Stephen M. Bainbridge

The new corporate governance in theory and practice

Forty years ago, managerialism dominated corporate governance. In both theory and practice, a team of senior managers ran the corporation with little or no interference from other stakeholders. Shareholders were essentially powerless and typically quiescent. Boards of directors were little more than rubber stamps. Today, the corporate governance landscape looks vastly different. The fall-out from the post-Enron scandal and implementation of the Sarbanes-Oxley Act have resulted in shareholder activism becoming more widespread, while many observers call for even greater empowerment. The notion that the board of directors is a mere pawn of top management is increasingly invalid, and as a result, modern boards of directors typically are smaller than their antecedents, meet more often, are more independent from management, own more stock, and have better access to information. The New Corporate Governance in Theory and Practice offers an interdisciplinary analysis of the emerging board-centered system of corporate governance. It draws on doctrinal legal analysis, behavioral economic insights into how individuals and groups make decisions, the work of new institutional economics on organizational structure, and management studies of corporate governance. Using those tools, Stephen Bainbridge traces the process by which this new corporate governance system emerged, and explores whether such changes are desirable or effective. Available in OSO: http://www.oxfordscholarship.com/oso/public/content/law/9780195337501/toc.html

The Case for Limited Shareholder Voting Rights

Recent years have seen a number of efforts to extend the shareholder franchise. These efforts implicate two fundamental issues for corporation law. First, why do shareholders - and only shareholders - have voting rights? Second, why are the voting rights of shareholders so limited? This essay proposes answers for those questions. As for efforts to expand the limited shareholder voting rights currently provided by corporation law, the essay argues that the director primacy-based system of U.S. corporate governance has served investors and society well. This record of success occurred not in spite of the separation of ownership and control, but because of that separation. Before changing making further changes to the system of corporate law that has worked well for generations, it would be appropriate to give those changes already made time to work their way through the system. To the extent additional change or reform is thought desirable at this point, surely it should be in the nature of minor modifications to the newly adopted rules designed to enhance their performance, or rather than radical and unprecedented shifts in the system of corporate governance that has existed for decades.

Shareholder Activism and Institutional Investors

Recent years have seen a number of efforts to extend the shareholder franchise, principally so as to empower institutional investors. The logic of these proposals is that institutional investors will behave quite differently than dispersed individual investors. Because they own large blocks, and have an incentive to develop specialized expertise in making and monitoring investments, institutional investors could play a far more active role in corporate governance than dispersed individual investors traditionally have done. Institutional investors holding large blocks thus have more power to hold management accountable for actions that do not promote shareholder welfare. Their greater access to firm information, coupled with their concentrated voting power, might enable them to more actively monitor the firms performance and to make changes in the boards composition when performance lagged. In fact, however, institutional investor activism is rare and limited primarily to union and state or local public employee pensions. As a result, institutional investor activism has not - and cannot - prove a panacea for the pathologies of corporate governance. Activist investors pursue agendas not shared by and often in conflict with those of passive investors. Activism by investors undermines the role of the board of directors as a central decision-making body, thereby making corporate governance less effective. Finally, relying on activist institutional investors will not solve the principal-agent problem inherent in corporate governance but rather will merely shift the locus of that problem.

Privately Ordered Participatory Management: An Organizational Failures Analysis

American industrial enterprises long organized their production processes in rigid hierarchies in which production-level employees had little discretion or decision making authority. Recently, however, many firms have adopted participatory management programs purporting to give workers a substantially greater degree of input into corporate decisions. Quality circles, self-directed work teams, and employee representation on the board of directors are probably the best-known examples of this phenomenon. These forms of workplace organization have garnered considerable attention from labor lawyers and economists, but relatively little from corporate law academics. This is unfortunate, both because the tools routinely used by corporate law academics have considerable application to the problem and because employee participation is ultimately a question of corporate governance. According to conventional academic wisdom, perceptions of procedural justice are important to corporate efficiency. Employee voice promotes a sense of justice, increasing trust and commitment within the enterprise and thus productivity. Workers having a voice in decisions view their tasks as being part of a collaborative effort, rather than as just a job. In turn, this leads to enhanced job satisfaction, which, along with the more flexible work rules often associated with work teams, results in a greater intensity of effort from the firms workers and thus leads to a more efficient firm. Although this view of participatory management has become nearly hegemonic, the academic literature nevertheless remains somewhat vague when it comes to explaining just why employee involvement should have these beneficial results. In contrast, my article presents a clear explanation of why some firms find employee involvement enhances productivity and, perhaps even more important, why it fails to do so in some firms. Despite the democratic rhetoric of employee involvement, participatory management in fact has done little to disturb the basic hierarchial structure of large corporations. Instead, it is simply an adaptive response to three significant problems created by the tendency in large firms towards excessive levels of hierarchy. First, large branching hierarchies themselves create informational inefficiencies. Second, informational asymmetries persist even under efficient hierarchial structures. Finally, excessive hierarchy impedes effective monitoring of employees. Participatory management facilitates the flow of information from the production level to senior management by creating a mechanism for by-passing mid-level managers, while also bringing to bear a variety of new pressures designed to deter shirking.

A Behavioral Economic Analysis of Mandatory Disclosure: A Thought Experiment Turned Cautionary Tale

Mandatory disclosure is a defining characteristic of U.S. securities regulation. Issuers selling securities in a public offering must file a registration statement with the SEC containing detailed disclosures, and thereafter comply with the periodic disclosure regime. This regime has been highly controversial among legal academics. Some scholars argue market forces will produce optimal levels of disclosure in a regime of voluntary disclosure, while others argue that various market failures necessitate a legal mandatory disclosure system. To date, however, both sides in this debate have assumed, inter alia, that market actors rationally pursue wealth maximization goals. In contrast, this paper draws on the emergent behavioral economics literature to ask whether systematic departures from rationality, such as herd behavior or the status quo bias, might result in a capital market failure. The paper concludes that such a market failure could occur, especially in emerging markets, but also contends that one should not jump to the conclusion that legal intervention in the form of a mandatory disclosure system is necessary, especially insofar as the highly evolved U.S. capital markets are concerned. The paper concludes with a cautionary note against the potential for behavioral economics to be glibly invoked as a justification for government intervention.

Preserving Director Primacy by Managing Shareholder Interventions

This is a draft chapter for a forthcoming research handbook on shareholder power and activism. This chapter provides an analysis of shareholder activism based on the so-called director primacy model of corporate governance, which argues for a board-centric, rather than a shareholder-centric, understanding of corporate governance.Even though the primacy of the board of director primacy is deeply embedded in state corporate law, shareholder activism nevertheless has become an increasingly important feature of corporate governance in the United States. The financial crisis of 2008 and the ascendancy of the Democratic Party in Washington created an environment in which activists were able to considerably advance their agenda via the political process. At the same time, changes in managerial compensation, shareholder concentration, and board composition, outlook, and ideology, have also empowered activist shareholders.There are strong normative arguments for disempowering shareholders and, accordingly, for rolling back the gains shareholder activists have made. Whether that will prove possible in the long run or not, however, in the near term attention must be paid to the problem of managing shareholder interventions.This problem arises because not all shareholder interventions are created equally. Some are legitimately designed to improve corporate efficiency and performance, especially by holding poorly performing boards of directors and top management teams to account. But others are motivated by an activist’s belief that he or she has better ideas about how to run the company than the incumbents, which may be true sometimes but often seems dubious. Worse yet, some interventions are intended to advance an activist’s agenda that is not shared by other investors.This chapter proposes managing shareholder interventions through changes to the federal proxy rules designed to make it more difficult for activists to effect operational changes, while encouraging shareholder efforts to hold directors and managers accountable.

An overview of insider trading law and policy: an introduction to the Research Handbook on Insider Trading

In most capital markets, insider trading is the most common violation of the securities laws. It is certainly the violation that has most clearly captured the public’s imagination. Surely no other corporate or securities law doctrine has provided the plot line of as many crime thrillers and motion pictures as has insider trading. Insider trading also long ago captured the attention of academic lawyers and economists to a degree few other topics in corporate law or securities regulation can match. As a result, it attracts scholars in fields ranging from pure legal doctrine to empirical analysis to complex economic theory. This volume collects cuttingedge scholarship in all of these areas by many of the leading experts in insider trading law and economics. Insider trading jurisprudence is strongly skewed towards US law. This emphasis is not mere academic parochialism or chauvinism, however. The USA remains the world’s largest capital market. More important for present purposes, the USA was one of the first jurisdictions to ban insider trading and remains the jurisdiction in which the ban is most energetically enforced. To be sure, insider trading bans are now on the books in many jurisdictions and there is growing global emphasis on fighting the practice. A number of the chapters in this volume focus on these developments. Much of the volume nevertheless is appropriately devoted to US law. The long history and highly developed body of US law on the subject suggest that studying the legal doctrine and policy underpinnings of the US prohibition of insider trading will reward study not only for US corporate and securities law scholars, but for those of all countries. Accordingly, this Introduction provides a foundation for the chapters that follow by setting out the basic US legal rules and the policy debate those rules have engendered.

Regulating Insider Trading in the Post-Fiduciary Duty Era: Equal Access or Property Rights?

This essay was prepared for a forthcoming book on the law and economics of insider trading. In Chiarella and Dirks, the Supreme Court based insider trading liability on a breach of a disclosure obligations arising out of a fiduciary relationship. The resulting narrowing of the scope of insider trading liability met substantial resistance from the Securities and Exchange Commission (SEC) and the lower courts. Through both regulatory actions and judicial opinions, the SEC and the courts gradually chipped away at the fiduciary duty rationale. In recent years, the trend has accelerated, with several developments having substantially eviscerated the fiduciary duty requirement. The current unsettled state of insider trading jurisprudence necessitates rethinking the foundational premises of that jurisprudence from first principles. This essay argues that the correct rationale for regulation insider trading is protecting property rights in information. Although that rationale obviously has little to do with the traditional concerns of securities regulation, this article further argues that the SEC has a sufficiently substantial advantage in detecting and prosecuting insider trading that it should retain jurisdiction over the offense.

Constraints on Shareholder Activism in the United States and Slovenia

Prepared for a conference and text on Slovenian corporate governance, this article examines the corporate governance role of the large institutional investors that dominate the stockownership of privatized Slovenian corporations. In contrast to the U.S. model in which ownership and control is separated, stockownership is widely dispersed, and shareholder power is diffuse, as famously described by Berle and Means, the privatization process resulted in highly concentrated ownership of Slovenian corporations. The question presented here is whether such concentration is desirable. The article acknowledges that shareholder activism on the part of large institutional investors offers some economic benefits by potentially constraining agency costs, but contends that those benefits come at too high a cost. Two lines of argument are pursued. First, there is a substantial risk that large shareholders will use their control to self-deal or otherwise disadvantage minority shareholders. Experience teaches that the risk of self-dealing is especially significant in transition economies, such as Slovenia. Second, the U.S. model of separated ownership and control, dispersed stockownership, and diffuse shareholder control offers significant efficiency advantages. Neither shareholders nor any other constituency have the information or the incentives necessary to make sound decisions on either operational or policy questions. Overcoming the collective action problems that prevent meaningful shareholder involvement would be difficult and costly. Accordingly, shareholders will prefer to irrevocably delegate decisionmaking authority to some smaller group; namely, the board of directors. Given the significant virtues of discretion, preservation of managerial discretion should always be the null hypothesis. The separation of ownership and control mandated by U.S. corporate law has precisely that effect. The further constraints on shareholder activism provided by U.S. securities law, accordingly, likely have a strong efficiency justification. The article then provides a doctrinal overview of those constraints. Four specific aspects of U.S. securities law are examined: (1) disclosure requirements pertaining to large holders; (2) shareholder voting and communication rules; (3) insider trading laws; and (4) short swing profits rules. The article concludes by summarizing the comparable provisions of Slovenian law, noting that Slovenian law in many respects parallels the U.S. model. Unfortunately, continued state ownership and the political influence of large holders cast doubt on whether Slovenia will muster the will to meaningfully constrain the power of its institutional investors.

The Parable of the Talents

On its surface, Jesus’ Parable of the Talents is a simple story with four key plot elements: (1) A master is leaving on a long trip and entrusts substantial assets to three servants to manage during his absence. (2) Two of the servants invested the assets profitably, earning substantial returns, but a third servant — frightened of his master’s reputation as a hard taskmaster — put the money away for safekeeping and failed even to earn interest on it. (3) The master returns and demands an accounting from the servants. (4) The two servants who invested wisely were rewarded, but the servant who failed to do so is punished. Neither the master nor any of the servants make any appeal to legal standards, but it seems improbable that there was no background set of rules against which the story plays out. To the legal mind, the Parable thus raises some interesting questions: What was the relationship between the master and the servant? What were the servants’ duties? How do the likely answers to those questions map to modern relations, such as those of principal and agent? Curiously, however, there are almost no detailed analyses of these questions in Anglo-American legal scholarship. This project seeks to fill that gap.