Category: Corporate Law

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The Supreme Court’s Theory of Corporate Political Activity

In an earlier post, I outlined an argument that – despite having attracted a fair amount of criticism – the Supreme Court’s vision of corporate political activity may have substantial normative merit from a corporate governance perspective.  In this post, I’ll describe that vision in two related parts.  First, whose expressive rights are being vindicated when corporations engage in political activity?  And second, what internal governance structures should regulate how and when corporations speak?

The first question raises a tricky issue at the intersection of constitutional law and corporate theory.  Corporations are legal fictions, albeit exceedingly useful ones.  They are not self-aware, they have no conscience, and they cannot act or speak except through human beings. Yet, the law has long treated corporations as legal “persons” for most purposes, including eligibility for many (though not all) constitutional protections. This treatment poses a metaphysical question: just what sort of “person” is a corporation?  To answer this question, the Supreme Court has historically relied on several theories of the corporation: the grant (or concession) theory, the aggregation theory, and the real entity theory.  Briefly, the grant theory views the corporation as purely a creature of the state, having only the rights and protections provided by statute, and thus broadly vulnerable to government regulation. The aggregation theory looks past the corporate form to the individual members or shareholders exercising their freedom of associating for some legitimate business, and concludes that corporations must thus have whatever powers and privileges necessary to vindicate the rights of those underlying constituents. The real entity theory posits that corporations exist independently of their constituents or the statutes authorizing them, and are thus a distinct entity entitled to all (or at least most) of the rights of natural persons. The Supreme Court’s corporate jurisprudence has, infamously, cycled repeatedly and inconsistently through each of these theories, often employing multiple theories in the same case.

In contrast to this general indecisiveness, though, the Court’s corporate political speech cases fairly clearly adopt a version of the aggregate view.  I treat the language from the cases in more detail in this paper, but the core idea – which flows from the early cases concerning corporations’ right to lobby, through Bellotti and more recently Citizens United – is that First Amendment speech rights inure to human beings.  Thus, when corporations speak they do so on behalf of the human constituents acting collectively through the corporate form.  As Justice Scalia explains in his Citizens United concurrence: “[t]he authorized spokesman of a corporation is a human being, who speaks on behalf of the human beings who have formed that association.”

As to the second question, the Court gives a firm but vague response: shareholders, acting through the procedures of corporate democracy, decide whether and how their corporations should engage in public debate.  Yet, it’s not exactly clear what the Court means by “corporate democracy.”  As a matter of corporate law, that concept is not self-defining; the proper allocation of decision-making power between managers and shareholders is one of the central, unresolved debates in modern corporate law.  One can, however, glean three key principles from the Court’s decisions.  First, the decision-making process is necessarily majoritarian. Some shareholders may dissent from the decision, but their remedy (if any) lays elsewhere.  Second, the process must actually vindicate shareholders’ concerns.  The Court concluded that shareholders need no legal protections external to corporate law because any “abuse[s]” – referring to managerial decisions that do not accord with the majority’s desires – can be “corrected by shareholders” through this process.  Finally, the Court seems to contemplate something broader than merely the representative democracy of electing the board.  As Justice Powell notes in Bellotti, shareholders should be able to privately order their preferences as to corporate political activity by “insist[ing] on protective provisions” in the corporation’s constitutional documents, which would bind managerial authority ex ante.

Some claim that the combination of these criteria simply illustrates the Court’s misunderstanding of modern corporate law.  Shareholder control rights within public firms are largely illusory.  Even a majority of shareholders cannot insist on corporate action outside of certain limited circumstances, and the directorial election process usually leaves much to be desired in terms of disciplining management.

I argue, though, that there is a ready-made governance structure that conforms with this framework: allow shareholders to enact intra-corporate bylaws regulating corporate political activity, which (in most jurisdictions) they can do unilaterally by majority vote.  In the next post, I’ll explain the mechanics of this approach, describe potential limitations arising from current jurisprudence concerning the scope of the shareholder bylaw power, and discuss pragmatic benefits to this form of private ordering.

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Call for Papers: National Business Law Scholars Conference

I am delighted to pass along the following notice from the organizers of the National Business Law Scholars Conference.  I’m also honored to report that they have asked me to deliver the keynote at this year’s conference, and I look forward to doing so.  

Deadline Extended to May 31

We have received an enthusiastic response to the Call for Papers for the National Business Law Scholars Conference, scheduled for June 12-13, at The Ohio State University School of Law.  We will have additional openings for anyone who would like to make a presentation but has not yet responded.  Thus, we have extended the deadline to MAY 31st.  See the Call for Papers, re-posted below with the extended deadline date, for details on how to submit:

National Business Law Scholars Conference: Call-for-Papers

The National Business Law Scholars Conference (NBLSC)  will be held on Wednesday, June 12th and Thursday, June 13th at The Ohio State University Michael E. Moritz College of Law in Columbus, Ohio.  This is the fourth annual meeting of the NBLSC, a conference which annually draws together dozens of legal scholars from across the United States and around the world.  We welcome all on-topic submissions and will attempt to provide the opportunity for everyone to actively participate.  Junior scholars and those considering entering the legal academy are especially encouraged to participate.

To submit a presentation, email Professor Eric C. Chaffee at echaffee1@udayton.edu with an abstract or paper by MAY 31, 2013.  Please title the email “NBLSC Submission – {Name}”.  If you would like to attend, but not present, email Professor Chaffee with an email entitled “NBLSC Attendance”.  Please specify in your email whether you are willing to serve as a commentator or moderator.  A conference schedule will be circulated in late May.

Conference Organizers:

Barbara Black (University of Cincinnati)
Eric C. Chaffee (University of Dayton)
Steven M. Davidoff (The Ohio State University)

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Publicity and Illegality in Organizations

“Corporations do not commit crimes, people do,” would be a good thing for everyone to remember but those who like to vilify the corporation too readily forget.  A valuable new research paper canvasses much of the literature about wrongdoing by people in corporations. Rosa Abrantes-Metz and Danny Sokol focus on cartels that violate antitrust laws, shifting the lens from the firm level to those within a corporation and offering a broader review of screens useful to combat illegality.  It’s a great contribution to and synthesis of the literature.  

I will draw on its lessons as I revise the current edition of my accounting textbook written for use in law schools, as well as to reflect on the corporate governance aspects of this problem, addressed in several important passages of my collection of Warren Buffett’s letters to constituents of Berkshire Hathaway.

Buffett’s writings address the tone at the top and promoting a culture of compliance. As CEO, he sends a biannual letter to his managers emphasizing that the most important job of every one of Berkshire Hathaway’s 300,000 employees is preserving Berkshire’s reputation.  For 25 years, that memo has included some version of this sentence:  “We can afford to lose money, even a lot of money, but we can’t afford to lose reputation, even a shred of reputation.”

Another point he repeats will be of special interest to lawyers among our readership.  He says it is not enough to comply with the law or letter of law. Berkshire must apply a stricter test, called the New York Times test: we would be happy to have all our activities written up on the front page of a national newspaper in an article written by an unfriendly reporter.  It is a much more poignant test than whether you comply with a particular antitrust law or accounting principle.

I call the toughest battle to fight concerning compliance the disease of the crowd. A common defense of sketchy behavior is that everyone else is doing it.  In that letter, Buffett explains that such a  response is usually an excuse rather than a reason. If so, the action probably should be avoided.  To implement such a policy, Buffett offers  senior managers a hotline to him directly if they detect even a whiff of dubious behavior. Those managers pass that message down the ranks and establish parallel hotlines from their troops to them.

Above all, once wrongdoing is detected, swift and public action is required. The worst thing managers can do when they discover illegalities by their employees is try to hide it.  In America, people are very forgiving of substantive errors or even wrongs. They are relentlessly unforgiving of attempts at evasion, duplicity, or hiding things.  (“It’s the cover up, stupid.”) Although Jonathan Macey has recently released an interesting book lamenting the decline of reputation as the constraint portrayed in economic models, it remains a powerful force.  Read More

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Board Composition—Old Wine in New(er) Bottles

It’s a pleasure to join Concurring Opinions this month. The internet can be a little touch-and-go in China—I was in central China last week, with only limited access—but I hope to contribute some thoughts as the “Beijing correspondent” over the next few weeks.

For those who have not yet been to Beijing, let me commend it to you. Beyond the tourist attractions (and there are many), there is much going on in China as the country begins to lower the cost of central government, enhance domestic consump¬tion (and inward investment), and promote a deeper capital market. Every day brings something new.

Perhaps as surprising is the ubiquity of U.S. corporate governance—in particular, the director-monitor model—as a standard against which domestic alternatives are measured, notwithstanding some fundamental differences in corporate structure and financial markets.

As some may be aware, my co-authors and I recently addressed the role of directors beyond monitoring in a working paper, entitled Lawyers and Fools: Lawyer-Directors in Public Corporations (available here; forthcoming, The Georgetown Law Journal). Read More

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Delaware Chancery Court’s Role Understated Accidentally

The State of Delaware, often seen to compete to attract the chartering of businesses, makes a strange pitch for its Chancery Court, one that seems intended to brag suitably but which accidentally is watered down to the trivial:

The Delaware Court of Chancery is widely recognized as the nation’s preeminent forum for the determination of disputes involving the internal affairs of the thousands upon thousands of Delaware corporations and other business entities through which a vast amount of the world’s commercial affairs is conducted.

The statement (my emphasis added) meant to say that the Chancery Court is among the best business law courts in the country, probably true.  Instead it says that the court is the best at a narrow specialty: the internal affairs of business entities chartered in Delaware (which, it then notes, are important in global commerce).

The next sentence tries to make up for the modesty, but it both comes too late and overstates with its use of the words “unique” and “unmatched”:

Its unique competence in and exposure to issues of business law are unmatched.

Government officials charged with promoting Delaware’s business sophistication need a rewrite.

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Defending Citizens United?

My thanks to Danielle and her co-bloggers for inviting me to share some of my thoughts.  This is my first foray into blogging, and I’m thrilled to join you for awhile.  I’d like to start by discussing a current project, which examines the internal governance of corporate political activity.  Comments, suggestions and critiques are most welcome.

Corporate political activity has long been an exceptionally contentious matter of public policy.  It also raises a hard and important question of corporate law:  assuming corporations can and will engage in political activity, who decides when they will speak and what they will say?  In several cases, the Supreme Court has provided a relatively clear, albeit under-developed, answer:  “[u]ltimately, shareholders may decide, through the procedures of corporate democracy, whether their corporation should engage in debate on public issues.”  (First Nat’l Bank of Boston v. Bellotti, cited with approval in Citizens United v. FEC).

This corporate law aspect of the decision has attracted substantial criticism alongside widespread calls for major reforms to corporate and securities laws.  Some argue that the Supreme Court misunderstands the reality of modern corporate law, insofar as shareholders have little practical ability to constrain managerial conduct.  Others question why political decisions should be made by either shareholders or managers, rather than some broader group of corporate stakeholders.  A third group claims that political activity is just another corporate decision protected by the business judgment rule.  Thus, empowering shareholders in this regard would improperly encroach on the board’s plenary decision-making authority.

Yet, despite these concerns, there may be pragmatic and normative merit to the Supreme Court’s approach.  In a current paper – “Democratizing Corporate Political Activity” – I present a case for shareholder regulation of corporate political activity through their power to enact bylaws.  I’ll describe the argument in more detail in subsequent posts, but, briefly, I present three normative justifications for this governance structure.  First, it may mitigate the unusual and potentially substantial agency costs arising from manager-directed corporate political activity.  Second, it may increase social welfare by: (i) reducing deadweight losses and transaction costs associated with rent-seeking; and (ii) making corporations less vulnerable to political extortion.  Third, if corporate speech can shape our society’s distributional rules, corporate law should not interpose an additional representative filter in the democratic process.  That is, we should not assume that investors – merely by purchasing stock in a public company, often through an intermediary such as a mutual fund – grant managers the unilateral authority to engage in political activity on their behalf.

With that said, I should be clear upfront that there are important challenges and objections to each of these arguments.  I will describe the main concerns as I proceed.

The next post will lay out the Supreme Court’s vision of corporate political activity, and explain why the shareholder bylaw power best fits the Court’s description of shareholder democracy in this context.

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Why Other People’s Money is The Best Hollywood Film About Business

Go down the list of Hollywood films about business and you will find one biting portrayal of capitalism after the next. As the late Larry Ribstein documented and explained, all of the following movies and most other artistic renderings have this biased flaw: Erin Brockovich, A Civil Action, The Constant Gardner, Blood Diamond, Michael Clayton, Pretty Woman, Wall Street (or take older examples such as Dinner at Eight or The Hudsucker Proxy or those once listed by Forbes as epitomizing this genre, such as Citizen Kane, The Godfather, It’s A Wonderful Life, Glengarry Glen Ross).

That’s why I find Other People’s Money (1991) refreshing, and probably the best Hollywood film about business (contrary to dominantcontending, opinion).  The movie is among the few nuanced artistic portrayals of corporate life. The play, and the movie it became, presents two sides of the story when conflicts arise between economic imperatives and socially pleasant outcomes. That’s why I often assign the film as part of my course in Corporations  (hello students!).

OPM pits against each other two men seeking to control the destiny of an ailing New England family company in the dying industry of manufacturing wire and cable: a greedy and creepy takeover artist called Larry “the Liquidator” Garfield (in the film played by Danny DeVito) and the patrician lord of the target company named Jorgenson (Gregory Peck, making for perfect casing of both roles).

Garfield opens with a monologue celebrating money, along with dogs and doughnuts, and denigrating love and basic human kindness. In his first encounter with Jorgenson, Garfield announces that the New England company is worth “more dead than alive.”

Jorgenson sniffs at such short-termism, stressing moral aspects of business life, and refuses either to pay Garfield to go away or borrow money to navigate through the difficult times. Garfield counters with assertions about free enterprise, Darwinian markets and the imperatives of business change.

The drama pursues this contrast between “doing right” and “doing well” through a proxy fight for corporate control. It climaxes with an exchange of speeches at a special meeting of shareholders.

Jorgenson acknowledges the financial losses currently facing the company, stressing that they are due to the rise of fiber optics that impaired demand for wire and cable.  But he makes the pitch for tradition, loyalty, and sticking with the company and its employees through tough economic patches.   Admitting that the company’s niche business may have become anachronistic, he argues that it will be able to re-purpose itself and prosper over the long term, if only everyone would be patient.

Jorgenson lambasts Garfield as a mere money-man who gets rich by using other people’s money yet “creates nothing, builds nothing, runs nothing.” He gets a standing ovation when thundering against

 murder in the name of maximizing shareholder value, substituting dollar bills where a conscience should be. . . . A company is more than money. Here we build, we care about people.

Garfield follows by saying “Amen,” and calling Jorgenson’s plea to save the company a mere prayer, one that fails to appreciate earthly economic reality, essentially referencing Schumpeter’s famous principle of “creative destruction.” Fiber optics rendered wire and cable obsolete and the best thing to do is recognize that fact, sell off the company’s remaining assets, and move on. He explains:

This company is dead. I didn’t kill it; it was dead when I got here This business is dead, let’s have the decency to sign the death certificate and invest in the future. Who cares [about the employees]? They didn’t care about you. . . . Employee wages went up way more than stock. Who cares? Me. I’m your only friend. I’m making you money; that’s the only reason you became shareholders. You want to make money, invest somewhere else, create new jobs. . . At my funeral you’ll leave with a smile on your face and a few bucks in your pocket – that’s a funeral worth having.

Who wins?  [Spoiler Alert: Answer Coming.]

The shareholders vote with Garfield, siding with a capitalist over Jorgenson’s impassioned plea for broader concerns. That is somewhat unusual in Hollywood films about business, where the capitalist’s argument rarely carries the day.

Here the referendum accepts that what may be the downside of capitalism, short-term effect on employees and communities, can be outweighed by its salutary long-term effects of moving forward on a clean slate towards ultimately brighter futures all the way around. It turns Jorgenson’s view of the long-term around on itself.

On the other hand, the Hollywood film version of the art adds a scene that did not appear in the stage version: Garfield falls in love with Jorgenson’s daughter and the two hatch a plan to sell the dying firm to its employees who will then repurpose it along the lines Jorgenson envisioned. A happy ending is snatched from the jaws of creative destruction after all.  As Larry Ribstein wrote in his assessment of this twist, which thus ultimately does not stray too far from Hollywood’s favored pathways: “Capitalism is acceptable only if it has a heart.”

 

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Auditing’s Snafu: Foreign Secrecy and Impaired Audits

Many US companies maintain substantial global operations, with increasing volumes of business done in China; many foreign companies are listed on US securities exchanges.  This cross-border expansion makes the reliability of financial reports created in foreign locales increasingly important.  Yet, in tandem with this cross-border expansion, there have been increasing assertions abroad, including in China, that local secrecy laws restrict access to the work papers of auditors, frustrating the ability of US federal authorities to enforce US securities laws designed to promote financial reporting integrity.

The snafu was joined this week in a case where the SEC is seeking access to audit work papers of a Deloitte affiliate in Shagnhai but the firm refuses.  The firm’s lawyers cite Morrison v. National Australia Bank, the 2010 SCOTUS ruling that, absent explicit language, federal statutes are seen as intended to apply within the US, not be extraterritorial.  It said that the federal securities laws lacked such explication.   

Furthermore, for Deloitte to comply with the SEC’s requests, the lawyers said, would risk committing a serious crime under Chinese law, one punishable by imprisonment. Deloitte’s lawyers say that the combination of Morrison and Chinese secrecy laws puts the records beyond the SEC’s reach.

Lawyers for the SEC object that these points cannot possibly be seen to limit the SEC’s administrative subpoena power under which it has demanded the Deloitte documents. But, during oral argument, the SEC’s lawyers did not acquit themselves well, according to one report, as they could not readily cite the precise legal authority supporting their position. 

Deloitte says there isn’t one and that the appropriate procedure to handle such cross-border securities matters is by diplomacy not enforcement. In this view, the SEC is wrong to proceed against Deloitte in court but must dispatch appropriate US officials to broker a resolution with Chinese regulatory counterparts.

The stakes are high for both sides in the case, of course, and for investors and students of auditing. After all,  audits endow financial statements with credibility. Shareholders are willing to pay for audits in exchange for that credence value.  But if an auditor’s work papers are top secret, inaccessible even to a regulatory overseer, how much of an audit’s credence value is lost? Is it still rational for shareholders to condone paying the auditor’s fee?

When the credibility of financial statements are in doubt, investors should shun their issuer and sell the stock.  A critical mass of shareholders of companies affected by this snafu might do well to follow that old-fashioned Wall Street Rule. If they did, then, along with such companies, the need to resort to either a diplomatic or enforcement solution would disappear. Read More

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The Essays of Warren Buffett: Third Edition

It’s a pleasure to report that this weekend marks the release of the third edition of The Essays of Warren Buffett: Lessons for Corporate America.  Originally published as the centerpiece of a symposium sponsored by Cardozo Law Review in 1997 at which Warren Buffett debated 20-some law professors (listed after the jump) on every important issue facing corporate America, this book is a thematic arrangement of Buffett’s annual letters to the shareholders of Berkshire Hathaway from 1977 to the present.

As I explain in my Introduction,  the central theme uniting Buffett’s essays is that the principles of fundamental business analysis, first formulated by his teachers Ben Graham and David Dodd, should guide investment practice. Linked to that theme are management principles that define the proper role of corporate managers as the stewards of invested capital, and the proper role of shareholders as the suppliers and owners of capital. Radiating from these main themes are practical and sensible lessons on the entire range of important business issues, from accounting to mergers to valuation.

The book has particular significance for devotees of behavioral economics who are skeptical of strong claims about market efficiency, as the book provides both the philosophical architecture of value investing and the intellectual defense of that practice, which distinguishes sharply between price and value.
UPDATE:  Read More

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Word Clouds of Buffett’s Letters

Here are word clouds I created to visualize words Warren Buffett used most frequently in two of his famous letters to Berkshire Hathaway shareholders, the first based on his newest letter (2012, released Friday) and the second based on his oldest (1977).

The word “billion” has (inevitably) replaced the word “million;” Charlie (Munger) has assumed a preeminent position; acquisitions matter greatly now but not then; insurance float matters more in 2012 while insurance underwriting mattered more in 1977; BNSF and GEICO are big today, along with newspapers, not the textile company or trading stamp business as was true back then.  Quite a few other changes should be obvious as well.  Among the similarities: the centrality of earnings to discussions of corporate performance (particularly as compared to cash flow or dividends).

 

Buffett 2012 Letter Word Cloud

 

 

Buffett 1977 Letter Word Cloud

 

 

 

 

 

 

 



 

 

 

 

 

 

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