Legal Theory Blog

Thompson on Globally Integrated Corporations

Robert B. Thompson (Vanderbilt University - School of Law) has posted Globally Integrated Corporations as 'Good for the Country': The Impact of Soft Law (Vanderbilt Public Law Research Paper No. 08-35) on SSRN.  Here is the abstract:

Societal control over corporations in part depends on the answer to the question of whether there are sufficient incentives or controls on corporations to insure their interests parallel those of society, or in a paraphrase of a famous statement of a half-century ago, is what is good for General Motors good for the country? This paper addresses the traditional way that governments have sought to constrain corporate behavior, how that interaction shifts when corporate subsidiaries are involved, and finally how outsourcing can again readjust that dynamic yet again. Where there are three possible methods to externalize - the use of the corporation itself, a subsidiary as a separate and distinct liability-capturing device, and the ability to move assets outside the country of regulation - soft law becomes a larger player in defining a societal response.

Broughman on Independent Directors & VC-Backed Firms

Brian J. Broughman (University of California, Berkeley - School of Law) has posted The Role of Independent Directors in VC-Backed Firms on SSRN. Here is the abstract:

This paper seeks to explain the widespread use of independent directors in the governance of VC-backed firms, and in particular their use as "tie-breakers" on the boards of these firms. I show that allocating a tie-breaking vote to an unbiased "arbiter" can reduce the opportunism that would result if either the VCs or the entrepreneur were to control the board. Consistent with my theory, data from Silicon Valley startups illustrate several mechanisms entrepreneurs and VCs use to select an unbiased independent director. I conclude by considering implications for corporate law and fiduciary obligations in VC-backed firms.

Thompson & Edelman on Corporate Voting

Robert B. Thompson and Paul H. Edelman (Vanderbilt University - School of Law and Vanderbilt University School of Law) have posted Corporate Voting (Vanderbilt Law Review, Forthcoming) on SSRN. Here is the abstract:

Discussion of shareholder voting frequently begins against a background of the democratic expectations and justifications present in decision-making in the public sphere. Directors are assumed to be agents of the shareholders in much the same way that public officers are representatives of citizens. Recent debates about majority voting and shareholder nomination of directors illustrate this pattern. Yet the corporate process differs in significant ways, partly because the market for shares permits a form of intensity voting and lets markets mediate the outcome in a way that would be foreign to the public setting and partly because the shareholders' role is more limited than that of citizens in the political process. The most developed theory of corporate voting, Easterbrook & Fischel's economic based theory from the 1980s, describes shareholder voting as the best means to fill gaps in incomplete contracts; shareholders as the residual owners have the best economic incentives to exercise such discretion. Such a theory supports unfettered shareholder action substantially broader than what actually exists.

In this article, we set out a new theory for shareholder voting based on information theory and more particularly voting as a method of error-correction. Like the prior theory, our approach explains why, among various corporate constituencies, only shareholders may vote. More importantly, our theory provides a more consistent theoretical foundation for explaining the few issues on which shareholders actually do vote. We use this approach to address the recent development of empty voting, a process where investors have used innovations in finance such as derivatives, equity swaps and share lending, to obtain voting rights in a corporation stripped of any financial interest in the company. The error-correction purpose of corporate voting requires that there be alignment between the voting right and the underlying financial interest of shares as has been illustrated in the traditional corporate law practices of one share/one vote and bans on vote buying and contracts that separate voting rights and financial interests. We propose that courts reinvigorate these principles to police empty voting. Our theory also provides a superior framework in which to assess proposals for increased shareholder power in corporate governance.

Davidoff on Private Equity

Steven M. Davidoff (University of Connecticut School of Law) has posted The Failure of Private Equity on SSRN.  Here is the abstract:

Throughout the Fall 2007 and into the new year 2008 private equity firms repeatedly attempted to terminate pending acquisitions. The litigation surrounding these purported terminations and heightened scrutiny directed upon the terms of private equity agreements opened a revealing window on a number of supposed "flaws" in the private equity structure. This Article seeks to understand whether these failures existed, and if so, what caused them. It does so by examining the forces driving the construct and evolution of private equity and the rationale for private equity's structure and specific contractual terms. I find that the private equity contract, the structure of private equity, is a rich, textured environment. The terms of the contractual relationships between the private equity firm and the acquired company are analogous to an iceberg; they form only the publicly available view of a much deeper understanding between the parties. In the non-public sphere, parties to private equity contracts utilize norms, conventions, reputational constraints, language and relational bonding to fill contractual gaps, override explicit contractual terms, and achieve a negotiated solution beyond the four corners of the contract. The attorney as transaction cost engineer in the private equity context consequently structures the private equity contract by paying heed both to contractual terms and law, contractually created forces and non-legal factors. But attorney reliance on these extra-contractual factors and forces makes the private equity structure path dependent and resistant to change. In light of these findings, the failures of the pre-Fall 2007 private equity structure were particularly a failure by attorneys to innovate and negotiate terms in full contemplation of such events. Reliance upon extra-legal forces permitted attorneys to leave private equity contracts incomplete and otherwise justified sloppy and ambiguous drafting. The result was a number of contract breaches and purported terminations by private equity firms with uneconomic consequences for targets subject to these failed acquisition attempts.

Sale on In re Caremark International Inc. Derivative Litigation

Hillary A. Sale (University of Iowa - College of Law) has posted Good Faith's Procedure And Substance, In Re Caremark International Inc., Derivative Litigation (THE ICONIC CASES IN CORPORATE LAW, Macey, ed., West/Thomson, 2008) on SSRN. Here is the abstract:

Good faith produces good procedures and good procedures produce good outcomes. These statements are descriptive of much of Delaware's corporate law as well as the Delaware courts' approach to fiduciary duties. In re Caremark International Inc., Derivative Litigation exemplifies this approach through its emphasis on monitoring and good-faith processes and procedures as well as through its procedural place in history. This essay explores the procedural elements of Caremark and the cases that followed and expanded its contours while focusing on the ways in which Caremark's procedure and substance are intertwined.

Caremark exemplifies the connections between procedure and substance in several ways. For example, Caremark and its progeny shifted the focus from exculpable care claims to non-exculpable good-faith claims. It took several opinions to change the motion-to-dismiss pleading standards, but Caremark initiated this transition. Further, as the pleading process changed and cases survived the motion to dismiss, good faith evolved from a procedural pleading mechanism to a defined, substantive directorial obligation, expanding the duty of loyalty from its traditional, financial-conflict-based focus. Additionally, the pressure for the settlement in Caremark arose, in part, out of the then-recent federal organizational sentencing guidelines: rules created through a process designed to diminish perceived inequities and judicial discretion. Caremark is also a procedural opinion, approving a proposed and agreed-upon settlement (thus generally eliminating the likelihood of appeal), but rather than simply evaluating the claims and terms, it develops and sets forth descriptions of director obligations in an era of tremendous corporate growth and expansion. Sarbanes-Oxley's section 404, although several years later in time, creates federal disclosure requirements around internal controls and procedures - the same type of systems at issue in Caremark. In doing so, Congress and the Securities and Exchange Commission pressured Delaware to update is law on directorial roles. The result was the other good-faith opinions in this essay that arose in part from the federal process and pressure.

Broome & Krawiec on Board Diversity & Signaling

Lissa L. Broome and Kimberly D. Krawiec (University of North Carolina at Chapel Hill - School of Law and University of North Carolina at Chapel Hill - School of Law) have posted Signaling Through Board Diversity: Is Anyone Listening? (University of Cincinnati Law Review, Forthcoming) on SSRN. Here is the abstract:

The ethnic and gender make-up of corporate boards has been the subject of intense public and regulatory focus in many countries, including the United States, in recent years. Of particular interest has been quantitative research on the impact, if any, of board diversity on corporate performance. This body of work leaves substantial gaps in our understanding of the precise mechanisms by which board diversity may alter the corporate environment, if indeed it does. In this symposium, we discuss some preliminary findings from our first 21 of a series of confidential, semi-structured interviews of 45 to 90 minutes in length with corporate directors. Due to multiple board service, these interviews represent 60 public company board experiences.

We limit our discussion in this Symposium to an analysis of the rationale for board diversity that figured most prominently in the interviews with our initial sample of respondents: signaling theory. Although signaling is frequently mentioned by our respondents and other researchers as a rationale supporting board diversity, we conclude that the distribution of costs and benefits of board diversity in "good" firms versus "bad" firms is unknown. We thus are unable to conclude that "bad" firms are not mimicking the signal, undermining the stability of board diversity as a meaningful signal. We, therefore, approach blanket assertions of the signaling benefits of board diversity with caution. We conclude that the signaling rationale for board diversity is at its strongest under particular conditions that may not exist at all corporations at all times.

Bainbridge on Smith v. van Gorkom

Stephen Bainbridge has posted Smith v. Van Gorkom on SSRN. Here is the abstract:

Smith v. Van Gorkom arguably was the most important corporate law decision of the 20th century. The supreme court of a state widely criticized for allegedly leading the race to the bottom held that directors who make an uninformed decision face substantial personal liability exposure. In so doing, the court breathed new life into the law of fiduciary duties.

For example, Van Gorkom presaged Unocal's significant expansion of judicial review of corporate takeovers. Indeed, a Van Gorkom-based inquiry into whether the board was fully informed remains a key component of the Unocal methodology. Likewise, Van Gorkom laid the foundation for the subsequent Caremark decision and the resulting expansion of judicial inquiry into whether the board of directors exercised proper oversight of its subordinates. In fact, most of the modern edifice of corporate fiduciary duties rests in some degree on the Van Gorkom decision.

The perception that the decision had significantly increased director liability exposure drove dramatic changes in the D&O liability insurance market. In turn, important legislative initiatives soon followed, including the now nearly universal liability limiting charter provisions authorized by Delaware General Corporation Law § 102(b)(7).

Not surprisingly, the case generated great controversy and, in fact, continues to do so. Did the Trans Union board of directors actually deserve the criticism heaped upon it by the Delaware Supreme Court? Does the Court's decision actually deserve the criticism heaped upon it by most commentators? This essay provides the back story to this remarkable decision and concludes that the gist of the decision is sound.

And here is Henry Manne's take.  And some comments by Larry Ribstein.  And Brett McDonnell.

Bainbridge on Investor Activism

Stephen M. Bainbridge (University of California, Los Angeles - School of Law) has posted Investor Activism: Reshaping the Playing Field? on SSRN. Here is the abstract:

Shareholders of U.S. corporations historically tended towards rational apathy. Holding small blocks that were unable to affect the outcome of the vote and faced with the considerable costs associated with gathering sufficient information to make an informed decision, they adopted the so-called Wall Street Rule (it was easier to switch than fight). In the last 15 years or so, a growing number of commentators and investor activists have claimed that the rising importance of institutional investors has the potential to reshape the field by empowering shareholders to become active players in corporate governance.

This paper situates investor activism in the so-called director primacy theory of corporate governance. In so doing, it demonstrates that the separation of ownership and control typical of U.S. public corporations has significant efficiency benefits. It then argues that shareholder activism threatens to undermine the advantages of director primacy without offering significant countervailing gains.

Accordingly, the paper concludes that pending regulatory proposals to expand shareholder governance rights should be viewed with suspicion.

Ahdieh on Rule 14a-8

Robert B. Ahdieh (Emory University School of Law) has posted The Dialectical Regulation of Rule 14a-8: Intersystemic Governance in Corporate Law (Journal of Business & Technology Law, Vol. 2, p. 165, 2007, Securities Law Review, Vol. 40, 2008) on SSRN. Here is the abstract:

In recent years, Rule 14a-8 of the Securities Exchange Act - first adopted more than sixty years ago to increase shareholder participation in corporate governance - has been the subject of a flurry of litigation, scholarly analysis, and SEC rulemaking. Most recently, following several years of debate, the SEC issued a significant clarification of the rule, reversing the Second Circuit's hotly contested interpretation of it in AFSCME v. AIG. For the most part, the debates surrounding Rule 14a-8 - including in the latter case - have focused on the scope of the rule's exceptions. This paper, selected for reprinting in the Securities Law Review's forthcoming volume of the year's top securities law articles, attempts to go beyond those exceptions, to suggest a fundamental rethinking of the nature and operation of the rule.

Specifically, the paper explores Rule 14a-8 as an occasion for what I have termed "intersystemic governance" - an embrace of cross-jurisdictional overlap and engagement in regulatory design and function. In its very structure, thus, Rule 14a-8 calls on the SEC to interpret and apply state law. Properly utilized, this scheme offers an opportunity for the development of regulatory norms that meaningfully integrate both federal and state values of corporate governance and shareholder participation. To this end, among other reforms, I propose a shift in the SEC presumptions applicable to no-action letters, praise Delaware's recent constitutional amendment to permit SEC certification of questions to the Delaware courts, and highlight various opportunities for heightened discourse. By means such as these, a more integrated - and ultimately more efficient - regime of shareholder participation may begin to emerge.

Ahdieh on Intersystemic Securities Regulation

Robert B. Ahdieh (Emory University School of Law) has posted From Federal Rules to Intersystemic Governance in Securities Regulation (Emory Law Journal, Vol. 57, No. 1, 2007)) on SSRN.  Here is the abstract:

In this brief essay, prepared as part of a symposium on "The New Federalism: Plural Governance in a Decentered World," I explore the regulatory dynamics at work: (1) in the operation of Securities Exchange Act Rule 14a-8, (2) in the interventions of then-Attorney General Eliot Spitzer in the national securities markets, and (3) in recent steps by the Securities and Exchange Commission to reconcile U.S. and international accounting standards. In each case, a distinct dynamic of regulatory interaction - what I term "intersystemic governance" - can be observed. In such cases, overlapping jurisdiction combines with various sources of interdependence to produce a regulatory scheme that goes beyond regulatory cooperation supporting each jurisdiction's pursuit of its own goals. Rather, it may produce something akin to joint, or intertwined, regulation of relevant individuals, institutions, or subject-matter. In such regimes, discrete sets of regulatory rules may collapse into a collective whole.