Firm Value and Intracorporate Arbitration

Abstract

Intracorporate arbitration provisions (IAPs) shift disputes over firms’ internal affairs from public courts to private arbitration. These disputes affect the agency costs associated with governing a company, which in turn affect firm value. Thus, a firm that adopts an IAP should expect it to cause an increase or decrease to firm value. Beyond their effects on firm value, IAPs will also test assumptions about shareholders’ ability to discipline corporate management and states’ authority to regulate firms formed under their laws. In anticipating the emergence of IAPs, markets, practitioners, and scholars must confront what they are to look like and how they are to work. This prospect is uncertain. An IAP could increase firm value by, for example, limiting unmeritorious litigation, or it could reduce firm value by, for example, insulating management from meritorious claims. This article shows that IAPs will not lead inextricably to either of those outcomes. In doing so, it asks a simplifying question: for a given firm, will adopting an IAP likely lead to its value going up, or down?

That question is answered by viewing IAPs as a tool by which firms may treat the civil procedure that is applied to their intracorporate disputes as a value lever. Civil procedure determines whether meritorious claims are vindicated and whether unmeritorious claims are defeated. In addition, civil procedure determines both how long it takes to reach resolution and what resources are required to do so (assuming the substantive law and facts remain constant regardless the procedure). In other words, whether an intracorporate dispute is resolved fairly and efficiently is determined by the civil procedure chosen for it. Those two factors — how claims are resolved on the merits and what is required in terms of time and resources to resolve them — represent agency costs that help drive firm value up or down. Because “up” is preferable, this article introduces a normative, institutional model of intracorporate arbitration aimed at achieving that outcome, in which a firm adopting an IAP must make a credible commitment to a credible arbitral institution.

Keywords: shareholder derivative suits, intracorporate arbitration, securities arbitration, arbitration, corporate governance