When Adam Levitin and I taught The Law of Money seminar a year ago, not one student chose to write about bitcoin. We congratulated ourselves on drawing young people hip enough to ignore the hype emanating from googly-eyed technophiles and smug pundits, and beefed up the readings on silver in 18th century China. The rude awakening came last spring, when bitcoin gobbled up half the class and forced me to wrestle with the problem of legal writing about financial innovation. Jeanne Schroeder’s lovely Bitcoin and the Uniform Commercial Code saved the day. The article reads at first like an old-fashioned doctrinal piece of the sort that have become rare. That would be valuable enough, but the bigger payoff for me was seeing a patient sifting of bitcoin through the UCC illuminate the work of legal institutions at the intersection of finance and technology.
Most students said that they wanted to write about fintech-y stuff because it was new and hot and law firms were all over it. However, defining “it” became a problem, especially for bitcoin. At a high level of generality, bitcoin is a protocol designed to extract, represent, and circulate value using a decentralized system for recording transfers (blockchain). ((The Khan Academy has a very helpful set of videos on the basic idea.)) Putting transfer verification in the hands of the public at large makes the blockchain hard to manipulate, and makes transfers faster and cheaper.
Depending on your perspective, bitcoin could be a currency, a payment system, a commodity, an economy, a political system, or a flash in the pan. Law papers about bitcoin tend to follow a handful of templates. For example, they might survey the regulatory response (are regulators competing for turf?… stifling innovation? …fueling regulatory arbitrage?), compare institutional designs for a given function (what makes a good parallel currency? …how have payment systems built trust?), or analyze internal governance (is blockchain democratic? … fair? …stable?).
Schroeder eschews a comprehensive take on bitcoin, and zeroes in on the challenge it poses for the UCC’s taxonomic worldview. Her analysis is of serious practical importance, because bitcoin’s classification as collateral under Article 9 of the UCC could make or break its ability to function as a payment medium. The UCC also makes a great lens for thinking about bitcoin because of its self-consciously modern roots and fascination with commercial practice. The result is a scale model for the broader task of managing financial innovation in a fragmented regulatory regime.
The article first lays out why bitcoin cannot be money under the UCC, and why it matters. Along the way, the reader gets to ponder the logic of physical possession and the magic of proceeds under the UCC, including a supremely teachable hypothetical. Schroeder makes a compelling argument that bitcoin’s exclusion is not primarily a matter of outdated definitions limiting money to government payment media (Sec. 1-201(b)(24)), but is part of the fabric of the Code. Money under the UCC is essentially physical cash, which is hard to encumber and easy to move. Cleansed of its past each time it passes from hand to hand, money can zip through the stream of commerce. Physical possession is central to the UCC’s regime for transferring cash, but make zero sense for electronic currencies. As a result, even if the definition were fixed, the functionality would be impaired. Instead of super-negotiable money, bitcoin is most likely be classified as a “general intangibles,” a catch-all category prone to lingering encumbrances, which would make it hard to transfer and useless as a payment medium. ((Schroeder offers an amendment, which would assemble elements of super-negotiability under the UCC and adapt them for bitcoin and other cryptocurrencies; however, that is properly a minor part of her argument.))
Wading through the weeds of attachment and perfection (which somehow feels urgent in Schroeder’s telling), the reader might miss a bigger point about financial innovation and the UCC. The Code still stands as one of the most ambitious statutory modernization projects in U.S. history; it swept centuries of legal contrivance off the field with a flourish, and became indispensable to the financialization of the U.S. economy, including derivatives and structured finance. This flamboyantly modern code seems to hold an oddly quaint view of money, securities, and financial assets. Bitcoin looks like a blip in what has already been a decades-long story of friction and adaptation.
Illustrating the point, the second half of the article revisits the history of amending Article 8 of the UCC to create a regime for transferring investment securities not represented by physical certificates. The initiative was meant to reflect market and regulatory responses to the Wall Street paperwork crisis of the late 1960s and early 1970s, which saw brokerage houses buried in an avalanche of paper that they could not process.
All else equal, it makes sense to model a regime for transferring electronic money on the one for transferring securities that lack physical form—except that the reform process for securities was a mess. UCC revisions for “uncertificated securities” had initially stumbled over the clunky way they recorded transfers. Technology has since caught up with the law: blockchain solves the recording problem. But market participants did not wait around for blockchain; they found a workaround using custodial holding in the late 1970s. Federal legislation and more UCC revisions adapted to the new market-institutional reality, elaborating a category of “securities entitlements” (essentially, claims on the intermediaries), which coexists with the ill-fated uncertificated securities. Today’s bitcoin holders could also achieve negotiability using the securities entitlement regime, but they may have to sacrifice some of bitcoin’s decentralization ethos by having to rely on intermediaries.
In the end, blockchain’s capacity to replace “confusing metaphors of tracing rules … with the reality of actual tracing” seems a lot more promising and a lot more scary than bitcoin’s monetary designs. For this reason, and doctrinal dividends notwithstanding, the lasting contribution of Schroeder’s article is probably not in the law of bitcoin. The value is in her careful case study of how a legal system should assimilate potentially disruptive innovation. The UCC is massively invested in its taxonomies, while innovations such as bitcoin often defy existing categories. Schroeder’s article guides its readers through the history and policy behind the Code’s taxonomies, taking its architecture and bitcoin’s political aspirations seriously throughout. The result is a pragmatic and novel meshing of the two.
Rory Van Loo, Rise of the Digital Regulator
, 66 Duke L. J.
1267 (2017), available at SSRN
Consumers and corporations today exist in a world of highly intermediated markets. Digital intermediaries aid consumers in their decisions with more and more regularity. They sort the good from the bad, the expensive from the inexpensive, the suitable from the inappropriate. Private and public digital intermediaries collectively act as a soft regulatory force in the marketplace. Private intermediaries like Amazon, AirBnB, Priceline, Carfax, Google, Houzz, and Zillow help consumers make purchasing decisions on goods and services like diapers, automobiles, airline tickets, hotel rooms, summer vacations, car rentals, furniture, apartments, and almost everything under the sun. Public intermediaries like the Consumer Financial Protection Bureau and the Affordable Care Act via their mortgage calculator and insurance exchanges, respectively, assist consumers make key life decisions about buying a home and purchasing health insurance. All of these innovative tools, made possible by technologically-driven intermediation, are generally designed to lead to better, more informed decisions in the absence of heavy-handed government regulation – but do they? How do we better ensure that such innovative, digital intermediaries work in the best interests of consumers? How should we think about law and regulation in the marketplace given the rise of these digital intermediaries?
In his recent article, Rise of the Digital Regulator, Professor Rory Van Loo explores these and other questions concerning digital intermediaries. These questions will likely be some of the most vexing and consequential ones for corporations, law, and society in the near future as many of the most valuable and disruptive businesses today are in the business of serving as digital intermediaries for consumers. Professor Van Loo’s article has two core motivations: (1) it highlights the under-appreciated shortcomings and challenges posed by digital intermediaries; and (2) it offers early sketches of potential legal reforms to better address the rise of digital intermediaries.
The article highlights many of the failings and frailties of digital intermediation that are often overlooked in the enthusiasm and allure surrounding them. Private intermediaries frequently operate in uncompetitive landscapes because of the huge barriers to entry posed by the access, accumulation, and analysis of the large volumes of data necessary to create workable, appealing interfaces. Furthermore, because of significant start-up and maintenance costs coupled with the lack of competition, private intermediaries sometimes skew their results to promote options that are more profitable to them, and less sensible to the consumer. Travel websites, for instance, do not always highlight the best choices for consumers; rather, they frequently highlight options of paid sponsors without clear disclosures to the consumers. Public intermediaries face similar issues. They frequently operate with little competition and face huge cost constraints in creating the data analytics capabilities needed to produce a workable framework for the public. Moreover, public intermediaries are subject to the political pressures of elected officials, policymakers, and special interests that sometimes run contrary to the best interests of a majority of the public.
To address some of the shortcomings faced by private and public intermediaries, the article provides a few touchstones to consider. In particular, the article contends that regulation of private intermediaries should focus on promoting more disclosures, encouraging smart competition and improving consumer protection. As for public intermediaries, the article contends that regulation should focus on “adequate funding, anticapture mechanisms, performance metrics, and fully exercising information-collection powers.” (P. 1315.) Ultimately, the article calls for a “uniform lawmaking initiative” akin to the Uniform Commercial Code to design rules and guidelines to govern digital intermediaries. Mindful of the institutional and political barriers inherent in that recommendation, the article contends that this may be one of the best, most realistic paths forward.
The rise of digital intermediaries has presented, and will continue to present some of the clearest benefits and most vexing challenges for consumers, corporations, and regulators. As the marketplace becomes more driven by data, algorithms, and artificial intelligence, digital intermediaries will play an ever-important role in helping us hear the whispers of signals amid the cacophony of noise. More and more, the laws and rules affecting corporations are going to be about the laws and rules of digital intermediaries. In the end, the power to intermediate and to filter is essentially the power to choose. It is an awesome power that must be thoughtfully exercised and carefully governed. Whether our analog political and rulemaking processes are up to addressing the challenges posed by digital intermediaries in a timely fashion remains an important, open question. Nevertheless, as we begin to think about how best do so, Professor Van Loo’s article offers an instructive, early map for the road ahead.
Camden Hutchison, Progressive Era Conception of the Corporation and the Failure of the Federal Chartering Movement
, Colum. Bus. L. Rev
(forthcoming, 2017), available at SSRN
Good history, including good legal history, sheds light on our own times. Well-written history, peopled with recognizable figures and marked by a strong narrative arc, also makes for good reading. In a new article, Camden Hutchison brings a precise historical eye and an engaging storytelling style to the understudied area of corporate legal history. His topic is Progressive Era corporate law reform, and particularly the question of why the United States failed to develop a federal corporate law regime in that period (and, of course, since).
Hutchison investigates how it could be that “in an era marked by ambitious efforts to reform the national economy, the [federal] chartering movement would distinguish itself, both in the breadth of its political appeal and the decisiveness of its failure”. His conclusions are illuminating and relevant. Once again, in the current era of populist discontent and economic inequality, we find ourselves confronting fundamental questions about the corporate form, the relationship between private wealth and the public interest, and about what a “progressive” corporate law regime might actually seek to accomplish.
Hutchison’s rich, thoroughly researched article is one product of a doctoral degree in history combined with several years of corporate practice with a global law firm. He draws on extensive primary sources to tell the story of US corporate law from state corporate chartermongering in New Jersey in the latter 1800s, through failed federalization efforts during the Roosevelt and Taft Administrations, and beyond. Federal chartering was a national political issue in the Progressive Era. Following the dramatic growth of industrial corporations during the “great merger movement” of 1895-1904 and through to the Federal Trade Commission’s establishment in 1914, the federal corporate chartering and antitrust movements were politically interconnected. Hutchison is a careful historian who does not overclaim about his story’s contemporary relevance, but his account nevertheless raises some provocative possibilities.
For example, Progressive Era reformers understood corporate law in a broader, more political economy-informed sense than the field tends to permit today. Corporations were not just neutral legal vehicles for achieving corporate aims or, more pointedly, for maximizing shareholder wealth. Rather, Progressive Era policymakers saw corporations as “quasi-public instruments of the state, whose legal privileges were contingent upon provision of a public benefit”. Note that we are still decades before Karl Polanyi published The Great Transformation (1944). Polanyi’s notion – it is a critique – of the market economy as a sphere of competitive capitalist human activity free of public or moral claims does not seem to inhibit Progressives’ enthusiasm for reform. These many decades later, after living through some remarkable extremes in thinking about what efficient markets can be expected to achieve on their own, we could do worse than to revisit these Progressive Era assumptions. In insisting that corporations assume public obligations in exchange for the benefits of incorporation, some Progressive Era reformers share a starting point with scholars such as Anna Gelpern and Erik Gerding, and Bob Hockett and Saule Omarova, who scrutinize the deep structures of finance and financial regulation in the service of a more contemporary progressive politics.
This is not to say that Progressive Era reformers had a particularly well developed or accurate understanding of how corporations and their constituent parts operated. We are pre-Berle and Means’ The Modern Corporation and Private Property (1932) here too. Progressive Era reformers tended not to distinguish between investors and managers, ownership and control; it was “corporations” versus the “public”. Many of the reformers’ ostensibly public-oriented priorities, like concerns over “watered” stock or corporate disclosure, would be understood as investor protection mechanisms today. Then, they were understood as weapons against inflated dividends and monopolistic pricing. Some Progressives’ thinking was fuzzy, if not downright mistaken, about how certain initiatives aimed at the public interest (e.g., automatic bankruptcy proceedings for overcapitalized corporations) would adversely affect not only corporate interests but shareholders’ and other stakeholders’ too. But considering the public interest as distinct from some “corporate” corporate one reminds us of the conceptual vice in which Berle and Means have held corporate law theory. Especially given the ways in which financial and legal innovations have shattered the atoms of the corporation, and the share, we may even wonder whether the separation of ownership from control is still the most salient or interesting divide around which corporate law should orient itself. Perhaps, understanding why Progressives framed the conversation in terms of public interest and concentrated economic power has the potential to inject fresh life into corporate law theory generally.
For scholars of policy change, the failure of federal chartering also offers a cautionary tale. Logistical details and labels were not fatal – when a movement has momentum, people in favour of “federal chartering” can also get behind “federal licensing”, and vice versa. But superficial consensus can mask deep ideological disagreement. Corporatist and anti-corporate forces were aligned around the high level objective of federal chartering, but for divergent reasons. Anti-corporate advocates like William Jennings Bryan saw federal chartering as a means of supplanting overly permissive state acts. Corporatist progressives were a somewhat varied bunch (and not always “progressive” as we might use the term), but included some who saw federal corporate licensing as a bulwark against federal antitrust enforcement! Once it came to hammering out the details, then, the scope for agreement turned out to be exceedingly – indeed, impossibly – narrow. The failure of the Hepburn Bill in 1909, which foundered on small businesses’ opposition to exempting labor unions and agricultural collectives from the Sherman Act, is one of several fascinating narratives in Hutchison’s article. And yet, as he observes, there is more than one way to skin a cat. Corporate federalization may have failed, but for better and for worse at least some of its less controversial objectives, including mandatory corporate disclosure, were eventually achieved through other federal legislative regimes.
Social and intellectual memory can be in scarce supply in times of upheaval and uncertainty. In this article, Camden Hutchison makes a welcome contribution in helping us see the trajectory and priorities of corporate law thinking across a broader historical time frame.
Cite as: Cristie Ford, Plus ça Change
(June 14, 2017) (reviewing Camden Hutchison, Progressive Era Conception of the Corporation and the Failure of the Federal Chartering Movement
, Colum. Bus. L. Rev
(forthcoming, 2017), available at SSRN), https://corp.jotwell.com/plus-a-change/
Vindicating the Duty of Loyalty: Using Data Points of Successful Stockholder Litigation as a Tool for Reform
, Bus. Lawyer
(forthcoming 2017), available at SSRN
At least since Karl Llewellyn crossed back over the Mississippi on his return from Montana, legal scholars have understood the value of lived experience as necessary to demonstrate the significance of legal theory. One could even note the rise of empiricism over the last several decades as a further development of this kind of insight. Yet laboratory empiricism can teach only so much. Important as it is, taken alone it can miss the trees that populate the forest.
Joel Edan Friedlander’s new paper is important precisely because it comes up to us from a place that numbers and theory alone cannot reveal. A highly experienced member of the Delaware plaintiffs’ bar, Friedlander writes in response to recent developments that threaten further to limit the already highly limited institution of shareholder litigation.
Despite their rather unsavory origins, restrictions on shareholder litigation help to keep in check the possibility of corporate extortion by plaintiffs whose only real interest in vindicating shareholders’ rights is a quick settlement and high legal fees. Yet it is also the case that such suits serve the important function of enforcing against corporate directors those fiduciary duties that have been left still standing. While the litigation process can be abused, so can the corporate process, and no better legal institution for the insured integrity of the latter has yet been designed.
Although Friedlander’s own personal interest in continued shareholder access to the courts is obvious, this paper is nicely balanced with real-world facts and modest claims. Empirical studies have demonstrated the worthlessness of much shareholder litigation, except of course to plaintiffs’ lawyers. But as Friedlander notes from the start, those studies fail to understand that many such cases are settled without judicial opinion, thus escaping the notice of scholars. He sets out to use eight highly successful cases in which he has participated in order to analyze which potential reforms will achieve their goal of weeding out meretricious litigation without destroying significant value-adding lawsuits.
Four basic reforms are at issue: early settlement of disclosure claims; laws permitting fee-shifting bylaws; laws restricting expedited discovery; and the application of the business judgment rule to controlling shareholders upon compliance with certain procedural niceties.
As to early disclosure settlements that would preclude deeper investigation that could (and sometimes does) reveal the existence of significant loyalty claims, Friedlander approves of recent Delaware developments restricting early dismissal and suggests that courts also could rely more heavily on questions of adequacy of shareholder representation to ensure that plaintiffs’ counsel is interested in more than simply hit and run.
He explores the problems inherent in fee-shifting arrangements, analyzing several cases to demonstrate the almost preclusive effect they would have on meritorious litigation at a premature stage. While I was not especially surprised by the size of defendants’ legal fees, it did strike me as both interesting and impressive to see how relatively inexpensively plaintiffs’ firms (or at least Friedlander’s firm) can litigate. In any event, the asymmetry in fees would operate to preclude much meritorious litigation, just as security for expense statutes did with respect to derivative suits.
Somewhat related is the importance of expedited discovery. Giving due credit to the merits of restricting expedited discovery in and of itself, he assesses this reform in light of diminished fiduciary protections in cases where an informed and disinterested shareholder majority approves the deal. Left with substantive fiduciary protection and an obligation to produce only board minutes, proxy statements, and other corporate documents, defendants can pretty much prevent plaintiffs from getting past the door. Friedlander stresses the importance of emails and other forms of internal communication that would be revealed in discovery as essential to establishing a meritorious cause of action. Finally, he discusses the expansion of the business judgment rule to controlling shareholders as yet a further justification for demanding more balance in procedural litigation rules.
Friedlander’s work is important. It is important to scholars as a cautionary tale about paying as much mind to what you don’t know as to what you do know. More importantly, it highlights significant dimensions of shareholder litigation that argue in favor of cautious reforms that would sustain the possibility of significant shareholder recovery in appropriate places. With any sort of meaningful fiduciary duty increasingly melting away like Greenland’s glaciers, it may be all we have left.
Cite as: Ezra Mitchell, The Baby and the Bath
(May 18, 2017) (reviewing Joel Friedlander, Vindicating the Duty of Loyalty: Using Data Points of Successful Stockholder Litigation as a Tool for Reform
, Bus. Lawyer
(forthcoming 2017), available at SSRN), https://corp.jotwell.com/the-baby-and-the-bath/
Students of organizations know that numbers can drive action and uncounted outcomes can get lost despite their mission centrality. The strategy of “Management by Objectives” was praised for providing a focus, preventing drift, and criticized for ignoring that which is difficult to count, misdirecting energies. Those of us in law schools know how rankings can help align us to serve students, but also can involve us in wasteful (or just less than optimum) activities to improve our rankings. More importantly, the rankings may deter our pursuing difficult but crucial pedagogies, whose importance may be unappreciated by students and the rankings.
Oren Perez’s The Green Economy Paradox is critical in the best sense. It digs deep into the numeracy problem, recognizing both the good and the bad. It is also comprehensive, in examining a broad range of indexes that might foster sustainable activities, by counting what corporations do in multiple ways. Rather than directing goals or processes, rankings “simply” count and hope that comparisons with others, and with previous years’ results, will move corporations toward sustainable activities. The numbers of rankings are increasing. This week, I learned that my university is joining the “Sustainability Tracking Rating System of the American Association for Sustainability in Higher Education.” One can hope that this Association ponders Perez’s fine article.
Corporate social responsibility has moved from laws, codes and guidelines (both hard and soft) to reports. Rather than telling corporations how to behave, the indexes ask corporations to count and report their numbers. Rather than giving corporations numbers “to hit,” these indexes only ask for reports, with the Global Reporting Initiative (GRI), beginning in 2000, currently the most pervasive reporting scheme. The convergence on reports, rather than directives, has been aided by ISO 14001 and the European Union’s Eco-Audit and Management Scheme (EMAS) which also emphasize counting. The international accounting profession sells assurance of GRI reports, in line with the International Auditing and Assurance Standards Board’s ISAE 3000 (2013), which authorizes assurance engagements other than those that deal with financial information.
Although these reports are often spoken about as “benchmarking,” they institute a process without a standard or mark against which to benchmark. Perez explains that they posit “development paths” (P. 170) in which firms can grow in both profits and sustainability. Perez concludes that this overestimates the “win-win” (P. 172) possibilities under capitalism, but he nicely explains how counting alters the internal dynamics of firms: “When a firm uses new routines for selecting, ordering, and processing information, it changes the trajectory and cognitive horizon of the organization.” (P. 176.)
Counting also can influence corporations by influencing purchasers of stock. Much like law schools wanting to appear good for students, corporations want to please stock funds that invest on the basis of sustainability numbers. Perez pays careful attention to the Dow Jones Sustainability Indices (DJSI) and the FTSE4Good Index Series (FTSE4Good). Reviewing the evidence, Perez concludes that these funds have had some effects on steering monies to companies engaged in sustainability reporting, but criticizes the funds for not reporting on how their sustainability practices compare to non-listed firms. They present information that buttress their claims of supporting sustainability, not information that might challenge it. What is not counted may be as important as what is counted.
There is a democratic deficit in the move from directives to reports. The stock indexes exert a governance function, for example individuals who seek sustainable investing rely on which stocks are chosen for the indices. Who makes these choices? On what bases? Perez serves on the board of a Tel-Aviv Stock Exchange version of DJSI and FTSE4Good. In Tel-Aviv public directors serve. This practice is not followed in New York and London. GRI criteria are developed after industry consultation. Should others be involved? The promoters of these indexes will tout their transparency. They are transparent as to what they count. But, not what they have chosen not to count. Perez suggests that the stock funds should count carbon emission and gender diversity in corporate boards. (P. 210.) He suggests that the GRI process should be open to more constituencies than are presently involved in its decisions as to what corporations should count.
Of the world’s 250 largest companies that report on social responsibility, 82% follow the GRI reporting guidelines for their industry. (P. 166, n. 53.) I would like to see case studies of how the GRI reporting process influences action at these firms. The case study should be longitudinal and should imagine what is not being reported. Whether and how the Global Reporting Initiative responds to such studies will answer the challenges that Perez has set for it and other sustainability indexes.
David Skeel, The Bylaw Puzzle in Delaware Corporate Law
, 72 Bus. Law.
1 (2016/2017), available at SSRN
Although corporate bylaws are, by and large, the mundane and technical instruments of day-to-day governance that most understand them to be, they have nevertheless become a key front in the battle for corporate governance supremacy. Shareholders, for their part, possess an inalienable statutory right to adopt, amend, and repeal bylaws, and this represents the only corporate governance action of any consequence that shareholders can undertake unilaterally—prompting creative efforts by activists to augment their own governance power at the expense of boards via this mechanism. At the same time, however, the Delaware General Corporation Law (DGCL) authorizes corporations to give directors concurrent bylaw authority via the charter—a power often granted, permitting boards to respond in kind. This straightforwardly tees up a collision of competing shareholder and board authority in Delaware corporations that neither the courts nor the legislature have definitively resolved.
In the article cited above, David Skeel examines these dynamics through recent clashes that prompted targeted responses from both the courts and the legislature alike. The Delaware Supreme Court, in decisions issued in 2008 and 2014 respectively, struck down a proposed bylaw requiring the corporation to reimburse shareholder proxy expenses under certain circumstances, but then upheld a “loser-pays” bylaw aimed at restricting corporate litigation. “This divergence of outcomes is mildly puzzling by itself,” Skeel observes, “but the outcomes get even more puzzling when we consider the response of Delaware lawmakers,” as the legislature swiftly “overruled its courts each time” (in 2009 and 2015 respectively). (P. 4.) Skeel’s article deftly unravels this “bylaw puzzle,” but in so doing looks well beyond competing conceptions of corporate governance. In Skeel’s view, the bylaw puzzle ultimately provides a lens through which to perceive more clearly some of the most fundamental political and institutional dynamics driving the formation of Delaware corporate law—including the differing institutional postures of Delaware’s courts and legislature, the threat posed by the potential for shareholders to file corporate lawsuits outside Delaware, and Delaware’s complex interactions with the federal government as alternative sites of corporate law production.
As a threshold matter, the Delaware Supreme Court’s divergent responses to what Skeel broadly terms “proxy access” versus “shareholder litigation” bylaws would appear easily squared with one another—both reflect “Delaware’s solicitude for directorial discretion.” (P. 13.) Explaining the Delaware legislature’s responses, however, is a bit more challenging—particularly given that “the Delaware legislature rarely steps in to reverse the course of Delaware corporate law.” (P. 10.) In these instances the legislature definitively overruled the court, establishing that the bylaws (and thus the charter) may provide for proxy access and expense reimbursement (DGCL §§ 112-113), while prohibiting loser-pays provisions (DGCL §§ 102(f), 109(b)) and permitting forum selection provisions only if the specified forum is Delaware (DGCL § 115). Skeel acknowledges the possibility that these responses reflect “a perception that Delaware’s courts went a little too far in their zeal to protect directorial discretion,” prompting the legislature “to adjust the balance of authority . . . in a more shareholder-oriented direction.” (P. 13.) But he rightly observes that nagging questions persist—notably, why the legislature reacted so swiftly, and why those reactions took the forms they did. Answering these questions, Skeel argues, requires an account of the larger political and institutional realities conditioning the development of Delaware corporate law.
As to proxy access, Skeel suggests (following Mark Roe) that the Delaware legislature’s swift response likely aimed to “preempt federal regulators and Congress by establishing a framework for proxy access before Congress completed its work on the Dodd-Frank Act”—a framework reflecting a firm-by-firm, opt-in approach contrasting sharply with the anticipated mandatory federal rule. (P. 17.) As to shareholder litigation, however, the notion that Delaware acted in the shadow of the federal government appears less compelling. “If Delaware were trying to implicitly preempt the SEC, it might have limited loser-pays provisions without banning them altogether.” (P. 19.) So what prompted the legislature’s extreme response?
Here, Skeel provides a richly nuanced “public-choice” account of the “credibility conundrum” that shareholder litigation bylaws posed for the courts. Skeel observes that “Delaware needs cases,” and that if “shareholders started filing their lawsuits in other states, the Delaware engine would soon begin to struggle.” (Pp. 19-20.) He suggests, however, that endorsing exclusive forum clauses resolved problems associated with multi-forum litigation at the cost of creating a more fundamental problem—a slippery slope toward more restrictive forms of bylaws that “would seriously chill litigation and might be especially attractive to corporate managers and directors.” (P. 21.) In essence the legislature stepped in to halt this dynamic, with prodding from Delaware’s corporate bar.
Just as operative, however, was the perceived need to insulate “the credibility of the Delaware judiciary” itself. (P. 23.) Skeel observes that the “most obvious way to promote Delaware’s interests is to establish generous rules for compensating attorneys without regularly imposing liability on managers and directors,” but that this risks creating a perception that Delaware’s judges are “participating in a form of implicit collusion” inconsistent with their “role as moral arbiters in corporate law.” (P. 24.) In this light, the legislature stepped in with “patently self-interested” shareholder litigation rules because, as a political matter, it could; “Delaware’s obvious self-interest is less problematic for its legislature than for its courts,” Skeel explains, adding that in “restricting shareholder litigation bylaws, Delaware lawmakers extracted the Delaware judiciary from an awkward predicament while also furthering Delaware’s interest by ensuring that cases come to Delaware rather than elsewhere.” (P. 26.)
In creating a corporate governance device that shareholders and the board alike can each unilaterally amend, the Delaware legislature effectively deferred a number of the most fundamental issues in corporate law to case-by-case determination in the courts, while naturally retaining its own ability to step in with situation-specific statutory provisions, incrementally sketching out the contours of these competing reservoirs of power. That story has continued to unfold through proxy access and shareholder litigation bylaws, and Skeel’s treatment of the resulting “bylaw puzzle” teases out some of the most fundamental political and institutional drivers of Delaware corporate law. He predicts that we can expect similar legislative interventions in response to future developments, not solely where a perceived crisis requires a swift and “decisive signal that the rules have changed,” but also where required to bolster “judicial credibility”—a delicate calculus, to be sure, requiring that “long-term benefits of removing the issues from the courts” be weighed against “any short-term damage” resulting from express disapproval of the court’s own treatment of a given subject. (Pp. 28-29.) While such interventions will likely remain rare, those that do occur will undoubtedly prove illuminating—and Skeel’s article provides a deeply insightful guide to their meaning and significance.
Jens Dammann, Business Courts and Firm Performance
(U. Tex. Research Paper No. 564, 2017), available at SSRN
Professor Jens Dammann’s paper titled Business Courts and Firm Performance is a bold attempt to answer a vexing question concerning the efficacy of state business courts. The paper can be summed up with a simple phrase and minor qualification: business courts are important (outside of Delaware). Specifically, the paper addresses the question of “whether giving publicly traded corporations access to business courts to litigate their internal corporate affairs benefits firm performance.” (P. 1.) The paper answers this question affirmatively. More importantly, the paper provides a long-awaited empirical justification to claims that business courts, outside of Delaware, are a positive development for publicly traded firms in the sense that these courts impact a corporation’s bottom line. The underlying hypothesis of Dammann’s paper is that business courts improve corporate performance by reducing/policing managerial self-enrichment (e.g., stealing, misappropriation, entrenchment). (P. 6.)
Delaware’s business courts have been the premier forum for high-profile corporate litigation for over a half century. And many publicly traded firms incorporate in Delaware, in part, to seek access to Delaware’s Court of Chancery. Despite Delaware’s preeminence as a hub for corporate litigation among publicly traded firms, over the past thirty years, many other states have created their own specialized business trial courts. Outside of Delaware, there are approximately 25 specialized business courts and 5 complex litigation programs. (P. 3, Table 1.) State actors, often through judicial decree or legislative action, created these courts to respond, in part, to general problems related to litigating in state courts: lack of judicial expertise on business and commercial matters, lengthy proceedings, unpredictability, and so on. (P. 2.) Scholars offer and debate the reasons behind this surge of state business courts such as preventing corporate migration, attracting out-of-state companies, generating litigation business for lawyers, reincorporations, encouraging investment, and jurisdictional competition. (P. 5.) The scholarly treatment of state business courts, however, lacks a satisfying explanation for what economic value publicly traded firms actually derive from litigating internal corporate disputes in state business courts. To be fair, observers often provide anecdotal support for the idea that firms value access to highly quality business courts and derive general benefits from them such as speed, expertise, and greater certainty.
Paper’s Central Findings
The paper’s primary findings are as follows:
- The creation of state business courts is associated with approximately a three-percentage point increase in firm performance, as measured by return on assets. (P. 4, 15, 21.) These results are both statistically and economically significant.
- Firms incorporated in states with access to business courts seem more likely to become the target in a merger with positive cumulative abnormal returns. The increased returns are both statistically and economically significant. (P. 4, 20.) This result supports the idea that business courts serve an important function through policing managerial entrenchment.
This empirical paper contains a detailed explanation of the study’s methodology, so I will not focus on it here. (P. 7-15.) Instead, I will focus on the paper’s findings that have wide-ranging implications for scholars, firms, and state actors.
Paper’s Contribution to the Existing Body of Literature
Dammann’s paper contributes to multiple threads of academic literature. There is already a wide body of literature on the macro-level relationship between institutions, the rule of law, and economic development. This study reflects how business courts (i.e., legal institutions) are a potential mechanism through which jurisdictions, foreign and domestic, may promote economic growth and investment. (P. 5.) There is also a growing body of empirical literature on the relationship between courts and firms. These studies often explore the relationship between courts and the enforcement of largely external third party contracts. By contrast, this paper uniquely focuses on how access to business courts for internal corporate disputes impacts firm performance. Finally, this paper also advances the growing body of legal literature on the growth and efficacy of business courts. There is limited empirical work in this area, and virtually nothing examining the impact of state business courts on firm economic performance until now.
Paper’s Implications for Scholarly Debate and Future Research
Specialized Courts as a Disciplining Mechanism in Corporate Governance
Courts are one of multiple corporate governance mechanisms that discipline managers (e.g., remuneration, markets, etc.). Dammann’s paper reveals how business courts can serve as a complementary disciplining mechanism for corporate managers and, in doing so, positively impact firm economic performance. This result seems intuitive and consistent with existing corporate governance theory. Yet the legal literature, until now, remained rather silent on this empirical question, in large part, because it is quite difficult to assess the specific economic impact of courts. When firms choose one jurisdiction over another, they inevitably consider multiple factors beyond courts that are not easy to disentangle. Dammann both acknowledges these challenges and attempts to address this critical gap.
Justification for Specialized Business Court Litigation and Establishment
The above findings support past, present, and future state efforts to establish specialized business courts. They also provide an economic justification for firms to incorporate and litigate their internal affairs in jurisdictions with specialized business courts. The paper complements and bolsters the anecdotal and reputational justifications for establishing specialized courts. Reputation is often used as a heuristic for quality in firm decision-making processes such as incorporation and forum selection. Decision-makers often rely on reputation where there is an absence of reliable information on quality or performance. This paper will contribute to future efforts to quantify how business courts contribute to firm performance. Such efforts provide more information, which, in turn, can be relied upon by firms when deciding where to incorporate and/or litigate corporate disputes.
Additionally, state actors—courts and legislators—now have economic evidence related to the impact of business courts on firm performance. States, equipped with this study and future research, could provide more concrete economic evidence for firms to litigate in state business courts. Establishing expert courts for dispute settlement is perhaps a cost effective way to attract firm investments. The paper cites the Delaware Court of Chancery’s relatively small annual budget of $4.9 million dollars and asserts that the costs associated with establishing expert courts is a “small price to pay for a 3.2 to 3.7 percentage points increase in ROA [return on assets].” (P. 21.)
Specialized Business Courts versus Alternative Dispute Resolution
Although not directly addressed in Dammann’s paper, the recent proliferation of specialized business courts provides a counter-narrative to the general trend toward greater use of alternative dispute resolution (e.g., arbitration) and the movement away from courts. Specialized business courts, when properly constituted, may yield multiple benefits that are both firm specific and systemic. This paper highlights how courts, through limiting managerial self-enrichment, improve firm performance. Beyond resolving individual disputes, one cannot disregard how business litigation also generates systemic public benefits in the form of legal opinions that provide guidance for parties. This is not the case for arbitration where there often is no requirement or incentive for a publicly shared written record beyond the immediate parties to the dispute. The key issue here is not whether litigation is superior to arbitration in the broad sense. Perhaps, the more important issue is capturing the contexts in which litigation before specialized courts is more desirable for firms (e.g., internal affairs, external affairs, etc.). Future research may answer this question.
In conclusion, Dammann’s paper is a must-read for scholars interested in the function and impact of state business courts.
“Market efficiency” is one of the most widely used, and frequently over-used, concepts in modern financial economics and its cross-disciplinary offspring, law and economics. Every student taking corporate finance or securities regulation knows about the Efficient Market Hypothesis. Every policy proposal must grapple with the issue of how it would impact the relevant market’s “efficiency.” And, of course, innumerable law review articles employ the vocabulary of “market efficiency” to support a variety of doctrinal, empirical, and normative claims. Yet, this theoretically elegant concept often seems to be a rather imperfect representation of what actually happens in real-life financial markets. The latest financial crisis made this problem simply impossible to ignore. Of course, a sensible way to bridge the gap between theory and practice is to refine or revise the theory, so that it provides a better explanation of the relevant reality. That’s easier said than done, however. Not surprisingly, the post-crisis explosion of academic writings on financial markets and regulation has produced disappointingly little by way of true theoretical advancement, at least so far.
Dan Awrey’s new article, The Mechanisms of Derivatives Market Efficiency, is one of the few rare exceptions in that respect. It is cleverly framed as an attempt to update and extend the theoretical framework originally laid out by Ron Gilson and Reinier Kraakman in their canonical 1984 article, The Mechanisms of Market Efficiency. Gilson and Kraakman were the first to identify and map out the key channels through which any particular piece of new information, depending on the cost of acquiring and processing it, gets incorporated into the publicly-traded stock prices. Among other things, they explained how numerous professional traders (broker-dealers, research analysts, investment managers, etc.) obtain, process, and disseminate costly private information, thus collectively enabling stock market prices to move to the new optimal levels.
Since its publication in 1984, Gilson and Kraakman’s article has been enormously influential in shaping both the dominant understanding of how capital markets operate and the mainstream debates on how they should be regulated. Ironically, however, the 1990s already marked the beginning of a qualitatively new era in modern finance. The rise of over-the-counter (OTC) derivatives trading, in particular, has been a true game-changer for the structure and operation of global financial markets. As Awrey points out, OTC derivatives markets are fundamentally different from the traditional highly regulated, order-driven, and deeply liquid markets for publicly-traded securities. And, insofar as Gilson and Kraakman’s theory was developed in the context of the traditional stock market, it does not offer a satisfactory explanation of how derivatives markets manage the challenge of informational efficiency.
Awrey begins his project of extending their theory beyond its limited original context by spelling out how derivatives contracts differ from publicly-traded stocks. As executory contracts performed over time, derivatives necessarily involve idiosyncratic counterparty credit risk. Derivatives markets lack the benefits of transparency and liquidity provided by the organized and regulated stock exchanges. Instead, derivatives markets are organized around a small network of large financial institutions—the “dealers”—that run huge portfolios of client trades and quote bid and ask prices to one another. These key features of derivatives explain the existence of potentially severe informational problems in these markets, such as the extremely high costs associated with finding derivatives counterparties, monitoring their performance, and properly pricing bespoke instruments.
Furthermore, as Awrey argues, even where traders can see actual prices of derivatives trades, they are generally unable to “decode” the relevant economic information in Gilson and Kraakman’s sense. This is a result of the high contractual malleability and heterogeneity of derivatives contracts. Because the cost of trading with a particular counterparty depends on many trade-specific factors (the counterparty’s creditworthiness, the terms of the contract, the amount and quality of collateral, the overall economic relationship with the same counterparty, etc.), the stated price of the contract does not fully reflect its de facto economic price. Awrey quite brilliantly depicts this phenomenon as an iceberg, where the stated contract price is only its visible tip (the “bright side” of a derivative contract) while the rest of the economically relevant contractual terms are hidden from view (the “dark side” of a derivative contract).
Building on this insight, Awrey identifies four principal mechanisms of informational efficiency in derivatives markets. The first mechanism is the network of derivatives dealers at the center of derivatives markets who, by virtue of their market-making function, produce and disseminate critically important information. The second mechanism is the supporting network of inter-dealer brokers and electronic trading platforms, which facilitate exchange of information among dealers. The third mechanism is the highly specialized and interlinked contractual and legislative regimes that govern enforceability and operation of critical contractual arrangements, such as close-outs and the treatment of collateral in the event of a counterparty bankruptcy. The final mechanism is the global market-wide standardization of derivatives contracts, mainly through the efforts of the International Swaps and Derivatives Association. Awrey’s article explains how these four mechanisms interact to enable derivatives markets to overcome informational challenges posed by the “dark side” of derivatives. Although very different from Gilson and Kraakman’s archetypal forms of informed or uninformed trading in public stock markets, these institutional arrangements are what ultimately enable the flow of otherwise prohibitively costly and largely unusable trade information in derivatives markets.
Identifying and examining these four mechanisms of derivatives market efficiency allows Awrey to assess the efficacy of various post-crisis regulatory reforms, including mandatory systems of pre-trade and post-trade reporting, new prudential regulation of derivatives dealers, and the shift to centralized derivatives trading and clearing. Awrey’s most intriguing and far-reaching normative conclusion, however, goes beyond these familiar measures and envisions central banks taking a more active role as the “ideal market-makers” uniquely positioned to ensure the necessary liquidity and informational efficiency of derivatives markets. My big hope is that he expands on this idea, which is near and dear to this reviewer’s heart, in future work.
There are many reasons to like Dan Awrey’s article. He has a genuinely deep practical understanding of derivatives markets, which does not come from simply “reading up” on the subject for purposes of writing an article. The article is superbly framed and executed: the scope of the inquiry is well-defined, the theoretical “hook” is extremely effective, and the argument is laid out clearly and convincingly (and without unnecessary over-claiming). Even a derivatives expert will learn a lot from reading this piece. What makes this article especially noteworthy, however, is that it offers an intellectually inspiring deep rethink of one of the core concepts in mainstream financial economics. In that sense, Awrey’s update of the theory of “market efficiency” is very much in line with other recent law-and-finance scholarship that seeks to deconstruct and demystify such fundamental theoretical and policy-shaping concepts as “financial intermediation” and “safe assets.” I excitedly look forward to our collective next step on this path toward a better—more accurate and empowering—understanding of modern finance.
Anat R. Admati, It Takes a Village to Maintain a Dangerous Financial System
in Just Financial Markets? Finance in a Just Society
(Lisa Herzog ed., forthcoming 2017), available at SSRN
It Takes a Village to Maintain a Dangerous Financial System, a chapter by Anat Admati in a forthcoming book should be required reading for legislative actors who are thinking about reviewing rules of financial regulation introduced after the onset of the global financial crisis.
Before the global financial crisis, policy-makers believed in risk-free assets and risk mitigation techniques. The Basel Committee on Banking Supervision developed capital adequacy standards to identify and neutralize a range of risks associated with the business of banking. But the crisis revealed weaknesses in the standards, and in their divergent and inadequate implementation, as well as new risks that the standards did not address. At the same time, as Andrew Haldane, Chief Economist at the Bank of England, has acknowledged, “the economic and financial crisis … spawned a crisis in the economics and finance profession.” In responding to the financial crisis, the G20, the Basel Committee on Banking Supervision, the Financial Stability Board, and the IMF announced a new commitment to focus on improving international standards for bank regulation and to ensure that the standards were implemented effectively. Regular reports by these bodies note concerns relating to financial stability, but suggest that they are making progress in achieving the agreed objectives for financial, and particularly bank, regulation.
The official, rather sanguine, view that financial regulation is becoming more effective faces challenges from two perspectives: that of financial firms and others who argue that regulatory burdens are too onerous and are reducing access to credit, and that of critics who argue that the post-crisis regulatory changes do not go nearly far enough. Jeb Hensarling, the Chairman of the House Financial Services Committee has proposed The Financial Choice Act to undo some of the effects of the Dodd-Frank Act. The EU Commission acknowledged in November 2016 after reviewing responses to a call for evidence on the EU regulatory framework for financial services that “targeted follow-up action is required in … reducing unnecessary regulatory constraints on financing the economy; enhancing the proportionality of rules without compromising prudential objectives; reducing undue regulatory burdens; making rules more consistent and forward-looking.” These developments imply something of a slide back to pre-crisis thinking.
But we may never really have moved beyond this pre-crisis mindset in any real sense despite the crisis, as Anat Admati’s chapter argues. The chapter builds on previous work, but is shorter than The Bankers New Clothes, her co-authored book with Martin Hellwig, and is an elegantly written and beautifully constructed piece which explains financial regulation as flawed due to the work of a range of “enablers.” The “enablers work within many organizations, including auditors and rating agencies, lobbying and consulting firms, regulatory and government bodies, central banks, academia and the media.” Part of the problem Admati identifies is the familiar issue of revolving doors recently illustrated by the decision of José Manuel Barroso, former President of the EU Commission, to work for Goldman Sachs. Admati writes that revolving doors “contribute to excessive complexity of regulation, because complexity provides an advantage—and creates job opportunities—to those familiar with the details of the rules and the regulatory process. Complexity also opens more ways to obscure the flaws of the regulations from the public and create the pretense of action even if the regulations are ineffective.”
This issue of regulatory complexity is an important one. But regulatory complexity can be used as an argument in different ways. In the chapter, Admati warns that the problem that expertise is constructed in ways that exclude critical and outsider views is still with us post-crisis, and she discusses the impact of spin and particular narratives on financial regulation (for example, showing how writing about capital is often misleading, and how bankers invoke the specter of “unintended consequences.”) We can see this sort of use of spin and narrative in the Hensarling Financial Choice proposal. The proposal is supported by a “comprehensive outline” which applies a complexity critique to Dodd-Frank, explicitly relying on Andrew Haldane’s Dog and the Frisbee speech (which the comprehensive outline refers to as having “achieved notoriety among financial regulators and scholars). But the proposed unravelling of much of Dodd-Frank would still leave in place much of the complexity of financial regulation in the US.
Admati’s chapter begins with a powerful comparison of safety in banking and aviation. Admati argues that whereas all of the actors in aviation safety have incentives to ensure safety this is not the case with respect to banking where “banks effectively compete to endanger.” The chapter ends with an injunction:
Entrenched and powerful systems resist change, but a just society must not tolerate a situation in which critically important systems like the financial system are run against the interests of the vast majority. More people must become aware of the problem and understand what is wrong. Then they must demand that policymakers do better.
Cite as: Caroline Bradley, An Unsafe Financial System
(December 6, 2016) (reviewing Anat R. Admati, It Takes a Village to Maintain a Dangerous Financial System
in Just Financial Markets? Finance in a Just Society
(Lisa Herzog ed., forthcoming 2017), available at SSRN), https://corp.jotwell.com/an-unsafe-financial-system/
Sometimes reading a book about one’s own field can be a painful experience, not because there’s anything wrong with the book, but because the book is so instructive and insightful as to highlight one’s own shortcomings of knowledge and understanding. I had this bittersweet experience with Jerry Davis’ The Vanishing American Corporation.
The vanishing corporation in question is the big, publicly-traded manufacturer that dominated both economy and society from the end of World War II through the 1970s. Since 1980, this kind of company has been disappearing, relatively speaking. But we knew that, didn’t we? Sure, what with restructuring and downsizing, our awareness is keen. But I’m not sure we have appreciated the extent of the change and grasped its implications. That’s where Jerry Davis comes in. Davis, who is on the both the business and sociology faculties at Michigan, brings the perspectives of both disciplines to bear as he takes a broad view of the evolving role that corporations play in society. The presentation is also historical, as makes sense for an account that asks us to compare what we have now with what we have lost. The book takes us from post-war managerialism and a world where the big corporation is far and away the dominant employer, to the economic crisis of the 1970s and eroding confidence in American managers, to the leveraged restructuring of the 1980s, and finally to the tech-centered present. The focus is on employment, welfare provision, and the corporation’s social presence in tandem with an account of the evolution of shareholder-manager relations and corporate governance. The big corporation starts to shrink after 1980 and keeps on doing so. This starts with a big bang: the conglomerate bust up of the 1980s, and with it, the end of life-time career tracks and narrow salary dispersions within corporate hierarchies. Thereafter, between competition abroad and shareholder value maximization at home, the process continues more quietly but just as determinedly. Gradually, corporate institutions give up (or, in some cases, default on) the responsibilities for social welfare provision they assumed in the years after World War II. Today, a company centered in a national economy in which welfare provision was remitted to the state in the years following World War II is ceteris paribus a fitter competitor than a US company saddled with the burden of providing medical benefits for its employees. Meanwhile, what were once corporate careers have evolved into temporary corporate jobs, and not all that many of them, particularly in the tech sector. Future generations may not get corporate jobs at all, instead performing piecework tasks distributed through internet clearinghouses.
For this corporate law academic, Davis’ account comes as a needed corrective. We have spent a quarter century in the field worrying about excess management power and agency costs against a policy template that depicts shareholders as a legally disabled class holding a species of permanent regulatory entitlement. In Davis’ view of the world, the decisive phase of the struggle between managers and shareholders ended before 1990. It was all over but the shouting once managers internalized shareholder value maximization as the appropriate corporate goal and turned it to their own advantage by revamping compensation systems, with the losers being the vast class of employees lacking capital endowments. Where once industrial organization posed a continuing question of “make or buy,” now there was a clear, simple answer: “buy,” and buy from wherever labor is cheapest. And don’t worry too much about your purchase’s more particular origin abroad, at least so-long as dirty facts don’t get out and catch the public eye.
One ends up wondering what the future holds for our students. Davis does too, offering two scenarios, one bleak and the other optimistic, the optimistic one focused on a new localism facilitated by technological advance. Unfortunately, the optimistic projection, while spirited, is also highly imaginative and does not outweigh the bleak one in the mind of the reader.
Summing up, this is a splendid, holistic view of recent corporate history, stated for the most part as a succession of fact. The prose is clear and lively. The narrative line is strong, and fleshed out with telling anecdotes and impressive statistical showings and comparisons. The voice is passionate, but resolutely and consistently reasonable. I warmly commend The Vanishing American Corporation for a stark and instructive perspective on a story with which we are all familiar.
Cite as: Bill Bratton, Corporate Dystopia
(November 7, 2016) (reviewing Gerald F. Davis, The Vanishing American Corporation: Navigating the Hazards of a New Economy (2016)), https://corp.jotwell.com/corporate-dystopia/