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.
Dec 12, 2023 Caroline Bradley
Quinn Curtis, Mark C. Weidemaier, & Mitu Gulati,
Green Bonds, Empty Promises (February 6, 2023). Virginia Public Law and Legal Theory Research Paper No. 2023-14, Virginia Law and Economics Research Paper No. 2023-05, UNC Legal Studies Research Paper No. 4350209. Available at
SSRN.
Climate change adaptation (moving towards net zero by shifting to renewable energy and changing behaviors so that we produce fewer greenhouse gas emissions) and mitigation (building resilience in the face of the impacts of climate change) are expensive, and must be paid for somehow. Policy-makers accept that climate change mitigation and adaptation require co-operation between public authorities and private business, and a combination of public and private finance. Green bonds promise to be a component of addressing this need for financing, as well as the interests of investors who want to invest in sustainability. But do they really do this? The urgency of the need to address climate change, together with our reliance on private finance as an important part of the proposed solution, means that this is a really important question. In order to address climate change, green bonds should finance green or sustainable activities, and, preferably, activities that would not otherwise be funded.
In Green Bonds, Empty Promises, Quinn Curtis, Mark C. Weidemaier, and Mitu Gulati present the results of their study of a dataset of green bonds issued between 2012 and 2022 and of interviews with market participants. The authors say that in credible green bonds they would expect to see mechanisms to increase the cost of non-compliance, but, instead, they find “a concerning lack of enforceable promises” (P. 56.) They find some language of commitment in more than half of the bonds in the dataset, although they state that, for varying reasons, they are likely to be overstating the extent to which issuers make firm green commitments (e.g. pp. 17,19). But even where green promises are made, they are not backed up by the usual enforcement mechanisms: none of the bonds in the sample “expressly makes it an event of default for the issuer to fail to live up to its green promises.”(P. 24.) In addition, the authors find that green bonds are evolving away from enforceability over time, now including disclaimers excluding a failure to comply with green promises from the application of a catch-all events of default provision and disclaimers of any duty to pursue green objectives.
The authors find the lack of legal enforceability of green promises in green bonds to be something of a puzzle. Although some of the market participants they interviewed suggested that the market worked on the basis of reputation rather than on legal enforceability, they prefer an explanation that focuses on the incentives of issuers and investors. ESG funds can use holdings of green bonds to demonstrate their credibility, but “investors in green funds are almost certainly not sensitive to whether the underlying bonds in ESG funds’ portfolios are backed by strong legal enforcement.” (P. 45.) On the other hand fund investors do care about performance, and enforceable green promises would likely lead to lower returns on the green bonds (the “greenium” ). The authors emphasize that they are not arguing that issuers are failing to meet their green promises, rather that they are not legally bound to meet them. Green bonds are not necessarily tools for greenwashing, but they could be.
Certification schemes for green bonds do not currently focus on enforceability of green promises, and the authors suggest that one way to address this issue would be to change this. The regulatory focus in the EU and the US on characteristics of funds that market themselves as green or ESG funds is another development that could address enforceability of green promises. The recently agreed EU Green Bond standard, a voluntary standard, adopts a different, regulatory, approach which focuses on ensuring that proceeds of a green bond are in fact allocated to environmentally sustainable activities as defined in the EU taxonomy, imposing regulatory requirements on issuers and on external reviewers, backed by sanctions. But it is not clear whether green bond issuers will choose to opt into this regime.
Green Bonds, Empty Promises is a useful resource for information about how green bond documentation is constructed and drafted. In arguing that end investors want to be investing in ESG products, but probably also want the returns associated with non-ESG bonds, the authors bring us back to the question whether we really can rely on finance to address climate change. And, in thinking about this question it is really useful to be reminded to think about climate finance as involving more than defining what is and is not green or sustainable, but to think about the details of the documents involved in market transactions.
Cite as: Caroline Bradley,
Unpacking Green Bonds, JOTWELL
(December 12, 2023) (reviewing Quinn Curtis, Mark C. Weidemaier, & Mitu Gulati,
Green Bonds, Empty Promises (February 6, 2023). Virginia Public Law and Legal Theory Research Paper No. 2023-14, Virginia Law and Economics Research Paper No. 2023-05, UNC Legal Studies Research Paper No. 4350209. Available at SSRN),
https://corp.jotwell.com/unpacking-green-bonds/.
Oct 6, 2023 Bill Bratton
We in business law tend to be creatures of the law reviews. Good new books don’t come along very often. When one does appear, it is doubly welcome. A History of Securities Law in the Supreme Court, by A.C. Pritchard and Robert B. Thompson, recently published by Oxford Press, is that rare, good book. It is absolutely, doubly welcome.
Pritchard and Thompson present every one of what turns out to be 134 cases. For the reader it is a bit like taking a law school course—the material goes case by case. This may not sound enticing, but please believe me when I say that it is, for the authors are master teachers. It is just that the medium is the written word rather than an oral presentation. Excellent writing is called for and Pritchard and Thompson answer the call. This book is fun to read.
I suspect that knowing the plot line in advance helps. The book makes no attempt to teach the basic securities law course, even as it is unabashedly instructional. The focus is on the top court and how it dealt with the business law cases falling within its remit rather than on the mechanics of registering securities or establishing exemptions from registration. At the same time, the book has tremendous value as a supplement to basic education in the field. The reader comes away with all sorts of information the basic course does not supply. There is a load of value added, for the stories are not just superb case summaries. The authors have gone to the archives and draw on the justices’ correspondence, conference notes, memos, and draft opinions to give us a sequence of illuminating case-based stories.
The account’s progress is roughly chronological. But a topical organization emerges to thicken the plotlines. Once one gets past enactment and the early cases on constitutionality, the Holding Company Act and the Chandler Act, one encounters a sequence of substantive clusters—first judicial review of agency process, then definitional and boundary issues, then on to insider trading and private litigation, and, finally, to federalism. Within each cluster the chronology is completed—we pick up the topic at its start and carry it through to today.
The account tracks the history of administrative law. Agency deference and purposive interpretation dominate the early years—the SEC almost always wins. Textualist exactitude follows along with a checkered record of results for the agency. Private enforcement, consistently supported by the agency, rises and then gets its wings clipped, but not so much as to prevent it from evolving into the billion-dollar business that it is today.
Mighty personalities come to dominate the account. Frankfurter and Douglas take center stage in the early years to be followed by Lewis Powell, who emerges as the story’s hero at its climactic stage. The post-Powell era is a denouement, with a diminution in the number of interesting cases for study as securities law goes to the Court’s back burner. If there’s a villain, it is Douglas. Much as I wanted to resist his appearance in this role, I have to admit that it emerges intrinsically from the story and, perhaps, this particular justice’s self-involved approach to things. Frankfurter, who had personality problems of his own, is the tragic character, bereft of influence despite superior technical expertise and manifest genius. Finally, a nifty subplot emerges in the back and forth between the top court and securities law’s mother court, the Second Circuit, along with welcome, albeit brief, appearances by the Learned and Gus Hand, Jerome Frank, Henry Friendly, and my old boss, William H. Timbers.
I have always thought that we overdo the Supreme Court in our teaching and scholarship. Now I am not so sure. Meanwhile, this book should be on the desk of every teacher of not only securities but corporations. I expect to be going back to it regularly.
Sep 8, 2023 Andrew F. Tuch
- Michael Klausner & Michael Ohlrogge, Was the SPAC Crash Predictable?, 40 Yale J. Reg. 101 (2023).
- Michael Klausner, Michael Ohlrogge & Emily Ruan, A Sober Look at SPACs, 39 Yale J. Reg. 228 (2022).
- Michael Klausner & Michael Ohlrogge, SPAC Governance: In Need of Judicial Review, (Nov. 19, 2021), available at SSRN.
- Michael Klausner, Michael Ohlrogge & Harald Halbhuber, Net Cash Per Share: The Key to Disclosing SPAC Dilution, 40 Yale J. Reg. 18 (2022).
- Michael Klausner & Michael Ohlrogge, Is SPAC Sponsor Compensation Evolving? A Sober Look at Earnouts, (Jan. 31, 2022) available at SSRN.
Few scholars have done more to illuminate little-understood but vitally important areas of corporate and securities practice than Michael Klausner and Michael Ohlrogge. Their work has been an essential guide to the boom in special purpose acquisition companies (SPACs). Once a remote corner of securities practice, mergers of SPACs suddenly became a mainstream method for taking companies public. And just as suddenly, they faltered. The boom having now ended, Professors Klausner and Ohlrogge ask: “Was the SPAC Crash Predicable?” It is the title of their latest article. The answer, they think, is yes.
In the article, Professors Klausner and Ohlrogge replicate much of the analysis of an earlier, critically important study coauthored with Emily Ruan. At the time, the group promised a “sober look” at SPAC transactions and presented compelling evidence that SPACs are a rigged game. That evidence attracted strong industry skepticism but has since become broadly accepted. The influence of their findings is apparent in the Securities and Exchange Commission’s proposed SPAC reforms and in recent decisions from the Delaware Court of Chancery.
A Sober Look at SPACs made vital contributions to the literature, establishing how the capital structure of SPACs stacks the odds against public shareholders who retain their shares through the course of a SPAC merger. These shareholders have the option to redeem their shares at $10 pre-merger or remain invested in the SPAC, thereby becoming shareholders in the post-merger company. A Sober Look showed that conventional SPAC features, including the issuance of heavily discounted shares to sponsors, free warrants to IPO investors, and cash disbursements to deal advisors, significantly diluted the position of public shareholders. Consequently, on a cash basis, the value of SPAC shares was substantially less than $10 per share at the time of merger. In the article’s cohort of 2019–20 SPAC mergers, the mean and median net cash per SPAC share was $4.10 and $5.70, respectively, depending on the time period. This finding suggests that around half the value that public shareholders invested was effectively lost by the time of merger.
In addition, A Sober Look demonstrated a strong positive correlation between a SPAC’s pre-merger dilution and post-merger performance. The lower a SPAC’s net cash per share at the time of a proposed merger, the lower the post-merger company’s share prices. This correlation existed immediately after the merger and strengthened as post-merger time went on (including one month and one year later)—the result of share prices falling gradually. The results were striking: on average, a reduction of one dollar in net cash per share resulted in a corresponding decrease of one dollar in post-merger value for SPAC shareholders. Furthermore, at the point when post-merger prices settled, post-merger SPAC shares were worth roughly the same amount as the net cash per SPAC share at the time of the merger—far less than the redemption price of $10. This suggests that, in negotiating merger terms with SPACs, target companies were aware of the dilution inherent in SPACs and that public shareholders, rather than target shareholders, bore those costs.
Was the SPAC Crash Predictable? builds on A Sober Look by assessing a significantly larger number of transactions over a longer and more recent period of time. The new findings are consistent with the earlier ones. First, dilution is extensive, as evidenced by mean and median net cash per share of $6.40 and $7.10, respectively. Second, Professors Klausner and Ohlrogge again identify a strong positive correlation between pre-merger dilution and post-merger performance, measured at various intervals after the merger. Once more, the evidence suggests that public SPAC shareholders rather than target shareholders bear the costs of dilution inherent in SPACs.
Based on this statistical analysis, Professors Klausner and Ohlrogge conclude that the SPAC crash was predictable: knowing that public shareholders’ interests were heavily diluted, we should have predicted that these shareholders would want to exercise their redemption rights, jeopardizing the viability of SPAC mergers. The game was not sustainable. Indeed, as Professors Klausner and Ohlrogge also demonstrate, SPAC redemptions eventually spiked, leading to abandoned deals or deals delivering little cash to targets.
In Net Cash Per Share: The Key to Disclosing SPAC Dilution, Professors Klausner and Ohlrogge join with Harald Halbhuber, an experienced Wall Street lawyer and advisor to SPACs, to detail how net cash per share in SPACs should be calculated and disclosed to public shareholders. In SPAC Governance: In Need of Judicial Review Klausner and Ohlrogge tackle the corporate law implications of the SPAC structure, arguing—in reasoning consistent with that later adopted by the Delaware Court of Chancery—that SPAC fiduciaries’ conduct should be reviewed under the entire fairness standard. In Is SPAC Sponsor Compensation Evolving? A Sober Look at Earnouts, they address sponsor earnouts, rejecting claims by SPAC advocates that these techniques for remunerating sponsors address concerns about conflicts and dilution.
Professors Klausner and Ohlrogge could hardly be more authoritative. But, inevitably, their work also leaves us with unanswered questions. Among them is why the SPAC crash did not arrive sooner. Even after A Sober Look’s publication and the significant attention it attracted, public investors continued piling into SPACs.
Second, why were market prices so slow to reflect the value of post-merger SPACs? Professors Klausner and Ohlrogge show that on the day after a merger, the market valued post-merger companies above $10, indicating a market view that these deals were value-increasing. But prices then dropped gradually, declining to the net cash value some 12 months later. This evidence is hard to square with our conventional understanding of markets’ informational efficiency. Even after A Sober Look laid bare the expected relationship between pre-merger dilution and post-merger performance, the market valuation process only slowly yielded accurate figures on SPAC targets.
While the SPAC boom has ended, SPAC-related scholarship will have continued importance. Interest in alternatives to traditional IPOs remains strong, and the appetite for SPAC mergers may rebound if deal terms shift, as they have in the past—or at least if investors believe they have shifted. The SEC has yet to finalize its reforms to SPAC regulation. And the rush of SPAC lawsuits shows no signs of abating.
Cite as: Andrew F. Tuch, Explaining the SPAC Crash, JOTWELL (Sep. 8, 2023) (reviewing Michael Klausner & Michael Ohlrogge, Was the SPAC Crash Predictable?, 40 Yale J. Reg. 101 (2023); Michael Klausner, Michael Ohlrogge & Emily Ruan, A Sober Look at SPACs, 39 Yale J. Reg. 228 (2022); Michael Klausner & Michael Ohlrogge, SPAC Governance: In Need of Judicial Review, (Nov. 19, 2021), available at SSRN; Michael Klausner, Michael Ohlrogge & Harald Halbhuber, Net Cash Per Share: The Key to Disclosing SPAC Dilution, 40 Yale J. Reg. 18 (2022); Michael Klausner & Michael Ohlrogge, Is SPAC Sponsor Compensation Evolving? A Sober Look at Earnouts, (Jan. 31, 2022) available at SSRN), https://corp.jotwell.com/explaining-the-spac-crash/.
Jul 31, 2023 Tom C.W. Lin
Pamela Foohey & Christopher K. Odinet,
Silencing Litigation Through Bankruptcy, 109
Va. L. Rev. __ (forthcoming 2023), available at
SSRN (February 20, 2023).
It is often said that crisis reveals character. In adversity, an individual’s values and integrity are tested and brought into the light – to shrink or steel in the crucible of calamity and conflict. Perhaps the same can be said of corporations and corporate governance in crisis.
In a forthcoming article, Silencing Litigation Through Bankruptcy, Professors Pamela Foohey and Christopher Odinet offer an insightful, critical view of how some corporations have responded to crisis by using bankruptcy law to silence survivors, exacerbate injuries, and hurt the public in the face of significant litigation. Through a thoughtful examination of businesses and other organizations using the bankruptcy code as a sword to cruelly suppress rather than a shield to carefully reorganize, the article makes a persuasive case for rethinking and reforming legal and business practices during crisis. In doing so, the article informs, expands, and challenges the ways one thinks about corporate governance.
To start, the article contextualizes the space of its argument and analysis by focusing on the use of bankruptcy in circumstances involving potentially calamitous and socially significant litigation that it terms “onslaught litigation.” The term “refers to alleged wrongful conduct that produces claims from multiple plaintiffs against the same defendant or group of defendants. When collected, the magnitude of claims and lawsuits presents the possible financial or operational crippling of the defendants over the long-term, or else will require the defendant to devote tremendous operational resources and time to the litigation because of its public saliency.” (P. 2.) Recent examples of onslaught litigation includes cases relating to opioids, gun violence, asbestos, and sexual abuse involving major corporations and organizations like Purdue Pharma, Johnson & Johnson, 3M, Boy Scouts of America, and various Catholic dioceses.
Next, the article explains how Chapter 11 of the bankruptcy code has been (mis)used by some corporations to “to bypass procedural justice and to shut down discussion of their purported wrongdoings.” (P. 3.) To be sure, the article does not claim that all corporate uses of bankruptcy in the presence of litigation are problematic. Rather, in response to onslaught litigation, some companies have deleteriously used bankruptcy as a means to stay a plethora of pending actions, suppress vital information, release third parties, and harm the greater public good. Often in these scenarios, the voices of victims are silenced, responsible parties are not fully held liable, and society is deprived of meaningful opportunities to heal and repair serious damages.
The article concludes by offering a variety of reforms and proposals to help curb the misuses of Chapter 11 bankruptcy and their detrimental effects in situations involving onslaught litigation. It does so mindful of the complicated governance and tactical considerations involving onslaught litigation, but also hopeful of a better path forward.
During a time when there is much discussion about the appropriate roles and purposes of corporations and about what it means to be a “good corporation,” this article by Professors Foohey and Odinet presents a valuable new perspective for thinking and rethinking the terms of ongoing corporate governance debates. Too often debates about corporate objectives, responsibilities, and stakeholders are framed in the context of core corporate operations during periods of relative calm and good fortune. Less so are such debates framed to include periods of crises and distress, like during reorganization and bankruptcy in response to onslaught litigation. Ironically, the concerns of shareholders, stakeholders, and society often matter a lot more when a business is fighting to survive than while it is thriving. Too frequently contemporary corporate governance debates fail to account for the full, topsy turvy life cycle of a business. It would be akin to measuring a person’s character based solely on their deeds when healthy and happy, while not considering their choices when distressed and debilitated.
In the end, timely and timeless debates about good corporate governance need to better capture the entire life cycle and varying volatility of businesses, covering periods of decline and distress as well as periods of growth and success. Corporate law and corporate governance should not end where bankruptcy law and reorganization begin. Many bankruptcy decisions are not just purely financial, and devoid of social impact. Rather, they are also decisions about corporate governance and corporate social responsibility, or perhaps more precisely termed, decisions about corporate social bankruptcy. As such, Professors Foohey and Odinet’s recent article offers us a valuable lens to see differently, act differently, and perhaps to do better in corporate governance – during times of calm and crisis, during times of boom and bankruptcy.
