Sloppy, Inconsistent Federal Corporate Governance

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Lawmaking is a sloppy spectacle, perhaps especially amid crisis like now when Congress offers conditional financial assistance to save private banks and car makers. It is possible that once the entire process is complete a coherent law will result. So far, Congressional actions are not encouraging—and may worry even those scholars and policy analysts who may generally prefer moving from state-by-state corporate law production to a federal corporate law regime.

First, there appears to be no principled basis to distinguish the federal corporate governance conditions proposed to be imposed on the auto industry under the House bill (HR 7231) voted up yesterday and the comparatively loose conditions imposed on the financial industry under the economic stabilization act passed two months ago.

Principal examples are limitations on dividends (to be imposed on car makers but not on banks), limitations on corporate jets (car makers can’t own or lease them but banks can) and limitations on executive compensation (stringent for Detroit, weak for financiers).

Second, the draft House bill has some internal inconsistencies and provisions that are redundant because they already exist in federal law. These concern standards for executive compensation and corporate governance to be specified by a Presidential designee. 12(b)(2).

One pair of provisions seems hard to reconcile. One imposes a total ban on incentive pay to a company’s 25 highest-paid employees. 12(b)(3)(D). Another limits incentive pay to the 5 highest-paid employees so as to avoid promoting taking “unnecessary and excessive risks that threaten the [company’s] value.” 12(b)(3)(A). So the former bans top-dog payments entirely while the latter allows for conditional payments, to very top dogs, so long as they do not promote unnecessary or excessive risks.

Other bill provisions suggest an intention to privilege the conditional payment provision. It says that a company can recover any incentive compensation payments that were made if it turns out they were made based on materially inaccurate financial reporting. 12(b)(3)(B). That remains a strange provision, however, because such a recovery provision already exists in federal law, courtesy of the Sarbanes-Oxley Act of 2002, the hastily passed law that responded to the corporate accounting fraud scandals of the early 2000s.

The bill does another very bold thing not achieved even in the revolutionary atmosphere that resulted in Sarbanes-Oxley incrementally enacting federal corporate law usually left to states. The bill would flat out ban compensation plans that encourage accounting manipulation. 12(b)(3)(E). This is a problem for all companies and all compensation plans. It is not obvious why this rule must apply to auto makers borrowing from the government and not to financial institutions or any other company for that matter.

As to jets, finally, 12(b)(4) says car makers with outstanding government support “may not own or lease any private passenger aircraft, or have any interest in such aircraft” and existing interests don’t violate this provisions so long as the company “demonstrates to the satisfaction of the President’s designee that all reasonable steps are being taken to sell or divest such aircraft or interest.” Nothing like that applied to financial institutions and there does not seem to be any principled basis for it.

It seems instead to reflect the circus that one Member of Congress created at hearings rebuking the car makers’ CEOs for coming to Washington in expensive jets to ask for federal financial assistance. It is symptomatic. Explanations for the sloppy and inconsistent federal corporate governance regime emerging in these legislative exercises appear to reside in expediency, politics and lobbying—not rational judgment concerning what is optimal corporate governance, good economics or good law.

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