Nov 15, 2024 Tom C.W. Lin
Many businesses today are subjected to a myriad of regulations. In order to ensure compliance with the large and dynamic bodies of federal, state, and local rules, many businesses create internal policies and systems to facilitate adherence to the law. However, such policies and systems exist in a dynamic marketplace filled with resource constraints and other business considerations. So, how do corporate managers construct internal compliance policies for their firms? What rules and regulations do they prioritize? How do they design internal systems to reflect the realities of law and enforcement?
In a recent article, Strategic Compliance, Professor Geeyoung Min offers a sharp and insightful perspective on these questions and more. Through an astute and deep analysis of a hand-collected dataset of corporate policies on insider trading and related party transactions from companies making up the Standard and Poor’s (S&P) 500 index, Professor Min reveals the policy customizations that occur at the firm level. Specifically, she reveals how firms customize internal policies on insider trading and related party transaction, oscillating between stringency and leniency. These revelations illuminate, inform, and interrupt conventional understandings about corporate compliance and internal policies.
The article begins by grounding its examination in the larger corporate and legal context of growing demands for written internal corporate policies. According to Professor Min, this rise in demand for firm-based policies is driven in large part by regulatory enforcement actions, shareholder engagement, and recent court decisions concerning the oversight duties of corporate directors and officers. In response to the rising demand, firm managers and compliance departments have produced more policies tailored to the unique regulatory and businesses concerns of their firms. Collectively, the article explains that this dynamic of corporate policy production serves as a private ordering mechanism for corporate law and compliance.
Next, Professor Min examines her hand-collected data from S&P 500 companies, demonstrating that corporate policies are not static but are actively tailored to either tighten or relax compliance depending on the perceived intensity of external oversight and enforcement. The data indicated that insider trading policies tend to be more stringent, often extending beyond the requirements of federal common law on insider trading. For instance, many companies prohibit trading in any other company’s stock based on material, nonpublic information, a stance that exceeds the traditional insider trading doctrine. Conversely, the data indicated that related party transaction policies at the examined companies often include categorical exclusions or waivers that narrow the scope of prohibited actions.
The article then explains that this divergence in corporate policy stringency and leniency is a strategic move to allocate compliance resources effectively, focusing them on areas with higher external enforcement while relaxing controls in areas with less regulatory scrutiny. Professor Min calls this approach “strategic compliance,” and defines it as firm behavior whereby “[c]orporate policies amplify the incentives to implement stringent internal monitoring where external enforcement is rigorous and adopt lenient internal monitoring where external enforcement is weak.” (P. 433.) Additionally, Professor Min argues that while strategic compliance is “not necessarily problematic,” it can lead to regulatory vacuums and hinder the ability of firm managers to acquire important governance and compliance information. (P. 434.)
The article closes by proposing a set of pragmatic recommendations for firms, shareholders, regulators, and prosecutors to better align and incentivize corporate policies with the larger goals of corporate compliance aimed at better corporate governance. These recommendations are proffered with the intention of better harnessing the benefits of firm-specific policy customization to reflect external regulatory realities.
Modern businesses have to comply, manage, and respond to a growing and complex set of regulations. As such, it is not surprising that much attention, discussion, and resources have been dedicated to understanding and improving business regulation, compliance, and governance in recent years. Good corporate compliance initiatives should not be merely about avoiding liability and enforcement actions. Instead, they should be centered on effectuating the larger welfare-enhancing and profit-enhancing objectives of better corporate governance. Ultimately, corporate policies, corporate compliance, and corporate governance—when working well in concert—should have shared values and shared aims.
Toward that end, this recent article by Professor Min provides a fresh, informative framework for creating internal corporate policies and compliance programs that better align with the values and aims of good corporate governance. Given resource constraints and other competitive business pressures, creating and sustaining such policies and programs consistently is a difficult task, but Professor Min’s insights should make the task clearer, more principled, and ultimately more achievable going forward.
Oct 17, 2024 Joan MacLeod Heminway
The rise and dominance of institutional investors in public company stockholder profiles has increasingly shifted significant scholarly and popular attention toward those institutions and away from individual investors. Market factors periodically refocus attention on retail investors, however. One of those factors in recent years has been the meme stock phenomenon, which attracted widespread public attention in early 2021 when the common stock of GameStop Corp. and AMC Entertainment Holdings Inc. achieved record high public market prices. The continued salience of activist retail investors recently has been reinforced by a meme stock resurgence that has again put GameStop and AMC in the news.
The ongoing work of Professors Sergio Alberto Gramitto Ricci and Christina Sautter is helping to educate many audiences about legally significant demographics that shed light on current retail investors and their behaviors. Specifically, their joint work addresses ways in which investors’ behaviors have responded to the nearly universal availability of wireless access through a variety of ubiquitous devices (including especially cell phones). This broad-based wireless access has created a new cadre of “wireless investors” who collect and share investment information through social media and Internet applications and buy and sell securities through online trading platforms.
In Wireless Investors & Apathy Obsolescence, Gramitto Ricci and Sautter focus on the potential for wireless investors to overcome investor apathy. They describe that apathy and explain its genesis. They then illustrate why the advent of wireless investors may more optimally empower retail shareholders.
Specifically, Gramitto Ricci and Sautter assert that retail investors have been apathetically ceding their voting power to institutional investors and other large shareholders. They explain that retail Investor voting power, viewed through the eyes of an individual investor, provides too little potential benefit. Moreover, although individual retail investors could aggregate their voting power, the cost of doing that has been perceived to be too great. This perceived lack of power has encouraged investor disengagement and indifference in the form of free riding on the voting of larger shareholders.
Analogizing this pattern of investor thinking to the individualistic decision making that operates in game theory’s prisoner’s dilemma, Gramitto Ricci and Sautter argue that efficient collaboration among retail investors—looking at shareholder power as a cooperative venture—may allow retail investors to overcome barriers to collective action and collaborate. That efficiency is possible, they hypothesize, if wireless investors harness the available tools and properly direct their efforts toward productive collaboration. They offer theoretical and practical support for their ideas.
The article’s insights (and embedded take-aways from Gramitto Ricci and Sautter’s earlier work) are relevant to several large-scale business law topics. Two are most salient for me: shareholder primacy and the reasonable investor standard. Each area of inquiry and debate connects with the composition or behaviors of corporate shareholders.
Whether addressing shareholder primacy as a matter of the locus of corporate governance power as among the corporation’s internal constituents (through, e.g., voting or derivative litigation) or in terms of the objective of board decision making, shareholder apathy and coordination may be important to analyses and judgments. In shareholder primacy debates, assumptions often are made about the nature and interests of corporate shareholders. Changes in the identity and engagement of shareholders may alter those assumptions.
Similarly, the reasonable investor standard (which is incorporated in materiality definitions used in, among other things, federal securities regulation) is rooted in an understanding of investor (including shareholder) identity and conduct. The standard is intended to be objective. But investment markets and investors evolve over time. Thus, objective assessments of them also must evolve. Wireless Investors & Apathy Obsolescence, taken alone or together with Gramitto Ricci and Sautter’s related work, provides evidence of changes in equity investment markets and shareholder behavior patterns that may be significant to applications of the reasonable investor standard.
There is much to value in Gramitto Ricci and Sautter’s Wireless Investors & Apathy Obsolescence. Their explorations at the intersection of wireless investing and shareholder voting apathy provide readers with new information that is immediately useful to corporate governance and corporate finance doctrine and practice. In their own words: “[t]he substantial change of context in which retail investors operate is set to determine a new norm in investing and corporate governance.” The continued and increasing presence of wireless retail investors in securities trading and shareholder voting underscores the importance of this work.
Sep 17, 2024 Atinuke Adediran
Are corporations responsible for addressing racial inequality? In a timely and compelling examination of corporate race relations during the civil rights movement and current corporate processes and decision-making on race, Gina-Gail S. Fletcher and H. Timothy Lovelace, Jr. argue in their article, Corporate Racial Responsibility, that corporations are responsible for addressing racial inequality because they have historically been inescapably involved in it.
The authors’ historical exploration of race and corporate relations is an important contribution to scholarship. The authors show that corporate engagement in race is not new. It extends back to the time of slavery and became much more extensive during the civil rights movement. As the authors document, sit-ins at hotels, restaurants, and other segregated businesses were catalysts for the civil rights movement.
Businesses were drawn to voluntary desegregation, which was woefully unsuccessful as evidenced by accounts in cities like Birmingham, Alabama and Atlanta, Georgia. It was not until the passage of Title II of the Civil Rights Act of 1964, mandating that businesses desegregate, that change began to occur. The authors explain that this is compelling evidence that mandates succeed while voluntary action, a form of corporate social responsibility, does not.
With history as the backdrop, the authors address contemporary debates on corporations’ engagement with issues of racial inequality, focusing on three specific issues: the critique that companies are becoming “woke,” the belief that addressing race may negatively impact corporate profitability, and the idea that companies are engaged mostly in “cheap talk.” Regarding the critique that companies are now becoming woke, the authors remind us that criticisms like this mirror segregationists’ resistance during the civil rights era. History also shows that the desegregation project, much like corporate support for racial equity today, has support across the political spectrum. On the belief that racial equity is in tension with profitability, the authors explain that there are many non-pecuniary benefits of racial equity not often captured in these criticisms. On cheap talk, the authors note the value in public affirmations of racial equity, which can be used for tangible action toward change.
The authors further argue that past and present iterations of corporate engagement in racial equity present a market-fundamentalist, value extractive approach to racial equity that reifies existing hierarchies. Market fundamentalism means that corporations tend to engage in racial equity work when it is worthwhile financially, such as when there is support for the business case for diversity. Like market fundamentalism, value extraction is about obtaining value from people of color without attempting to change the underlying arrangements that support racial inequality, such as establishing structures to ensure board diversity.
However, even the business case for diversity is not always enough. During the civil rights movement, white business owners had little to no incentive to voluntarily desegregate or recognize the dignity of Black people regardless of the potential profitability of desegregation. Today, scholars of corporate governance recognize the flaws of the business case. And empirical research shows that the business case has a negative impact on belonging for underrepresented groups, including Black people, women and LGBTQ+ individuals.
The authors make two categories of proposals for change to address market-fundamentalism and value extraction. The first category is proposals that can easily be implemented and, in some cases, have already been implemented by companies. The second are bolder and will be more challenging to implement in this politically fraught environment. In the first category are measures like changes to board composition, pay equity, employee resource groups, internal tracking of diversity goals, and partnerships between companies and racial justice nonprofits. In the second category are things like requiring third party suppliers and law firms to improve corporate diversity. In the past, corporations have required law firms to staff matters with more diverse lawyers. However, current political tension has made these kinds of approaches more controversial. Another more challenging recommendation is to develop “corporations of conscience” who will lobby the government for new civil rights laws. Corporations of conscience “seek to advance racial justice in any situation regardless of profitability.” (P. 425.) In my view, this is a call to action for corporations to do better despite conservative pressures to squash corporate engagement with race.
Aug 13, 2024 Ann Lipton
Hilary J. Allen,
Interest Rates, Venture Capital, and Financial Stability, __
U. Ill. L. Rev. __ (forthcoming), available at
SSRN (March 8, 2024).
The last decade has seen a transformation in patterns of corporate organization. Enabled by loosened restrictions on private capital raising, venture capital firms have fueled the creation of a new ecosystem of large, privately held “unicorn” companies that are so well capitalized that they have not sought to access the public markets. That shift has been accompanied by a host of new questions about optimal governance arrangements, fiduciary obligations, the positive externalities of securities disclosure, fraud prevention, the role of shareholder agreements, and the disciplining effect of the capital markets.
In her new paper, Interest Rates, Venture Capital, and Financial Stability, forthcoming in the Illinois Law Review, Professor Hilary Allen adds a new question: what are the risks to financial stability? Allen claims that low interest rates fueled the growth of venture capital, which is itself prone to inflating bubbles and exacerbating panics. She ultimately argues that financial regulators need to be more attuned to unexpected places where funding tends to flow during periods of accommodative monetary policy.
Allen begins by tracing how an especially prolonged low interest rate environment—first in the wake of the great financial crisis, then again in the wake of covid—encouraged investors to reach for yield, resulting in a veritable geyser of venture capital funding. Venture capital, Allen next explains, is prone to inflating asset bubbles, in large part because the close social ties between VC firms and founders encourage “herding” toward similar businesses. Additionally, VC firms operate on a “power law,” whereby they expect most investments will fail but a few will become outsized hits. The model structurally encourages inflated optimism and a lack of vetting, and—due to the inability to short private company stocks—the absence of mechanisms to express pessimism. The upshot is, VC funds, flush with cash, created a bubble in startup firms concentrated in a small number of industries: ultrafast delivery companies and fin tech—particularly crypto.
From there, Allen explores the systemic implications. Most obviously, VC herding and the startup bubble resulted in a concentration of funds at Silicon Valley Bank—which in turn led to a run on Silicon Valley Bank when it suffered from a sudden rise in interest rates. Nearly simultaneously, two banks heavily exposed to crypto, which was also adversely affected by rising interest rates, also failed. The resulting loss of confidence in small and regional banks forced the FDIC to guarantee even uninsured deposits in order to protect the larger banking system. Allen recognizes, of course, that there were other factors at play, but she attributes the three bank failures at least in part to VC and crypto concentration.
Allen also warns of the potentially destabilizing effects of crypto itself, which thus far have only been avoided because crypto has not (yet) been fully integrated with traditional finance. Crypto is an ideal investment for VC funding, Allen explains, because of its minimal startup costs, rapid growth based on sentiment and—so long as crypto is not treated as a security—ease of exit through sale of tokens rather than the traditional route of an IPO or a merger. These factors encouraged VC firms to make large crypto bets, and, now that they are committed to the technology, they have turned to political lobbying to erode the guardrails that have thus far prevented crypto from contaminating the broader financial system. That possibility, Allen maintains, continues to pose a threat to stability.
Allen ultimately concludes that, for the specific case of crypto, the best protection is enforcement of the existing securities laws to prevent the quick buildup and exit on which VC depends. More generally, however, Allen argues that financial stability regulators should set their sights on VC funds, due to their general opacity, and their unique ability to “magnify bubbles on the upswing, and panics on the downswing.”
Interest Rates, Venture Capital, and Financial Stability is thus a strong addition to existing literature on the unintended consequences of a trend that began in the 1980s and has accelerated since then, namely, the increasing ease with which operating companies (and investment funds) can raise capital outside of the federal securities disclosure system. Those changes shaped today’s VC industry, and the consequences that follow.
Cite as: Ann Lipton,
Venture Capital and Financial Stability, JOTWELL
(August 13, 2024) (reviewing Hilary J. Allen,
Interest Rates, Venture Capital, and Financial Stability, __
U. Ill. L. Rev. __ (forthcoming), available at SSRN (March 8, 2024)),
https://corp.jotwell.com/venture-capital-and-financial-stability/.
Jul 16, 2024 Da Lin
How can we better understand the scope of inequity and track its evolution?
By any metric, gender gaps are ubiquitous within senior ranks of the legal profession. Women have outnumbered men in law schools since 2016 but represent only 20% of all equity partners at multi-tier law firms, are 2 to 3 times more likely than male faculty to occupy non-tenure track and interim dean positions, and make up only 12 to 22% of those who have argued before the U.S. Supreme Court over the past decade. Yet these figures, although striking, don’t capture the full scope of the inequality. Qualitative studies consistently reveal, for instance, that female attorneys have different professional experiences than their male counterparts, exit the profession earlier, and face greater obstacles advancing in their careers.
The persistence of gender and racial inequities in the legal profession is not new, nor are questions surrounding their causes, effects, and potential solutions. But a recent article, Gender and the Social Structure of Exclusion in U.S. Corporate Law, by Afra Afsharipour and Matthew Jennejohn offers an intriguing avenue to better answers.
The article begins with an explanation of the capacity of network analysis to provide insight into how individuals and groups are differently situated. The starting point is “the simple notion that relationships among individuals, or the ‘nodes’ of a network, can be represented as connections, or ‘links,’ among them.” (P. 1830.) Accordingly, the distribution of links captures the distribution of relationships among network participants, and could thus yield information on participants’ influence, status, and access to career-advancing opportunities.
For instance, some nodes may be more central within the network than others—i.e., some nodes may have many connections to a widespread number of nodes and therefore be at the heart of a network, while others may have few connections and be relegated to the periphery. Or some nodes may be “brokers” between two clusters within a network, while other nodes may be thickly embedded within one of the two clusters. (P. 1831.)
One challenge of studying networks stands out from this explanation: what should count as a “relationship”? In the context of professional networks, advantages that could conceivably flow across a connection between two attorneys vary depending on whether, for example, they worked on the same case, worked at the same large law firm, or were both members of a bar association. Clearly mindful of this, Afsharipour and Jennejohn meticulously guide readers through the design of their analysis. Their article examines the network of Delaware Court of Chancery judges and litigators with a dataset comprising 2,769 lawyers involved with 15,077 unique civil actions from 2004 through 2020. Links are formed when lawyers work on a case together as either the assigned judge or an attorney listed on the docket for that case.
Unpacking this network reveals not only that a wide gender gap exists and persists among Chancery litigators. Afsharipour and Jennejohn’s analysis also yields nuanced insights into the disparate relationship dynamics experienced by male and female lawyers within the network. They find, for example, that women are disproportionately excluded from the “core” of the Chancery litigation network, missing out on advantages in access to information and capacity to influence doctrinal evolution. This isolation sticks over time: far more men than women are able to build dense connections over the course of their careers and maneuver to the center of the network. Moreover, the work environments of female Chancery litigators are uniformly dominated by men. Zooming in on the immediate links surrounding several well-connected female attorneys, Afsharipour and Jennejohn find distinct “sub-networks” (repeated interactions between a cluster of attorneys) that are comprised mostly of men and from which the focal attorney herself is sometimes excluded. In other words, “these women, though highly central in the overall network, are [still] on the periphery of their own personal collection of professional connections.”
Afsharipour and Jennejohn avoid the temptation to claim that their findings indicate causal or even correlative relationships between network structure and outcomes. They readily acknowledge that professional advantages are also transmitted through means not captured by their data. Instead, they modestly aim to “awaken scholarly interest” in the ways that network analysis can enrich and perhaps shift our thinking on inequity. I am confident that this terrific project will mark just the beginning of a vast research frontier.
Cite as: Da Lin,
Network Effects, JOTWELL
(July 16, 2024) (reviewing Afra Afsharipour, Matthew Jennejohn,
Gender and the Social Structure of Exclusion in U.S. Corporate Law, 90
U. Chi. L. Rev. 1819 (2023)),
https://corp.jotwell.com/network-effects/.
Jun 13, 2024 Matteo Gatti
Roberto Tallarita’s recent Harvard Business Review article, “AI Is Testing the Limits of Corporate Governance,” insightfully discusses the upheaval at OpenAI last November, when its CEO, Sam Altman, was temporarily ousted by the board, a move quickly reversed to thwart his potential departure to Microsoft with key team members.
Tallarita’s piece showcases the inadequacies of traditional corporate governance mechanisms in managing the unique challenges posed by artificial intelligence (AI). His evaluation of the OpenAI board actions is based on two key observations. He asserts that conventional corporate governance design is ill-equipped to mitigate the existential risks associated with AI. This shortcoming arises from a fundamental clash between the pursuit of profit and societal goals. In scenarios where financial incentives are as compelling as they have been for a disruptive entity like OpenAI, profit motives are likely to take precedence. Notably, OpenAI diverged from typical governance by securing investments for an entity fully controlled by a nonprofit, a rare approach in the tech sector.
Tallarita’s second point is that, despite customizing an AI firm’s governance to counter profit motives, without carefully crafted rules, the pull towards profit remains strong. The transaction planners at OpenAI did not go far, possibly because, as Tallarita suggests, they had no real incentives to craft an airtight prohibition on pursuing profits; after all, they made large investments. As a result, while investors could not formally have a say in the firm, they could, as Microsoft was planning to, hire Sam Altman directly, which is essentially akin to “buying” OpenAI without paying its shareholders, as Tallarita points out. This will always be a problem whenever a firm is heavily constrained in its governance design, but its talent and knowledge can easily be “acquired and redeployed free from these constraints.” There is more: even if one writes a perfect contract that fully prevents the company from pursuing profits, Tallarita believes that in equilibrium, such a company would be much less successful at attracting new capital than other firms that are more ambiguous about whether profits could be attained. This is because, obviously, investors are after profits. Hence, even if we all agree that AI should not be developed to cause existential harm to society, because of an inherent “race to profits” caused by how capital markets work, we cannot look at corporate governance for solving AI-related externalities.
This does not mean that corporate governance solutions for AI firms are irrelevant. Tallarita suggests that corporate governance experts should keep experimenting to find ways to combine profit and safety; arguably not an easy task but something unescapable. He believes that retaining the profit motive in AI holds more promise than attempting to curb greed and ambition. While he does not offer an overall roadmap to achieve this goal, he suggests that board composition should become a top priority and that AI companies should appoint directors with different viewpoints and greater cognitive distance than ordinary companies, with boardroom norms rewarding time commitment and robust discussion.
While this type of arrangement would lead to improvement, Tallarita warns that corporate governance is ultimately an ineffective policy tool to counter the existential risk posed by AI. Drawing from incomplete contracts theory, he posits that the main safety valve that corporate governance offers, which is assigning residual rights of control over certain assets to one party when an unforeseen circumstance arises, may not work with AI. “[W]hat happens if the AI becomes uncontrollable?” He suggests that the AI firm will have a hard time turning off the machine. Because we cannot rely on corporate action, he recommends deploying “extraordinary legal controls . . . of the kind used to regulate nuclear proliferation or biohazard.” True, “good corporate governance can help in the transitional phase, [but] the government should quickly recognize its inevitable role in AI safety and step up to the historic task.”
Implications for AI regulation
First, the piece is informative and timely for its AI-related implications. As we are still in the initial phases of AI development, the OpenAI board debacle is instructive for future regulatory endeavors. Despite the uneasy relationship between the tech sector and regulation, especially in the U.S., this is hardly the field where U.S. policymakers can hide behind the false choice between digital regulation and innovation. Given AI’s global impact, ideally, a multilateral approach would be most effective. For now, only the EU AI Act imposes stringent regulation. However, it remains unclear whether its unilateral and extraterritorial measures will foster cooperation or, conversely, create regulatory antagonism.
Implications for corporate governance more generally
Tallarita’s commentary examines the role of corporate governance in AI, concluding that it offers limited solutions, especially in mitigating the technology’s inherent risks. However, his article also highlights the inherent limitations of relying on corporate governance and private mechanisms to address significant societal challenges. This is a point well worth making, for the limitations are daunting. To see why, consider the practical mechanics of relying primarily on private ordering and corporate governance to solve our society’s problems. We could leave our existing governance arrangements in place and remit implementation to the discretion of the board of directors, continuing to rely on an incomplete contracting framework. Alternatively, we could write more complete contracts, thereby imposing social directives on the board.
There are precise reasons why incomplete contracts work reasonably well in generating value for investors. Boards benefit from discretion and minimal judicial oversight, especially in decisions without conflicts of interest or changes in control. This latitude is largely because managerial and investor interests often align, a result of pressures and scrutiny from capital, labor, and corporate control markets. Additionally, executive compensation structures provide strong incentives to maximize shareholder value. However, replicating this alignment towards non-profit goals presents challenges. Typically, managers are rewarded more for increasing shareholder value than for achieving other objectives. Despite ESG-focused experts’ attempts to rectify this, existing compensation models still struggle to advance broader societal or environmental goals (as Tallarita himself and Lucian Bebchuk note elsewhere). If alignment does not work, board control cannot be relied upon, exactly what Tallarita warns about with respect to AI risk.
Therefore, in the absence of breakthroughs on how to recalibrate managerial incentives (via compensation or otherwise), the only viable way to adapt corporate governance towards the societal goals we want corporations to pursue is to write more specific contracts. Whether this strategy will succeed hinges largely on corporate law practitioners. However, a persistent concern is ensuring fair and robust representation of societal interests at the negotiation table. Tallarita’s article suggests that corporate lawyers, owing to their allegiance to paying clients like management or investors, may not effectively champion these interests. Moreover, there’s a noticeable absence of precedents to guide us. Sure, we must experiment, but how? Via stakeholder-appointed directors, possibly with veto power over certain sensitive matters? Adopting bonding mechanisms such as green pills to protect the climate? Providing standing to sue derivatively to certain classes of stakeholders? Recalibrating executive compensation? Explicitly expanding fiduciary duties and limiting exculpatory provisions? The list can go on and these questions are expected to persist, presenting ongoing challenges for corporate planners. Certainly, Tallarita’s stimulating work will come in handy.
May 16, 2024 Robert Rosen
Some data show that the recent significant increase in board diversity is less well explained by NASDAQ and CA regulations than by the Black Lives Matter Movement. How did the BLM Movement against police behavior become a call for racial justice that reverberated in corporate boardrooms? More generally why do CEOs, boards, and managers (members of what C. Wright Mills would call the “power elite”) pursue (or want to appear to be pursuing) ESG policies? This article answers such questions by identifying the increasing power of some of the millennial generation — those born between 1981-1996 — as consumers, employees, and investors.
As the authors show “Social issues can become financial problem in short order.” (P. 304.) Their examples are Black Lives Matter, Me-Too and Climate Change. If this article were written today, they might discuss the Governors of Florida or Texas and index funds value-diversifying their funds ( e. g. Catholic faith-based investors), with the consequent loss in the index fund’s concentrated voting power. As the authors admit, “current views on ESG are polarized.” There is conflict within the power elite. The Millennial Corporation: Strong Stakeholders, Weak Managers reveals strategies for getting ESG into corporate action.
That corporations respond when they are targeted specifically — by politicians or boycotts of their products, walkouts by their employees, or shareholder proposals — is not difficult to explain, especially today when social media can multiply such attacks. Sometimes fighting back means to compromise. The power of general social movements — ones not targeted at one’s corporation — to influence corporate decision-making is more difficult to understand. This article examines channels through which a general social movement for better ESG can get into corporations.
When the article was written, even firms “indifferent to the social demands of ESG understand that being labeled a bad corporate citizen when it comes to climate or diversity can have effect on firm value.” (P. 297.) The authors provide multiple examples where being objectified as anti-ESG was costly for companies and the individual careers of their managers: “Considering the risks that managers face from ESG failures, the inability to diversify this risk, and their option to mitigate with firm resources, it is simply incorrect to assert that managers have no incentive to promote ESG.” (P. 299.) Even more, their incentives support “what sometimes seem to be excessive responses” (P. 262) to external pressures for ESG. When the article was written, the ESG movement was on the move.
The authors portray the millennial generation as the carrier of the ESG movement. They generalize that millennials are committed to living their values and that they value what might be called “woke:” Millennials “generally care about the environment, diversity, and economic inequality.” They are “seeking to live their lives consistent with a set of social values.” (P. 306.) They are willing to pay more and earn less from corporations that have ESG credibility. “Poor ESG performers would have difficulty in employing, selling to, and attracting investor” millennials. (P. 281.)
The authors demonstrate five channels through which the rising economic significance of the millennial generation influences CEO incentives regarding ESG performance. First there are direct actions targeting corporations, such as product boycotts. Second, millennial decisions about where to work, what to buy, and how to invest can increase the market value of companies with ESG credibility. Because millennial values are not uniform, there are multiple contenders for a piece of millennial power. At the time of the article, ESG was winning among the millennials to whom many corporations are responsive.
The final three channels depend not on the effects of action by millennials but by those of investment intermediaries and operating corporations who reify millennials in the ways that the authors depict. The third channel derives from index funds recognizing a generational shift in wealth to millennials. Index funds ascribed to millennials the values that the authors assert and so marketed ESG products and voted their shares for ESG to attract millennials. The fourth channel depends on hedge funds that cater to the index funds’ preferences for ESG. Hedge funds can weaponize ESG to attract votes, making ESG a stalking horse for their control challenges. Both of these channels depend on the consolidated shareholder power of the largest index funds, power that is being reduced as they multiply funds for the anti-woke. The last channel concerns how corporations use their political power. Historically, corporations have invested corporate resources to fight regulation. Exposure of corporate anti-ESG actions has generated poor publicity. In response, there can be a decrease in such lobbying. This lets regulators increasingly pursue the policy preferences of the reified millennials.
The authors surely simplify in asserting values shared by a generation. Yet, they demonstrate that some corporations act as if all millennials who matter to them are pro-ESG. As the authors insightfully note, “Investors, consumers, and employees are not distinct groups of individuals. They are the same individuals interacting with companies in various ways.” (P. 304.) These individuals are different from other millennials, at least because they have resources that corporations value. The authors claim they are describing “bottom-up social pressure.” But their point is that some millennials are entering the power elite and those who do so bring with them a distinct set of interests.
The ESG coin has an opposite side. Many corporations resist ESG and it is increasingly clear that there can be costs incurred by companies identified with ESG. This article does not explore this resistance and its economic/political/social supports. But some inferences can be drawn. This article might be read as arguing that, in response to this growing bottom-up anti- “woke” demand, managers will overinvest corporate resources in not being “woke.” But this article’s analysis is richer than that. It does not simply show that corporations are open to social/political demands in their environment (about which there is a vast literature). It also reveals how generational power can be deployed. The success of the anti-woke movement, the article would predict, depends on whether and how corporations value the movement’s supporters as consumers, employees, and investors.
There is a vast literature about class conflict between capital and labor. Erik Olin Wright and his collaborators and students are particularly worth noting for their description of intra-class conflict within the working class. After all, many wonder why there is so little international, let alone national, working-class power. This article is a welcome addition to a smaller literature on conflicts within elites (a better term than “ruling classes”). It always is important to understand the powerful. This article enhances this understanding by focusing on intra-class conflict within a polarized power elite and describing the use of generational power by the current boomers.
The article usefully points out that “Lawyers, accountants, consultants, rating agencies, data providers like Standard and Poors, ISS, and MSCI” and “third-party standard-setters like the Sustainability Accounting Standards Board and GRI” create an “ESG ecosystem.” (P. 267.) For example, “law firm memos now advise managers to search within for ESG weaknesses and fix them to avoid being targeted by activists.” (P. 261.) There is even a marketing industry that constructs who are the “millennials” (and what are their interests and values). Corporations (and law professors) reasonably accept the constructs. In sum, there are now sectors of the corporate power elite who advance ESG. In so doing, all act on the incentives facing them in their place in the market but in addition some respond to values (including professional ethics). The approach taken in this article by Michal Barzuza, Quinn Curtis and David H. Webber can usefully be employed in looking at this niche or eco-system of elites.
Apr 12, 2024 Brett McDonnell
Those who, like me, spend much of their time focused on corporate law know that over the past decade or so there has been a serious re-examination of the traditional American understanding that corporate directors and officers should focus exclusively on advancing the interests of their shareholders. Many in the field will also be aware of a related debate over the conventional consensus that securities regulation should focus on protecting financial investors. Fewer corporate law scholars, though, may have paid as much attention to questioning within antitrust law of the focus on protecting consumers or within bankruptcy law on protecting creditors.
And fewer still will have pondered the connections between the debates going on within these separate though related fields. Aneil Kovvali explores those connections in his recent article, Stakeholderism Silo Busting. In corporate law, securities regulation, antitrust, and bankruptcy law, a decades-old consensus maintains that the law should focus exclusively on protecting one specific group. But within each field, rebels are now calling upon decision makers to consider the interests of various stakeholders. In his article, Kovvali describes shared arguments that are made by traditionalists and by those questioning traditions within each of the four fields. He further argues that considering developments in the fields together could yield new insights and practical suggestions.
Kovvali starts with a brief historical recounting of the four fields. He argues that during the Progressive era of the turn of the previous century, corporate law, antitrust, and disclosure developed as ways to check the power of large corporations and their leaders. This includes a take on the classic Dodge v. Ford Motor Co. case as being aimed at limiting the power of Henry Ford. In the New Deal and post-war periods, regulators searched for ways to stabilize the economy. Beginning in the 70s, influenced both by the law and economics movement and by a focus on economic efficiency, the current orthodoxy focused on protecting one specific group within each of the four areas of law came into being. In our new(ish) century, the financial crisis and the pandemic have helped create serious pressure on that seventies paradigm.
Next, Kovvali lays out a series of arguments that are being made across the four legal fields. He first presents a variety of arguments that stakeholderists make. His subheadings express the arguments nicely: “Businesses have the power to create dire problems unless they are constrained…. Businesses have the power to address important problems, and so they should…. Because of its flexibility, business law can address important problems at lower cost…. The political system is unable to provide adequate solutions.” Kovvali then presents leading arguments from defenders of the single-constituency orthodoxy, again well-described in the subheadings: “Properly understood, the single criterion already addresses the problems that stakeholderists are concerned about to a satisfactory degree…. Because of the generally voluntary nature of business law, a different approach would lead only to perverse consequences…. Trying to integrate more stakeholder interests would mean sacrificing analytical clarity and clear prescriptions…. There are no agents who can be trusted to manage the resulting trade-offs and complexity…. This is the responsibility of some other area of the law…. Using business law in this way could reduce the likelihood of more meaningful external reforms.” These arguments all look familiar, and Kovvali is fair and thorough in presenting many of the best arguments and counter-arguments from each side.
The paper’s final section explores possible benefits that could be realized by pursuing the stakeholderism debate across the four legal areas. Some of these benefits would appear as improved scholarly theories. Comparative analysis could show how contingent developments have led to different systems of business law across different countries. A general equilibrium approach could try to analyze developments across a variety of kinds of markets. Another approach could be rooted in a Coasean analysis of how the law treats different kinds of coordination rights (this draws upon the work of antitrust scholar Sanjukta Paul).
Kovvali finishes with suggestions for practical techniques and solutions which could be developed across the four fields. Stakeholderism would benefit if its advocates could come up with measures and methods for comparing the relative size of impacts of decisions on different kinds of stakeholders. Tools from the different fields could be used together to address broad problems such as climate change and empowering workers. Considering the impact of policies across the legal fields may help avoid unintended consequences.
Linking the debates over the role of stakeholders in corporate law, securities regulation, antitrust, and bankruptcy seems like a natural project as soon as one reads this paper’s abstract. The summary and analysis of shared leading arguments for and against stakeholderism is on its own worth the price of admission (which isn’t high, the paper is an enjoyable read). The suggestions for future theoretical and practical explorations in the final section are more speculative and tentative. But they could prove very fruitful.
Mar 18, 2024 Andrew F. Tuch
Many of us find it hard to imagine that firms seeking to maximize profits would credibly commit to reducing their greenhouse gas (GHG) emissions. But in Green Pills: Making Corporate Climate Commitments Credible, Oxford professors John Armour, Luca Enriques, and Thom Wetzer argue there is reason to believe that such firms, even in the absence of regulation, might credibly commit to “net-zero” targets. The article lays out a case for such optimism and proposes a mechanism through which corporate managers can enhance the credibility of commitments.
Green Pills initially describes a world in which profit-maximizing companies might eventually credibly commit to reducing GHGs even without regulatory intervention, because a green transition not only imposes physical and transition risks but also creates profitable commercial opportunities. Even as investors are largely climate-indifferent—meaning that they are unwilling to pay more for companies that make significant headway in mitigating their impact on climate change—Armour, Enriques, and Wetzer believe “it is likely that at some point firms will reach a tipping point and conclude their future profits will be maximized by aligning their business model with net zero.” (P. 291.) (Net zero refers to the goal of cutting a firm’s net GHG emissions to as close to zero as possible within a stated time frame). But change of this sort may be a long time in coming. Any gains from transition are likely to be long-term and unexpected, while costs will be certain and immediate. In the minds of corporate managers—whose expected job tenures and therefore time horizons are short—the costs of reducing GHG emissions will weigh more heavily than the benefits, making managers “likely to be highly conservative in their transition policy.” (P. 300.)
But how might managers behave if shareholders in their corporations include influential climate-conscious investors? Here Armour, Enriques, and Wetzer make a key contribution, arguing that climate-conscious investors can trigger stock-price effects, giving corporate managers incentives to make credible climate commitments. Climate-conscious investors “place a higher valuation on firms that are making headway toward reducing emissions” (P. 300) than do climate-indifferent investors. Some such investors have green preferences; others have strictly financial motives but attribute a higher value than does the median investor to firms that credibly commit to reducing their emissions. Either way, these investors’ willingness to pay more for clean companies can shift those companies’ stock prices.
The claim that investors’ willingness to pay can affect stock price is a vital one, as well as a challenge to orthodox finance theory. The conventional view holds that the price of a company’s stock is determined by sophisticated investors paying attention to the company’s fundamental financial data—namely, measures of the company’s risk and return. In response, Green Pills marshals theoretical and empirical evidence in support of climate-conscious investors’ ability to move stock prices. On the theoretical side, the authors note that as climate-conscious investors’ demand for clean stocks increases, they can bid up prices of these stocks, creating a premium, or “greenium.” Arbitrage by climate-indifferent investors may fail to reverse the greenium due to the potentially “large volume of capital coming from climate-conscious investors” (P. 303) and the greater expense of short positions relative to long positions. On the empirical side, there is already evidence of climate-conscious investors triggering stock-price increases. The authors detail studies showing that firms that appeal to climate-conscious investors trade at a premium, although the economic significance of this price effect is currently “quite modest.”
While there is reason to believe that climate-conscious investors can drive up stock prices for clean firms, Armour, Enriques, and Wetzer do not claim that corporate managers are, at this point, seeking to attract these specific investors. Instead, “the extent to which managers respond to the preferences of climate-conscious investors depends on the significance of these investors’ presence in the marketplace and the intensity of their valuation differential from that of climate-indifferent investors.” (P. 306.) The calculus for managers is to minimize the sum of the cost of carbon emissions and of emissions avoidance, minus the premium generated by climate-conscious investors. Accordingly, if this premium is large enough, managers will have real incentives to attract these investors.
That threshold has apparently not yet been reached—but when it is, how are managers to appeal to climate-conscious investors? An important means might be net-zero and other climate commitments. However, rational climate-conscious investors will suspect that firms are greenwashing or that these commitments aren’t commitments at all—that they are reversible. What is needed are credible climate commitments.
Here, the authors clear brush, dismissing the potential of existing corporate-governance mechanisms to ensure credibility. Securities litigation offers little hope because climate claims are often forward-looking. Firms might shape compensation packages, structure their boards, and hold say-on-climate votes with eye toward appealing to climate-conscious investors, but each of these mechanisms depends on shareholders siding with those climate-conscious investors. Even corporate purpose statements may be unwound by a majority of shareholders.
The authors propose an eminently sensible and elegantly designed alternative to these existing governance mechanisms that fall short. They argue that what they call “green pills” can establish commitments that climate-conscious investors will find credible. According to this proposal, a company would enter into a standard contract with investors or a third party, promising to pay a given sum, either to investors or a third-party, if the company fails to deliver on its transition milestones. Firms may calibrate their levels of commitment. As the authors note, “the firm should only be willing to commit to payment that has an ex ante valuation equivalent to the climate-conscious investors’ additional valuation of the commitment.” (P. 323.) The authors contend with multiple potential complications, among them that the scheme would be subject to heightened judicial review. Importantly, the use of green pills is likely to be reviewed under the business judgment standard of review.
Green Pills warrants a close reading. The article’s challenge to orthodox pricing theory is itself detailed and persuasive, and the claims on behalf of the green-pills proposal are careful yet hopeful. Those who regard profit maximization—as reflected in share prices—as a barrier to credible net-zero pledges might find real possibilities here. Indeed, share prices could well be the mechanism through which climate-conscious investors express their preferences, hastening the green transition.
Feb 19, 2024 Omari Simmons
Nearly two-thirds of workers have access to an employer-sponsored retirement plan (P. 324.) Consequently, retirement security is a salient issue in US politics and corporate governance. BlackRock, Vanguard Group, and State Street, the three largest investment managers, who own about 20 percent of every company in the S&P 500 Index, offer a menu of mutual funds and other services for employer-sponsored retirement plans. (P. 308.) Institutional investors’ prominence and putative conflicts of interest are hot topics among scholars and regulators. (Pp. 307-21.)
Natalya Shnitser’s must-read article, The 401(k) Conundrum in Corporate Law, argues that these concerns and efforts, however well-intentioned, are based upon shaky theoretical foundations: (i) a description of how employer-sponsored retirement plan decisions are executed that does not reflect the evolution of plan governance and (ii) reliance on outdated information that fails to consider recent trends showing less biased voting decisions among fund managers. The article deftly captures the intersection of corporate governance and employee benefits law.
Paper’s Central Findings
Retirement Business Theory and its Shaky Foundations. The article describes a prevailing “retirement business theory” that emphasizes the potential for conflicts of interest among mutual fund managers. The theory maintains that to avoid losing lucrative retirement-plan business from large corporate employers, the managers act passively or vote pro-management when exercising shareholder voting rights. It is proffered as a reason to examine and even restrict such passive voting practices. However, the research supporting it is outdated and does not reflect the current state of affairs (P. 321) including how plan-investment menu choices and service-provider decisions are generated. Like some scholars, the Securities and Exchange Commission and other regulators have invoked the retirement business theory to justify interventions that could have unintended, adverse consequences.
A More Accurate Description of Retirement-Plan Decision-making. Shnitser offers a more accurate description of the relationship between institutional investors and employer-sponsored retirement plans. Contrary to other scholarly accounts, the article illustrates that corporate management now has more limited influence on retirement plan decisions concerning investment menu options and service providers. Due to recent legal and other developments, corporate directors’ and officers’ influence has been attenuated. The ERISA regime and fiduciary duties attempt to constrain managers from making decisions contrary to the interests of plan participants and beneficiaries. (P. 323-29.) These decisions are now delegated to a plan committee “comprised of employees and advisors with relevant expertise and with appropriate fiduciary training.” (P. 323.) The committees often work in accordance with an investor policy statement (IPS) designed to guide investment and service provider decisions. The IPS sets goals and helps to ensure that plan decisions are made in the interests of participants and that fees are reasonable.
Other Key Factors Disciplining Plan Decision-making
Litigation
Over the past 15 years, ERISA litigation challenging plan management and excessive plan fees has increased in frequency and velocity. Retirement plans have considerably changed as a result. More than 200 cases were filed between January 2020 and June 2022. (Pp. 329-33.) Lawsuits are normally brought as class actions on behalf of thousands of current and former plan participants and beneficiaries. Allegations in these cases fall into two general categories: (i) excessive recordkeeping and administrative fees charged to plan participants and (ii) the “selection and retention” of underperforming and underpriced investments. (Pp. 329-33.) Scrutiny from plaintiff attorneys and the Department of Labor discourages board member and C-suite participation in plan decision-making. Managerial influence is still possible but more muted.
Insurance Markets
Managers of retirement plans customarily are protected by fiduciary liability insurance. Fiduciary insurance providers have a keen interest in litigation risk and tend to monitor and inquire into retirement plan governance, in particular its fiduciary processes and practices and approaches to monitoring investments and benchmarking vendors. (Pp. 328-29.) The insurers’ monitoring role is pivotal and has increased the formality and professionalism of plan committee governance.
These relatively recent trends and developments help to explain why mutual funds, particularly index funds, once passive, are increasingly willing to challenge corporate management. Mutual fund managers have less reason to be concerned about their votes’ impact on retaining or attracting retirement business from U.S. public companies. These fiduciary decisions cannot be made hastily or arbitrarily, or companies risk costly lawsuits and fines.
Paper’s Implications for Scholarly Debate and Future Research
The article calls for updated data and additional research on assumptions about fund manager bias because recent trends point to a sharp reduction. The lack of evidence supporting the retirement business theory points to other decision-making drivers.
The evolving role of plan committees in response to litigation and insurance risks has increased their discipline, professionalism, and routine adherence to protocols for decisions about investment options and service providers. These forces insulate mutual fund managers from corporate retaliation while enhancing their independence and potential for activism. These evolving trends and others—for example, well-designed pass-through voting mechanisms—may reduce conflicts of interest—benefiting plan participants and retirees. This article is timely because red-state lawmakers are currently riding a wave of anti-ESG backlash, ostensibly to protect the retirement security of Americans. This situation illuminates the connection between employee benefits law and contemporary corporate governance.
