Janis P. Sarra

New Governance, Old Norms, and the Potential for Corporate Governance Reform

While the new governance approach to corporate governance offers intriguing ideas about participatory governance, it cannot evade the effects of economic self‐interest. This article addresses three nested concerns relating to the potential of new governance in the corporate context, using three specific examples that illustrate the challenges. The first case illustrates that new governance principles cannot be easily integrated with models of corporate governance that rest on the logic of shareholder primary. The second case study offers an example of a new governance type corporation, but illustrates that new governance faces thorny internal structural challenges, given economic incentives and power imbalance. The third example illustrates that even without these normative and structural problems, new governance would face issues arising out of current strategies employed by corporate decision makers to hedge their own personal risk through equity swaps and other derivatives products, which in turn create new incentives for shirking their responsibilities.

Economic Rehabilitation: Understanding the Growth in Consumer Proposals under Canadian Insolvency Legislation

Economic rehabilitation is the notion underlying Canada’s Bankruptcy and Insolvency Act (BIA), providing consumer debtors with an opportunity for a “fresh start” through the mechanism of bankruptcy or making a proposal to their creditors for payment of their debts on terms that allow them to rehabilitate their financial status. This article undertakes a comparison of consumer proposals and consumer bankruptcies, examining 5,773 individual insolvencies in the past two years, with a view to discerning choices by individual insolvent debtors of insolvency proceeding. It compares causes of financial distress, income levels, quantum of debt and the assets of those filing proposals or bankruptcies. The data indicate that overextension of credit is a primary cause of insolvency, being 20% to 24% the primary cause across all cohorts. Home mortgage liability is significant for the Division I proposal debtors, but less significant for bankrupts, many of whom do not have equity in homes. Credit card debt is a serious problem across all groups. Credit card debt, unlike fixed loans such as mortgages, can quickly escalate, is owed at much higher interest rates that can rapidly compound financial distress, and the lack of a defined payment plan, other than a minimum payment, means that consumer debtors are not encouraged to pay these debts first, leading to longer term financial distress. Yet, to date, insolvency policy does not really factor the nature of this debt into policy development. Job loss and seasonal employment together are a significant cause of insolvency across Division II consumer proposal debtors (26%), Division II business proposal debtors (33%), and bankrupts (28%), but less so for Division I proposal debtors (16%). These data suggest that there are broader economic and social challenges that need to be addressed, as financial distress is often beyond the control of the individual debtor. To date, there is little linkage in Canada between economic stimulus and employment policy development and insolvency law policy development. Medical reasons are also a significant cause for Division II business proposal debtors (15%) and bankruptcy (11%), compared with the other cohorts. However, it is uncertain whether medical bills and lack of coverage, or medical problems resulting in inability to earn sufficient income are the real source of the financial distress. Equally, medical debt may be masked if consumer debtors have paid for medical bills by credit card on exit from hospital or particular outpatient services, as is the normal practice in some regions. The study offers both observations on the data and recommendations for future research and policy development.

Credit Derivatives Market Design, Creating Fairness and Sustainability

Now that the first wave of the financial crisis has been resolved through the coordinated efforts of regulators and banks, it is important to address some of the systematic weaknesses of the current financial system. One such weakness is the inappropriate incentive effects of the market for credit derivatives, and in particular, for credit default swaps. As a risk management tool, credit derivatives were originally an effective means of diversifying lending risk. Credit derivatives have worked to cover exposures where there have been credit events of the underlying reference entities. To date, the global market for derivatives has operated largely without regulatory oversight; yet it is increasingly evident that deficiencies in the market contributed, at least in part, to the liquidity crisis in the financial sector, resulting in massive injection of public funds in numerous jurisdictions. As structural adjustments are being made to ensure long term financial stability, the credit derivative market needs timely, targeted, and effective adjustment, with a measure of regulatory oversight. Credit default swaps (CDS), by far the most common form of credit derivative, are illustrative. There are two critical points at which intervention is required. The first is at the purchase and sale stage, where there is a serious lack of transparency regarding both material adverse risks associated with the reference entity and material risk in respect of the protection seller’s ability to settle the CDS if a credit event occurs. There is also a lack of due diligence and disclosure by those who are recommending CDS products to less sophisticated purchasers. Second, at the point of settlement and restructuring proceedings, there is a threat to current public policy goals of rehabilitating financially distressed businesses where they are viable, given structural and incentive effects for derivatives that are both physically and cash settled. The disconnection between economic interest and legal interest runs contrary to fundamental insolvency law principles adopted by numerous jurisdictions. In this respect, there needs to be a balancing of public law principles, those advancing the goals of insolvency law and those advancing the effective operation of capital markets. At times they align, at others, they are in sharp disaccord. This brief article addresses these two issues, offering ten recommendations for immediate action. More fundamentally, there needs to be public debate regarding the “casino” aspect of the current market for credit derivatives.