I would like to thank Christine and everyone at Conglomerate for hosting the Junior Scholars Workshop and for having me as a participant. Receiving this sort of detailed and informed feedback is extremely valuable for those of us just starting out. As Christine noted, I was originally slated to participate in this Workshop two years ago, during what we in New Orleans refer to as the Pre-Katrina days. These last two years have been long and interesting ones, and I regard this belated entry in the JSW as yet another sign that, for me at least, life is returning to some semblance of normalcy.

I'll be back later in the day to discuss the substantive points made by my expert panel of commenters. For now, I just wanted to share my enthusiasm for the JSW and express gratitude to those who have made it possible.

Trey, I very much enjoyed the read.

Marty Lipton and Jay Lorsch (HBS) wrote an article some time ago (early 1990s?) that mused about turning corporate directors into full-time professionals. Their proposal was a bit of a reach, but thought-provoking.

The commentary posted thus far has been insightful and has focused my attention on a few areas where I can improve the piece between now and its submission. I'd like to thank Professors Heminway, Fairfax, and Bodie (and Nowicki in advance) for their time and attention, and I'd also like to take a brief moment to respond to at least some points raised by their thoughtful critiques.

Response to Heminway:

I have been thinking about her question as to whether a re-occurring shareholder vote will provide benefits adequate to justify its costs. Of course, if shareholders widely use the method to repeal (or later re-insert) these charter provisions, then the value, at least as perceived by these shareholders who are making use of the new mechanism, would seem to far outweigh the relatively low transaction costs. Additionally, I believe the periodic vote will provide adequate value, even if rarely used, for at least two reasons. First, simply knowing that the liability shield can be revoked may impact director behavior, even if shareholders never in fact vote to remove a 102(b)(7) provision from the corporate charter. Second, courts may respond to the fact that shareholders consciously re-affirmed an exculpatory provision and uphold the dismissal of some lawsuits instead of trying to manipulate other law (as exemplified by the duty of good faith in my paper) to find liability.

Response to Fairfax:

The connection between 102(b)(7) and 10b-5 first caught my attention when I was preparing a board presentation shortly after the outside directors of Enron and WorldCom used personal funds to settle those shareholder lawsuits. During my research, I was shocked when I read the defendants motions to dismiss. Asserting that the 10b-5 claims must be dismissed for lack of scienter, they read like plaintiff allegations in a duty of care case: meetings were short and not substantive, we relied on management almost completely, no one understood what we were approving. The flaw in the system that I took mental note of at the time was that these directors were pleading duty of care breaches as a 10b-5 defense. The point of that sub-section of my article is that they ought not be allowed to do so, and absent 102(b)(7), they would not be.

Response to Bodie:

Your suggestion of providing context for my proposed solution by discussing the shareholder empowerment literature is a fantastic one. As mentioned in my response to Prof. Heminway, I believe there is value in holding a vote even if those votes rarely succeed, but the power of the argument is much stronger to the extent I can show that these shareholders will not only be given meaningful choices, but will be MAKING meaningful choices.

Thanks again to all. This has been fun, and a valuable learning experience to boot.

Is there any reason 102(b)(7) has to be all or nothing? Should we consider a system of greater or lesser damage caps, tied to a performance metric of some kind? Asking the shareholders to flip the liability switch on and off is one possible response, but given all of the costs associated with determining shareholder desires, I wonder if a more nuanced set of statutory lawsuit protections might better align incentives.

Vic

Glad a good conversation has gotten started here. I am responding to Vic's suggestion. I like the thought.

In part of Trey's paper, he does mention the possibility of an "in between" solution, noting that corporations have not really taken advantage of that flexibility in crafting charter provisions under the existing exculpation statutes. Perhaps he can incorporate your idea, Vic, in a more consistent thread throughout the article, including in his shareholder referendum suggestion.

Just a thought . . . .

Joan

Trey, this is a response to you on your two reasons why a periodic shareholder vote will provide adequate value, even if rarely used. I would like to see you expand on each to convince me (no need to do so here, unless you want to).

As to your first reason, what makes you believe that director behavior may be impacted even if shareholders never in fact vote to remove an exculpation provision from the corporate charter? My experience with boards of directors leads me to think otherwise. Shareholder voting has been a relatively weak determinant of director behavior, yes? But, of course, that's what you're trying to change, isn't it? Greater shareholder control, even if not exercised may have effects. But behavioral biases may offset those effects. In other words, before we can endorse your belief, we must better understand what makes directors behave properly. Give me a bit more to work with here . . . .

As to your second point, I will admit that you may have more faith in courts than I have. I would love to think that they would "respond to the fact that shareholders consciously re-affirmed an exculpatory provision and uphold the dismissal of some lawsuits instead of trying to manipulate other law . . . to find liability." But is there evidence (perhaps from some other area of corporate governance litigation?) that courts are likely to "listen" to shareholders in that way? In many cases (tender offer/takeover litigation being one), it often seems to me that the court believes it knows what's best for shareholders (those poor little lost lambs!) and imposes its will on them.

A thought somewhat related to both points is that you may want to read Amitai Aviram's recent piece "The Placebo Effect of Law: Law's Role in Manipulating Perceptions," 75 Geo. Wash. L. Rev. 54 (2006). Based on my recollection of that article, there may be some arguments in there that help inform your arguments. It's an interesting bit of scholarship, regardless. Also, under the heading "Can Law Function Without Official Enforcement?" in Bernie Black's and Reinier Kraakman's "A Self-Enforcing Model of Corporate Law," 109 Harv. L. Rev. 1911 (1996), you may find some interesting observations relevant to your paper. Of course, you’ll want to address some of Steve Bainbridge’s arguments in his recent article responding to Lucian Bebchuk’s arguments for increased shareholder control over corporate governance: “Response to Increasing Shareholder Power: Director Primacy and Shareholder Disempowerment,” 119 Harv. L. Rev. 1735 (2006). Prior work on shareholder primacy by Bebchuk and by Glommer Gordon Smith and co-commentator Matt Bodie also informs your paper, as you well know. I will let Gordon or Matt pick up that thread, if either is so inclined.

Reactions? Lest I sound like a grumpy old woman, I should note that both of your ideas have promise. I just want to see you better develop them.

Joan

Vic,

Your observation concerning the uniformity of 102(b)(7) charter provisions is a revealing one. There is nothing in the statute itself that provides corporations with such a stark, binary choice - either eliminate all liability or do nothing. The statutory language allows corporations to either limit or eliminate personal liability in any manner that they see fit within certain limits.

I discuss in my article a recent study by Michael Klaussner, where he notes this discrepancy and posits that learning externalities are preventing corporations and their shareholders from experimenting and narrowly tailoring these exculpatory provisions to fit their specific situations. His solution in that piece is for state corporation statutes to provide menus of alternatives for corporastions to choose from when first incorporating such a provision into their charters.

I view my proposed solutions as consistent with Klaussner's approach. My focus is less on determining exactly what the charter provisions should say, and more on getting corporations to consider whether it is in the interests of shareholders to adopt more limited provisions, or do away with them altogether. Ideally, under my approach, if shareholders demonstrate that they care about these exculpatory provisions and are reluctant to allow maximum relief to directors, the corporations themselves will develop the damage caps and performance metrics that you reference. There is ample evidence to suggest that limits and conditions developed by a corporation to fit its individual situation will often be superior to an off-the-rack provision that a legislature would devise.

Thanks for raising such an interesting point.

I'm not convinced on your 10b-5 point. I agree that a shirking director may have a better argument for negating scienter than a diligent director. However, the shirker would be much more exposed than the diligent director to federal securities laws claims that don't require scienter such as '33 Act Sections 11 and 17(a) and '34 Act Section 18(a) as well as state law claims of bad faith. IMHO, this potential liability for shirking more than counteracts any "incentive" to shirk re: 10b-5.

Joan,

Thanks for the comments and the cites.

I do think there's one element of our discussion where I have a good chance of persuading you, and that is on the potential impact on director behavior by shareholder actions short of actually repealing any exculpatory charter provisions.

First, I concede that if my proposal magically appeared in the DGCL and was roundly ignored by everyone, director behavior wouldn't change. However, a different course is more likely. First, some sort of positive momentum would actually precede amending the DGCL to incorporate my suggestion. In that context, if a major shareholder expressed concern about the scope of a corporation's exculpatory provision during the year that its renewal were on the ballot, I believe those shareholders would have significant negotiating leverage to demand revisions, and boards would be incentivized to listen attentively.

There are several real-world analogies to this situation. Boards faced with a poison pill shareholder proposal often negotiate with the shareholder in order to get it removed. Many corporations have recently adopted majority voting provisions when faced with shareholder support for the idea. Even Disney, in many ways a poster child for board intransigence in the face of shareholder protest, adopted a lead director after a campaign to withhold votes from directors garnered a substantial minority vote, even though the withhold campaign would not have technically accomplished anything had a majority voted to withhold.

I believe shareholders would be well-situated to accomplish similar results if my proposal were incorporated into the DGCL and other state statutes.

Trey:

Your last comment is something that I think should be in the paper. Given your substantial real world experience, you shouldn't shy away from using that in developing your policy proposals. There's a tension in your paper between (a) liability waivers are bad and (b) shareholders should be able to create such waivers (as long as they periodically reapprove them). I think there is a middle ground there, but you kind of have to thread the needle to get there. Discussions about how the proposal might play out in real life would help the reader see that the waivers may have problems but that we should still allow shareholders to adopt them.

Also, just to pick up on what Joan mentioned, you should consider how shareholder primacy fits in to your argument. On the one hand, you could say it plays a minor role, since what you're concerned about is a straightforward agency costs problem. But I'm thinking primarily about the "ends" of shareholder primacy, as Stephen Bainbridge describes them. (Both shareholder primacists and stakeholder theorists would agree that directors should manage the company competently.) Your policy proposal, on the other hand, is all about the "means" of shareholder primacy. I agree that the debate between Bebchuk and Bainbridge over the role of shareholders within the corporation should play a central part in your paper.

Glad to see the discussion moving forward -- and I hope this all helps with the paper.

Matt

will there be a post collecting all the papers at the workshop (if there is not one already)? thx.

Andy Grewal

I am sympathetic to Joan Heminway's "grumpiness." I'd be the last person to excoriate exercises in pure reason, but I'd still like to see some empirical work showing that most of the current bubble of corporate governance work is something other than the availability heuristic at work. There are 9,000 publicly traded companies in the U.S. - is it really the case that 102(b)(7) and its ilk are a problem for them work the intellectual energy?

The only empirical work cited in the article (I think) is the Bradley and Schipani study, which I have not read. I'm skeptical it supports the claim that directors are "incentivized" to bad behavior, because just on the description, it sounds to be a macro look at share prices (and I'd want to dig through the methodology). Assuming it is methodologically sound, I would think about giving it more airplay at the outset as the basis for thinking there is a problem, rather than merely inferring, as a deductive exercise, that 102(b)(7) causes a problem. The sense otherwise, at least to me, is the hammer in search of a nail problem.

Oops. "worth the intellectual energy."

Hey, Jeff. Nice to hear from you. How are things up there in my old stomping grounds?

I endorse in this posting the comments by Trey, Matt, and Jeff, in turn.

Trey: You're absolutely right on the shareholder proposal point, based on my experience, although there are some boards who take a different view. Stating your case as you did here, and acknowledging the capacity for boards to differ in their reactions to shareholder proposals will strengthen the paper.

Matt: You make a very valuable point to Trey in "releasing" him to reflect on his practice experience. Bully for you! And there's more support for your views in legal scholarship now than there has been in the past. In doing so, however, we all are best advised to reference specific examples (with citation support), and we must, of course, avoid divulging client confidences. (But we all know that, right?)

Your "thread the needle" point also is incredibly well taken and well stated.

Jeff: Don't tell my husband that you're sympathetic to my grumpiness. He'll view you as having encouraged me!

Although it is outside the comfort zone of many of us who, like me, really struggled with statistical analysis in college, it is critically important that we mine the ever-growing body of empirical work to support our proposals. This is why your comment holds so much value to Trey and others. I find great joy now in searching SSRN and other online sources for newly released papers, and I also have found oodles of buried treasure in searching JSTOR for social sciences resources. So, I will just add those specific suggestions to Jeff's nifty observation.

Ciao.

Joan

Bill,

I think our views may be closer than your comment suggests.

First, I do not believe directors anywhere are sitting in a boardroom saying "Let's blow this meeting off. It's less work for us, and it bolsters our scienter defense. See you on the first tee!" Second, I agree and acknowledge in my paper that, in cases involving a registered public offering of securities, incentives provided by Section 11 (where directors want to retain a potential due diligence defense) should effectively counteract those provided by 10b-5.

My contention regarding 10b-5 is, I believe, a modest one, and it supposed to act as one of many pieces of evidence in Part II of my article claiming that we should be concerned about the current effect of 102(b)(7). I am arguing (and probably either failing to explain it clearly enough or overstating my case in my paper) that 1) the law, by defining culpable conduct, sets norms and provides incentives for behavior, 2) the current interplay between 10b-5 and 102(b)(7) creates an undesirable situation where shirking is preferred to diligent conduct, 3) this concern is not hypothetical because director defendants in 10b-5 litigation have raised this shirking as a defense, and 4) the ability of defendants to do so exposes a defect in the status quo.

Fair enough. I do think characterizing the issue as providing an "incentive to shirk" is an overstatement. I would suggest characterizing it as "leading to absurd result" or the like.

Just a note to clarify my comment, "Given your substantial real world experience, you shouldn't shy away from using that in developing your policy proposals." I was thinking not of using specific anecdotes or war stories in the paper, but rather of using the "sense" you develop through experience of whether something would work or not. I think a lot of scholarship is based on the sense of things we develop in law school, in practice, in teaching, and in our daily lives. For example, Joan says: "My experience with boards of directors leads me to think otherwise." If you have a sense of how this provision might work in real life, don't be afraid to explain how a hypothetical board might be cowed into better behavior through the threat of a revocation.

I appreciate and agree with Matt's clarification and did not mean to suggest otherwise in my prior comment.

Joan

Jeff,

You raise an interesting issue about the usefulness of having empirical data to support reform proposals like the one in my article.

I'm not aware of any recent studies that directly show economic harm resulting from 102(b)(7), and I agree that it would be great for me to have one. I think part of the reason for the lack of data is the ubiquity of exculpatory provisions - it's hard to organize a study of the consequences of a certain choice when all of the subjects make the same choice. However, the recent work I am aware of (the Klausner study cited in my article is the most apt example) does provide empirical data that indirectly supports my proposal. Those studies address the limitations of the contractarian theory of the firm. Klausner concludes that "while the contractarian theory was a useful starting point for economic analysis of corporate law, more research demonstrates that as a description of reality, or as a basis for policy prescription, the theory falls short."

This conclusion bears directly on 102(b)(7) because it is a contractarian statute. So, we do have empirical evidence that the theoretical underpinnings of the statute are flawed. We have, at least I argue we have, a number of negative consequences flowing from the current statute. I believe that combination gives sufficient ballast to a proposal seeking reform. Your mileage may vary.

Thanks for the thought-provoking comment.

Trey, I have a healthy but not dogmatic skepticism about the ability to factor out the impact of the exculpatory provisions on director performance as measured by shareholder value, as you point out.

To Matt Bodie's point about real world intuitions, mine is that for the spectrum of directors on about 95 to 98% of the ethical bell curve, a little shaming goes a long way. Hence, even the possibility of being found liable for breach of the duty of care, even without money damages, and having to have invoked your d&o coverage to pay your defense costs, has an in terrorem effect on the directors. At least, that was my personal observation. As to the incorrigible 2 to 5%, the question is whether the cost of directing the law to cover their sins is worth it.

I agree with you, Jeff.

Let's also keep in mind that some of the director choices we have been referencing today (e.g., not negotiating with a shareholder in response to a shareholder proposal) may not, and should not, be a breach of fiduciary duty. We should not want directors to fear making hard decisions that may still be in the best interest of the corporation.

Joan

To close the loop on this discussion, Elizabeth Nowicki has posted her comments here: http://www.truthonthemarket.com/2007/07/10/professor-trey-drury-personal-liability-for-directors/

Thanks to everyone for taking the time to read my paper and make such thought-provoking comments.