We often hear that entrepreneurship is important to the economy. But what exactly is “entrepreneurship”? There is a broad and growing literature connecting institutions with entrepreneurship in the fields of law, economics, finance, and business generally. Legal scholars in this field typically focus on the role of “law” and treat “entrepreneurship” as a taken-for-granted concept that does not need any discussion. Yet, it is important to recognize that researchers in the broader non-legal literature on the relationship between institutions and entrepreneurship have been struggling to define and measure “entrepreneurship.” Empirical research that measures entrepreneurship inaccurately may lead to flawed conclusions including legal policy recommendations.
In their article, Measuring Entrepreneurship: Do Established Metrics Capture Schumpeterian Entrepreneurship?, Henrekson and Sanandaji evaluate different country-level measures of entrepreneurship and find that virtually all the widely-used metrics fail to capture high-impact Schumpeterian entrepreneurship – the kind of entrepreneurship that policymakers hope for.
The authors start by analyzing and applying the definition of Schumpeterian entrepreneurship. Schumpeter’s definition focuses on the revolutionary function of entrepreneurship, rather than the employment status, and does not include routine business activity. Based on this, the authors identify four categories of business activity: (1) routine and low impact (e.g. mom and pop shops); (2) routine and high impact (e.g. firms that grow large through routine activity in real estate); (3) Schumpeterian and low impact (e.g. recently created innovative startups); (4) Schumpeterian and high impact (e.g. entrepreneur-founded firms that have grown large through technological or business innovations).
The authors construct four measures of high-impact Schumpeterian entrepreneurship, including venture capital-funded IPOs, self-made billionaire entrepreneurs, unicorn startups, and young top global firms founded by individual entrepreneurs. They also compile six measures of entrepreneurship commonly used in the literature, including: number of new entities with limited liability per capita (source: World Bank), business ownership rate (source: Global Entrepreneurship Monitor (GEM)), low/high expectation total early-stage entrepreneurial activity (GEM), self-employment as a share of total employment, and self-employed with employees as a share of total employment.
Using data based on 64 countries, the authors find that their four independently constructed and manually collected measures of high-impact Schumpeterian entrepreneurship have a strong correlation with one another and share a consistent underlying pattern. The factor underlying the four measures is positively correlated with economic (e.g., GDP per capita, R&D spending as a share of GDP, education and human capital index) and institutional (e.g., international property rights index, corruption perception index) variables. Meanwhile, the six commonly used measures of entrepreneurship, except for the number of new limited liability entities per capita, are explained by a different underlying factor, which is related to small business activity and negatively correlated with the economic and institutional variables. According to the authors, the finding that the number of new limited liability entities per capita appears to capture Schumpeterian entrepreneurship may indicate that incorporated firms have higher growth potential than unincorporated ones.
This article offers insights for the study of law and entrepreneurship. It is important to distinguish different types of entrepreneurship and use relevant metrics. Different legal institutions may produce different kinds of entrepreneurial activity, and different types of entrepreneurship may need different legal infrastructure. Scholars of law and entrepreneurship should be aware that most existing cross-country empirical studies in the field measure entrepreneurship as small business activity, which is distinct from the Schumpeterian entrepreneurship that plays a critical role in innovation and economic transformation. This excellent article gives us interesting and useful metrics of Schumpeterian entrepreneurship with which we may conduct empirical research to further examine the relationship between law and innovative entrepreneurship.
Cite as: Li-Wen Lin, Law and (Which?) Entrepreneurship
(June 16, 2021) (reviewing Magnus Henrekson and Tino Sanandaji, Measuring Entrepreneurship: Do Established Metrics Capture Schumpeterian Entrepreneurship?
, 44 Entrepreneurship Theory & Prac.
733 (2020)), https://corp.jotwell.com/law-and-which-entrepreneurship/
Dorothy Lund & Elizabeth Pollman, The Corporate Governance Machine
, 122 Colum. L. Rev.
(forthcoming, 2021), available at SSRN
Indictments of shareholder primacy have grown increasingly common. Confronted with the pressing challenges of climate change, structural racism, and the spread of disinformation, legal scholars are revisiting the timeworn question of the purpose of a corporation and its standard answer: to maximize shareholder wealth. For the most part, this discussion has rigidly centered on the role of corporate law. Do cases like Dodge v. Ford and eBay v. Newmark require corporations to have a shareholder-oriented purpose? Is shareholderism the inevitable consequence of laws that place the power to elect corporate directors in the hands of shareholders alone?
Dorothy Lund and Elizabeth Pollman’s thought-provoking new article, The Corporate Governance Machine, reminds us however that shareholder primacy is actually the product of a complex system, of which the law is just one component. The “corporate governance machine,” as they define it, is the “governance system in the United States composed of law, markets, and culture that orients corporate decision-making toward shareholders.” Lund and Pollman argue that law may in fact “be the least important” force propelling this machine in its current direction. Market players, such as proxy advisors, stock exchanges, and ratings agencies, as well as entities that propagate cultural norms, such as professional education and media institutions, bear substantial responsibility for amplifying and reinforcing shareholder primacy.
As Lund and Pollman deftly illustrate, ideas that enter the corporate governance machine eventually either develop a shareholder value sheen or fade into irrelevance. Think, for example, of the movement pushing corporations to consider environmental, social, and governance (ESG) goals. ESG co-opted the goals of an earlier corporate movement advocating for “corporate social responsibility” (CSR). As understood by Howard Bowen, who coined the term in the 1950s, CSR referred to a corporation’s moral obligations to society regardless of the impact on investors. It addressed “the obligations of businessmen to pursue those policies to make those decisions, or to follow those lines of action which are desirable in terms of the objectives and values of our society.” But starting in the 1980s, spurred by the rise of the law and economics movement, scholars began to discuss the “business case” for CSR and explore the link between it and financial performance. In turn, CSR shed its prosocial justifications and adopted investor-oriented ones instead, transforming into ESG.
Lund and Pollman show how legal and extralegal players in the corporate governance system both fueled this shift. Once ESG became perceived as beneficial for investors, it gained the enthusiastic support of the legal community because it elided the difficult debate over the proper ends for corporate decisionmaking. In turn, market participants who had ignored CSR embraced ESG because they saw a profit opportunity: “[a]s investors started to accept the notion that integrating ESG measures could mitigate risk and create shareholder value . . . ratings agencies began providing ESG metrics, institutional investors offered ESG funds, and thousands of investment professionals billed themselves as ‘ESG analysts.’” Today, calls for greater attention to and transparency surrounding corporate ESG initiatives nearly all use the language of shareholderism. This orientation, in turn, shapes cultural and managerial perceptions about the kinds of ESG activities a corporation should undertake.
Appreciating how the corporate governance machine functions can broaden our understanding of the U.S. corporate landscape. It can explain features that law, by itself, cannot. The language of corporate reform, for example, has been decidedly shareholder-centric for decades. Even proposals that aim to enhance corporate accountability to the public as a whole, such as mandatory ESG disclosures and board diversity mandates, are primarily justified as benefitting investors economically in the long run (possibly resulting, as Lund has suggested in other contexts, in a type of “discursive harm”). The corporate governance machine also illuminates the near universality of certain pro-shareholder governance structures in public U.S. companies, such as annual elections, majority voting, and independent directors. These arrangements are not required by law and may even be suboptimal in some cases, but as soon as companies go public, they are all pushed to conform to a common shareholder-oriented blueprint by stock exchanges, ratings agencies, proxy advisors, and other market and cultural forces.
Most importantly, the corporate governance machine explains the stickiness of shareholder primacy in the United States. Because shareholderism is not the product of law alone, incremental legal reforms that offer corporate managers more discretion to consider stakeholders’ interests will not by itself change corporate behavior so long as the other components of the apparatus (the institutional actors and our cultural acceptance of shareholder primacy) remain intact. Lund and Pollman offer this conclusion bluntly, saying “the larger war has been won” by shareholderists. But they also put forth a partial silver lining for critics of shareholderism by noting that the definition of shareholder value can and has evolved to incorporate broad stakeholder interests.
Through richly historical accounts and a range of detailed examples, The Corporate Governance Machine adds much-needed complexity to conventional narratives on why shareholder primacy has dominated over competing theories in the United States and proven so hard to dislodge. At a time when companies’ actions and impact are increasingly under scrutiny, this article will almost certainly spark important conversations.
Roy Shapira, A New Caremark Era: Causes and Consequences
, 98 Wash. U. L. Rev.
__ (forthcoming, 2021), available at SSRN
It is well known that corporate compliance departments’ effectiveness depends on the quality of information they receive. In A New Caremark Era: Causes and Consequences, Professor Roy Shapira argues that providing information to attorneys for plaintiffs also can enhance compliance. Delaware courts have broadened and are broadening shareholder inspection rights, interpreting DGCL §220. When plaintiff attorneys take advantage of this procedural change, their cases can survive motions to dismiss. Shapira traces out the substantive consequences of this expansion of access: It puts teeth into their Caremark arguments.
Demonstrating a confidence in their abilities to prevent fishing expeditions and quickly dismiss strike suits, and generally to engage in what Shapira calls “micro-management,” Delaware courts minimize the costs to corporations of expanding discovery. Also demonstrating a confidence in corporations’ abilities to properly respond to discovery requests, Delaware courts also have found that the absence of records can demonstrate a violation of Caremark duties. As a result, corporations increasingly will paper their decision-making. Even if this is only window-dressing, Shapira insightfully explains that when it is known that these papers are discoverable, internal compliance will be enhanced.
This Article reviews a chain of cases in which the Delaware Supreme Court reversed Chancery dismissals of Caremark claims. Substantively, their important contribution is that board failure to monitor “mission critical risks” violates the duty of loyalty. Procedurally, their important contribution is an expansion of pre-filing inspections under section 220.
The Article then reviews developments in Delaware regarding shareholder rights to inspect a corporation’s “books and records.” Shapira calls it “The Liberation of Section 220.” The limitations that inspection requests must show both proper purpose and scope have been eased. Hearsay, especially news reports, has been held to show a credible basis for a proper purpose. Informal communications such as emails and social media postings are now within the proper scope. Section 220 inspections are no longer limited to meeting minutes and similar corporate records.
Courts regularly have dismissed derivative actions because the complaints merely restate public information. Expanding pre-filing discovery enables attorneys who take advantage of section 220 to get their complaints past motion to dismiss. When courts then ensure that cases proceed in the best interests of the corporation, their results both formally and informally, especially in the presence of reputational sanctions, enhance corporate compliance.
One of the most interesting aspects of Shapira’s argument is that he traces how these Delaware Supreme Court reversals are played out in law firm news releases. Shapira sees these as “advisory memos.” He finds that they “implore” directors to “start working harder” on compliance and “make sure that proper documentation exists.” They “admonish their clients to create better reporting and information system and documentation.” As a result, Shapira concludes, better Caremark compliance will result.
Lauren Edelman has studied similar self-advertisements by HR consultants and she found that they led to greater power and security for HR actors, in part by overstating the results of judicial decisions. It is clear that the news releases that Shapira analyzes sell reasons to employ lawyers. They are advertisements for how the firm can be hired to help corporations. It is less clear if they go beyond the holdings of the judicial decisions to which they respond. If Shapira is right that these memos change corporate behaviors in the directions suggested by the Caremark line of cases, then perhaps we should praise the increasingly competitive corporate law environment that generates these “want ads,” and not be overly concerned about their accuracy. Even if I am less sanguine than Shapira about what lawyers will supply once hired, Shapira deserves credit for bringing into legal literature the analysis of these self-advertisements. They exist in many areas of the law and have consequences that deserve analysis, as Shapira has demonstrated.
Michal Barzuza, Quinn Curtis & David H. Webber, Shareholder Value(s): Index Fund ESG Activism and the New Millennial Corporate Governance
, 93 S. Cal. L. Rev.
__ (forthcoming, 2020), available at SSRN
Index funds have become a subject of intense scrutiny, first and foremost, because they are enormous. BlackRock, Vanguard, and State Street – the “big three,” with several trillion dollars in assets under management collectively – control around one-quarter of the stock of the S&P 500 companies. Accordingly, there is keen interest in understanding how they exercise the rights associated with that mountain of stock. As a threshold matter, why exert themselves at all, when their passive management model thrives on low fees, and therefore low costs? And why, despite these incentives, have they become increasingly vocal on sustainability-related matters, sometimes described as “environmental, social, and governance” (ESG) issues? As Michal Barzuza, Quinn Curtis, and David Webber argue in the paper cited above, the answer may relate to an overlooked dimension of the competition among these major institutions – the urgent effort to attract Millennial assets.
Whereas actively managed funds aim to beat the market, and accordingly compete on performance, index funds simply aim to match the market, and accordingly compete on price. Index funds cannot sell underperforming stocks because, by definition, they track a particular index, and they would seem to lack any straightforward incentive to engage in activism because this drives up costs and correlatively diminishes the competitiveness of their fees. As the authors acknowledge, this view of the matter is consistent with evidence showing that “index funds vote their proxies, but rarely initiate shareholder action, and have small – but growing – corporate governance operations.”
Nevertheless, Barzuza, Curtis, and Webber document “extensive index fund activism around board diversity and other social issues.” Notably, these index funds “have not been afraid to aggressively challenge boards when companies are not responsive to calls for gender diversity, including voting against current directors” – an approach initially adopted by State Street and followed soon thereafter by others. Meanwhile, climate change has also become a major focus, with BlackRock leading the charge and others following suit.
How might this be squared with the fee structure and associated incentives described above? Given the mixed results of the empirical literature, the authors argue that “conventional shareholder value creation is unlikely to explain index funds’ commitment to promoting diversity.” Meanwhile, given the Department of Labor’s skepticism regarding the compatibility of ESG investment with investment duties under ERISA – applicable to 401(k) plans, from which “the big three hold vast sums” – they argue that “regulatory uncertainty around index funds’ social activism … is evidence against the view that these governance interventions are explained as a means of staving off regulatory intervention.”
A more plausible explanation, they argue, lies in a different direction – an increasingly heated competition to secure assets from investors who increasingly care about these issues. “In the coming decades,” they observe, “between $12 and $30 trillion will be transferred to Millennials,” generally understood to mean those born in the 1980s and 1990s. This will represent “the largest intergenerational wealth shift in history,” and a growing body of research indicates that Millennial investors are more likely to invest based on ESG considerations than are others. These developments have not been lost on the big index funds, which “are taking Millennial wealth seriously.” Accordingly, “competition for their assets – and future assets – has already begun in earnest.”
The authors’ novel insights certainly provide a helpful means of understanding the index funds and their role in corporate governance generally. At the same time, however, the evidence that they marshal to support their argument may also illuminate the degree to which various forms of sustainability-related initiatives might plausibly be advanced by this important category of institutional investors. Notably, the tension they cite between the desire to “avoid challenging management because they fear loss of access to companies’ 401(k) platforms,” on the one hand, and the desire to appeal to Millennial investors, on the other, may help explain why the index funds have pursued some ESG issues more energetically than others. For example, they suggest that “fear of confronting management may explain index funds’ more cautious approach to climate change so far.” Whereas “Millennials care about both diversity and climate, the gender composition of a corporate board is a far less sensitive issue for most firms than their carbon footprint.” Accordingly, index funds may “intervene aggressively when the cost is low and tread lightly when it is not.” In each context, they argue, it is “a straightforward cost-benefit calculation.”
Clearly much work remains to be done regarding the significance and impacts of the business models and ESG-related activism of index funds. Likewise, Millennial wealth and values will remain dynamic subjects of study for decades to come. In the meantime, Barzuza, Curtis, and Webber’s analysis sheds new light on their complex interactions, and reveals dynamics that may have profound impacts on these investment structures and their potential to promote corporate sustainability.
Cite as: Christopher M. Bruner, Index Funds and Millennial Assets
(March 22, 2021) (reviewing Michal Barzuza, Quinn Curtis & David H. Webber, Shareholder Value(s): Index Fund ESG Activism and the New Millennial Corporate Governance
, 93 S. Cal. L. Rev.
__ (forthcoming, 2020), available at SSRN), https://corp.jotwell.com/index-funds-and-millennial-assets/
William Moon’s thought-provoking recent paper, Delaware’s New Competition, examines whether there exists an international market for corporate law. Moon’s paper captures a trend in which certain offshore jurisdictions are emerging as corporate lawmakers and attracting publicly traded firms. Specifically, the paper analyzes how a small group of island nations, or “havens”, are developing legal infrastructures that attract public companies. It explores how and why foreign nations might compete for a market share of “American” corporations.
Paper’s Central Findings
Moon’s paper moves beyond the domestic charter competition narrative centered on Delaware to explore its international and comparative dimensions. The popular view of offshore incorporation is that it is largely driven by tax considerations. (Pp. 1417–18.) Moon considers another aspect of the jurisdictional product bundle: corporate law.
To the extent that the internal affairs doctrine applies to foreign incorporation, there is presumably an international market for corporate law. (Pp. 1418–22.) The article considers whether companies with (i) significant US-based operations that might incorporate in a foreign jurisdiction or (ii) primary operations outside of the United States but seeking to raise capital by listing on a US-based exchange shop for corporate law produced by foreign nations. (P. 1424.)
The article focuses on three jurisdictions—Bermuda, the British Virgin Islands, and the Cayman Islands—that have more in common than their location in paradise. In fact, they share several key characteristics with Delaware—(i) credible commitment due to a reliance on fees; (ii) limited interest group dynamics; and (iii) dispute settlement capabilities—but the substance of their law diverges from Delaware’s in distinct ways.
Credible Commitment and Fees
Like the small state of Delaware, these small islands are dependent on corporate fees (Pp. 1430–32), which increases their sensitivity to private-sector corporate governance preferences. For example, the British Virgin Islands generate significant government revenue from corporate registration fees—as much as 58 percent in 2017. (Pp. 1430–32.)
Limited Interest Group Dynamics
The paper provides an interesting discussion of how offshore jurisdictions make corporate law. In some ways, the process loosely resembles the dynamics in Delaware. The similarities may explain how these jurisdictions can easily adapt their law to attract companies. Prominent private-sector lawyers and law firms are instrumental in writing the content of corporate governance rules in leading offshore jurisdictions. In essence, they function as de facto lawmakers. Local interest groups also benefit from foreign offshore incorporations. The local private sector helps firms navigate local administrative requirements, and some jurisdictions even mandate that companies have a resident director. (Pp. 1432–37.)
Automatically creating a judicial system like Delaware’s is hard for offshore jurisdictions. To meet the challenge, they have launched specialized business courts with arbitration-like dispute settlement features, including greater privacy. (Pp. 1437–43.) Moreover, whereas Delaware judges have to be Delaware citizens, offshore jurisdictions can recruit foreign citizens who are highly regarded judges and experienced commercial lawyers.
Substantive Law Differences
Despite similarities, leading offshore jurisdictions diverge from Delaware when it comes to substantive law. Whereas Delaware relies on extensive caselaw and a litigant-driven system, offshore jurisdictions have enacted relatively clear-cut statutory laws that are more prescriptive in the absence of case volume. Their laws are also arguably more permissive, with fewer mandatory rules. Companies desiring to opt out of some mandatory rules under the US corporate law regime can incorporate offshore. These jurisdictions offer limited protections for minority shareholders; derivative suits are rare; and shareholder inspection rights are limited and, in some instances, forbidden. (Pp. 1444–50.) Corporations can even limit, opt out of, or waive certain fiduciary duties, such as the duty of loyalty. Bermuda, an extreme case, allows corporations to waive all fiduciary duty claims against directors and officers, except in the event of fraud and dishonesty. (Pp. 1444–50.)
Paper’s Implications for Scholarly Debate and Future Research
Scholars have thoroughly debated Delaware’s jurisdictional dominance and reached a point of general consensus: despite several attempts, no other states pose a significant competitive threat to Delaware’s dominance, and federal government encroachment is the only palpable domestic threat. A few scholars have focused on the international and comparative dynamics of incorporating in offshore jurisdictions, but most focus on tax-inversion strategies.
A New Frontier of Competition
Moon’s paper builds upon the corporate-chartering conversation by highlighting a new frontier of competition. Even if robust US interstate competition is mostly a myth, leading offshore “havens” may compete for incorporations. Certainly, at the moment, the degree of competition between offshore jurisdictions and Delaware is limited, but the incentives and contextual factors necessary for competition are in place.
Most of the discussion concerning offshore jurisdictions presumes that taxes are the overwhelming reason that companies decide to incorporate offshore. Moon introduces more nuance. The incorporation decision loosely resembles the purchase of a bundled product composed of many features. When incorporating, companies and their advisors presumably consider such factors as corporate law, dispute settlement, taxes, and other regulations, but, in practice, these jurisdictional features can be difficult to decouple. The article underscores the need for future research to capture the deeper nuances of these considerations that may lead to offshore incorporation.
A Race to the Bottom?
Critics might assert that the emergence of offshore jurisdictions reflects a race to the bottom, with minimal standards for corporate managers and limited shareholder protections. Meanwhile, proponents can argue that significant legal variation among these jurisdictions makes this judgment too sweeping. Instead, offshore jurisdictions may offer an extended menu of corporate-law options and serve as laboratories for innovation.
Where are the other Stakeholders?
Beyond limiting minority shareholder rights, offshore incorporation may also sidestep stakeholder and third-party interests. Small offshore jurisdictions, like the small state of Delaware, are insulated from robust interest-group dynamics which, in turn, may result in corporate law that is less receptive to third-party concerns.
In conclusion, Moon’s paper is a must-read for scholars interested in the international dimension of the incorporation debate.
History is the key to understanding U.S. banking law and regulation. History also repeats itself. Professor Art Wilmarth’s new book sheds new light on these oft-repeated propositions. It tells a multi-layered, richly textured story of how the rise of U.S. universal banks – diversified financial conglomerates clustered around publicly-backed banks – led both to the Great Depression of the 1930s and the Great Recession of the post-2008 era. On that basis, it makes a case for breaking up today’s universal banks and shadow banks and reestablishing the legal wall separating banking from the capital markets.
The book has been eagerly anticipated by all of us in the banking law and financial regulation academic community. Professor Wilmarth has devoted much of his long and fruitful scholarly career to studying the dysfunctional effects of excessive conglomeration in the U.S. banking sector. His knowledge of the subject is unparalleled (as some of us often joke, Art has probably forgotten more banking law than we will ever manage to learn!). Taming the Megabanks brings all of that immense knowledge into a compelling narrative of a decades-long process that gave us today’s corporate behemoths: Citigroup, JPMorgan, Bank of America, and a few other familiar names.
Professor Wilmarth traces the origins of America’s universal banks back to the late nineteenth-early twentieth centuries, when large commercial banks began expanding into lucrative securities underwriting and trading. The book shows how, in the wake of the World War I and through the “roaring 1920s,” commercial banks’ competition with investment banks fueled incredible speculation in stocks and bonds, which ended in the momentous market crash of 1929. It was in response to the Great Depression that followed it that Congress adopted the Glass-Steagall Act of 1933, which prohibited deposit-taking banks to engage in, and to affiliate with, securities and other financial services firms.
Professor Wilmarth gives a fascinating account of the “long and tortuous journey” that culminated in the passage of the statute. His description of banking industry executives’ public appeals to “service to community” and “market efficiency,” in particular, made me chuckle with weary recognition. It is, of course, hardly surprising that big banks fought the proposed prohibition on mixing deposit-taking with speculative trading with all their might. In subsequent decades, they worked even harder to get around and ultimately to dismantle the Glass-Steagall regime. Professor Wilmarth walks the reader through the intricate sequence of legal and regulatory actions from the early 1980s on, which gradually undermined the prohibition on banks’ securities trading and underwriting activities, leading to the formal repeal of that prohibition in the Gramm-Leach-Bliley Act of 1999. The book discusses the growth of mortgage securitization and derivatives markets, along with the growth of “too big to fail” financial conglomerates, driving the “toxic credit bubble” that finally burst in the fall of 2008.
Drawing the many parallels between the Great Depression and the post-2008 Great Recession, Professor Wilmarth focuses on the fundamentally different character of the legislative response to these two situations. He criticizes the Dodd-Frank Act of 2010 for its failure to restore the institutional wall between publicly-backed banks and the increasingly unstable shadow banking sector. He concludes the book by arguing in favor of adopting a new Glass-Steagall Act, as the key reform necessary to diminish systemic risks in the financial system, reduce the size and disproportionate market power of bank-centered conglomerates, and protect the public from devastating financial crises.
Undoubtedly, not everyone will agree with this idea. Some may find Professor Wilmarth’s proposal too radical – and perhaps a bit anachronistic. Others may point out that it is not exactly novel: in recent years, there have been multiple calls for, and attempts to introduce, a new Glass-Steagall Act. Yet, everyone with an interest in, or desire to understand, U.S. financial regulation and prospects for reform should read Professor Wilmarth’s book. It is incredibly well-researched, densely packed with facts, deep, and thoughtful. It makes a strong case for an important structural change. And it is bound to be part of the canon.
Sarah C. Hann, Corporate Governance and the Feminization of Capital
(Dec. 8, 2020), available at SSRN
In her working paper, Corporate Governance and the Feminization of Capital, Sarah C. Haan unearths the lost history of female shareholding and the crucial role gender bias and stereotypical depictions of women may have played in the creation of a corporate law system and ideology that promoted managerialism—to the benefit of white males. From the beginning of the twentieth century to the start of the Great Depression, corresponding with the rapid rise to dominance of the modern corporation, women had grown from an insignificant portion of the nation’s stockholders to a majority in many publicly traded firms; by the mid-1950s women were a numerical majority of all owners of publicly-traded stock. In the two decades before the Great Depression, reformers worried about the looming influence of the emerging modern corporation, and many advocated protecting and reinforcing shareholder power as the appropriate antidote.
The Great Market Crash of 1929 and the election of Franklin Roosevelt in November of 1932 provided the crisis and the opportunity to remodel corporate governance. However, rather than increasing the shareholder governance role, corporate theorists and policymakers preferred laws and legal institutions that fostered and supported managerialism. Haan convincingly argues that the path taken corresponded with gender-biased beliefs concerning the capabilities and appropriate roles of men and women, and that Berle and Means’ The Modern Corporation and Private Property (“The Modern Corporation”), published in the summer of 1932, played and continues to play a central role in how corporate law is theorized and understood.
As the early years of the twentieth century unfolded, corporate managers, policymakers, and theorists noticed and commented on the rapid emergence of women as stockholders. As the bull market of the 1920s took flight, brokerage firms targeted women stock purchasers, and the proportion of women in the total stockholding census continued to rise. Nonetheless, as Haan meticulously details, commentators, even progressives, uniformly portrayed women as lacking the capacity or experience to make investment decisions or participate in corporate management. Women were cast as inherently passive and needing protection; their proper action field was the home, not the corridors of corporate power. One of many comments cited by Haan is that of William Ripley, writing in 1927:
The average stockholder is entirely unqualified to engage actively in management. For a surprisingly large number of great corporations more than half of the shareholders are women—in American Telephone for 1926, 200,000 of the 366,000 were on the distaff side. Such a multitude are ill-fitted by training—begging the moot point of sex—to govern directly, less so than in politics. These business issues are far less simple, far less moral, and they make less appeal to the imagination than those in the field of government.
Ripley’s representative comments are particularly interesting given his mentoring relationship with Adolf Berle, the principal author of The Modern Corporation, and they occurred just as Berle and his research assistant Means were beginning work on their seminal opus. When published in 1932, The Modern Corporation captured influential citizens’ attention in the run up to, and early stages of, the New Deal. It provided an empirically-rich account of the extent to which the corporation had come to dominate many sectors of the American economy during the first three decades of the twentieth century, and how many corporations were now effectively controlled by their managers due to the wide dispersal of stock ownership. Moreover, policy makers and lawmakers were given a sense of urgency by Berle and Means’ prediction that management control and shareholder dispersal would steadily increase, and that the old model of an entrepreneur-controlled firm, like the Ford Motor Company, would become the rare exception.
What Haan adds to our understanding of Berle and Means’ account of the modern corporation and its influence is the hidden role of gender bias. In the rich empirical tapestry Berle and Means wove, one important datapoint was missing—the gender of the modern corporation’s shareholders. While ignoring gender in their compilation of stockholder data, Berle and Means persistently characterize stockholders as intrinsically passive, a term which Haan persuasively argues was well understood at the time as a prototypically feminine trait. Moreover, argues Haan, while shareholder dispersion was then well understood and so termed, The Modern Corporation is the first important work to term stockholding as by its very nature passive; passivity was not a choice but a structural reality, much as society then viewed the female as inherently unfit to participate in the rough and tumble world of business. And given the inescapability of their passive “feminine” nature, Berle and Means argued that stockholders had agreed to a role subordinate to managers, who, of course then as now were nearly all men, a fact The Modern Corporation also ignored.
Haan’s working paper proceeds from the New Deal to the present, providing vignette after vignette of the rise of female stock ownership and the almost complete failure of corporation managers, lawmakers, or theorists to accord or support an active management role for stockholders. She then traces the decline of female stock ownership as institutions gradually displaced natural persons of all genders. She, then sketches the consequence of the rise of institutional stock ownership—the effective masculation of stock ownership—given the male dominance of stock fund management, and the accompanying shift in corporate law and theory to better accommodate a more active shareholder role.
Haan’s working paper is a sweeping, provocative, and almost totally new synthesis of long-forgotten historical details, coupled with a beginning examination of currently dominant corporate law theories and the centrality of stockholder passivity to those theories. She asks her readers to consider the question that lurks throughout her paper: “Does it matter if a concept so fully embedded in our discipline originated in gender bias?” Haan argues that it does, and describes a research agenda that emerges for those who agree.
This is a must-read article for every teacher and student of corporate law. One can enjoyably digest the text in one sitting, and then devote countless hours to exploring the incredibly rich footnotes and cited sources. Regardless of whether one agrees with Haan’s conclusions, a reader will take away a much more nuanced understanding of the nature of the modern corporation and the gender biases which it still reflects.
Fifteen years ago, U.S. legal scholarship treated central banks like the neglected stepchildren of bank regulation and administrative law: hardly anyone wrote about them, and no one who did not work for them seemed to care. The financial crisis that began in 2007 put the Federal Reserve, the Bank of England, and the European Central Bank in the middle of national and global crisis response strategies, and instantly made central banks the center of attention in a rich and fast-growing legal literature that continues to attract exciting new scholars.
Nonetheless, ceding central banks to economists for so long turned out to be costly: lawyers have spent much of the last decade fleshing out the underlying assumptions and basic terms of the debate, and deciding whether and how to assimilate economists’ theories of central banking into their own. The foundational question of distribution—how central banks’ monetary policy and financial stability activities distribute resources and allocate losses from crises among constituents—has lingered especially awkwardly over this area.
The slightly-stylized standard view associates distribution with fiscal policy, politics and legislatures. In this view, monetary and financial stability policies of the sort conducted by central banks do not distribute: they are for everyone at once, no one in particular, and best left to independent technocrats. This standard view is increasingly at odds with public perceptions of central banks as purveyors of bailouts for the few and peanuts for the rest. The disjunction can become a big political problem, freshly salient in the face of the multi-trillion-dollar response to the COVID-19 pandemic. The pandemic response again put central banks at the center, and took me back to Nadav Orian Peer’s pre-pandemic article situating the Federal Reserve at the intersection of political battles over corporate concentration, regional and sectoral development and, of course, money.
Orian Peer’s claim is that the Federal Reserve’s Lender of Last Resort (LOLR) function, which has been analyzed almost exclusively in financial stability terms—preventing and stopping contagious bank runs—represents a political settlement over credit allocation at the start of the 20th century.
In conventional textbook accounts, the LOLR stands ready to lend to solvent but illiquid banks in the face of panic withdrawals by depositors. It solves a coordination problem. In theory, the LOLR does not take credit risk because the solvent bank puts up good collateral for the emergency loan. In practice, central bank collateral eligibility can become a pitched political battle, because an asset that can be pledged to the central bank in exchange for cash when markets freeze up is way more liquid—and therefore way more valuable—than one that cannot be exchanged for cash. This in turn invites questions about capture, which dominate progressive accounts of LOLR.
Orian Peer’s article challenges conventional accounts in a way that is considerably more granular and interesting than a capture story. He focuses on three sets of constituents: large corporations, newly arrived on the scene in the mid-19th century, small businesses in East Coast urban areas, championed by Democrats, and Midwestern farmers. The three groups had very different credit needs, and used different instruments to access credit against the background of massive reserve concentration in New York City, which had become entrenched under the National Banking Acts in the aftermath of the Civil War.
Rapidly growing corporations primarily sought long-term funding for capital investments, mergers, and acquisitions. They issued stock and longer-term debt in the securities markets, which in turn relied on speculators’ willingness to buy these securities on credit. Speculators primarily financed themselves with very short term, secured, and therefore relatively cheap “call loans” from banks, which preferred call loans to other assets for their cash-like liquidity. Orian Peer cites contemporary sources that put call loans at nearly 10 percent of all bank deposits in the system shortly before the Federal Reserve Act was passed. Call loans were notoriously volatile—when banks needed cash, they called the loans—deepening and amplifying the link between commercial banks and the stock market.
Banks’ demand for cash was heavily seasonal. Farmers in the Midwest borrowed during planting season, often with no ability to repay until harvest time. Agrarian interests sought to distribute reserves more evenly across the United States (dethroning New York), boost the supply of long-term credit for farm economies in the West, and stabilize seasonal fluctuations in credit supply. They pressed for the new central bank to accept “accommodation loans” of nine months or longer as collateral for its liquidity support. In contrast, small businesses in urban areas focused on short-term “commercial paper,” working capital financing from the securities markets, with maturity of up to 90 days—for instance, to tide a merchant over between the purchase and sale of their inventory.
Abstracting from the details of the historical account, debates over collateral eligibility for call loans, commercial paper, and accommodation paper —as over Greek government securities, U.S. municipal bonds, car loans, home mortgages, and small business loans a century later—are not just about stopping bank runs. They are at least as much about who controls the supply of credit, about whether large corporations get to grow bigger and industries more concentrated, about the value of farmland and the prospect of stability in neglected regions and sectors of the economy. The article makes the connection between financial stability and credit allocation feel intuitive, and helps frame more fruitful lines of inquiry into the distributive work of central banks.
Cite as: Anna Gelpern, Central Banks’ Distribution, Revisited
(November 16, 2020) (reviewing Nadav Orian Peer, Negotiating the Lender of Last Resort: The 1913 Federal Reserve Act as a Debate over Credit Distribution
, 15 N.Y.U. J.L. & BUS.
367 (2019)), https://corp.jotwell.com/central-banks-distribution-revisited/
Mariana Pargendler, Veil Peeking: The Corporation As a Nexus for Regulation
, _ U. Pa. L. Rev.
_ (forthcoming), available at SSRN.
It is time to retire the term “veil piercing” from debates about corporate rights. Scholars have been drawn to the veil piercing language because of the tendency of courts to ignore the separate legal personality of a corporation when determining whether it may assert a particular constitutional or statutory right. For example, in Burwell v. Hobby Lobby Stores, Inc., the Supreme Court looked to the religious beliefs of the shareholders in allowing the corporation to claim protection under the Religious Freedom Restoration Act. Yet cases like Hobby Lobby, in which shareholders assert a corporate right to avoid an otherwise applicable law or regulation, are quite different from veil piercing cases in which creditors seek to access shareholder assets in satisfaction of a corporation’s debt. These deviations from following the general rule of “corporate separateness” are analytically and functionally distinct.
In her forthcoming article, Veil Peeking: The Corporation As a Nexus for Regulation, Professor Mariana Pargendler gives us new language for discussing the variety of circumstances in which the law looks behind the corporation or disregards its separate legal personality. Pargendler starts by reviewing the concept of asset partitioning as an essential characteristic of the corporate form. Over the past two decades, distinguished scholars have illuminated the importance of asset partitioning for establishing the key corporate features of entity shielding, limited liability, and capital lock-in. But, as Pargendler explains, the partitioning between the assets of the corporation and those of its shareholders is only one dimension of corporate separateness. Corporate legal personality also separates the legal or regulatory spheres of the corporation from its shareholders—she terms this “regulatory partitioning.” And when the general rule of separate legal or regulatory spheres is disregarded, and shareholder rights or detriments are imputed to the corporation, she calls this “veil peeking.”
The article is at once both creative and classic. It nimbly draws connections between diverse areas of law such as antitrust, discrimination, and tax, to observe a basic yet important characteristic of the corporate form: it exists in a separate legal sphere from its shareholders. That is, the legal rights, duties, privileges, and detriments of a shareholder are generally not projected onto the corporation, which instead has its own separate existence that functions as a nexus for regulation.
For instance, a shareholder might have a race, nationality, jurisdiction, and criminal status that is different from the corporation in which she has invested. This concept is no small matter—the separate legal life of the corporation from its shareholders allows for the operation of large-scale enterprise with numerous shareholders and transferable shares. Corporations and stock can be valued irrespective of shareholder identity. Regulatory partitioning additionally presents costs as well as benefits—because the corporation serves as a separate nexus for legal attribution, it can facilitate regulatory arbitrage.
Moving beyond these foundational observations regarding regulatory partitioning, Pargendler’s exploration of the veil-peeking exception shows that it arises in a variety of circumstances, resulting in both shareholder-friendly and shareholder-unfriendly outcomes. Veil peeking might at times permit the assertion of shareholder rights against the state or ascribe to corporations some of the constraints applicable to the individuals that control them.
Given the varying regulatory contexts in which these issues arise, a singular test for veil peeking does not emerge—yet here again, Pargendler’s thoughtful analysis helps shine a light on the range of approaches and their distinction from the concept of veil piercing. The article admirably begins the task of drawing together the threads of a centuries-long struggle with the question whether to ascribe the legal rights or detriments of shareholders to the corporation. Pargendler brings fresh perspective and order to the topic, providing corporate law thinkers with the opportunity to make connections to other areas of law and to see with new eyes the essential characteristics of the corporate form.
Vincent S.J. Buccola, Jameson K. Mah, and Tai Zhang, The Myth of Creditor Sabotage
, __ U. Chi. L. Rev.
__ (forthcoming), available at SSRN.
I love really good contrarian papers. They teach me things, and they don’t come along very often. Let’s face it, we academics tend to run in herds and our work tends to conform to our herd’s paradigm. Now, there may be more than one herd roaming in a given field—in corporate law we have at least three and maybe more—so that even the most argumentative, tendentious piece is less contrarian than it is directed at an opposing herd’s paradigm. The contrarian paper I have in mind works differently. It takes aim at a basic assumption shared amongst all members of all herds and tells us that that’s not what’s going on at all.
I also love really good papers about derivatives. There are certainly more than a few of these, but they don’t add up to very many given the importance of the subject matter and the concomitant need for investigation and learning. Corporate law professors for the most part don’t want to go there, preferring the comfier and less technically demanding precincts of corporate governance.
“The Myth of Creditor Sabotage,” forthcoming in the University of Chicago Law Review and co-written by Vincent S. J. Buccola, an Assistant Professor at Wharton, Jameson K. Mah, an Investment Analyst at Cyrus Capital Partners, and Tai Zhang, a member of the Wharton class of 2020, hits both of these buttons. It is a really good, deeply contrarian paper about credit derivatives. I knew it was going to be special when the sheer orneriness of the introduction gave me a pleasant jolt. My pleasure grew as the analysis unfolded.
So what sacred cow is being targeted by Buccola, Mah, and Zhang (BMZ)? I’ll describe it in herd terms. Corporate law professors of all stripes are constantly on the lookout for skewed incentives. This is most clearly true of law and economics types (“skewed incentives lead to suboptimal outcomes”) but is hardly their exclusive provenance (“self-dealing is unfair”). Find a skewed incentive and an unaccountable actor and you’ve got law review paydirt. Such papers often conclude with a call for law reform but need not do so. One can just as easily write a paper arguing against law reform on the ground that market controls assure backstop correction if not full accountability (whatever that is). CEOs, controlling shareholders, and plaintiffs’ lawyers are corporate law’s leading examples of unaccountable actors afflicted with skewed incentives. But the cast of nefarious characters grows all the time. We now hear about index funds, asset managers, investment bankers, proxy advisors, and, of course, hedge funds. I have written more than a few of these papers myself.
BMZ target the conventional wisdom surrounding the most recent development in the history of opportunistic hedge fund value destruction—the bankruptcy of Windstream, a large telecommunications provider, as a result of successful litigation by Aurelius, a net short vulture fund. The story is long and technical, so if anything confuses the reader of the brief summary that follows, the best palliative is to read BMZ. The thing to bear in mind is that the New York financial community (especially the corporate bar) was mesmerized as these events unfolded. Windstream-Aurelius was in 2017-2019 what Unocal, Revlon, and Paramount were in earlier decades.
Windstream did a complex asset partition to avail itself of REIT-based relief from double taxation. New legislation was closing the loophole, so Windstream needed to hustle. An internal sale-leaseback to and from a new shell subsidiary is the standard means to this particular end, but in this case it ran up against a sale-leaseback covenant in a trust indenture covering an issue of Windstream’s 6 3/8% Notes. To end-run the covenant, Windstream reconstituted itself with a new top-tier holding company and had the holding company take the lease back from the new sub asset transferee. Now, the property transferred continued to be used by the original asset transferor, the corporate obligor on the 6 3/8% Notes. But there was no lease to it from the holding company, which was now the nominal lessee. Instead, there was just a vaguely denominated arrangement under which payments flowed from the transferor-obligor using the assets to the holding company. (Are you still with me?) If the arrangement was not a “lease” within the meaning of the sale-leaseback covenant, there was no violation.
The bondholders let the deal go upon its completion in 2015. Nothing happened for the succeeding two years. Then Aurelius showed up as the holder of the majority of the 6 3/8% Notes, purchased at a discount. (An outright majority is necessary to assure an absolutely unimpeded right to enforce an event of default under the covenant and accelerate the entire bond issue.) Aurelius sued. Windstream defended with a literal read of the indenture and a backdoor attempt to upset Aurelius’s majority control of the bond issue. The indenture was openended, permitting the issue of more 6 3/8% Notes. Windstream set up an exchange offer of new 6 3/8% Notes to holders of its other bond issues, pursuant to which it minted enough new 6 3/8%s (and consents to waive the covenant) to undercut Aurelius’s lawsuit.
Windstream lost anyway. In U.S. Bank National Association v. Windstream Services, LLC, 2019 WL 948120 (S.D.N.Y.), Judge Furman rejected its reading of the sale-leaseback covenant, going with a substance over form interpretation. He also threw out the votes of the new 6 3/8% Notes, based on some highly technical limitations on new note issuance set out in the indenture. It is a well-executed, straightforward opinion, well within the ordinary interpretative parameters of bond cases decided over the past several decades.
Now for the twist in the wrist of the story. The Southern District’s judgment vested the acceleration of the 6 3/8%s, causing the cross-default clauses in Windstream’s other bond issues to go off like firecrackers. Windstream filed in chapter 11 two weeks after the Southern District’s opinion came down, at great cost not only to its shareholders but to its bondholders. It was a loss that was not shared by Aurelius, provided that Aurelius was net short as a credit default swap (CDS) protection buyer. And, as Bloomberg’s Matt Levine told us, everybody in the financial community assumed that to have been the case. The bankruptcy filing was a CDS credit event, leading to payout to the CDS protection buyer of the difference between face value and the post-bankruptcy value of the bond. On this read, Aurelius, a financial predator, successfully had inflicted suffering on all other Windstream constituents as it pursued a jackpot payoff conditioned on the company’s destruction. Much wailing and teeth-gnashing followed in the financial press and in the blogsphere. Creditor sabotage—covenant enforcement by a net short hedge fund—was corporate America’s Big New Problem. Indeed: Has there ever been a less accountable, more incentive incompatible player than Aurelius?
Now to BMZ, who do a deep dive into complex mechanics of bondholding, credit protection, and solvency to rebut the Big New Problem diagnosis. The net short play, they say, makes sense only to the extent that bankruptcy is the probable result, and that critical chapter 11 filing follows only to the extent the target runs out of liquidity. BMZ show that these days even distressed companies have places to turn to stay afloat. In fact, the proliferation of CDS has expanded the set of liquidity sources—in recent years protection sellers have been seen extending credit to distressed issuers of reference securities (if only to tide the securities’ issuer over until the CDS contracts’ expiration dates).
BMZ’s theoretical framework is Coasian. They show us a long cast of interested parties with stakes in keeping the target out of chapter 11 and the means to effect that result by mutual agreement. A beneficial trade, they say, can be expected. Happily, this is not a Cartoon Coasian solution where a Chicago Wizard waves a magic market wand and makes everybody better off. The authors acknowledge and confront numerous frictions. It is worth noting that such an account would not have been credible three decades ago, when everyone assumed that incentive skews and bondholder unaccountability made it impossible to solve problems of distressed issuers outside of bankruptcy. Things have changed since 2008, as the practitioners have developed a new spaces for successful contractual composition. In this new environment, BMZ’s Coasian move is quite plausible.
BMZ, having gotten this far, still have a problem. How can creditor sabotage not be the Big New Problem when we just saw a net short saboteur bring down a big company and make a killing? In the paper’s second part, BMZ meet this objection with a case study of Windstream-Aurelius. It makes for gripping reading. They run the numbers, reconstructing Aurelius’s position and laying out the stakes and returns and appraising the risks. The incentive take is that Aurelius went into the engagement to enforce the trust indenture and pick up the difference between the bond’s accelerated face value and the discounted value of the bonds at purchase (or such lesser amount as agreed to in a settlement); Aurelius, viewed ex ante, had no incentive to pursue the objective of pushing Windstream into bankruptcy and collecting on CDS. Per the terminology of Marcel Kahan & Edward Rock, Hedge Fund Activism in the Enforcement of Bondholder Rights, 103 Nw. U. L. Rev. 281 (2009), Aurelius sought to levy a “breach tax” and not to destroy the company. The ultimate negative result stemmed mostly from bad decisions made by Windstream’s managers, who misjudged the risks and stonewalled when they should have settled. The account is very, very well done, and teaches volumes about investments in distressed bonds and CDS.
The authors close with a succinct discussion of policy implications. They brief current positive law and contractual solutions to the Big New Problem with equanimity. No policy axes are ground even as caution is counselled. They also address implications “for rhetoric:” If creditor sabotage is a nothingburger, why all the brouhaha? A myth is being spun, say BMZ, (1) because it suits the interests of corporate managers, (2) because vulture funds “revel in a Machiavellian ethos,” and (3) because of “general anxiety about financialization.” Fair enough. I would add a fourth explanation, though. When managers transfer value from bondholders to their shareholders with tricked up asset partitions and stilted, literal readings of language in indentures, the bondholders are not supposed to win even as they’ve just been screwed. The managers after all are just doing their fiduciary duty to maximize shareholder value and the bondholders have skewed incentives (true) and are unaccountable (also true). The skewed incentive-unaccountability glove does fit. But not well. I prefer a different characterization, viewing the fact pattern not as “corporate governance” but as a case of contract performance, breach, and enforcement. Performance and breach is a world of tradeoffs where optimality has little to do with the present matters for decision. The value implications have to be left over for the future. And, if a contractual allocation has turned out to be dysfunctional—and this happens all the time in debt contracting—the term in question needs to be redrafted in the next generation of bond contracts. This too happens all the time, with the Big New Problem being solved as new money gets loaned. Finally, when a clever asset partitioning ploy goes sideways, managers shouldn’t stonewall. They should follow BMZ to stop posturing, consult Coase, and settle.
Cite as: Bill Bratton, Big New Problem Deflated
(September 8, 2020) (reviewing Vincent S.J. Buccola, Jameson K. Mah, and Tai Zhang, The Myth of Creditor Sabotage
, __ U. Chi. L. Rev.
__ (forthcoming), available at SSRN), https://corp.jotwell.com/big-new-problem-deflated/