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“If you count it, it will count:” From Directives to Reports Refined

Oren Perez, The Green Economy Paradox: A Critical Inquiry into Sustainability Indexes, 17 Minn. J. L. Sci. & Tech 153 (2016).

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.

Cite as: Robert Rosen, “If you count it, it will count:” From Directives to Reports Refined, JOTWELL (April 20, 2017) (reviewing Oren Perez, The Green Economy Paradox: A Critical Inquiry into Sustainability Indexes, 17 Minn. J. L. Sci. & Tech 153 (2016)),

Bylaws, Politics, and the Institutional Structure of Delaware Corporate Law

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.

Cite as: Christopher M. Bruner, Bylaws, Politics, and the Institutional Structure of Delaware Corporate Law, JOTWELL (March 22, 2017) (reviewing David Skeel, The Bylaw Puzzle in Delaware Corporate Law, 72 Bus. Law. 1 (2016/2017), available at SSRN),

The Impact of Business Courts (Outside of Delaware)

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.1 And many publicly traded firms incorporate in Delaware, in part, to seek access to Delaware’s Court of Chancery.2 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.

  1. John Armour, et al., Delaware’s Balancing Act, Ind. L.J. 1345, 1398 (2012). []
  2. Jill Fisch, The Peculiar Role of the Delaware Courts in the Competition for Corporate Charters, 68 U. Cin. L. Rev. 1061 (2000). []
Cite as: Omari Simmons, The Impact of Business Courts (Outside of Delaware), JOTWELL (February 22, 2017) (reviewing Jens Dammann, Business Courts and Firm Performance (U. Tex. Research Paper No. 564, 2017), available at SSRN),

This Is Not Your Parents “Market Efficiency” . . .

Dan Awrey, The Mechanisms of Derivatives Market Efficiency, 91 N.Y.U. L. Rev. 1104 (2016).

“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.

Cite as: Saule T. Omarova, This Is Not Your Parents “Market Efficiency” . . ., JOTWELL (January 25, 2017) (reviewing Dan Awrey, The Mechanisms of Derivatives Market Efficiency, 91 N.Y.U. L. Rev. 1104 (2016)),

An Unsafe Financial System

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, JOTWELL (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),

Corporate Dystopia

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, JOTWELL (November 7, 2016) (reviewing Gerald F. Davis, The Vanishing American Corporation: Navigating the Hazards of a New Economy (2016)),

Friends Don’t Let Friends Trade on Inside Information

Sarah Baumgartel, Privileging Professional Insider Trading, Ga. L. Rev. (forthcoming 2016), available at SSRN.

Just when you thought it was safe to avoid yet another article on insider trading comes Sarah Baumgartel’s imaginative and insightful paper. Baumgartel’s point of entry is several recent and pending cases that in some ways extend, and in other ways limit, the peculiar misappropriation theory, a judicial development that continues to prove not only that bad cases make bad law but that they also can make for good scholarship.

Before I get into a few of the details, here’s the bottom line: The misappropriation theory, and especially the Commission’s redaction of “confidential relationship” in Rule 10b5-2, are yet another example of facilitating the economic inequality that has achieved such prominence in contemporary discourse. Baumgartel doesn’t quite put it this way, but she does argue that the manner in which the misappropriation theory has come to impose liability on traders who received their information in the context of personal and often intimate relationships while providing exculpation for professionals and managers who trade on that information satisfies neither the information-protective function of modern insider trading law nor the market fairness rationale that often is invoked. Instead, it sends your golf buddy or your sister to jail while allowing business professionals to reap harvests from fields that ordinary people can’t even locate.

Baumgartel briefly suggests that insider trading law is the result of powerful interests protecting their rents, and this certainly is plausible. She also sees the expansion of insider trading law from professional relationships to personal relationships as a “jurisdictional hook” on which to hang liability for nothing more than personal ethical misconduct, a trend that she situates in other areas of the law.

She also asks that we bid goodbye to the market fairness rationale for insider trading prohibitions. How can it be fair to let professionals benefit from insider trading while precluding market participants whose only hope of getting access to that type of information is the mere dumb luck of personal relationships? She even suggests that fairness, as developed in this context, is an irrational concept. Questioning what fairness means in this context, she reduces it to “nothing more than getting information the owner did not authorize you to have.” Even a cursory reading of the quoted material shows that the word “fairness” has no serious meaning here.

Ultimately, insider trading law is about securing one’s right to protect and use one’s confidential information as one sees fit. Fairness has nothing to do with it, nor does any other market regulatory purpose. It really is a branch of property law (along with the personal ethical regulation mentioned above).

All of this is woven through a doctrinal examination of case law and regulation and, to this reader, provides an example of what really good doctrinal work looks like. Baumgartel amasses the evidence, analyzes it closely, and then steps back and asks: Why does all this matter? While legal change, even if incremental, could result from such work, Baumgartel helps us to see the big picture of what actually is transpiring beneath the details. By doing so, she fits her subject nicely into contemporary social narratives and political debates and unveils rather prosaic material as part of a much bigger (and troubling) trend.

There are a lot of ideas here. Baumgartel has much to say but not much room in which to say it. I get the sense that there are at least several papers waiting to be generated from this one. And I look forward to seeing them all. This is an excellent paper in its own right, but it also reveals the potential its author has for important future work.

Cite as: Ezra Mitchell, Friends Don’t Let Friends Trade on Inside Information, JOTWELL (October 7, 2016) (reviewing Sarah Baumgartel, Privileging Professional Insider Trading, Ga. L. Rev. (forthcoming 2016), available at SSRN),

See. Spot. Catch. Frisbee. (… or Behold the Simple Elegance of Bank Capital, Upside-Down)

Heidi Mandanis Schooner, Top-Down Bank Capital Regulation, 55 Washburn L.J. 327 (2016).

In the words of one younger and wiser colleague, “prescriptions are empty calories for law review editors.”1 Many fabulous articles uncover new histories, new facts, new frames … only to fizzle around the obligatory Part V, with its half-hearted defense of a model law or regulatory gimmick, that orphan child born of perfunctory comments in faculty workshops.

The latest article by Heidi Mandanis Schooner, based on her endowed lecture at Washburn Law School, is a rare counterexample—a stunningly simple reform idea that would literally upend the paradigm of bank capital adequacy, dispensing with some of today’s most urgent and intractable financial regulatory debates. The Washburn Law Journal symposium issue (which includes insightful commentary on Schooner’s lecture) and her spinoff testimony before the Senate Banking Committee are rich food for legal, economic, and policy thought—but are not very well-packaged, and could easily get lost in the buzz and dazzle of the fast-growing scholarly field.

Here are the problem and the fix, in a nutshell.

Under the existing regime, banks and a growing set of other financial firms must keep a minimum cushion of regulatory capital (roughly meaning equity and certain junior liabilities) to absorb losses in the event their assets decline in value. If its cushion is too small, a firm might fail, depositors and other senior creditors might lose money, and other firms and markets might succumb to contagion. To prevent or contain a financial crisis, the state might step in with a bailout.

The proper size of the capital cushion is the subject of a huge, nasty, and mostly unresolved academic and policy debate, which Schooner recounts briefly in her piece. The “consensus” range is somewhere between 4 percent and 40 percent, reflecting different methodologies and normative perspectives. In practice, the floor has been set by international agreement: since the late 1980s, the successive Basel Accords have articulated global norms for bank capital adequacy, and ever more convoluted ways of measuring it. Basel I, II, and III reflect technocratic and political accommodation among regulators who oversee the world’s largest financial institutions and markets.

Crucially, the burden of going above the floor is on the state. U.S. officials have successfully used administrative discretion for decades to raise the effective capital requirements for most banks above the absolute minima—but failures and crises came anyway, leading many to argue that capital cushions were still too small.

In a delightfully legal move, Schooner would simply flip the burden. Instead of starting with, say, 8 percent and working up to, say, 15 percent, using a host of complex formulas and byzantine administrative procedures—regulations might start at 20 percent and give regulated firms a chance to argue it down to 15 percent. As she puts it towards the end of her Senate testimony, “[c]onceptually, capital regulation would be set … as ‘prudent’ capital as opposed to ‘minimum’ capital.”

This is ingenious because it flips two arguments at once—the argument over math, and the argument about its normative underpinnings. When the standard is “minimum,” the market failure paradigm dominates. In contrast, “prudent” could be defined in terms of banks’ public functions and the risk preferences of the taxpaying public.2

Schooner’s prescription is broadly in line with the precautionary trend in financial regulatory scholarship – a rich crop of proposals to limit and license financial products and activities, reflecting a healthy skepticism about financial innovation and post-crisis risk aversion on the part of the public. Hers stands out for its radical simplicity. It would require no new administrative apparatus, and, if anything, might do away with some of the complexity that has come to define financial regulation.

As Erik Gerding notes in his comment, the upside-down capital idea follows another regulatory precept—captured in Andrew Haldane’s metaphor of the dog and the Frisbee—to fight complexity with simplicity. Top economists have shown that identifying the right minimum level of capital against financial crises is incredibly hard, perhaps even harder than finding a formula for consistently catching a Frisbee. Dogs learn to catch Frisbees without formulas. Flipping capital regulation on its head might dispense with a few formulas as well.

As Gerding and Brett McDonnell rightly note in the symposium, Schooner’s inspired concept does not escape the essential criticisms directed at all bank capital regulation – namely, that regulating some firms more stringently, or more effectively, could drive finance beyond the regulatory perimeter, and spawn new regulatory arbitrage strategies. McDonnell also notes that there are risks to firms and to society from setting capital thresholds too high. Both critiques are fair, but they are not particular to Schooner’s argument. If you are going to regulate bank capital at all, it is hard to see why you wouldn’t do it upside down.

My own frustration with the article is that the absolutely brilliant core contribution is buried way too deeply for most readers to reach, and takes up much less of the text than it should. I am also uneasy about Schooner’s term for the proposal, “Top-Down Capital Regulation,” which to me connotes a clunky dirigisme, potentially overshadowing the subtle elegance of her idea.3

In the grand scheme of things, these are quibbles, perhaps pointing to an opportunity for the author to expand on her insight in another article or two.

  1. The colleague’s name is withheld until such time as he no longer need care what the editors think. []
  2. To align incentives, Schooner also argues that managers should have personal liability in the event they successfully argue for a cushion that turns out to be too low—although she does not fully develop the idea. []
  3. The existing regulatory paradigm is called “Bottom-Up,” which I associate with people power, in a world that is anything but. []
Cite as: Anna Gelpern, See. Spot. Catch. Frisbee. (… or Behold the Simple Elegance of Bank Capital, Upside-Down), JOTWELL (September 8, 2016) (reviewing Heidi Mandanis Schooner, Top-Down Bank Capital Regulation, 55 Washburn L.J. 327 (2016)),

Of Firms and Fees

Kathryn Judge, Intermediary Influence, 82 U. Chi. L. Rev. 573 (2015).

Prominent economic theories rooted in the seminal work of Ronald Coase have long suggested that firms in a marketplace exist and work to reduce transaction costs, but the explanatory powers of these theories fail to reflect some of the realities of the modern marketplace. In many instances, particularly in the financial industry, it appears that firms exist and work to increase, rather than decrease, transaction costs. In her recent article, Intermediary Influence, Professor Kathryn Judge examines this peculiar phenomenon and offers a persuasive claim that helps to explain this persistent and consequential marketplace curiosity in finance.

The central claim of Professor Judge’s article is aptly summed in the title of the piece: intermediary influence. If one wonders why certain financial arrangements are the way they are, the article suggests the answers likely lies in fees and the firms that collect them. Specifically, the article argues that:

[T]hrough repeatedly helping parties to overcome barriers to transacting, intermediaries develop informational and positional advantages relative to the parties that they serve. These advantages are critical to intermediaries’ capacity to provide value, but they also put intermediaries in a superior position to influence the evolution of institutional forms. In addition, intermediaries of a particular type will often be fewer in number and better organized than the parties that they serve. This makes intermediaries relatively better positioned to shape laws and regulations and to otherwise act to promote institutional arrangements that serve their collective interests. For these reasons, intermediaries often succeed in their efforts to promote and entrench high-fee arrangements.

(P. 590.)

To bolster her claim that certain intermediaries work to add needless transaction costs to the marketplace, Professor Judge offers evidence with case studies of financial intermediaries such as exchanges, stockbrokers, mutual funds, and credit default swap dealers. In each instance, the entrenched intermediary took action that solidified or moved the marketplace toward a high-fee position even when lower cost alternatives seemed viable. Professor Judge suggests that partially as a result of such intermediary influence, the financial industry is less efficient, more intermediated, more complex, and more fragile.

The explanatory strengths of the article are persuasive and powerful. They provide guidance for the current paths of finance, and raise questions about the road ahead. How does one pragmatically and politically go about rechanneling intermediary influence towards greater efficiency and economic welfare mindful of strong incumbent self-interest to oppose such changes? Why have the forces of new technology and greater competition been much more disruptive to entrenched intermediaries in other industries relative to those in finance? What factors make certain intermediary influence more powerful than others? Are there non-economic beneficial purposes to high fees, such as gatekeeping, that we should maintain over time? Are intermediary influence and high fees existential facets of modern finance given its complex and intermediated nature? The answers to these and other lines of inquiries find both fertile ground and green shoots in Professor Judge’s article when one thinks about the large questions looming over the future of financial markets and financial regulation.

Because financial markets are truly markets of intermediaries, financial regulation is truly regulation of intermediaries. And because intermediaries influence, they must be influenced. Thanks to the work of Professor Judge, policymakers and researchers thinking about how best to regulate the financial industry must think harder about how best to repurpose and refashion the influence of financial intermediaries towards more productive and efficient ends.

Cite as: Tom C.W. Lin, Of Firms and Fees, JOTWELL (July 26, 2016) (reviewing Kathryn Judge, Intermediary Influence, 82 U. Chi. L. Rev. 573 (2015)),

Thinking About Monitoring

Veronica Root, Modern-Day Monitorships, 33 Yale J. on Reg. 109 (forthcoming 2016), available at SSRN.

The study of organizational compliance is now proliferating in American law schools. Over the past decade, new courses, new programs, and new scholarship have focused increasing attention on this area. In recognition of the importance of organizational compliance as a free-standing field of inquiry, the American Law Institute has launched the drafting of Principles of the Law, Compliance, Enforcement, and Risk Management for Corporations, Nonprofits, and Other Organizations. This project – and the work it inspires – should advance our understanding of a framework for thinking about organizational compliance. Veronica Root’s work on monitorships, including her most recent piece on Modern-Day Monitorships, is a meaningful contribution to one piece of that framework.

Much of the existing work on organizational compliance focuses on “gatekeepers,” which reassure the public that a corporation is complying with its obligations. Professor Root has focused her scholarship on the enforcement side, helping us to understand the special role of “monitors,” which enter the scene after a compliance failure is manifest.1 The role of monitors is to investigate wrongdoing and make recommendations for future compliance. In her most recent article, Root describes “modern-day monitorships” and argues for a more nuanced understanding of these important enforcement institutions.

Professor Root traces the origins of modern-day monitorships to the familiar court-appointed monitors, which go by various names, including “master,” “special master,” “receiver,” or “trustee.” These monitors have been used for many years to assist courts along a range of responsibilities in resolving complex litigation, from fact-finding to the creation and implementation of remedies.

Professor Root contends that the traditional court-ordered monitorships served as the model for a new form of monitorship, deployed by governments or administrative agencies in a context of increased regulatory oversight. The challenge for a government faced with an organizational wrongdoer is to get the organization back on the right path, possibly over a period of many years. According to Professor Root, “In regulatory grey areas, it is often difficult to predetermine a set of mandates that an organizational wrongdoer should follow going forward.” (P. 123.) Thus, the role of monitors changed from “performing rote compliance enforcement” in the wake of a finding of wrongdoing to “assisting in the development of a remediation program.” (Id.) Meet the modern-day monitorship, used by courts, government agencies, and (increasingly) private organizations.

While modern-day monitorships can be employed in diverse circumstances, Professor Root describes four core attributes: modern-day monitors are “(i) independent, private outsiders, (ii) employed after an institution is found to have engaged in wrongdoing, (iii) who effectuate remediation of the institution’s misconduct, and (iv) provide information to outside actors about the status of the institution’s remediation efforts.” (Id.)

The most common modern-day monitorships are for purposes of regulatory enforcement, as described above, but modern-day monitorships often perform functions beyond the development of a remediation program. The modern-day monitor, like a gatekeeper, may lend reputational capital to the wrongdoer, but in this context to facilitate rehabilitation. Or, when acting under a court order, some modern-day monitors may exercise a great deal of discretion in defining and remediating past harms. Professor Root also suggests a public relations benefit (beyond the use of reputational capital) from modern-day monitorships, when the wrongdoer voluntarily hires a monitor and charges the monitor with providing a public accounting of the investigation, along with suggestions for remediation measures.

Among the many legal issues that arise from the widespread use of monitors is that “modern-day monitorships … lack a technical source of legal authority governing their use.” (P. 142.) (Note that the ALI project is not a “Restatement of the Law,” which would be primarily addressed to courts to clarify established law, but rather a “Principles of the Law,” which is to be primarily addressed to legislatures, administrative agencies, private actors, or courts where there is little established law.) Some commentators have proposed more robust legal framing of monitors, but Professor Root argues that differences in context make the development of overarching principles challenging. More specifically, she discusses the lack of desirability of one-size-fits-all rules for court involvement, transparency, confidentiality, and monitor duties. The bottom line is that “differences amongst monitorships matter when considering common issues of monitorship reform.” (P. 152.)

Professor Root’s examination of monitorships is careful and detailed, and she includes in the final section of her paper several additional considerations that “lawmakers, scholars, and the public should contemplate” as they think about monitorship regulation. (P. 153.) This piece and her previous work on the monitor-“client” relationship are worthy of close reading by anyone who is interested in advancing his or her thinking about this emerging field.

  1. See Veronica Root, The Monitor-“Client” Relationship, 100 Va. L. Rev. 523 (2014). []
Cite as: D. Gordon Smith, Thinking About Monitoring, JOTWELL (June 24, 2016) (reviewing Veronica Root, Modern-Day Monitorships, 33 Yale J. on Reg. 109 (forthcoming 2016), available at SSRN),