Professor Bainbridge...on law, politics, religion, culture & food

Smith v Van Gorkom

I’ve posted to SSRN a paper entitled simply Smith v. Van Gorkom.

Abstract: Smith v. Van Gorkom arguably was the most important corporate law decision of the 20th century. The supreme court of a state widely criticized for allegedly leading the race to the bottom held that directors who make an uninformed decision face substantial personal liability exposure. In so doing, the court breathed new life into the law of fiduciary duties.

For example, Van Gorkom presaged Unocal’s significant expansion of judicial review of corporate takeovers. Indeed, a Van Gorkom-based inquiry into whether the board was fully informed remains a key component of the Unocal methodology. Likewise, Van Gorkom laid the foundation for the subsequent Caremark decision and the resulting expansion of judicial inquiry into whether the board of directors exercised proper oversight of its subordinates. In fact, most of the modern edifice of corporate fiduciary duties rests in some degree on the Van Gorkom decision.

The perception that the decision had significantly increased director liability exposure drove dramatic changes in the D&O liability insurance market. In turn, important legislative initiatives soon followed, including the now nearly universal liability limiting charter provisions authorized by Delaware General Corporation Law § 102(b)(7).

Not surprisingly, the case generated great controversy and, in fact, continues to do so. Did the Trans Union board of directors actually deserve the criticism heaped upon it by the Delaware Supreme Court? Does the Court’s decision actually deserve the criticism heaped upon it by most commentators? This essay provides the back story to this remarkable decision and concludes that the gist of the decision is sound.

Keywords: board of directors, business judgment rule, Van Gorkom, Trans Union, corporate governance, Delaware

JEL Classifications: K22

Investor Activism

Today it was my turn at the Federal Reserve Bank of Atlanta’s 2008 Financial Markets Conference. I presented my paper Investor Activism: Reshaping the Playing Field?:

Abstract: Shareholders of U.S. corporations historically tended towards rational apathy. Holding small blocks that were unable to affect the outcome of the vote and faced with the considerable costs associated with gathering sufficient information to make an informed decision, they adopted the so-called Wall Street Rule (it was easier to switch than fight). In the last 15 years or so, a growing number of commentators and investor activists have claimed that the rising importance of institutional investors has the potential to reshape the field by empowering shareholders to become active players in corporate governance.

This paper situates investor activism in the so-called director primacy theory of corporate governance. In so doing, it demonstrates that the separation of ownership and control typical of U.S. public corporations has significant efficiency benefits. It then argues that shareholder activism threatens to undermine the advantages of director primacy without offering significant countervailing gains.

Accordingly, the paper concludes that pending regulatory proposals to expand shareholder governance rights should be viewed with suspicion. 

Laptops in the classroom

The debate makes Newsweek:

The tech revolution at the nation’s top law and business schools, where students now routinely use laptops and wireless connections in class, has created an insurgent population: professors, who believe they’re losing the fight against wandering minds. In retaliation, at schools such as Harvard, Yale and Columbia, some profs have banned laptops from class altogether. In a more measured approach, the University of Chicago Law School cut its classroom Wi-Fi signal this spring, citing an “epidemic” of Web browsing during lectures, while at UCLA law, profs can activate a “kill switch” to disable Wi-Fi if they sense an attention deficit. The results, they say, are striking. “I’m getting much better eye contact,” says Michigan law professor Richard Friedman, who installed a no-laptop policy in January. “It’s been like renewing an acquaintance with an old friend.” To others, though, the crackdown lets the real culprits off the hook. “If you’re so boring that students are zoning out, you ought to rethink if you should be teaching,” says UCLA law professor Stephen Bainbridge—though he admits that he’s flipped the kill switch in his own classroom more than once. Tetris, anyone?

I discuss the issue in some length in my article Reflections on Twenty Years of Law Teaching: Remarks at the Rutter Award Ceremony.

SOX at 5 Years

At at the Federal Reserve Bank of Atlanta’s 2008 Financial Markets Conference, we’ve moved on to a panel on “SOX at 5.” (Shouldn’t that be “6”?) The keynote speaker is economist Ken Lehn. SOX co-author Michael Oxley is one of the panelists.

Lehn:

• SOX reform unlikely in near term.


• If reform does happen, firms conducting IPOs should be allowed to choose whether to comply with SOX. Because firms will structure IPOs to maximize proceeds, this market test would tell us a lot about whether SOX in fact is overall beneficial. (Opt out. or opt in?)


• Some firms have used leveraged stock repurchases to reduce their market float below $75 million, so that they are no longer accelerated filers and thus are not required (at present) to comply with SOX section 404.


• An SEC cost-benefit analysis of section 404 is forthcoming in June of this year, which will affect rulemaking to extend 404 application to microcaps.


• Event studies of SOX-related events mixed.


• Cross-sectional studies found that SOX had a negative impact on small, young, high growth firms.


• Most studies find that SOX had a negative impact on foreign firms cross-listed on US capital markets.


• Surveys and studies both suggest that corporate executives are less likely to take business risk post-SOX. Two papers (including one by Lehn) find that R&D spending declined post-SOX, suggesting that R&D funds were diverted to compliance costs.

Oxley then offered what I gather has become his standard defense: (1) my constituents made me do it and (2) it hasn’t turned out too badly. The latter is demonstrably disingenuous in light of the evidence Lehn recounted. As for the former, the admission that political expediency drove the process is a sad commentary on the extent to which the quest for perpetual incumbency has turned our modern politicians into spineless wimps. Whatever happened to the spirit of Edmund Burke: “Your representative owes you, not his industry only, but his judgment; and he betrays, instead of serving you, if he sacrifices it to your opinion.”?

Blogging Bernanke

FED Chairman Ben Bernanke is the keynote speaker at the Federal Reserve Bank of Atlanta’s 2008 Financial Markets Conference. He’s speaking on the FED’s recent liquidity actions.

Central banks can help alleviate a crisis by lending secured by borrowers’ illiquid assets, thus allowing the borrower to avoid having to conduct a fire sale of those assets into illiquid markets. He notes that the ECB and Bank of England have expanded their open market activities and broadened the types of collateral they accept.

He notes that the FED historically has been more limited than some other central banks because only depository institutions have had access to the discount rate and the FED insisted on liquid collateral in open market operations, The FED therefore has had to jury rig (my words, not his) its processes to address the recent liquidity crisis.

The reluctance of depository institutions to use the discount window arises because banks fear that their counterparts will draw adverse inferences if discount window borrowing were to become known, The FED is trying to make discount window borrowing more attractive to depository institutions.

Under the Term Auction Facility (TAF), the Federal Reserve will auction term funds to depository institutions. All depository institutions that are eligible to borrow under the primary credit program will be eligible to participate in TAF auctions. All advances must be fully collateralized. Each TAF auction will be for a fixed amount, with the rate determined by the auction process (subject to a minimum bid rate). Bids will be submitted by phone through local Reserve Banks. The program has worked well to inject new liquidity into the markets.

Primary dealers were thought to be largely immune to runs on the bank. Once it became clear that financial markets could become so severely illiquid that even REPOs were threatened, the FED decided to make extend open market operations to include primary dealers.

In March, the Feeral Reserve used its emergency powers to extend credit to JP Morgan to buy Bear Stearns. It also set up the Primary Dealer Credit Facility, which is an overnight loan facility that will provide funding to primary dealers in exchange for a wide range of eligible collateral and is intended to foster the functioning of financial markets more generally.

Conditions in financial markets have improved somewhat. Once conditions return to normal, he expects that the FED will pull back as a lender of last resort. Instead, financial institutions will have to look to private sources of funding.

Bernanke turns to the moral hazard problem inherent in central bank interventions of the sort the FED has recently undertaken. He thinks the best solution is ex ante regulation and supervision to ensure that private financial institutions adopt strong liquidity risk management programs, the next crisis will be easier to manage.

The text of the speech is here.

Romano’s “Institutional Investors and Proxy Voting”

I’m at the the Federal Reserve Bank of Atlanta’s 2008 Financial Markets Conference, where Yale law professor Roberta Romano is presenting her paper Institutional Investors and Proxy Voting: The Impact of the 2003 Mutual Fund Voting Disclosure Regulation. Very statistical. Regressions and all that.

She’s studying rules that “require mutual funds to disclose the policies and procedures they use to vote proxies relating to portfolio securities. The new rules will also require mutual funds to file with the SEC and make available to shareholders the specific proxy votes they cast. The new rules are intended to provide greater transparency for shareholders with respect to an important function performed by mutual funds given their significant presence in the equities markets.”

Her finding that post-rule change, when mutual fund voting on proxies became more transparent, the likelihood that mutual funds would vote in favor of equity executive compensation plans where outside directors owned a lot of stock in the company, A positive correlation between favorable votes and outside director stockownership makes sense if you believe (as I mostly do) Charles Elson‘s argument that outside director stock ownership has a significant positive incentive effect that encourages directors to be more effective monitors. But why would increased transparency make the correlation stronger? Curious.

It’s also interesting that mutual fund disclosure did not have the effect in voting that proponents expected. It suggests a certain degree of caution is necessary when assessing claims that increased transparency will have certain effects.

The discussant is Timothy Weithers who is Associate Director of the Graduate Program in Financial Mathematics at the University of Chicago.

Offers a great quote from Lawrence Summers:

Not so long ago, we were all Keynesians. (“I am a Keynesian,” Richard Nixon famously said in 1971.) Equally, any honest Democrat will admit that we are now all Friedmanites.

Weithers poses the interesting question of “where’s the regulatory capture?” In other words, what interest group benefited from the 2003 rule change? Hard to see one.

Did the rules increase transparency of voting to firms? If so, would firms that manage 401(k) plans have greater incentive to vote in favor of executive equity compensation plans?

Greetings from the 2008 Financial Markets Conference

I’m in Sea Island, Georgia, for the Federal Reserve Bank of Atlanta’s 2008 Financial Markets Conference, which this year is devoted to “taking stock” of the post-Enron financial market reforms. On Wednesday, I’ll be presenting a paper on shareholder activism. Today, Roberta Romano will be presenting a paper on ”Institutional Investors and Proxy Voting: The Impact of the 2003 Mutual Fund Voting Disclosure Regulation.”

Rutter Award

UCLA School of Law press release:

Stephen Bainbridge, the William D. Warren Professor of Law, was honored with the 2008 Rutter Award for Excellence in Teaching, which is presented annually to a professor who has demonstrated an outstanding commitment to teaching.

“We are here to celebrate Steve and his accomplishments in teaching,” Dean Michael H. Schill said. Dean Schill also described Professor Bainbridge’s popularity, saying that he taught a Business Associations class that had 154 students in it - the average size for the class is about 70 students.

After being presented with the award by founder Bill Rutter, Professor Bainbridge, a member of the UCLA Law faculty since 1997, gave a thoughtful speech in which he discussed his teaching style, aspirations for incorporating new technologies into his teaching and the public interest aspects of being a corporate lawyer. He reflected on his twenty years of teaching experience, including his gradual move from a Socratic teacher to a lecturer, and said that he looks forward to what he hopes is another twenty years of teaching.

“I’d like to think that this award in some way validates the evolutionary path my teaching has followed,” Professor Bainbridge said.

Here’s the video of the award ceremony and my acceptance speech in which I bash the Socratic method and say a few words in favor of the corporation as an object of study:

The text of my revised and extended remarks, Reflections on Twenty Years of Law Teaching: Remarks at the Rutter Award Ceremony, can be downloaded from SSRN:

Abstract: On April 16, 2008, the author received the UCLA School of Law’s Rutter Award for Excellence in Teaching. This essay consists of a revised and extended version of the remarks he gave on that occasion. In it, he addresses his progression from frustrated Socratic teacher to happy lecturer and his aspirations for incorporating new technologies into his teaching. He also reflects on the subject of his teaching - the American corporation - and argues that being a business lawyer is a very real form of public interest lawyering.

Keywords: Socratic method, legal education, public interest law