May 28, 2025 Robert Rosen
This article explores “normative” agency cost theory. It does so by examining its most discussed prescriptions for making healthy corporations (empowered shareholders, monitoring boards, pay-for-performance, and the market for corporate control). Presenting very impressive evidence, the article concludes that the remedies prescribed don’t work either to minimize managerial self-dealing or increase returns to shareholders. Yet despite the evidence, these remedies are still being prescribed. Professor Tingle’s confrontation with that fact is a singular contribution. Until I read this article, I believed the response “agency cost theory is good, it just has been poorly implemented; the dosages just need adjusting.” Professor Tingle offers a different response, the incontestability of agency theory’s “seductive simplicity” (P. 60).
Tingle reveals that normative agency theory’s continuing power derives from it telling a tale of temptation and seduction that “seems uncontroversial” (P. 15). It provides an account of how self-interested and unrestrained agents would act if given the opportunity to cheat. Without evidence, it assumes that “managers are systematically disloyal” (P. 59). And this assumption is not testable. If corporations were run by monks, the successes of their corporations would confirm the theory, and if their corporations were unsuccessful, the monks would be revealed to be disloyal by how they were selected or by their ignorance (Pp. 10-11).
Tales of temptation and seduction are universal. But they do not need to become normative. Chastity belts and chaperones can sometimes reduce disloyalty. When couples’ interests are aligned, that too can sometimes reduce disloyalty. But these need not become best practices. In fact, there are other sources for loyalty and attention to them will better determine long-term success. And, presuming disloyalty may itself induce it. It is a question of fact for each relationship how to promote loyalty (in the face of many possibilities for disloyalty). That is why there are so many different tales of temptation and seduction in literature. In this sense, agency theory has a genre. However, the empirical evidence reveals that the drama of corporate life is much more particularized.
Saying that a theory has legs is to refer idiomatically to its strength. Agency theory has long legs in part because of its many carriers. Agency theory legitimated monitoring and bonding costs. Furnishing them became the task for corporate governance, employing many. There is a “governance industry” of fund managers, fund advisors, proxy advisors, corporate consultants, regulators and legislators (P. 16). This is not to suggest venality. After all, even “corporate managers themselves” diagnose governance deficiencies and have their corporations take the prescribed remedies (P. 58). Furthermore, in some cases, “the market believes the agency cost theory story, but the market is wrong,” as with the undervaluation of dual-class stock companies (P. 27) and the mispricing of acquisitions (P. 45).
The governance industry thrives because agency theory is simplistic in another sense. The “best practices” so prized in corporate governance are easily implemented, no idiosyncratic, insider knowledge is required (P. 7). Governance inputs neither calibrate markets, prescribe competitive strategy, nor otherwise contribute to the business plan.
In part because of the governance industry, good governance has become an end in itself. No one demands proof of its effectiveness. “Outside of some rhetorical flourishes” (P. 61), governance industries do not stake their rewards on demonstrating the competitive advantage of their remedies. Hence, they are not undone when remedies, such as “shareholder activism,” turn out to have no empirical correlation with “business improvement” (P. 23). Despite agency theory’s justifications for its prescribed remedies having been “contradicted by all available evidence” (P. 36), there has been “no impact on the behavior of institutional shareholders, regulators, proxy advisors, or governance experts” (P. 32). Not agency theory but its prescriptions are normative. We apply its remedies even though they neither reduce agency costs (by firing shirking CEO’s) nor increase shareholder returns. We desire pay-for-performance plans without any demonstration that they improve shareholder returns. We approve of increases in shareholder power not because we actually subscribe to the precepts of agency theory but because agency theory has flourished in a context in which shareholders are understood to be “owners.” The sociology of these normative beliefs includes agency theory but is not determined by it. As Tingle notes, “Increasing shareholder power” may be justified because it “will lead to better corporate outcomes” (P. 15, emphasis deleted). However, the normative thrust of agency theory is only to sanction “increasing power relative to managers” (P. 13), not to give shareholders leadership, let alone control. What is being worked out by the governance industry are norms that are not of proper control but of ownership.
One reason that agency theory survives is that it takes a theory to beat a theory. Agency cost theory displaced managerial theories about the benefits of agents, theories whose simplistic optimism no one misses. Agency theory’s simplifying foundational assumption of “unfaithful agents” (P. 55), on the other hand, commands attention. Agency theory is part of a general attack on bureaucracies, as Oliver Williamson demonstrated. Michael Jensen wrote that without pay-for-performance, corporate leaders are “like bureaucrats” (P. 40). When “bureaucrat” is a term of opprobrium, agency cost theories reign. For a counterweight to agency theory, most observers look to stakeholder theory, which does add the common weal to the criteria of being a faithful agent. But it makes no attempt to beat agency theory’s account of agent motivation. Professionalism once was an alternative theory, but is no longer on the active list. How can it be revived when expertise is understood as undemocratic and largely a means for opportunism?
Despite its simplicity, agency theory is praised for going beyond corporate law’s “black box” understanding of the firm (Pp. 5, 55). But it does not go very far. It does not add to the classic actors of corporate law: shareholders, boards, and a poorly defined group of officers and managers. It opens the black box only to make assumptions about the actors’ motivations, tracing complications arising therefrom.
Agency theory, to the extent that it is “the most important theory in corporate law,” also distorts our responses to the evidence., including the evidence about its failed predictions. Consider its recommendations for independent directors. First, the evidence demonstrates that the rise of independent directors has increased agency costs, at least as judged by executive compensation. Second, the evidence demonstrates inside directors can be cost-beneficial: While they impose costs when monitoring themselves as board members, they often bring benefits, especially in complex or innovating environments. It follows that the prescribed best practice doesn’t work. Yet this result is not taken to contradict the theory. It only adds a caveat that requires better dosing. The theory, as Tingle emphasizes, renders these facts as “idiosyncrasies.” They do not perturb agency theory’s remedy of getting the proper mix of independent and inside directors.
Actually, the research Tingle reviews demonstrates that agency theory asks the wrong question and that “knowledge” is the important mediating variable. “Independent” and “inside” are weak surrogates for knowledge. If we were not limited by agency theory, we might look beyond board composition to better respond to the knowledge problem. For example, we might increase reporting lines to the board, such as the Chief Compliance Officer enjoys. Or we might engage workers, even creating a new monitoring board. Or, we could establish a powerful “Secretary to the Board” to loosen executives’ controls on what the board knows. Agency cost theory limits inquiry into the improvement of board governance. But it is strengthened by confining itself to the box already known to corporate law.
As Tingle puts it, agency cost theory creates “the invisibility of countervailing considerations” (P. 9). It misdirects by creating a search for a “Holy Grail,” “a technique” that perfectly aligns the interests of managers and shareholders (P. 10). And, it seduces us with a tale of undisciplined temptation. Fortunately, as Tingle concludes, “corporate actors’ attention and anxiety” are not on the temptations ascribed to them by agency theory, but “are focused on the firm’s competitive activities” (P. 61). They are not seduced by agency cost theory, despite their positive responses to the governance industry. Why should we be?
May 2, 2025 Brett McDonnell
Ann Lipton,
The Legitimation of Shareholder Primacy,
__ J. Corp. L. __ (forthcoming, 2025), available at
SSRN (Feb. 03, 2025).
The United States is going through a moment of extreme political strife and uncertainty. Delaware’s corporate law ecosystem is going through its own moment of strife and uncertainty, albeit with less stratospheric—but still high—stakes. Significant connections exist between the conflict occurring within these two systems, including but not limited to the techno-king himself, Elon Musk.
Ann Lipton explores some of those connections in The Legitimation of Shareholder Primacy. Lipton argues that the central corporate law norm of shareholder primacy was intended to shield Delaware law from political debate, but internal tensions within the concept combined with the political polarization of our times have battered that shield. The development of that argument features Lipton’s deep knowledge of corporate law and governance, which is tied here to an interesting political story.
Lipton ties shareholder primacy to Delaware’s role as the leading choice of state of incorporation for large public corporations. One of our smallest states crafting the law that governs our most powerful non-state economic actors raises hackles. Delaware needs to legitimate itself and its corporate law. It must tell a convincing story as to how its corporate law helps improve our world. Lipton argues that shareholder primacy plays a big part in that story.
At first glance that seems odd. Shareholder primacy imposes on corporate directors and officers the sole goal of making decisions that increase the wealth generated for shareholders. Why will an exclusive focus on shareholders satisfy those citizens who own few or no shares? Lipton sees a two-step argument. First, shareholder primacy constrains corporate managers more meaningfully than any other plausible legal rule. Second, profit-maximizing will largely be in the best interests of society generally so long as they function within mostly well-functioning markets constrained by regulations that limit externalities (shades of Milton Friedman). Delaware accomplishes the first step (constraining managers); the federal government should do the second. Recent controversies surrounding Delaware courts have called both parts of this argument into question.
Two lines of cases raise doubt as to whether Delaware case law’s protections really help shareholders. The first line concerns the procedural protections the courts have put in place for transactions involving controlling shareholders with a conflicting interest. Kahn v. M & F Worldwide Corp., required minority shareholder buyouts to be conditioned from the start of their negotiation on both approval by independent directors bargaining effectively and by a majority of the non-interested shareholders. In re Match Group, Inc. Deriv. Litig., extended those requirements to all transactions with interested controlling shareholders. Both powerful shareholders and much of the corporate bar have pushed back hard.
Perhaps the most dramatic and political important of these controlling shareholder cases was Tornetta v. Musk, concerning the approval of a truly mind-blowing level of compensation for Musk at Tesla, but conditioned on achieving perhaps even more mind-blowing increases in the stock price. Which he achieved. But the process of approving the shares was suspect in many ways, and so the Chancery Court struck down Musk’s pay package. Shareholders then approved it again. That second approval rather calls into question whether shareholders much care about Delaware’s formalistic protections. Lipton argues that the courts have nonetheless stuck to their guns in part because the procedures demonstrate constraints on management to citizens other than shareholders, serving to help legitimate Delaware’s corporate law, not to mention the power large corporations are allowed to wield.
Lipton tells a similar story for West Palm Beach Firefighters’ Pension Fund v. Moelis, where the Chancery Court struck down a type of shareholder agreement that was rather clearly invalid under Delaware law, but which had grown quite common in Silicon Valley startups. A ruckus ensued, and the Delaware legislature amended the law granting carte blanche to shareholder agreements.
In both cases the court followed formalistic rules designed to protect shareholders, but powerful shareholders and the corporate bar objected. In both cases the Delaware legislature amended the corporate law statute in response to those objections. Why, Lipton asks, are powerful managers and their lawyer lackeys willing to explode rules that serve an important legitimating function not just for Delaware but also for them? She speculates that because of the stalemate in politics at the federal level, rich and powerful shareholders feel emboldened to do as they please without fearing a withdrawal of their social license to operate. And so Delaware must fall in line, or risk a “Dexit” as companies leave for other states willing to be more pliable.
The second part of the argument, that markets and regulations will cause profit-maximizing corporations to act in the public interest, has also come under fire. This argument has always had a pretty obvious weak spot as a means to legitimate Delaware’s corporate law: It relies on regulation elsewhere to constrain corporations where market prices don’t reflect true social costs and benefits. If one thinks markets usually work well so regulation need not be terribly extensive, as Friedman believed, that’s not such a problem. But if markets are less effective than that so external regulation needs to be quite heavy, Delaware becomes very dependent on the federal government functioning effectively. Which is not a very comfortable position to be in. Much of Leo Strine’s writing in recent years struggles with this dilemma.
What’s a little state with a big corporate clientele to do? One tack, as Lipton explores, is to hope that markets can be made to function better. And the growth of ESG investing and activism has created potential hope on that front. If investors, employees, and customers all want to be associated with companies that behave in a socially responsible way, then concern for a good reputation will give corporations a strong economic incentive to behave well. For a while, it looked like that might work pretty well. But in the last few years, ESG has become a highly politicized battlefield, and many institutional investors and operating companies are becoming gun shy. Shareholder primacy was supposed to be non-political, and the business case for social responsibility was meant to maintain that neutrality. But in our current political climate, social responsibility is highly contested. The political maelstrom cannot be so easily avoided.
Another tack is to give weak external regulation a boost through encouraging corporations to put much more attention on ensuring they follow the law. Hence the Caremark duty for boards to monitor corporate compliance. This was initially an extremely weak duty, in the sense that the chances of being held liable for a violation of it were slim. But a blatantly weak duty may undermine the legitimacy of the law. And so recently courts have given Caremark somewhat more bite. But, Lipton argues, this then risks running into the fact that often breaking weakly-enforced laws is actually a profit-maximizing move. Shareholders may well not want their companies to put such a stress on corporate compliance. Doctrinally, this shows up in courts not counting potential profits from lawbreaking when considering harms to shareholders. Practically, Caremark has become a way of doing some of the work of external regulators. But that puts Delaware courts squarely in politicized decision making, which the shareholder primacy turn was supposed to avoid.
Lipton ends with a few questions about where Delaware and its corporations will head next. If Delaware relents on the prosocial directions of Tornetta and Caremark, or if it doesn’t and corporations Dexit to more friendly states, will the pitchforks of angry populists reveal themselves, as Lipton puts it? Or will Musk and company have rationally calculated that they no longer need a legitimating story of restraint on their power to cover their ambitions?
It’s not a conclusive ending. Nor necessarily a happy one. But it’s a story well told.
Apr 3, 2025 Anna Gelpern
Jeremy C. Kress, "
Least-Cost" Resolution, 43
Yale J. on Reg. __ (forthcoming, 2026), available at
SSRN (Sep. 03, 2024).
Banks have magic powers: they can conjure money out of thin air, send it across the street or around the world instantly, make your startup dreams come true, and these days, even make you a cappuccino. They are also fragile and toxic: liable to fail suddenly and bring people, firms, other banks, and entire economies down with them. Generations of reformers have tried to make bank failure more orderly, less destructive, and less costly to the public. Judging by the crop of papers inspired by the crop of bank failures in 2023, they have failed again.
Why do we keep failing at bank failure? This article by Jeremy Kress suggests a piece of the puzzle: we mismeasure success.
The U.S. regime for dealing with bank failure promotes a single-minded focus on minimizing costs to the industry-funded federal Deposit Insurance Fund (DIF) managed by the Federal Deposit Insurance Corporation (FDIC). Kress makes a compelling case that protecting the DIF increases the overall social cost of banking and bank failure: it contributes to systemic risk, reduces competition, and distorts incentives. His alternative to the prevailing “least-cost” test is a more holistic social cost assessment, which would require more rigorous oversight of the FDIC, and would be a hard sell in any political climate—but worth the fight in the long run.
To appreciate the broader implications of Kress’s contribution, consider the bank failure process and the FDIC’s role in it.
The FDIC wears many hats: it insures bank deposits up to a generous $250k, regulates and supervises insured banks, and when one fails, the agency serves as receiver to manage its resolution. The FDIC as receiver decides how to dispose of the assets and liabilities that make up the bank receivership. It could sell the bank, wholesale or piecemeal, or liquidate its assets and pay off the liabilities. Unless the FDIC as receiver finds a healthy bank to assume the failed bank’s insured deposits immediately, the FDIC as insurer pays insured depositors out of the DIF, and takes their place in line for the receivership proceeds.
The DIF is the principal pot of money available “to carry out [the FDIC’s] insurance purposes,” meeting its obligations as insurer and receiver. It is funded primarily from regular assessments paid by FDIC member banks. If the FDIC dips into the DIF to resolve a bank, it replenishes the fund with a special assessment on some or all of the remaining member banks. If the DIF runs out of money (as has happened twice since its establishment in 1935), the FDIC has standing authority to borrow from the U.S. Treasury and other sources, backed by the full faith and credit of the United States. This should be comforting to the public, but as Kress and others have pointed out, the FDIC has shunned this authority. Here Kress’s familiarity with the ecosystem pays off: from the agency’s perspective, tapping the Treasury reads as a taxpayer bailout, signals supervisory and actuarial failure, and counts towards the federal public debt limit, all of which invites unwelcome scrutiny.
All else equal, unloading a failed bank as a whole to a single buyer is faster and easier for the FDIC than sifting through, managing, and marketing bank bits and pieces. This is especially so when multiple banks fail at the same time, as they did in the Savings and Loan crisis of the 1980s and 1990s, the financial crisis of 2008-2009, and the would-be crisis of 2023.
Selling the whole bank rescues all its creditors—not just insured depositors—thereby avoiding tweets from furious financiers, front-page stories of shopkeepers struggling to meet payroll, and quite possibly a deeper crisis. It comes at the cost of entrenching expectations of future rescues, more industry concentration, and the associated distortions. Meanwhile, whole-bank sales often call on the FDIC to share in the risk of loss with the buyer. Empirical studies show that whole-bank sales tend to be costly for the DIF.
In 1991, Congress introduced the “least-cost” test to limit the FDIC’s discretion to use whole-bank sales and rescue uninsured creditors. At least in theory, the test should lead the FDIC to choose piecemeal liquidation if it would cost the DIF less than selling the entire bank franchise. For another example, if the failed bank’s closest competitor or a global conglomerate bids a smidgeon more than a community bank two towns over, the FDIC would have to take the competitor’s bid.
What is not to like about this cost-saving approach? Recent scholarship suggests plenty. Kress highlights dramatic cost estimate fluctuations, which make it hard to police compliance with the least-cost test. A valuable new study by Michael Ohlrogge suggests that the FDIC’s post-crisis resolution practice does not come close to fulfilling the statute’s cost-saving mandate. Ohlrogge proposes to reinvigorate the 1991 test by solving the underlying agency and time inconsistency problems.
Kress builds on these and other scholars’ insights to reach the opposite conclusion: the least-cost test must go because it targets the wrong costs. Prioritizing costs to the industry-funded DIF does not account for the benefits of competition, reducing systemic risk, and access to financial services, among others. There is plenty of evidence that consolidation and systemic risk have grown dramatically since 1991. Kress’s case studies illustrate how the least-cost test may help exacerbate these trends.
His intuition feels right to me because it reflects the political economy of banking. Deposit insurance should deter runs and protect small(ish) depositors. Bank resolution should allocate losses and limit spillovers from bank failure. Both are fraught with distortions, and entail costs and benefits to the public that are hard to quantify as a snapshot in time.
Like bankruptcy, the bank resolution regime is a complex political bargain. Managing bank failure entails intensely political tradeoffs that must reflect the changing institutional structure of finance, align incentives, and deliver broadly legitimate distribution. There is no obvious reason to think that costs to the DIF in a given case of bank failure are a proxy for any of that, and many reasons to worry that a focus on these costs fosters policy myopia.
This is not an argument against any cost test. The author argues for a far more expansive replacement of the current test, which would call for far more robust oversight of the FDIC’s decisions—and would surely set off a political battle. At least we would be battling over the right things.
Cite as: Anna Gelpern,
A Costly Cost Test, JOTWELL
(April 3, 2025) (reviewing Jeremy C. Kress, "
Least-Cost" Resolution, 43
Yale J. on Reg. __ (forthcoming, 2026), available at SSRN (Sep. 03, 2024)),
https://corp.jotwell.com/a-costly-cost-test/.
Feb 27, 2025 Bill Bratton
Corporate governance and corporate finance operate very differently as legal academic topics. With governance, there’s always some new legal development—a Delaware ruling, a provision in a corporate code, or a new SEC regulation. Failing that, the international corporate governance machine is a reliable generator of new material, whether a new wrinkle on a monitoring process or a substantive initiative falling inside the big tent of corporate purpose. With finance, law and legal theory are more in the back seat while practice takes the lead. Bankruptcy is the one important exception, but even there, practice has been trumping law in recent years as bankruptcy courts have passively turned the reins over to controlling creditors. Not that there aren’t developments in the practice to write about. There are. But this will be more a matter of tracking new wrinkles than accounting for great upheavals.
It is, accordingly, a big deal for legal finance when a whole new mode of financing springs up on the upper part of the right side of corporate balance sheets. The quick rise of private credit in recent years is just such a development. Jared A. Ellias and Elisabeth de Fontenay, The Credit Markets Go Dark, 134 Yale Law Journal 779 (2025), lays out the territory with diligence, clarity, and sophistication.
Private credit is to bonds and notes what private equity is to common stock. A financial intermediary organizes a limited partnership and sells limited partnership interests to institutional investors. Unlike private equity, where the partnership takes over companies, here the partnership lends money to companies, which are mostly medium and small sized. The terms of the loans tend to run three to six years. The loans are direct – no underwriter is involved. The partnership holds the loans to maturity—at least as yet, there is no secondary trading market in the paper. The partnership also jacks up its risk/return profile by borrowing up to one-half of its total capitalization (“back leverage”). The sector’s rapid growth has come mainly at the expense of bank term loan syndications.
Ellias and de Fontenay account for all of this by detailing what’s in it for each of the major players. It is a cogent way to proceed. First come the borrowers. They get speed, flexibility, and enhanced certainty and confidentiality. There’s an extra bonus in a case where the borrower has no publicly traded debt—going the private credit route deflects debt market discipline. Second come the equity investors in the private lender. They use the private credit vehicle as an indirect way of making loans themselves. They are in economic substance lenders, lenders which, instead of originating and monitoring loans through their own departments, outsource lending and monitoring to the private credit firm. These players get higher yields than are available in the bank syndication and junk bond markets. The loans come with tighter covenants and are made in an institutional context insulated from the creditor-on-creditor violence that has turned the syndicated loan market into a financial charnel house. Third and last come the asset managers. They get fees, which can be expected to scale down from the classic private equity two and twenty rip. They also get freedom of action: Because they are unregulated, they get to do things banks can’t do, like take positions in a company up and down its entire capital structure. (Yes, private credit lenders sometimes take stock positions in investee companies, interpolating the equity kicker into the portfolio directly rather than sneaking it in under a convertible security.) They also get favorable accounting treatment: Because they hold the loans to maturity, they can manage their portfolios free of the markdowns triggered by market price declines.
Now, I would have thought that a turn to hold-to-maturity lending under strict covenants would be a cause for celebration. But Ellias and de Fontenay see some problems. While the removal of market discipline might be nice for the borrowers and asset managers, there is a net loss of public information about the borrower. Jumping across the private-public divide (ahem), Ellias and de Fontenay term this “de-democratization.” They also identify a problem of growing intermediary power—the private lending firms overlap to some extent with the private equity firms. In effect, Blackstone, et al., are moving under the cover of darkness to get hold of the entire capital structures of large numbers of companies and nobody does anything to impose transparency or otherwise hold them in check. Even where the players are new (and not active on the private equity side), as they gain market share they displace markets as intermediaries, exposing the economy to institutional failure even as they shield it from market failure. Finally, once the private credit borrowers get into financial distress in large numbers (and they will), we are going to see a significant change in the chapter 11 fact pattern. Ellias and de Fontenay predict that private credit lenders will be more likely to accord slack to troubled companies, with potentially negative consequences for corporate performance. In addition, private credit lenders, as compared to the banks, will be looking to end up as the owners of reorganized companies. Lastly, the absence of market pricing will enhance the burden imposed on bankruptcy judges reviewing asset sales and reorganization plans.
I will close with a note regarding the study’s empirical basis. Because private credit is private, we don’t know as much about it as we know about regulated sectors like banking. Ellias and de Fontenay get high marks for doing what they can to surmount this barrier by gathering information on the portfolios of business development companies (BDCs). BDCs are regulated closed-end investment companies that raise capital from retail investors to make debt and equity investments in smaller companies. They report their portfolio holdings to the SEC. Private lenders raise about 10 percent of their capital through BDCs. The BDCs’ SEC filings thus offer an empirical, albeit indirect, picture of the private credit sector. Ellias and de Fontenay survey this data, yielding hard pictures of dollars loaned over time (up), numbers of loans (up), portfolio value (up), and lender debt-equity ratios (down).
Cite as: Bill Bratton,
Private Credit, JOTWELL
(February 27, 2025) (reviewing Jared A. Ellias & Elisabeth de Fontenay,
The Credit Markets Go Dark, 134
Yale L.J. 779 (2025)),
https://corp.jotwell.com/private-credit/.
Jan 31, 2025 Charles O'Kelley
Kyle Edward Williams, Taming the Octopus: The Long Battle For The Soul of The Corporation (2024).
In Taming the Octopus, historian Kyle Edward Williams focuses on the evolution of the modern corporation from its birth in the early days of the twentieth century to the present. This work deftly synthesizes a vast array of historical and legal research with the author’s own archival research. The result is a fast-moving, comprehensive, and captivating story of the people and events that have shaped scholarly and political debate about, and understanding of, the corporation and its place in society as the United States gradually assumed its place as world hegemon. This is a book intended for the informed citizen but should be of special interest to teachers of Corporations and related subjects, for here the reader will encounter the giants who have affected what we think and believe about what the corporation is and how it should be governed, as well as the debates that have raged throughout the life of the modern corporation.
The book begins and ends with the imagery of the modern corporation as an imaginary sea creature, an octopus as terrifying and as untamable as the giant squid in Jules Verne’s Twenty Thousand Leagues Under the Sea. That imagery had been used in books and editorial cartoons in the first decade of the twentieth century to caricature the might of emerging business behemoths, including the Standard Oil Trust, whose tentacles reached into every aspect of American life and controlled the politicians who acted counter to the public interest as the mighty creature demanded. The public indignation and resolve to combat this evil creature is an underlying theme throughout the book, which Williams identifies with three continuing tensions in the political and cultural life of the modern corporation.
The first tension concerns efforts to tame the octopus via a corporatist partnership between the modern corporation and the federal government. As Williams details, this effort was spearheaded by Teddy Roosevelt, who, before his presidency, had signaled a commitment not to destroy the corporation but “to make them subserve the public good.” After the financial crisis of 1907, Roosevelt backed legislation that offered exemptions from antitrust laws to corporations that chose to voluntarily register with the federal agreement, thereby agreeing to full financial transparency and a regime of close consultation and cooperation with government officials. Corporations uniformly opposed this first foray into corporatism, and the bill died in committee.
Corporatism again entered the playing field during the Great Depression and the early days of the Roosevelt Administration. Now, it was business leaders like Gerald Swope and Owen Young, as well as Roosevelt brain-truster Adolf Berle, who sought a corporatist partnership rather than federal direction of the economy under some American version of the communist regime evolving in Russia. They achieved initial, but short-lived, success with the soon-to-be-held-unconstitutional National Recovery Act. Nonetheless, a corporatist partnership emerged as the Securities Act of 1933, and the Securities and Exchange Act of 1934 adopted a disclosure rather than substantive regulatory approach to perceived problems with the stock market component of the modern corporation.
As Williams cogently recounts, the corporatist partnership and accompanying heyday of the manager continued through the 1960s, only crumbling when America’s years of unprecedented prosperity encountered the strong headwinds of international competition, the Arab oil embargo, and the collapse of the gold standard as the 1970s began.
Williams concludes his account of America’s corporatist dance with a concluding chapter titled “Larry Fink, President of the World.” In reading that chapter we are forced to consider: is America now entering a new form of corporatist partnership where the key actors are the modern corporation and the handful of institutional investors, primarily Blackrock and Vanguard, who in twenty years likely will own half of the shares in American corporations?
The second tension Williams identifies concerns efforts to have the federal government adopt a regime of federal chartering, thereby preventing the so-called race to the bottom that reformers attribute to the regime of state chartering. The desire for federal chartering had strong support by some members of Roosevelt’s inner circle from the beginning of the New Deal to near the end of the 1930s, but legislative efforts faltered as more pragmatic members of the inner circle and Roosevelt-confidant Felix Frankfurter supported the corporatist compromises.
A serious interest in federal chartering emerged again with the Vietnam War, and the Civil Rights struggle of the 1960s, which combined with the collapse of post-World War II prosperity to change public perception of the corporation. For a brief period running from around 1965 to 1980, the modern corporation came under attack for its role in the Vietnam War, its failure to advance social goals, and its irresponsibility in making unsafe products. Responding to Ralph Nader and his youthful disciples, Congress entertained a renewed effort to adopt federal chartering. That effort died as the 1970s closed and the Reagan Revolution and the Law and Economics revolution took power in politics and academic theorizing about the corporation.
The final theme identified and described by Williams is the use of the annual shareholders meeting as a forum not only to discuss shareholder economic interests but as a political conversation about the role of the corporation as a national and international citizen. Williams begins his treatment of this theme with the story of James Peck’s and Bayard Rustin’s efforts to use federal proxy rules and physical attendance at annual meetings to force the Greyhound Bus Line to desegregate seating in buses traveling in southern states. Along the way, Williams introduces the reader to serious “gadflies” like Wilma Soss, who championed the role of women stockholders, and independently wealthy Lewis Gilbert, who attended and prepared a report on hundreds of corporate meetings and resolutions from 1939 to 1979.
As Williams recounts, the role of socially and economically motivated shareholders continues to evolve with the emerging role of the institutional investor. The push and pull of the resulting conversations between corporate managers, shareholders, and the larger society plays a central role in forming a more socially responsible corporation.
Taming the Octopus is not a dry recounting of these themes. Rather, it is illustrated by the stories of actors who dominated each episode. The book references not only the usual suspects but also brings to life persons who might otherwise fade from memory. My favorite example is Henry Manne.
By now, we all know the role of Lewis Powell, his memo, and his influence on the Supreme Court in changing the course of corporation law history. Likewise, we remember the Milton Friedman article in the New York Times trashing the notion of corporate social responsibility and the so-called Chicago School of Law and Economics that achieved intellectual dominance in legal scholarship in the 1980s. Moreover, the scholarly work of economists Alchian, Demsetz, Meckling, and Jensen is still strongly remembered for their role in deconstructing the corporation as an institution and the elevation of the nexus of contracts theory of the firms. Williams gives each of these actors proper attention.
Delightfully, however, Williams gives much more attention to Henry Manne, his career, and his impact—attention woefully missing in many accounts of recent history. Over twenty years Manne’s summer Law and Economics Institutions provided a free education in basic microeconomic theory to more than six hundred law professors, and more than half of the then members of the federal judiciary, including Ruth Bader Ginsberg and Clarence Thomas. These scholars and judges went back to their day jobs with a new understanding of the economic purpose of the common law and new tools for understanding legislation affecting the corporation. Thus, It was Manne who brought to life through his students the teachings of law and economics. In twenty years, there may no longer be any judge or academic alive who attended Manne’s summer institutes. Perhaps Williams’ thoughtful recounting of Manne and his role will keep alive Manne’s important, if controversial, contributions to the evolution of the modern corporation and our understanding of its shortcomings and strengths.
This book should be on the recommended reading list of students looking to better understand the history of the corporation. For teachers, it would serve as a syllabus framework for a course in corporate social responsibility. For corporation law scholars, generally, this is not a book with new ideas to cite–rather, it is an engaging and quick read that will stimulate new ways of synthesizing your own ideas and research. In that regard, it forms a bookend of sorts with Adam Winkler’s, We The Corporations: How American Businesses Won Their Civil Rights (2018), which I reviewed in a previous Jot.
Jan 6, 2025 Gina-Gail Fletcher
In the wake of the extrajudicial murders of George Floyd and Breonna Taylor, millions protested across the U.S. and worldwide against the racial and social injustices that persist within society. The 2020 “racial reckoning” protests were the largest racial justice demonstrations in the U.S. since the Civil Rights movement of the 1950s and witnessed a broad spectrum of society coming together to demand redress for pervasive inequities across race, gender, and socioeconomic lines. Even companies, that had traditionally preferred to stand on the sidelines with respect to racial justice issues, stepped into the fray, publicly declaring their support for racial justice and promising to do their part to combat racial inequities. As part of these efforts, hundreds of companies since 2020 have voluntarily pledged to increase people of color within their ranks, specifying numerical targets and timelines for achieving these goals.
In her new paper, Racial Targets, published in Northwestern Law Review, Professor Atinuke Adediran tackles the thorny question: are corporate racial targets legally permissible? Adediran joins in conversation with several scholars who have been considering how the 2020 “racial reckoning” has impacted corporate behavior. To do so, she examines voluntary racial goals (i.e., racial targets) that companies have publicly established for themselves in response to shareholder, investor, and employee pressures to support racial equity. Adediran argues that racial targets are meaningfully distinct from racial quotas and, as such, despite the constitutional illegality of the latter, the former are within the boundaries of the law.
Before diving into the question of legality, Adediran first details the prevalence, contours, and features of racial targets. Using a rich dataset, she does both a quantitative and qualitative analysis of racial targets as disclosed in companies’ ESG and diversity reports between 2018 and 2023. Based on her analysis, Adediran categorizes racial targets into two groups: closed-end and open-end targets. The primary difference between the groups is that the former specifies a timeframe within which the company hopes to achieve its stated target, and the latter does not. Her empirical analysis provides details on the growing use, language used, and groups specified in racial targets, and sets the stage for the legal analysis on the permissibility of racial targets.
Adediran’s examination of voluntary racial targets is particularly timely in light of the current backlash against them. Critics of racial targets cast them as being the same as racial quotas and, with the recent successful challenges to race-conscious university admissions, there is concern that voluntary corporate racial goals may be next. Adediran asserts that “[a]lthough the post-2020 racial reckoning’s increase in racial targets appears new, there is a historical background for the… development of these targets….” This historical background, which Adediran richly provides, demonstrates that “companies are inclined to establish racial targets, carefully orchestrating them to comply with [both] Title VII and judicial precedents that made racial quotas illegal.
Adediran argues that racial targets differ from racial quotas in three meaningfully distinct ways that are key to the legality of targets. First, targets are private and voluntary pledges that companies choose to undertake. Second, targets do not apply to specific occupations and jobs but instead apply to the institution as a whole. Third, targets are non-binding, aspirational goals. These features, Adediran asserts, mean that racial targets ought to be analyzed under a standard that prioritizes corporate discretion, thereby allowing companies to create plans for their workforce that meet their needs and address their shortcomings.
Racial Targets is as thoughtful as it is timely, and it engages well with the thorny questions surrounding the legality of private, voluntary race-conscious goal setting in the workplace. Adediran provides a thoughtful empirical analysis of racial targets today and grounds our understanding of these corporate goals in their historical context, thereby painting a full picture of the ways in which courts have consistently viewed these private corporate decisions as legally permissible. In today’s fraught and polarizing environment, in which race-conscious decision-making is under attack, Adediran highlights the importance of looking back to understand what lies ahead.
Nov 15, 2024 Tom C.W. Lin
Many businesses today are subjected to a myriad of regulations. In order to ensure compliance with the large and dynamic bodies of federal, state, and local rules, many businesses create internal policies and systems to facilitate adherence to the law. However, such policies and systems exist in a dynamic marketplace filled with resource constraints and other business considerations. So, how do corporate managers construct internal compliance policies for their firms? What rules and regulations do they prioritize? How do they design internal systems to reflect the realities of law and enforcement?
In a recent article, Strategic Compliance, Professor Geeyoung Min offers a sharp and insightful perspective on these questions and more. Through an astute and deep analysis of a hand-collected dataset of corporate policies on insider trading and related party transactions from companies making up the Standard and Poor’s (S&P) 500 index, Professor Min reveals the policy customizations that occur at the firm level. Specifically, she reveals how firms customize internal policies on insider trading and related party transaction, oscillating between stringency and leniency. These revelations illuminate, inform, and interrupt conventional understandings about corporate compliance and internal policies.
The article begins by grounding its examination in the larger corporate and legal context of growing demands for written internal corporate policies. According to Professor Min, this rise in demand for firm-based policies is driven in large part by regulatory enforcement actions, shareholder engagement, and recent court decisions concerning the oversight duties of corporate directors and officers. In response to the rising demand, firm managers and compliance departments have produced more policies tailored to the unique regulatory and businesses concerns of their firms. Collectively, the article explains that this dynamic of corporate policy production serves as a private ordering mechanism for corporate law and compliance.
Next, Professor Min examines her hand-collected data from S&P 500 companies, demonstrating that corporate policies are not static but are actively tailored to either tighten or relax compliance depending on the perceived intensity of external oversight and enforcement. The data indicated that insider trading policies tend to be more stringent, often extending beyond the requirements of federal common law on insider trading. For instance, many companies prohibit trading in any other company’s stock based on material, nonpublic information, a stance that exceeds the traditional insider trading doctrine. Conversely, the data indicated that related party transaction policies at the examined companies often include categorical exclusions or waivers that narrow the scope of prohibited actions.
The article then explains that this divergence in corporate policy stringency and leniency is a strategic move to allocate compliance resources effectively, focusing them on areas with higher external enforcement while relaxing controls in areas with less regulatory scrutiny. Professor Min calls this approach “strategic compliance,” and defines it as firm behavior whereby “[c]orporate policies amplify the incentives to implement stringent internal monitoring where external enforcement is rigorous and adopt lenient internal monitoring where external enforcement is weak.” (P. 433.) Additionally, Professor Min argues that while strategic compliance is “not necessarily problematic,” it can lead to regulatory vacuums and hinder the ability of firm managers to acquire important governance and compliance information. (P. 434.)
The article closes by proposing a set of pragmatic recommendations for firms, shareholders, regulators, and prosecutors to better align and incentivize corporate policies with the larger goals of corporate compliance aimed at better corporate governance. These recommendations are proffered with the intention of better harnessing the benefits of firm-specific policy customization to reflect external regulatory realities.
Modern businesses have to comply, manage, and respond to a growing and complex set of regulations. As such, it is not surprising that much attention, discussion, and resources have been dedicated to understanding and improving business regulation, compliance, and governance in recent years. Good corporate compliance initiatives should not be merely about avoiding liability and enforcement actions. Instead, they should be centered on effectuating the larger welfare-enhancing and profit-enhancing objectives of better corporate governance. Ultimately, corporate policies, corporate compliance, and corporate governance—when working well in concert—should have shared values and shared aims.
Toward that end, this recent article by Professor Min provides a fresh, informative framework for creating internal corporate policies and compliance programs that better align with the values and aims of good corporate governance. Given resource constraints and other competitive business pressures, creating and sustaining such policies and programs consistently is a difficult task, but Professor Min’s insights should make the task clearer, more principled, and ultimately more achievable going forward.
Oct 17, 2024 Joan MacLeod Heminway
The rise and dominance of institutional investors in public company stockholder profiles has increasingly shifted significant scholarly and popular attention toward those institutions and away from individual investors. Market factors periodically refocus attention on retail investors, however. One of those factors in recent years has been the meme stock phenomenon, which attracted widespread public attention in early 2021 when the common stock of GameStop Corp. and AMC Entertainment Holdings Inc. achieved record high public market prices. The continued salience of activist retail investors recently has been reinforced by a meme stock resurgence that has again put GameStop and AMC in the news.
The ongoing work of Professors Sergio Alberto Gramitto Ricci and Christina Sautter is helping to educate many audiences about legally significant demographics that shed light on current retail investors and their behaviors. Specifically, their joint work addresses ways in which investors’ behaviors have responded to the nearly universal availability of wireless access through a variety of ubiquitous devices (including especially cell phones). This broad-based wireless access has created a new cadre of “wireless investors” who collect and share investment information through social media and Internet applications and buy and sell securities through online trading platforms.
In Wireless Investors & Apathy Obsolescence, Gramitto Ricci and Sautter focus on the potential for wireless investors to overcome investor apathy. They describe that apathy and explain its genesis. They then illustrate why the advent of wireless investors may more optimally empower retail shareholders.
Specifically, Gramitto Ricci and Sautter assert that retail investors have been apathetically ceding their voting power to institutional investors and other large shareholders. They explain that retail Investor voting power, viewed through the eyes of an individual investor, provides too little potential benefit. Moreover, although individual retail investors could aggregate their voting power, the cost of doing that has been perceived to be too great. This perceived lack of power has encouraged investor disengagement and indifference in the form of free riding on the voting of larger shareholders.
Analogizing this pattern of investor thinking to the individualistic decision making that operates in game theory’s prisoner’s dilemma, Gramitto Ricci and Sautter argue that efficient collaboration among retail investors—looking at shareholder power as a cooperative venture—may allow retail investors to overcome barriers to collective action and collaborate. That efficiency is possible, they hypothesize, if wireless investors harness the available tools and properly direct their efforts toward productive collaboration. They offer theoretical and practical support for their ideas.
The article’s insights (and embedded take-aways from Gramitto Ricci and Sautter’s earlier work) are relevant to several large-scale business law topics. Two are most salient for me: shareholder primacy and the reasonable investor standard. Each area of inquiry and debate connects with the composition or behaviors of corporate shareholders.
Whether addressing shareholder primacy as a matter of the locus of corporate governance power as among the corporation’s internal constituents (through, e.g., voting or derivative litigation) or in terms of the objective of board decision making, shareholder apathy and coordination may be important to analyses and judgments. In shareholder primacy debates, assumptions often are made about the nature and interests of corporate shareholders. Changes in the identity and engagement of shareholders may alter those assumptions.
Similarly, the reasonable investor standard (which is incorporated in materiality definitions used in, among other things, federal securities regulation) is rooted in an understanding of investor (including shareholder) identity and conduct. The standard is intended to be objective. But investment markets and investors evolve over time. Thus, objective assessments of them also must evolve. Wireless Investors & Apathy Obsolescence, taken alone or together with Gramitto Ricci and Sautter’s related work, provides evidence of changes in equity investment markets and shareholder behavior patterns that may be significant to applications of the reasonable investor standard.
There is much to value in Gramitto Ricci and Sautter’s Wireless Investors & Apathy Obsolescence. Their explorations at the intersection of wireless investing and shareholder voting apathy provide readers with new information that is immediately useful to corporate governance and corporate finance doctrine and practice. In their own words: “[t]he substantial change of context in which retail investors operate is set to determine a new norm in investing and corporate governance.” The continued and increasing presence of wireless retail investors in securities trading and shareholder voting underscores the importance of this work.
Sep 17, 2024 Atinuke Adediran
Are corporations responsible for addressing racial inequality? In a timely and compelling examination of corporate race relations during the civil rights movement and current corporate processes and decision-making on race, Gina-Gail S. Fletcher and H. Timothy Lovelace, Jr. argue in their article, Corporate Racial Responsibility, that corporations are responsible for addressing racial inequality because they have historically been inescapably involved in it.
The authors’ historical exploration of race and corporate relations is an important contribution to scholarship. The authors show that corporate engagement in race is not new. It extends back to the time of slavery and became much more extensive during the civil rights movement. As the authors document, sit-ins at hotels, restaurants, and other segregated businesses were catalysts for the civil rights movement.
Businesses were drawn to voluntary desegregation, which was woefully unsuccessful as evidenced by accounts in cities like Birmingham, Alabama and Atlanta, Georgia. It was not until the passage of Title II of the Civil Rights Act of 1964, mandating that businesses desegregate, that change began to occur. The authors explain that this is compelling evidence that mandates succeed while voluntary action, a form of corporate social responsibility, does not.
With history as the backdrop, the authors address contemporary debates on corporations’ engagement with issues of racial inequality, focusing on three specific issues: the critique that companies are becoming “woke,” the belief that addressing race may negatively impact corporate profitability, and the idea that companies are engaged mostly in “cheap talk.” Regarding the critique that companies are now becoming woke, the authors remind us that criticisms like this mirror segregationists’ resistance during the civil rights era. History also shows that the desegregation project, much like corporate support for racial equity today, has support across the political spectrum. On the belief that racial equity is in tension with profitability, the authors explain that there are many non-pecuniary benefits of racial equity not often captured in these criticisms. On cheap talk, the authors note the value in public affirmations of racial equity, which can be used for tangible action toward change.
The authors further argue that past and present iterations of corporate engagement in racial equity present a market-fundamentalist, value extractive approach to racial equity that reifies existing hierarchies. Market fundamentalism means that corporations tend to engage in racial equity work when it is worthwhile financially, such as when there is support for the business case for diversity. Like market fundamentalism, value extraction is about obtaining value from people of color without attempting to change the underlying arrangements that support racial inequality, such as establishing structures to ensure board diversity.
However, even the business case for diversity is not always enough. During the civil rights movement, white business owners had little to no incentive to voluntarily desegregate or recognize the dignity of Black people regardless of the potential profitability of desegregation. Today, scholars of corporate governance recognize the flaws of the business case. And empirical research shows that the business case has a negative impact on belonging for underrepresented groups, including Black people, women and LGBTQ+ individuals.
The authors make two categories of proposals for change to address market-fundamentalism and value extraction. The first category is proposals that can easily be implemented and, in some cases, have already been implemented by companies. The second are bolder and will be more challenging to implement in this politically fraught environment. In the first category are measures like changes to board composition, pay equity, employee resource groups, internal tracking of diversity goals, and partnerships between companies and racial justice nonprofits. In the second category are things like requiring third party suppliers and law firms to improve corporate diversity. In the past, corporations have required law firms to staff matters with more diverse lawyers. However, current political tension has made these kinds of approaches more controversial. Another more challenging recommendation is to develop “corporations of conscience” who will lobby the government for new civil rights laws. Corporations of conscience “seek to advance racial justice in any situation regardless of profitability.” (P. 425.) In my view, this is a call to action for corporations to do better despite conservative pressures to squash corporate engagement with race.
Aug 13, 2024 Ann Lipton
Hilary J. Allen,
Interest Rates, Venture Capital, and Financial Stability, __
U. Ill. L. Rev. __ (forthcoming), available at
SSRN (March 8, 2024).
The last decade has seen a transformation in patterns of corporate organization. Enabled by loosened restrictions on private capital raising, venture capital firms have fueled the creation of a new ecosystem of large, privately held “unicorn” companies that are so well capitalized that they have not sought to access the public markets. That shift has been accompanied by a host of new questions about optimal governance arrangements, fiduciary obligations, the positive externalities of securities disclosure, fraud prevention, the role of shareholder agreements, and the disciplining effect of the capital markets.
In her new paper, Interest Rates, Venture Capital, and Financial Stability, forthcoming in the Illinois Law Review, Professor Hilary Allen adds a new question: what are the risks to financial stability? Allen claims that low interest rates fueled the growth of venture capital, which is itself prone to inflating bubbles and exacerbating panics. She ultimately argues that financial regulators need to be more attuned to unexpected places where funding tends to flow during periods of accommodative monetary policy.
Allen begins by tracing how an especially prolonged low interest rate environment—first in the wake of the great financial crisis, then again in the wake of covid—encouraged investors to reach for yield, resulting in a veritable geyser of venture capital funding. Venture capital, Allen next explains, is prone to inflating asset bubbles, in large part because the close social ties between VC firms and founders encourage “herding” toward similar businesses. Additionally, VC firms operate on a “power law,” whereby they expect most investments will fail but a few will become outsized hits. The model structurally encourages inflated optimism and a lack of vetting, and—due to the inability to short private company stocks—the absence of mechanisms to express pessimism. The upshot is, VC funds, flush with cash, created a bubble in startup firms concentrated in a small number of industries: ultrafast delivery companies and fin tech—particularly crypto.
From there, Allen explores the systemic implications. Most obviously, VC herding and the startup bubble resulted in a concentration of funds at Silicon Valley Bank—which in turn led to a run on Silicon Valley Bank when it suffered from a sudden rise in interest rates. Nearly simultaneously, two banks heavily exposed to crypto, which was also adversely affected by rising interest rates, also failed. The resulting loss of confidence in small and regional banks forced the FDIC to guarantee even uninsured deposits in order to protect the larger banking system. Allen recognizes, of course, that there were other factors at play, but she attributes the three bank failures at least in part to VC and crypto concentration.
Allen also warns of the potentially destabilizing effects of crypto itself, which thus far have only been avoided because crypto has not (yet) been fully integrated with traditional finance. Crypto is an ideal investment for VC funding, Allen explains, because of its minimal startup costs, rapid growth based on sentiment and—so long as crypto is not treated as a security—ease of exit through sale of tokens rather than the traditional route of an IPO or a merger. These factors encouraged VC firms to make large crypto bets, and, now that they are committed to the technology, they have turned to political lobbying to erode the guardrails that have thus far prevented crypto from contaminating the broader financial system. That possibility, Allen maintains, continues to pose a threat to stability.
Allen ultimately concludes that, for the specific case of crypto, the best protection is enforcement of the existing securities laws to prevent the quick buildup and exit on which VC depends. More generally, however, Allen argues that financial stability regulators should set their sights on VC funds, due to their general opacity, and their unique ability to “magnify bubbles on the upswing, and panics on the downswing.”
Interest Rates, Venture Capital, and Financial Stability is thus a strong addition to existing literature on the unintended consequences of a trend that began in the 1980s and has accelerated since then, namely, the increasing ease with which operating companies (and investment funds) can raise capital outside of the federal securities disclosure system. Those changes shaped today’s VC industry, and the consequences that follow.
Cite as: Ann Lipton,
Venture Capital and Financial Stability, JOTWELL
(August 13, 2024) (reviewing Hilary J. Allen,
Interest Rates, Venture Capital, and Financial Stability, __
U. Ill. L. Rev. __ (forthcoming), available at SSRN (March 8, 2024)),
https://corp.jotwell.com/venture-capital-and-financial-stability/.
