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Abstract: The Enron case challenges some of the core beliefs and practices that have underpinned various positions in the debates about corporate law and governance, including mergers and acquisitions, since the 1980s. In particular, Enron raises at least the following problems for the received model of corporate governance: First, it provides another set of reasons to question the strength of the efficient market hypothesis, here, the company's dizzyingly high stock price despite transparently irrational reliance on its auditors' compromised certification. Second, it undermines faith in the corporate governance mechanism - the monitoring board - that has been offered as a substitute for unfettered shareholder access to the market for corporate control. In particular, the board's capacity to protect the integrity of financial disclosure has not kept pace with the increasing reliance on stock price performance in measuring and rewarding managerial performance. Third, it suggests the existence of tradeoffs in the use of stock options in executive compensation because of the potential pathologies of the risk-preferring management team. Fourth, it shows the poor fit between stock-based employee compensation and employee retirement planning. More generally, it raises questions about the shift in retirement planning towards defined contribution plans, which make employees risk bearers and financial planners, and away from defined benefit plans, which impose some of the risk and fiduciary planning obligations on firms. Although the disclosure, monitoring and other failures may lead to useful reforms, Enron also reminds us that there is a problem that cannot be solved but can only be contained in the tension between imperfectly fashioned incentives and self-restraint.
Enron, corporate governance, efficient market, accountants, directors, stock options, pensions
Abstract: Between 1950 and 2005, the composition of large public company boards dramatically shifted towards independent directors, from approximately 20% independents to 75% independents. The standards for independence also became increasingly rigorous over the period. The available empirical provides no convincing explanation for this change. This Article explains the trend in terms of two interrelated developments in U.S. political economy: first, the shift to shareholder value as the primary corporate objective; second, the greater informativeness of stock market prices. The overriding effect is to commit the firm to a shareholder wealth maximizing strategy as best measured by stock price performance. In this environment, independent directors are more valuable than insiders. They are less committed to management and its vision. Instead, they look to outside performance signals and are less captured by the internal perspective, which, as stock prices become more informative, becomes less valuable. More controversially, independent directors may supply a useful friction in the operation of control markets. Independent directors can also be more readily mobilized by legal standards to help provide the public goods of more accurate disclosure (which improves stock price informativeness) and better compliance with law. In the United States, independent directors have become a complementary institution to an economy of firms directed to maximize shareholder value. Thus, the rise of independent directors and the associated corporate governance paradigm should be evaluated in terms of this overall conception of how to maximize social welfare.
Abstract: Between 1950 and 2005, the composition of large public company boards dramatically shifted towards independent directors, from approximately 20% independents to 75% independents. The standards for independence also became increasingly rigorous over the period. The available empirical evidence provides no convincing explanation for this change. This Article explains the trend in terms of two interrelated developments in U.S. political economy: first, the shift to shareholder value as the primary corporate objective; second, the greater informativeness of stock market prices. The overriding effect is to commit the fi rm to a shareholder wealth maximizing strategy as best measured by stock price performance. In this environment, independent directors are more valuable than insiders. They are less committed to management and its vision. Instead, they look to outside performance signals and are less captured by the internal perspective, which, as stock prices become more informative, becomes less valuable. More controversially, independent directors may supply a useful friction in the operation of control markets. Independent directors can also be more readily mobilized by legal standards to help provide the public goods of more accurate disclosure (which improves stock price informativeness) and better compliance with law. In the United States, independent directors have become a complementary institution to an economy of firms directed to maximize shareholder value. Thus, the rise of independent directors and the associated corporate governance paradigm should be evaluated in terms of this overall conception of how to maximize social welfare.
Corporate Governance, Independent Directors, Shareholder Value, Managers
Abstract: The rules governing controlling shareholders sit at the intersection of the two facets of the agency problem at the core of public corporations law. The first is the familiar principal-agency problem that arises from the separation of ownership and control. With only this facet in mind, a large shareholder may better police management than the standard panoply of market-oriented techniques. The second is the agency problem that arises between controlling and non-controlling shareholders, which produces the potential for private benefits of control. There is, however, a point of tangency between these facets. Because there are costs associated with holding a concentrated position and with exercising the monitoring function, some private benefits of control may be necessary to induce a party to play that role. Thus, from the point of view of public shareholders, the two facets of the agency problem present a tradeoff. The presence of a controlling shareholder reduces the managerial agency problem, but at the cost of the private benefits agency problem. Non-controlling shareholders will prefer the presence of a controlling shareholder so long as the benefits from reduction in managerial agency costs are greater than the costs of private benefits of control. The terms of this tradeoff are determined by the origami of judicial doctrines that describe the fiduciary obligations of a controlling shareholder. In this article, we examine the doctrinal limits on the private benefits of control from a particular orientation. A controlling shareholder may extract private benefits of control in one of three ways: by taking a disproportionate amount of the corporation's ongoing earnings; by freezing out the minority; or by selling control. Our thesis is that the limits on these three methods of extraction must be symmetrical because they are in substantial respects substitutes. We then consider a series of recent Delaware Chancery Court decisions that we argue point in inconsistent directions: on the one hand reducing the extent to which a controlling shareholder can extract private benefits through selling control, and on the other increasing the extent to which private benefits can be extracted through freezing out non-controlling shareholders. While judicial doctrine is too coarse a tool to specify the perfect level of private benefits, we believe these cases get it backwards - the potential for efficiency gains are greater from sale of control than from freeze outs, so that a shift that favors freeze outs as opposed to sales of control is a move in the wrong direction. In particular we argue that the Delaware law of freeze outs can be best reunified by giving "business judgment rule" protection to a transaction that is approved by a genuinely independent special committee that has the power to "say no" to a freeze out merger, while also preserving what amounts to a class-based appraisal remedy for transactions that proceed by freeze out tender offer without a special committee approval.
Controlling and non-controlling shareholder rules, ownership, Delaware law, freeze outs
Abstract: This paper argues that the principal governance failure of the Enron board was to approve a disclosure policy that made the firm's financial results substantially opaque to public capital markets, despite also approving a compensation strategy that made managerial payoffs highly sensitive to stock price changes and despite its unwillingness to engage in intense monitoring of business results and financial controls. In comparable circumstances of constrained monitoring by public markets, LBO firms and venture capitalists undertake a vigorous monitoring role. Important provisions of the Sarbanes Oxley Act can be seen as correcting for a public board's probable inability to adequately monitor a complex corporate finance strategy, "corrective disclosure." But the Act also seems to contemplate immediate disclosure of material business developments even in circumstances where premature disclosure may well sacrifice shareholder value for very little gain in capital market efficiency. The paper criticizes such "price-perfecting disclosure." A further consequence of the Act's disclosure regime may be to shift governance authority away from management and the board toward shareholders, including in the case of hostile takeovers.
corporate governance, Enron, Sarbanes-Oxley, takeover law
Abstract: The corporate convergence debate is usually presented in terms of competing efficiency and political claims. Convergence optimists assert that an economic logic will promote convergence on the most efficient form of economic organization, usually taken to be the public corporation governed under rules designed to maximize shareholder value. Convergence skeptics counterclaim that organizational diversity is possible, even probable, because of path dependent development of institutional complementarities whose abandonment is likely to be inefficient. The skeptics also assert that existing elites will use their political and economic advantages to block reform; the optimists counterclaim that the spread of shareholding will reshape politics. This article tries to move the corporate governance convergence debate away from these familiar (and important) arguments towards an international relations perspective. This move has two implications. First, the pace of convergence in corporate governance is understood to depend crucially on a country's, or, perhaps more importantly, on a group of countries' commitment to a project of transnational economic and political integration. Second, this transnational project may be best advanced by the spread of diffusely-held public firms on the Anglo-American model, because such ownership structures facilitate the contestability of corporate control, which, crucially, helps curb economic nationalism. In particular, such contestability may be necessary for state-level acquiescence to crossborder merger activity, which creates economic organizations that are special conduits for the transnational flow of capital, good, services, and people, and, no less, a transnational attitude. So both as a positive and normative matter, strong form convergence responds to a particular sort of political aspiration, not necessarily efficiency objectives conventionally understood. Examples drawn from the evolution of German shareholder capitalism during the 1990s in the context of the European Union project will illustrate the argument.
corporate governance, comparative corporate governance, takeover bid, takeover law
Abstract: High levels of executive compensation have triggered an intense debate over whether compensation results primarily from competitive pressures in the market for managerial services or from managerial overreaching. Profs. Lucian Bebchuk and Jesse Fried have advanced the debate with their recent book, Pay Without Performance: The Unfulfilled Promise of Executive Compensation, which forcefully argues that the current compensation levels are best explained by managerial rent-seeking, not by arm's length bargaining designed to create the optimum pay and performance nexus. This paper expresses three sorts of reservations with their analysis and advances its own proposals. First, maximizing shareholder value is not, as a positive or normative matter, a sufficient framework for understanding the controversy or devising a remedy. Second, many of the compensation practices identified by Bebchuk and Fried as veritable smoking guns of managerial power may have benign explanations. Third, even accepting that the present corporate governance apparatus needs improvement in the executive compensation area, the better remedy is not a wholesale expansion of shareholder power, but a tailored serious of measures designed to bolster the independence in fact of the compensation committee. Most important, the SEC should require proxy disclosure of a Compensation Discussion and Analysis statement (CD&A) signed by the members of the compensation committee (or by the responsible independent directors for firms without a compensation committee). Such a CD&A ought to collect and summarize all compensation elements for each senior executive, providing bottom line analysis. This process ownership, reputation-staking, and publicity will strengthen the committee's hand against managerial pressure and will elicit both shareholder and public responses that necessarily contribute to the compensation bargain. In addition to the CD&A, serious thought should be given to a shareholder approval vote on the CD&A, following the new UK practice.
Executive compensation, corporate governance, stock options
Abstract: The new German Takeover Act contains anti-takeover provisions that reject the "board neutrality/shareholder choice" of the rejected draft of the 13th Directive. These anti-takeover provisions may have a particular (albeit temporary) justification as part of negotiating strategy to obtain a Directive with a "level playing field" approach to a wide variety of control barriers in the EU. This is because assent to cross-border mergers and the transnational economic integration associated with such mergers ultimately depends upon the control of economic nationalism. General vulnerability to takeover bids, in which acquirers who engage in value-reducing home country bias would face a control threat, can play a valuable role in controlling economic nationalism. Nevertheless, the German anti-takeover provisions would have much more adverse impact than the U.S. counterparts to which they are frequently compared. First, the favored U.S. defensive measure, the poison pill, is not available under prevailing German principles of preemptive rights and non-discrimination against any shareholder. German firms are likely to substitute irreversible, value-decreasing measures that were replaced in the U.S. by the pill, such as capital structure changes or asset dispositions. Second, the typical U.S. practice of annual shareholder elections of board members combined with heavy institutional investor ownership in large public firms means that managements are highly sensitive to public shareholder interests in considering a takeover bid. By contrast, German supervisory boards turn over much more slowly, and are co-determined. German management feels less legal and cultural pressure to adhere to public shareholder interests. Third, stock option-laden compensation packages make U.S. managers highly receptive to premium bids, especially because a takeover typically triggers the accelerated vesting of such options. German compensation arrangements do not now and, as a matter of culturally constraint, are unlikely to imitate the U.S. version. So if Germany insists too hard on a 13th Directive to its exact taste, it risks sacrificing internal and cross-border mergers that would produce efficiency gains and aid the EU transnational project.
takeover bid, anti-takeover law, corporate governance, comparative corporate governance
Abstract: Perhaps the key question in the corporate convergence debate is the extent to which parties will settle on a shareholder capitalism model, in which managerial accountability will be measured against a public shareholder wealth maximization criterion. The paper evaluates two particular events for the impact on German corporate governance: the privatization of Deutsche Telekom and the cross-border merger between Daimler Benz and Chrysler Corp. The Deutsche Telekom transaction had symbolic impact, because it made many Germans shareholders for the first time, but the terms of the transaction substantially protected these shareholders against risk and deprived them of governance rights. The Daimler Chrysler merger, on the other hand, is a major event in governance convergence because it should inject a substantial element of US-style shareholder activism into the governance of a major German corporation. The paper identifies several elements, including: the change in the shareholder body through a dilution of traditional German holders and the addition of U.S. institutional investors, the pioneering of a template for subsequent cross-border mergers involving German firms, the flexibility of German corporate law to shareholder initiatives, and the likely rippling impact of governance changes at Daimler Chrysler on other major German corporations.
Abstract: A series of important corporate governance questions are likely to be addressed by the Delaware Supreme Court in the near future: whether a board can in fact "just say no" to a hostile bid; whether a board can thwart a proxy fight to redeem a poison pill through a "continuing director" provision in its pill (what might be called "just say never"); and whether shareholders can use their power to amend bylaws to constrain the adoption and maintenance of a pill. It is important that these questions be resolved in a way that maintains a vibrant, if not unconstrained, corporate control market. This is because control markets potentiate the use of capital market signals in the monitoring of managerial performance, which is especially important in an especially competitive domestic and global economic environment. Despite increasing institutional investor activism, the realistic possibility of a hostile acquisition is a necessary ingredient to an optimal corporate governance regime for large public corporations in a stock-market centered capital markets system. The article argues in doctrinal terms that "just say no" is not the rule in Delaware and that, at a minimum, in the case of a firm with a staggered board the retention of a poison pill beyond the insurgent's initial electoral success is no longer reasonable. Similarly, pills with continuing director provisions (so-called "deadhand pills") violate Delaware statutes that govern the constitution of the board and director authority as well as fiduciary norms that protect the shareholder franchise. Finally, since statutory formalism does not resolve the question of shareholder bylaw amendment authority, the Delaware court should adopt a model of shareholder choice that in, reserving residual governance authority for shareholders, would permit such a bylaw that generally limited the use of poison pills.
Abstract: The current debate over shareholder access to the issuer's proxy for the purpose of making director nomination is both overstated in its importance and misses the serious issue in question. The Securities Exchange Commission's new e-proxy rules, which permit reliance on proxy materials posted on a website, should substantially reduce the production and distribution cost differences between a meaningful contest waged via issuer proxy access and a freestanding proxy solicitation. The serious question relates to the appropriate disclosure required of a shareholder nominator no matter which avenue is used. Institutional investors and other shareholder activists should focus their energies on working through the mechanics of waging short-slate proxy contests using e-proxy solicitations. Activist institutions need to prepare the disclosure package required under the existing proxy rules. Such disclosure may be tested (and refined) through litigation, but a standardized package should emerge relatively quickly that the institution could use in proxy contests without a control motive. Institutional investors need to become facile with the e-proxy model (including coordinating a practice for opting-in to web-access) and should appreciate the extent to which proxy advisory services will do much of the actual solicitation work. If institutions are unwilling to make the relatively modest investment to master the mechanics of e-proxy contest, both in their initiation as well as voting in support of them, then their role in corporate governance will necessarily be limited.
corporate governance, institutional investor, proxy contests, shareholders, directors
Abstract: Shareholder and public dissatisfaction with executive compensation has led to calls for an annual shareholder advisory vote on a firm's compensation pratices and policies, so-called "say on pay." Proposed federal legislation would mandate "say on pay" generally for US public companies. This paper assesses the case for such a mandatory federal rule in light of the UK experience with a similar regime adopted in 2002. The best argument for a mandatory rule is that it would destabilize pay practices that have produced excessive compensation and that would not yield to firm-by-firm pressure. This has not been the UK experience; pay continues to increase. The most serious concern is the likely evolution of a "best compensation practices" regime which would embed normatively-opinionated practices that would ill-suit many firms. There is some evidence of a UK evolution in that direction. This problem might be more pronounced in the US because US shareholders are even more likely than their UK counterparts to delegate judgements over compensation practices to a small number of proxy advisors who themselves will be economizing on analysis. The paper argues instead for a federally provided shareholder opt-in right to a "say on pay" regime, which would change the present reliance on precatory proposals in the issuer proxy which are in turn subject to the power delegated to shareholders under state law. Secondarily, the paper argues that any mandatory regime should be limited to the 500 the largest public companies by public market float and not cover the other 13,500 firms that make public disclosure. Compensation practices at key financial firms present a distinct set of safety and soundness issues because of potential systemic risk from a failure of such firms. These risks should be separately addressed.
executive compensation, corporate governance, shareholder voting
Abstract: This is a partial and preliminary draft prepared for the Conference on Cross-border Views of Corporate Governance sponsored by the Columbia Law School Sloan Project on Corporate Governance and the L'Ecole Polytechnique Federale (Zurich), March 1997. Thanks go to David Blass for research assistance, to Mark Roe for innumerable conversations on German corporate governance, to David Charny and Katherina Pistor, for comments and suggestions, and to the Sloan Foundation for financial support.
Abstract: Employee stock ownership is usually discussed in terms of its normative desirability as a model of workplace relations or its general (in)efficiency properties. This paper considers employee stock ownership transactions as an adjustment mechanism for economic change. The starting point is the "employee stock ownership" is not a self-defining form and that specific institutions of economic participation and governance participation very much affect the viability of any particular transaction. The paper then considers the various rationales for employee stock ownership in situations of economic transition, rejecting claims of "just allocation" but suggesting that such transactions can overcome bargaining pathologies and thereby conserve the value of the firm. One important question is whether employee stock ownership transactions produce a transitional organizational form that quickly reverts to the standard firm or an organizational form that manages economic transitions in a superior way. These issues are explored in the recent employee acquisition of a majority ownership of United Air Lines. The transaction provided for long-term employee ownership, not simply a transitional form, and so locked up the employee stock in an employee pension plan and provided employees with longterm governance rights. The evidence to date suggests that employee ownership has enhanced UAL's competitive position but that governance pressure from employees when their interests are directly at stake is a potentially destabilizing force.
Abstract: This article, based on an invited lecture, argues that the current corporate governance regime plays an insufficiently appreciated role as a shaping force in the current U.S. economic framework. The dominant corporate law norms and the particular distribution of shareownership have combined to produce a responsiveness to capital market signals that has made U.S. firms especially strong worldwide competitors. This responsiveness, and the associated economic success, is at risk because of continuing state legislative and judicial changes that increase management's ability to resist a hostile takeover bid. Institutional investor ownership and activism is insufficient; legal rules matter because they set the framework within which institutions (and catalytic forces like control entrepreneurs) can act. The paper traces the emergence of this corporate governance regime in the 1980s and 1990s, explains its importance to the emerging economic order, and focuses specifically on the Virginia antitakeover statutes and cases as a particularly troubling development.
Abstract: Current arguments to increase shareholder power in the large public U.S. corporation need to take account of the well-established historical practice of extensive delegation by shareholders of business decision-making and agenda-control to management and the board, what might be characterized as an absolute delegation rule. This practice sharply limits the power of shareholders to put either business or governance proposals to the shareholders for dispositive resolution. The paper, originally published in 1991 but newly relevant, argues that the rule is based on potential pathologies in shareholder voting rather than the inherent information asymmetry between shareholders and managers. Rational shareholders who know of this asymmetry (and know that others know) would simply vote against most shareholder proposals. But shareholder voting gives rise to potential cycling problems, as shifting shareholder majorities vie for preferred policies, and potential opportunism, as shareholders engage in side deals with management and other shareholders to extract rents in corporate decision-making. Since shareholding patterns are in part a response to control rights, deviations from the absolute delegation rule will predictably lead to greater block ownership, for defensive and offensive reasons. These concerns need to be addressed in arguments for the expansion of shareholder power.
Shareholder voting, Delegation, Management, Cycling, Shareholder Opportunism
Abstract: The "New Economic Order" in the United States is a regime of trade liberalization, a robust market in corporate control, and labor market flexibility. Among the consequences over the 1980-1995 period is a divergence between the growth rate of corporate profits and stocks prices, which have increased by approximately 250% in real terms, and wages, which have barely increased at all, except for the top quintile. Contrary to popular belief, employees have not significantly participated through their pension funds in this stock market appreciation. In the historically dominant defined benefit pension plan, the sponsoring firm, not the employee, is the residual claimant. Although employees are residual claimants of defined contribution plans, these funds have been underinvested in equity. In part this is because employees fear the volatility of equity returns. The article proposes a new capital market instrument, a "pension equity collar," that would take advantage of the longterm nature of pension fund investing to provide a guarantee of a minimum return close to the longterm average equity return in exchange for giving up (or sharing) the upside above the longterm average. Such an instrument could encourage greater employee equity investment and thus widen the distribution of the benefits of the New Economic Order. The article proposes that the U.S. Department of Labor initiate a rulingmaking project under Section 404(c) of ERISA to determine if such an instrument should be among the menu of choices provided to employees in defined contribution plans.
Abstract: The "New Economic Order" in the United States is a regime of trade liberalization, a robust market in corporate control, and labor market flexibility. Among the consequences over the 1980-1995 period is a divergence between corporate profits and stocks prices, which have increased by approximately 250% in real terms, and wages, which have barely increased at all, except for the top quintile. Contrary to popular belief, employees have not significantly participated through their pension funds in this stock market appreciation. In the historically dominant defined benefit pension plan, the sponsoring firm, not the employee, is the residual claimant. Although employees are residual claimants of defined contribution plans, these funds have been underinvested in equity. In part this is because employees fear the volatility of equity returns. The article proposes a new capital market instrument, a "pension equity collar,"that would take advantage of the long-term nature of pension fund investing to provide a guarantee of a minimum return close to the long-term average equity return in exchange for giving up (or sharing) the upside above the long-term average. Such an instrument could encourage greater employee equity investment and thus help employees hedge their human capital investments and also widen the distribution of the benefits of the New Economic Order. The article proposes that the U.S. Department of Labor initiate a ruling-making project under Section 404(c) of ERISA to determine if such an instrument should be among the menu of choices provided to employees in defined contribution plans.
Abstract: The collapse of the UAL employee stock ownership experiment in UAL's bankruptcy does not demonstrate the inevitable failure of the institutional form any more than the collapse of Enron shows the impossibility of the large publicly held corporation. Rather, UAL suffered from particular design flaws in its stock ownership plan and, more seriously, the absence of complementary institutions focused on the distinctive problems of employee-owned firms.
Abstract: Policy debates about the appropriate risk levels for individual retirement plans and social retirement plans (like social security) often pay insufficient attention to the inescapable trade-off between payment risk (the risk of insufficient funding for anticipated benefits) and short fall risk (the risk of insufficient benefits for a satisfactory retirement). Thus a prudent retiree rule would permit a prudent level of contingent funding of retirement payouts. Contingent funding - basing benefit expectations on funding sources that may not materialize - increases payment risk, yet pension systems without some contingent funding will produce inferior benefits in most states of the world, increasing shortfall risk. Contingent funding can take different forms: underfunding (in an actuarial sense) of defined benefit promises, which means reliance on the firm's continued profitability; a tilt toward equity investments in a defined contribution plan, including an appropriate level of employer own stock, and reliance on pay-as-you-go (PAYGO) funding of social security benefits in which each generation funds its predecessor's benefits. The case for the prudent retiree rule is strengthened through a better appreciation of the underlying risks to retirement security: demographic risk (too many retirees relative to workers); economic risk (insufficient economic growth) and distributional risk (non-effort-based individual economic outcomes). Policies that address these risks can significantly reduce the risks associated with contingent funding.
Abstract: By longstanding practice, shareholders of large public corporations have delegated almost all decision rights over business matters to the board of directors. Given current calls for shareholder empowerment, it is worth revisiting the basis for the existing practice, as reflected in this 1991 paper. Among other things, we see that this absolute delegation rule minimizes potential pathologies in shareholder voting, including possibilities for opportunistic side-dealings and destructive voting cycles. These risks must be addressed lest shareholder empowerment merely replace one set of problems with another.
Abstract: In the wake of the near-calamitous run on Money Market Funds during last fall’s financial meltdown that produced, among other things, an emergency Treasury deposit guarantee program, the SEC has recently proposed a modest set of reforms. The reform package aims to improve the quality of MMF portfolio securities, shorten maturities, enhance portfolio liquidity, and provide a smoother resolution process for occasions when an MMF has “busted the buck.” The Comment Letter argues that the SEC has failed to grapple with the fundamental problems with MMFs revealed by last fall’s financial crisis and, in the main, its proposals will exacerbate systemic fragility, not reduce it. It is widely appreciated that MMF holders receive an unpaid-for benefit through an implicit, if imperfect, government guarantee of their accrued balances. The flaw with the SEC’s approach is that the regulatory effort to substitute for explicit deposit insurance and to limit the implicit subsidy through restrictions on MMF portfolios adds systemic risk to financial intermediation by heightening the pressure on short-term money markets in the critical function of maturity transformation. This flaw turns out to be fundamental and requires a rethinking of the general MMF framework.
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