties owed by directors, equates the duty of directors with the duty to maximize profits of the firm for the benefit of shareholders.

In another article reflecting on his judicial career, Chancellor Allen indicated that he understood Delaware law as requiring directors, when they are not subject to the duty to maximize current stock value as in Revlon, to maximize the value for (hypothetical) stockholders who have entrusted their capital to the firm indefinitely.

In order for their argument to work, Lipton and Savitt therefore must join hands with what Strine called "forms of legal thought tied to deconstructionist linguistics and philosophy, such as critical legal studies," which "are premised on the idea that authors themselves can never understand what they intend to say or are in fact saying."

Basically, to paraphrase Strine, Lipton and Savitt are accusing Strine and other "accomplished jurists such as Chancellor Chandler, Chancellor Allen, and Justice Moore" with not understanding what they wrote, even though they wrote those opinions in high-profiles context and even though those jurists underscored their understanding of the importance of the subject matter they were addressing.

I think I understand why Lipton and Savitt are spewing the nonsense. First, I'm guessing they're assuming Elizabeth Warren will be the next President and they're trying to give their clients an argument against government-mandated corporate social responsibility. Why do I say that? How else would you explain this comment in their post?

We are deeply skeptical that mandatory corporate governance regulation is the solution.

Second, just as Lipton spent the 1980s defending corporate managers from corporate raiders during the heyday of the hostile takeover, he has spent much of recent years defending today's managers against activist hedge funds. Hence, he and Savitt justify their approach as being necessary to "curtail, if not eliminate, short-termism and to combat activist pressure for financial engineering focused on short-term gain."

I am not unsympathetic to both concerns. But that doesn't justify pretending that the law is other than what it actually is.

Much Buzz About the Internal Affairs Doctrine

Francis Pileggi:

For readers who follow the law regarding forum selection clauses, a recent article by Professor Joseph Grundfest should be of interest. The good professor addresses the December 2018 Court of Chancery decision in Sciabacucchi v. Salzberg (highlighted on these pages), and the intersection of Delaware law and Federal law in the context of forum selection clauses and the internal affairs doctrine. The abstract follows to his article titled: The Limits of Delaware Corporate Law: Internal Affairs, Federal Forum Provisions, and Sciabacucchi

A Harvard Forum post by Grundfest himself summarizes the paper. It explains the core problem and is typically punchy:

The Securities Act of 1933 provides for concurrent federal and state jurisdiction. Securities Act claims were historically litigated in federal court, but in 2015 plaintiffs began filing far more frequently in state court where dismissals are less common and weaker claims more likely to survive. D&O insurance costs for IPOs have since increased significantly. Today, approximately 75% of defendants in Section 11 claims face state court actions. Federal Forum Provisions [FFPs] respond by providing that, for Delaware-chartered entities, Securities Act claims must be litigated in federal court or in Delaware state court.

Sciabacucchi’s logic and conclusion are fragile. The opinion conflicts with controlling U.S. and Delaware Supreme Court precedent and relies critically on assumptions of fact that are demonstrably incorrect.

Moshen Manesh:

During a four-month span in late 2018, two events occurred at opposite ends of the country that could dramatically reshape the regulation of corporations in America. First, in September 2018, California enacted the nation’s first law mandating board gender diversity for all public corporations that are physically headquartered in California.[1] Second, in December 2018, the Delaware Court of Chancery in Sciabacucchi v. Salzberg ruled that a corporation may not in its governing documents regulate the rights of its shareholders arising under federal securities law.[2] Although seemingly unrelated, I argue in a forthcoming article that both events share at their core a challenge to the internal affairs doctrine – a doctrine that is at the foundation of the state-based system of corporate law in the United States. ...

Challenges at the edges of the internal affairs doctrine, like those that emerged in late 2018, are a problem unlikely to go away for Delaware. Since California enacted its first-in-the-nation board diversity statute, state legislatures in Illinois and New Jersey have considered similar bills. And earlier this year, an activist  shareholder initiated litigation against the New Jersey-chartered Johnson & Johnson, pressing it to adopt a bylaw provision mandating arbitration for all shareholder claims brought under federal securities law. These developments suggest that skirmishes at the frontiers of the internal affairs doctrine are likely to persist. And these skirmishes could both erode Delaware’s hegemony and fundamentally reshape the regulation of corporate America.

Ann Lipton:

By now, regular readers of this blog are aware that I’ve been especially forceful in arguing that litigation limits in corporate charters and bylaws can only address matters of corporate internal affairs, and that federal securities claims are beyond their scope.  Vice Chancellor Laster adopted a similar view in his Sciabacucchi v. Salzbergdecision, where he invalidated charter provisions that purport to require that all Section 11 claims against the company be brought in federal court.  Now that the matter is on appeal to the Delaware Supreme Court (Docket No. 346,2019) – and the opening brief is due today –  a lot of articles about the scope of the internal affairs doctrine are dropping. [She links a number of them]

Kevin LaCroix:

After the U.S. Supreme Court’s March 2018 decision in the Cyancase that state courts retain concurrent jurisdiction for ’33 Act liability actions, one idea that circulated was that companies could avoid securities class action lawsuits in state court by adopting a charter provision designating a federal forum for these kinds of suits. Unfortunately, in December 2018, Delaware Chancery Court Vice Chancellor Travis Laster held in Sciabacucchi v. Salzburg that under Delaware law federal forum provisions are invalid and ineffective, as discussed here. The Sciabacucchi decision, which is now on appeal, is the subject of a comprehensive critique in a recent article by Stanford Law Professor Joseph Grundfest, entitled “The Limits of Delaware Corporate Law: Internal Affairs, Federal Forum Provisions, and Sciabacucchi” (here). Professor Grundfest argues that Sciabacucchi was wrongly decided and that a under a “straightforward” application of applicable Delaware statutory law, federal forum provisions are valid and permitted.

I recommend reading all of them.

 

A First Challenge to California’s Board Gender Diversity Law

Cydney Posner:

As reported here on Bloomberg, a conservative activist group has filed a lawsuit, Crest v. Alex Padilla, in California state court on behalf of three California taxpayers seeking to prevent implementation and enforcement of SB 826, California’s Board gender diversity legislation. This appears to be the first litigation filed to challenge the new law. Framed as a “taxpayer suit,” the litigation seeks to enjoin Alex Padilla, the California Secretary of State, from expending taxpayer funds and taxpayer-financed resources to enforce or implement the law, alleging that the law’s mandate is an unconstitutional gender-based quota and violates the California constitution. 

I don't know enough about taxpayer standing under California constitutional law to know whether the lawsuit will survive a standing challenge. Nor do I know enough about equal protection law under the California constitution to know if the suit has substantive merit.

Interestingly, the issue about which I do know something is not involved in the suit:

Interestingly, there was no challenge to the legislation as a violation of the “internal affairs doctrine,” which generally provides that the law of the state of incorporation governs those matters that pertain to the relationships among or between the corporation and its officers, directors and shareholders. The new gender diversity mandate would likely be viewed as a matter of internal corporate governance, and Section 2115.5 of the new law purports to make the mandate expressly applicable to foreign corporations with outstanding shares listed on a major U.S. stock exchange—to the exclusion of the law of the jurisdiction in which the foreign corporation is incorporated. Of course, because of standing issues, different plaintiffs would have been required to make a claim of that nature.

Why are corporations defined as entities?

I offer an answer here.

Using corporate governance to effect social changes is fundamentally undemocratic

Omari Scott Simmons argues:

The embrace of shareholder activism as a tool to bring about broad social change is a welcome development. It reflects a trend of outsourcing public functions and values to private actors and stems in part from a frustration with interest group politics and existing democratic processes in the public context. However, overreliance on shareholder activism and similar private tactics may lead to an expectations gap; they are not an effective surrogate for persistent, organized, mobilized social movements that employ diverse tactics in traditional democratic venues.

What we are seeing these days is yet another attempt by the left to by pass democracy and achieve social changes they prefer without getting approval from a majority of citizens. The left used the courts to bypass democracy for years (See, e.g., Roe v. Wade). Now that the Supreme Court has a fairly solid conservative majority, the left is shifting to corporate governance to coerce corporate leaders--some of whom themselves are social justice warriors eager to cooperate--into adopting leftist policy preferences.

There's a law review article here.

Where Is Your Corporation's Principal Executive Office (Or Offices)?

Keith Paul Bishop offers some guidance to this question that became even more fraught with the passage of the California gender quota bill.

A tweet to the Business Roundtable re the law of corporate purpose

Memo to the @BizRoundtable: You don't get to "redefine" anything. Only the Delaware courts can change the law of corporate purpose. And, as you ought to know, Delaware comes down square on the side of shareholder wealth maximization. https://t.co/brym193M3U #BizRoundtable https://t.co/QHVpkG8rE6

— Professor Bainbridge (@ProfBainbridge) August 19, 2019

The Politics of Corporate Law

The political context in which corporate law is made is all too often ignored. Manabu Matsunaka has an interesting post on some recent scholarship, including his own work, on the subject:

Culpepper argues in his book Quiet Politics and Business Power: Corporate Control in Europe and Japan that salience of an issue (the extent to which a political issue draws the electorate's attention) determines whether politicians intervene in corporate law making When the salience of an issue is high, politicians act. Otherwise, they leave the issue to specialists. On the other hand, Cioffi and Höpner argue that center-left parties play a critical role in pro-shareholder reforms in their paper and in Cioffi’s monograph.

Still, the best thing I ever read on the politics of corporate law is Roberta Romano's Metapolitics and Corporate Law Reform, 36 Stanford Law Review 923 (1984).

Robert Anderson's Property Theory of Corporate Law

Robert Anderson at CLS Blue Shy Blog (editorial footnotes my own):

In a recent article, I develop a theory of the corporation as a legal entity based upon the foundation of property law, which I call a “property theory of corporate law.” This theory, unlike the contractarian perspective on the corporation, is capable of demarcating the distinctive features of corporate law from other contractual features.

In current legal scholarship, the dominant[1]view of the corporation is contractarian, one that sees the corporation as a nexus of contracts among factors of production. …

The contractarian perspective has profoundly influenced scholarly and judicial thinking on the corporation as a legal entity.[2]…

Yet the contractarian view fails to explain even the most fundamental and important aspects of shareholders’ relationships to the corporation, such as the mandatory rules of corporate law and fiduciary duties. 

I don’t buy either criticism. As for mandatory rules, it is true that “Contractarians contend that corporate law is generally comprised of default rules, from which shareholders are free to depart, rather than mandatory rules. As a normative matter, contractarians argue that this is just as it should be.” Stephen M. Bainbridge, Community and Statism: A Conservative Contractarian Critique of Progressive Corporate Law Scholarship, 82 Cornell L. Rev. 856, 860 (1997).

It is also true that mandatory rules pervade corporate law. But this observation “is far from fatal. In the first instance, most contractarians probably regard the theory's normative claim as being the more important of the two. As such, we cheerfully concede the existence of mandatory rules, while deploring that unfortunate fact. In the second, … many mandatory corporate law rules are trivial in nature. Finally, nontrivial mandatory rules are often subject to evasion by choice of form and jurisdiction.” Id. at 860-61.

“Under the contractarian model, fiduciary duties are gapfillers by which courts resolve disputes arising out of cracks in incomplete contracts.” Stephen M. Bainbridge, Director Primacy: The Means and Ends of Corporate Governance, 97 Nw. U.L. Rev. 547, 586 (2003). See generally Frank H. Easterbrook & Daniel R. Fischel, The Economic Structure of Corporate Law 90-93 (1991) (explaining that corporate law fiduciary duties should be understood as gap-fillers designed to plug holes in the inherently incomplete contract between the corporation and shareholders).

The role and nature of fiduciary duties in the contractarian theory of the firm was developed in an important series of articles, Ian Ayres and his collaborators, which argued that majoritarian defaults are not always desirable, even if a potentially dominant one can be identified. E.g., Ian Ayres, Making a Difference: The Contractual Contributions of Easterbrook and Fischel, 59 U. CHI. L. REV. 1391 (1992); Ian Ayres & Robert Gertner, Filling Gaps in Incomplete Contracts: An Economic Theory of Default Rules, 99 YALE L.J. 87 (1989); Ian Ayres & Eric Talley, Solomonic Bargaining: Dividing a Legal Entitlement to Facilitate Coasean Trade, 104 YALE L.J. 1027 (1995).

Among the alternative, non-majoritarian defaults they identify, the most relevant for our purposes are tailored defaults, muddy defaults, and penalty defaults. Fiduciary duties are an excellent example of a case in which muddy defaults are both appropriate and necessary. Stephen M. Bainbridge, Contractarianism in the Business Associations Classroom: Kovacik v. Reed and the Allocation of Capital Losses in Service Partnerships, 34 Ga. L. Rev. 631, 668 (2000).

In addition, Robert asserts that “the property theory argues that there are legal boundaries of the corporation.” I’m not heavily invested in the debate over the boundaries of the firm, so I’ll throw this one over to my friend and co-author Bill Klein:

In many modern ventures with dispersed claims and control it becomes futile to try to map out the boundaries of the firm or to apply traditional corporate law labels or concepts. Whether any particular firm is closer to the internet company or to the traditional, large hierarchical corporate structure is, of course, simply a question of fact. It is worth noting, however, that even General Motors and Ford Motor Company, which are often thought of as paradigms of the traditional hierarchical structure, have nontraditional equity structures and have restructured operations in such a way that the boundaries of the firms are no longer clearly demarcated. At an extreme, these boundaryless structures are often referred to as “virtual.”

Mitu Gulati et. al., Connected Contracts, 47 UCLA L. Rev. 887, 896–97 (2000).

Having said all that, I still think this is a very valuable contribution to the literature. Robert's critique called to mind a point I made some years ago:

Elegant and parsimonious models ... are more important for economists than for lawyers.Situation-specific mini-theories of behavior thus may be more useful for making legal decisions than a single unified theory like the traditional rational choice model.

Stephen M. Bainbridge, Why A Board? Group Decisionmaking in Corporate Governance, 55 Vand. L. Rev. 1, 55 (2002).

Similarly, it strikes me that the search for a unified field theory of the firm is unhelpful. Instead, much more useful is having a toolbox full of situation-specific mini-theories of the firm. If so, the interesting questions trying to determine what domains are best allocated to specific theories. See, e.g.,Stephen M. Bainbridge, Director Primacy: The Means and Ends of Corporate Governance, 97 Nw. U.L. Rev. 547, 596 (2003) (comparing the domains within which director primacy and team production models are useful).

Even if Robert does not convince us that he has come up with a unified field theory of the firm, he has convincingly suggested that property theory is a valid and useful situation-specific mini-theory.

Three open questions about California's Board of Directors Gender Quota Law

Keith Paul Bishop poses, but does not answer them.

Yours truly cited in a case involving right of refusal transfer restrictions in close corporations

The Westlaw headnote in Minority Dewey v. Bechthold, 18-CV-1739-JPS, 2019 WL 2193865 (E.D. Wis. May 21, 2019), explains:

Background: Minority shareholders of several closely held corporations and various related trusts and beneficiaries brought action against majority shareholders and corporations, alleging fraud and violations of Wisconsin state law in connection with their rights as shareholders, and seeking declaratory judgment that creation of transfer restriction on shares gave majority shareholders the ability to manipulate the books to force minority stockholders to sell their shares to the controllers at an artificially-depressed price, which rendered right-of-refusal provision in transfer restriction unreasonable and unenforceable as a matter of law. Defendants moved to dismiss for failure to state a claim. ...

Holdings: The District Court, J.P. Stadtmueller, J., held that: ... 

2 transfer restriction was not invalid, unreasonable, or unenforceable;

In support of that holding, the Court explained that:

Wis. Stat. § 180.0627(4)(a) permits right-of-refusal transfer restrictions that “obligate the shareholder...first to offer the corporation or other persons, whether separately, consecutively or simultaneously, an opportunity to acquire the restricted shares.” Most courts in Wisconsin (and throughout the country) uphold these restrictions if they are “reasonable” and if the party against whom the restriction is asserted had notice of the restriction. Allen v. Biltmore Tissue Corp., 2 N.Y.2d 534, 161 N.Y.S.2d 418, 141 N.E.2d 812, 816 (N.Y. Ct. App. 1957); Bruns v. Rennebohm Drug Stores, 151 Wis.2d 88, 442 N.W.2d 591, 596 (Wis. Ct. App. 1989) (acknowledging that “close corporations have a special need to control the number and character of shareholders”); Casper v. Kalt-Zimmers Mfg. Co., 159 Wis. 517, 149 N.W. 754, 756 (Wis. 1914) (noting that right-of-refusal restrictions reflect sound business policy).2 However, “if the by-law under consideration were to be construed as rendering the sale of the stock impossible to anyone except to the corporation at whatever price it wished to pay, we would, of course, strike it down as illegal.” Allen, 161 N.Y.S.2d 418, 141 N.E.2d at 816. Although Wisconsin courts routinely uphold these types of provisions, some courts have held that rights-of-refusal should be narrowly construed. Frandsen v. Jensen-Sundquist Agency, Inc., 802 F.2d 941, 945–46 (7th Cir. 1986) (applying Wisconsin law and holding that a right-of-refusal is not triggered by a merger). Finally, it is worth noting that there is no legally mandated option price. Rather, the option price is set at the discretion of the corporation. See Nichols Constr. Corp. v. St. Clair, 708 F. Supp. 768, 771 (M.D. La. 1989), aff'd mem., 898 F.2d 150 (5th Cir. 1990) (holding that “the mere failure to pay ‘fair value’ for stock under a stock redemption agreement” is not “fraud or breach of fiduciary duty.”); F.B.I. Farms, Inc. v. Moore, 798 N.E.2d 440, 448 (Ind. 2003) (“to the extent that restriction devalues the shares in the hands of any individual shareholder by reason of lack of transferability, it is the result of the bargain they struck”); see also Stephen M. Bainbridge, Corporate Law, § 14.2 (3d ed. 2015) (explaining the aforesaid and noting that, where a right-of-refusal provision is in place, even option prices set at fair market value will be dramatically discounted by potential third party purchasers to account for the bargain's low likelihood of success).