David Kershaw

Between Law and Markets: Is There a Role for Culture and Ethics in Financial Regulation?

The limits of markets as mechanisms for constraining socially suboptimal behavior are well documented. Simultaneously, conventional approaches toward the law and regulation are often crude and ineffective mechanisms for containing the social costs of market failure. So where do we turn when both law and markets fail to live up to their social promise? Two possible answers are culture and ethics. In theory, both can help constrain socially undesirable behavior in the vacuum between law and markets. In practice, however, both exhibit manifest shortcomings. To many, this analysis may portend the end of the story. From our perspective, however, it represents a useful point of departure. While neither law nor markets may be particularly well suited to serving as “the conscience of the Square Mile”, it may nevertheless be possible to harness the power of these institutions to carve out a space within which culture and ethics – or, combining the two, a more ethical culture – can play a meaningful role in constraining socially undesirable behavior within the financial services industry. The objective of this article is to explore some of the ways which, in our view, this might be achieved. This exploration takes place across two dimensions. In the first dimension, we hold constant the core internal governance arrangements – corporate objectives, directors’ duties, board composition, committee structures and remuneration policies – within financial institutions. We then examine how the law and markets might be leveraged to engender a more ethical culture in two important areas: bilateral counterparty arrangements and socially excessive risktaking. More specifically, we examine how ‘process-oriented’ regulation – backed by a credible threat of both public enforcement and reputational sanctions – might be employed with a view to reframing personal ethical choices and fostering a more ethical organizational culture within financial services firms. Intuitively, we would expect the success of this strategy to be a function of the incentives generated by existing internal governance arrangements. Lamentably, however, many of these arrangements give primacy to the financial interests of shareholders and managers over those of other stakeholders including, perhaps most importantly, society. In the second dimension, therefore, we examine how we might cultivate a more ethical culture through reforms of the core governance arrangements of financial institutions.

No End in Sight for the History of Corporate Law: The Case of Employee Participation in Corporate Governance

This article contests the claim made by Professors Hansmann and Kraakman that the end of history in corporate law has been reached and that this evolutionary last stop has no place for employees in corporate governance. The article analyses the theoretical foundations of this claim, namely Professor Williamsons transaction cost account of board control and Professor Hansmanns governance cost account of when worker ownership works and fails. It argues that while both costs place constraints on the form of efficient economic organization, neither cost can explain the absence of hybrid institutions, both real and imaginary, that would be both transaction and governance cost efficient and allow for employee participation in corporate governance. Accordingly, this article submits that if the end of history for corporate law has arrived, its identification is fortuitous, as the claim lacks theoretical support.

Measuring Management Insulation from Shareholder Pressure

We propose a management insulation index based on banks’ charter and by-law provisions and on the provisions of the applicable state corporate law that make it difficult for shareholders to oust a bank’s management. We show that banks in which managers were more insulated from shareholders in 2003 were roughly 18 to 26 percentage points less likely to be bailed out in 2008/09. We also find that banks in which the management insulation index was reduced between 2003 and 2006 were more likely to be bailed out. We discuss alternative interpretations of the evidence. The evidence is mostly consistent with the hypothesis that banks in which shareholders were more empowered performed poorly during the crisis.We propose a management insulation measure based on charter, bylaw, and corporate law provisions that make it difficult for shareholders to oust a firm’s management. Unlike the existing alternatives, our measure considers the interactions between different provisions. We illustrate the usefulness of our measure with an application to the banking industry. We find that banks in which managers were more insulated from shareholders in 2003 were significantly less likely to be bailed out in 2008/09. These banks were also less likely to be targeted by activist shareholders, as proxied by 13D SEC filings. By contrast, popular alternative measures of insulation -- such as staggered boards and the Entrenchment Index -- fail to predict both bailouts and shareholder activism.