Brett H. McDonnell

Dampening Financial Regulatory Cycles

Financial regulation should be countercyclical, strengthening during speculative booms to contain excessive leverage and loosening following crises so as to not limit credit extension in hard times. And yet, financial regulation in fact tends to be procyclical, strengthening following crises and loosening during booms. This paper considers competing descriptive and normative analyses of that procyclical tendency. All of the models and arguments considered are rooted in a public choice perspective on financial regulation, i.e. rational choice ideas drawn from economics and applied to politics, but with that perspective modified to take account of behavioralist biases in rationality, particularly the availability bias. That bias helps explain the procyclical tendency in financial regulation, as both the public and regulators ignore the threat of financial crises during boom times and become very focused on that threat when crises actually occur. The normal dominance of concentrated interest groups temporarily shifts as public attention turns to financial regulation following a crisis.The models considered here, though differ greatly in their normative conclusions, with some mainly criticizing the deregulation which occurs during booms, others mainly criticizing the regulation which occurs following crises, and yet others critical of the timing of both. The models differ in how they understand the balance of interest groups outside of crises and how likely that balance is to lead to outcomes that reflect the public interest, in how well they think the crisis-related public attention can be channeled to reflect the public interest, and in how they analyze the underlying vulnerability of financial institutions and markets and the intellectual difficulty of regulation. After analyzing these differing models, the paper considers historical evidence to try to choose among them, and then considers various administrative mechanisms which might help dampen the procyclical tendencies of financial regulation. Some of the procedures considered include bicameralism and the committee system in Congress, notice-and-comment rulemaking, hard look judicial review, independent agencies, sunset clauses, mandated agency studies, regulatory “contrarians,” and automatic triggers for various rules.

Setting Optimal Rules for Shareholder Proxy Access

Recent developments in Delaware concerning shareholder bylaws and the SEC proposal concerning shareholder proxy access have moved the U.S. closer to a set of optimal rules for shareholder proxy access in nominating director candidates, but not all the way there. These rules must address both the default rule which applies in the absence of agreement within a corporation to the contrary, and the altering rule which specifies who within a corporation may choose to opt out of the default provisions. Applying principles of accountability and freedom of contract, the optimal default rule would allow for certain shareholders to use the corporate proxy to nominate director candidates. The optimal altering rule would make it easy for shareholders to propose bylaws under the Rule 14a-8 process which opt out of the default provisions. Although it would be desirable were states to set these rules on their own, a degree of managerialism at the state level combines with the history of extensive SEC regulation of the proxy process to give the SEC an important role in helping set the rules. As matters currently stand, Delaware is appropriately flexible but has the wrong default rule, while the SEC’s proposal has the right default rule but too little flexibility.

Dynamic Statutory Interpretations and Sluggish Social Movements

This Comment argues that civil rights activists have focused too many resources on attempting to gain favorable statutory interpretations in court rather than pursuing changes in Congress. Though in some circumstances a judicial strategy may lead to greater short-run gains, it is less likely to change preferences in the long run. The Comment makes this argument using a modified version of William Eskridges game-theoretic model of the interaction between the Court, Congress, and the President. It also adds a second period to the game, with a legislative strategy more likely to shift preferences leftward in the second period. The Comment applies the theory to the Civil Rights Act of 1991, arguing that the 1989 Supreme Court decisions which provoked the Act may have helped civil rights activists by prodding them to return to activism focused on Congress. It concludes by suggesting that, in the present environment, a mass action strategy focused on changing long-run preferences rather than immediately changing the law either in the courts or in Congress might be most effective.

Are Efficient Antitrust Rules Always Optimal

Professors Gifford and Kudrle make a number of interesting and useful points. Their comparison of antitrust policy in the U.S. and the EU through the lens of four strands of policy-producer protection, rivalry, consumer surplus maximization, and wealth maximization-is of particular note. We will not take issue with their characterization of law and policy in the U.S. or the EU. We also will not argue with their preferred ultimate goal of improving the aggregate welfare of a societys entire population. 1

Short and Long Term Investors (and Other Stakeholders Too): Must (and Do) Their Interests Conflict?

In this chapter for an edited volume, we review and analyze theoretical and empirical questions raised by the ongoing debate over whether American public corporations face undue legal and market pressure to pursue short term profits. Orthodox theory holds that the highest ‘bucks’ should not necessarily be the ‘quickest’ – that is, that markets correctly value a company’s prospects, no matter how far in the future they are. Of course, given the time value of money, a long-term prospect has to be much better than a short-term one to be worthwhile. But the argument made with respect to shareholder activists, and to a lesser but still considerable degree corporate raiders, was that cost-cutting was being encouraged even if doing so saved less than the discounted value foregone.This argument is not consistent with orthodox theory. Here, we explain why this is so, consider reasons why that theory might be wrong, and make some suggestions for ways to proceed. In our view, there is plausible, and perhaps sufficient, evidence of a problem from shareholders’ perspective – corporations may indeed be shunning some potentially higher-yielding long-term strategies, emphasizing instead the short-term strategies that yield cash and savings in the short term. There may be a problem from the societal perspective as well, which is separate from but related to the question of short-term strategies. The market may be addressing the shareholder problem, although perhaps not sufficiently, and probably not sufficiently quickly. The societal problem, the underprovision of public goods, and the imposition of negative externalities, is far trickier to address. We offer some suggestions which might help on both fronts. That being said, in some cases, the conflict between a shareholder value maximization perspective and a societal perspective may be intractable.

Introduction: The Evolution of the Economic Analysis of Corporate Law: The evolution of the economic analysis of corporate law

This essay is the Introduction to the Research Handbook on the Economics of Corporate Law. After briefly surveying the origins of modern economic analysis of corporate law, it analyzes leading developments in recent decades. Major developments in the law and economics of corporate law have in some cases followed from developments in the law, including changes in fiduciary duty standards, the growth of shareholder activism, the increasing role of independent directors, changes in executive compensation, a new emphasis on various gatekeepers, federalization of corporate governance rules, and globalization. Other developments have followed from trends within economics, including some new ideas in the theory of the firm, greater emphasis on empirical research, a focus on market failures due to incomplete information, the growth of behavioral economics, and some increased emphasis on comparative institutional analysis. The essay speculates that future developments may include a new focus on systemic risk in light of the financial crisis and greater use of empirical research methodologies other than regression analysis. The essay concludes with an overview of the contributions to the volume, which is divided into five Parts: corporate constituencies, insider governance, gatekeepers, jurisdiction, and new theory.

Recent Skirmishes in the Battle Over Corporate Voting and Governance

This paper considers how some recent developments affect our understanding of the relative superiority of our mixed federal system of corporate lawmaking as compared with either a purely state system or a purely national one. The mixed federal system can potentially capture the gains of efficiency, flexibility, and responsiveness from state competition, while using the threat, and occasional reality, of federal intervention to reduce the tendency to managerialism of Delaware. The paper argues that on the whole this story fits the reaction to the corporate scandals of the nineties. The Sarbanes-Oxley Act moved regulation in a less managerialist direction, and Delaware courts have responded, albeit subtly. The paper also considers evidence for counter-stories. It may be that federal intervention has gone too far, and led to a worse outcome than the states on their own would have achieved. Some claim that Sarbanes-Oxley is an example of such federal over-reach. That might be true, but the evidence to date does not clearly support such a conclusion. On the other side, the ongoing leading role of Delaware in corporate lawmaking might be inhibiting the system from reacting as well as a purely national system would. The paper considers this possibility in the context of developments in the regulation of shareholder access to corporate proxy material for making board nominations. This skirmish remains in progress, but the latest battle, the Second Circuit opinion in AFSCME v. AIG, suggests the mixed federal system is working pretty well.