Mark J. Roe

A Theory of Path Dependence in Corporate Ownership and Governance

Corporate structures differ among the advanced economies of the world. We contribute to an understanding of these differences by developing a theory of the path dependence of corporate structure. The corporate structures that an economy has at any point in time depend in part on those that it had at earlier times. Two sources of path dependence--structure driven and rule driven--are identified and analyzed. First, the corporate structures of an economy depend on the structures with which the economy started. Initial ownership structures have such an effect because they affect the identity of the structure that would be efficient for any given company and because they can give some parties both incentives and power to impede changes in them. Second, corporate rules, which affect ownership structures, will themselves depend on the corporate structures with which the economy started. Initial ownership structures can affect both the identity of the rules that would be efficient and the interest group politics that can determine which rules would actually be chosen. Our theory of path dependence sheds light on why the advanced economies, despite pressures to converge, vary in their ownership structures. It also provides a basis for why some important differences might persist.

Public and Private Enforcement of Securities Laws: Resource-Based Evidence

Ascertaining which enforcement mechanisms work to protect investors has been both a focus of recent work in academic finance and an issue for policy-making at international development agencies. According to recent academic work, private enforcement of investor protection via both disclosure and private liability rules goes hand in hand with financial market development, but public enforcement fails to correlate with financial development and, hence, is unlikely to facilitate it. Our results confirm the disclosure result but reverse the results on both liability standards and public enforcement. We use securities regulators’ resources to proxy for regulatory intensity of the securities regulator. When we do, financial depth regularly, significantly, and robustly correlates with stronger public enforcement. In horse races between these resource-based measures of public enforcement intensity and the most common measures of private enforcement, public enforcement is overall as important as disclosure in explaining financial market outcomes around the world and more important than private liability rules. Hence, policymakers who reject public enforcement as useful for financial market development are ignoring the best currently-available evidence.

Political and Legal Restraints on Ownership and Control of Public Companies

Law and politics affect the financial structure of the public corporation, perhaps as much as economics. Law restricts financial institutions from holding large equity blocks and from networking the small blocks they do own. Impetus for these restrictions came from several sources: a public-spirited belief that financial stability would be fostered by financial fragmentation, American federalism (each state created its own insular set of financial institutions), rivalries between groups of financial institutions, and popular mistrust of powerful private financial institutions. The stability of many of these rules also derives from the political resistance that one would expect corporate managers and benefited financial institutions to offer to any change.

Chaos and Evolution in Law and Economics

I refine here the classical evolutionary model from law and economics by modifying it to accommodate three related concepts, one from chaos theory, another of path dependence, and a final one of politically-induced punctuated equilibrium from modern evolutionary theory itself. Although economic evolution selects out for extinction very inefficient results, and efficient results tend to survive, the evolutionary metaphor is by itself not rich enough to explain enough of what we see surviving, nor is it rich enough to explain fully how what survives survived. Within the looseness of acceptable efficiency, what survives depends not just on efficiency but on the initial, often accidental conditions (chaos theory) that establish an institutional structure inside which the economic players evolve. What survives also depends on the history of what problems had to be solved in the past -- problems that may be irrelevant today (path dependence); solutions to what later become irrelevant problems can be embedded in slowly-changing institutional structures. Although institutions cannot be too inefficient if they have survived, evolution toward efficiency constrains but does not fully determine the institutions we observe.

A Political Theory of American Corporate Finance

Why is the public corporation-with its fragmented shareholders buying and selling on the stock exchange-the dominant form of enterprise in the United States? Since Berle and Means, the conventional corporate law story begins with technology dictating large enterprises with capital needs so great that even a few wealthy individuals cannot provide enough. These enterprises consequently must draw capital from many dispersed shareholders. Shareholders diversify their own holdings, further fragmenting ownership. This combination of a huge enterprise, concentrated management, and dispersed, diversified stockholders shifts corporate control from shareholders to managers. Managers can pursue their own agenda, at times to the detriment of the enterprise.In the classic story, the large public firm survived because it best balanced the problems of managerial control, risk sharing, and capital needs. In a Darwinian evolution, the large public firm mitigated the managerial agency problems with a board of directors of outsiders, with a managerial headquarters of strategic planners overseeing the operating divisions, and with managerial incentive compensation. Hostile takeovers, proxy contests, and the threat of each further disciplined managers. Fragmented ownership survived because public firms adapted. They solved enough of the governance problems created by the large unwieldy structures needed to meet the huge capital needs of modern technology. In the conventional story, the large public firm evolved as the efficient response to the economics of organization.

Corporate Law’s Limits

A strong theory has emerged that the quality of corporate law in protecting distant shareholders primarily determines whether ownership and control separate. The theory helps to convincingly explain why separation is weak in transition and developing nations. But in several rich nations, although legal structures as measured protect shareholders well, separation is shallow. Something else has impeded separation. Separation should be narrow if shareholders face high managerial agency costs if ownership diffused. But most managerial agency costs are not corporate laws focus. Judicial doctrine attacks self‐dealing, not business decisions that hurt stockholders. Indeed, the business judgment rule puts beyond direct legal inquiry most key agency costs—such as overexpansion, overinvestment, and reluctance to take on profitable but uncomfortable risks. Even if a nations core corporate law is perfect, it directly eliminates self‐dealing, not most managerial mistake or most misalignment with shareholders. If the risk of managerial misalignment varies widely from nation to nation, or from firm to firm, ownership structures should also vary widely, even if conventional corporate law tightly protected shareholders everywhere from insider machinations. I show why this variation in managerial alignment is likely to have been deep.

Convergence and persistence in corporate governance

List of contributors Acknowledgments Introduction Jeffrey N. Gordon and Mark J. Roe Part I. System Issues: 1. The end of history for corporate law Henry Hansmann and Reinier Kraakman 2. A theory of path dependence in corporate ownership and governance Lucian A. Bebchuk and Mark J. Roe 3. Path dependence, corporate governance and complementarity Reinhard H. Schmidt and Gerald Spindler 4. Convergence of form or function Ronald Gilson Part II. Government Players: 5. The international relations wedge in corporate convergence Jeffrey N. Gordon 6. Property rights in firms Curtis Milhaupt 7. Modern politics and ownership separation Mark J. Roe Part III. Specific Institutions: 8. Norms and corporate convergence David Charny 9. Ungoverned production Charles Sabel 10. Substantive law and its enforcement Gerard Hertig 11. Cross-holding in the Japanese keiretsu J. Mark Ramseyer Index.

Understanding the Japanese Keiretsu: Overlaps Between Corporate Governance and Industrial Organization

We aim here for a better understanding of the Japanese keiretsu. Our essential claim is that to understand the Japanese system-banks with extensive investment in industry and industry with extensive cross-ownership-we must understand the problems of industrial organization, not just the problems of corporate governance. The Japanese system, we assert, functions not only to harmonize the relationships among the corporation, its shareholders, and its senior managers, but also to facilitate productive efficiency.

The Voting Prohibition in Bond Workouts

The Trust Indenture Act prohibits a binding vote of bondholders to change any core term-principal amount, interest rate, or maturity date-of a bond issue. In this Article, I show how the prohibition on a collective action clause inhibits a troubled companys ability to reorganize outside of bankruptcy. Moreover, the prohibition — a carryover of 1930s thinking — fails to implement satisfactorily the underlying original goals of individualized bondholder choice and bondholder protection. The bar on bond issue majority vote, collective action clauses should be repealed.

The Institutions of Corporate Governance

In this review piece, I outline the institutions of corporate governance decision-making in the large public firm in the wealthy West. By corporate governance, I mean the relationships at the top of the firm - the board of directors, the senior managers, and the stockholders. By institutions I mean those repeated mechanisms that allocate authority among the three and that affect, modulate, and control the decisions made at the top of the firm.Core corporate governance institutions respond to two distinct problems, one of vertical governance (between distant shareholders and managers) and another of horizontal governance (between a close, controlling shareholder and distant shareholders). Some institutions deal well with vertical corporate governance but do less well with horizontal governance. The institutions interact as complements and substitutes, and many can be seen as developing out of a primitive of contract law.In Part I, I sort out the central problems of corporate governance. In Part II, I catalog the basic institutions of corporate governance, from markets to organization to contract. In part III, I consider contract law as corporate laws primitive building-block. In Part IV, I briefly examine issues of corporate legitimacy that affect corporate governance by widening or narrowing the tools available. The interaction between political institutions and corporate governance institutions is an inquiry still in its infancy but promises large returns. In Part V, I re-examine corporate governance in terms of economies of scale, contract, markets, and property rights. Then I summarize and conclude.