Over at HBR, Mayer, the former dean of the Said Business School at Oxford, decries British best-in-breed corporate governance. A taste:
The form of capitalism that has emerged in Britain is the textbook description of how to organize capital markets and corporate sectors. It features dispersed shareholders with powers to elect directors and remove them with or without cause, large stock markets, active markets for corporate control, a good legal system, strong investor protection, a rigorous anti-trust authority — the list goes on.
The downside, though, is that exemplary as a form of control the British financial system might be, it systematically extinguishes any sense of commitment — of investors to companies, of executives to employees, of employees to firms, of firms to their investors, of firms to communities, or of this generation to any subsequent or past one. It is a transactional island in which you are as good as your last deal, as farsighted as the next deal, admired for what you can get away with, and condemned for what you confess.
While incentives and control are center-stage in conventional economics, commitment is not. Enhancing choice, competition, and liquidity is the economist's prescription for improving social welfare, and legal contracts, competition policy, and regulation are the toolkit for achieving it. Eliminate restrictions on consumers' freedom to choose, firms' ability to compete, and financial markets' provision of liquidity and we can all move closer to economic nirvana.
Last month I blogged about DealProf Steven Davidoff's piece on a few cases of hedge funds paying bonuses to their successful board candidates. Controversy has since swirled in the law prof blogosphere. Lawrence Cunningham of ConOp summarizes the action thusly:
A hot debate rages among corporate law professors amid one of the largest proxy battles in a decade: Hess Corp., the $20 billion oil giant, is the focus of a contest between its longstanding incumbent management and the activist shareholder Elliott Associates. Ahead of Hess’s annual meeting on May 16, where 1/3 of the seats on Hess’s staggered board are up, antagonists offer dueling business visions. They battle bitterly over such fundamentals as sectors to pursue, degrees of integration to have and cash dividend policy.
The professorial debate, more civil, is about a novel pay plan Elliott proposes for its director nominees, which Hess’s incumbents condemn and Elliott defends as suited to shareholders. On one side, all quoted inElliott’s investor materials circulated April 16, are me, Larry Hammermesh (Widener), Todd Henderson (Chicago), Yair Listoken (Yale) and Randall Thomas (Vanderbilt); on the other Steve Bainbridge (UCLA), Jack Coffee (Columbia) and Usha Rodriques (Georgia), all of whom have blogged since the matter was first reported by Steven Davidoff (Ohio State) in the New York Times April 2 (for which he connected with me for comment).
As in all such cases, Elliott proposes to pay nominees a flat fee of $50,000 each for their troubles and to indemnify them for legal liability. The novelty is that Elliott will provide incentive compensation to the group: if any Elliott nominee is elected as a result of this year’s contest, all nominees receive a bonus at the end of three years if Hess’s stock performs better than a group of industry peers. Elliott, not Hess, pays all bonuses.
Steve has since offered a response to Lawrence. My original post was pretty cursory, and given the subsequent debate, I've been thinking more about the issues. I have two points that are really more questions than answers:
First, Lawrence argues that the bonuses are "surgically tailored to tie the payoff to Hess’s stock price performance compared to competitors." But directors are supposed to act "in the best interests of the firm." Doesn't Elliott's scheme predispose the directors in question to a certain version of "the best interests of the firm" in an impermissible way? I.e., even if (and it is an "if" in some circles, at least) we're all agreed shareholder wealth maximization is the goal, these schemes enshrine one particular version for these directors. That may not be kosher.
Second, Jack Coffee suggested that, if successful, these directors should not be considered independent:
In the new world of hedge fund activism, we need to look to whether individual directors are tied too closely by special compensation to those sponsoring and nominating them. Once we recognize that compensation can give rise to a conflict of interest that induces a director to subordinate his or her own judgment to that of the institution paying the director, our definition of independence needs to be updated. Although not all directors must be independent, only independent directors may today serve on the audit, nominating, or compensation committees.
Director independence has interested me for a long time. In the Fetishization of Independence I distinguished between Delaware's situational notion of independence and securities law's static conception of independence meaning independence from management. SOX 301, unlike the exchanges, takes into account bare share ownership when assessing independence, since affiliates of the issuer are not independent. The question whether successful Elliott directors would be deemed affiliates would turn on the extent of Elliott's control of Hess. Coffee suggests that, even if Elliott is not an affiliate, its bonus program should be enough to render its nominees nonindependent.
This notion has intuitive appeal for me, but I'm having some trouble squaring it with how the logic of independent committees. Take compensation. It's clear why we want compensation committee members to be independent of management--managers have a conflict of interest when setting their own pay. But it's not clear that the Elliott nominated directors, even with their juiced incentives, have any particular disqualifying bias when it comes to setting executive compensation. Or maybe the concern is that they could wield their comp-setting powers in order to extort private benefits from management?
Currently under Dodd-Frank factors to consider in evaluating independence of comp committee members include the sources of the director's compensation and whether the director is affiliated with the issuer. So I have a hunch we're at the start of a long conversation about director compensation and independence.
Update: for even more from Steve and Lawrence, see here (including the comments).
Cross-posted at SocEntLaw.
One of my main criticisms of the Model Benefit Corporation Legislation (the “Model”) has been (and still is) the lack of guidance for directors. (See, e.g., here and here). The Model requires directors to “consider” seven different stakeholder groups (§301(a)), and directs them to pursue “general public benefit” but does not provide any priorities to guide directors. (§§102, 201(a)). The Model allows companies to choose one of more “specific public benefit purposes,” in addition to the “general public benefit purpose,” but does not require that any specific public benefit purpose be chosen. (§201(b)).
In contrast, Delaware’s proposal does require public benefit corporations (“PBCs”) to choose one or more specific public benefits (§362(a)), though the statute is not crystal clear on priorities and requires directors to “manage or direct the business and affairs of the public benefit corporation in a manner that balances  the pecuniary interests of the stockholders,  the best interests of those materially affected by the corporation’s conduct, and  the specific public benefit or public benefits identified in its certificate of incorporation.” (§365(a)) (emphasis added). (As a side note, the PBC's requirement to “balance” the stakeholder interests seems more onerous than the Model’s requirement to “consider” the interests.)
Even if directors' duties are owed to the corporation as a whole, I suggest that clear priorities are important. I attempted to explain the importance of priorities in my response to Professor Lynn Stout’s thought-provoking recent book: The Shareholder Value Myth:
- Professor Lynn Stout and others reject the need for a single metric and have argued that directors, like other human beings, balance the interest of various stakeholders. Among other examples of balancing by human beings, Professor Stout points to the ability of people to balance work and family. This article admits that directors do and should balance various stakeholder interests and does not argue for myopic focus on a single metric, but rather posits that clear corporate priorities can make that difficult balancing job easier.
- Using Professor Stout’s work/family example of balancing can help illustrate the point. Clearly defined priorities can help an individual make difficult decisions in the constant work/family balance. If an individual prioritizes family over work, that obviously does not mean that every decision leads to direct, short-term benefits for the family. For example, on occasion, that family-primacy individual will rightly choose to stay late at work and miss dinner. While that individual decision may have seemed to prioritize work over family, viewed in the long-term, the family may benefit from the resultant career security. Even if the long-term benefits do not actually come to fruition, most would agree that the individual should not be judged for her well-intentioned decision.
- The fact that humans certainly balance interests of various constituents, however, does not mean that priorities are unimportant. Priorities can help guide and can also provide weightings for the costs and benefits of any decision. Also, priorities most clearly help in critical situations. To continue with the work/family example, in a zero-sum game, how does one decide between work and family when the outcome of that decision is of critical importance to both? If an individual has clearly stated that family is a higher priority than work, this critical decision is more easily answered. Even if the priorities are not clearly stated, priorities will still drive the decision. Transparency as to the priorities makes things clearer to all involved and makes it less likely that the individual will drift from his or her true priorities. Similarly, directors would benefit from a clear corporate objective that includes specific corporate priorities.
While I would have preferred the proposed Delaware amendments to have made clear that the PBC’s top priority is its specific public benefit purpose, I think requiring PBCs to identify a specific public benefit purpose is a move in the right direction and likely to aid directors in decision making.
In my third and final post, on Delaware’s proposed amendments involving the PBC, I will talk about the social enterprise statutes and branding.
Cross-posted at SocEntLaw.
This is the first of three posts analyzing the proposed Delaware Public Benefit Corporation (“PBC”) amendments. The posts will compare the proposed PBC amendments to the Model Benefit Corporation Legislation (the “Model”).
In a few key areas, the PBC allows more private ordering that the Model. Perhaps the most striking difference is that the PBC does not require a third party standard for measuring public benefit (a cornerstone requirement of the Model) unless the requirement is included in the PBC’s certificate of incorporation or bylaws (§366(c)). In some ways, Delaware’s approach in the benefit corporation debate reminds me of how it handled the proxy access debate: expressly allow, but leave most of the details to the individual corporations.
That said, the PBC is not as flexible as the Flexible Purpose Corporation (“FPC”) (California) or the Social Purpose Corporation (“SPC”) (Washington); the PBC requires that the PBC be operated in a “responsible and sustainable manner” (§362(a)). That broad general statement in the proposed PBC amendments, which is not present in the FPC or SPC statutes, seems to be one of the main reasons B Lab, the primary force behind the benefit corporation movement, has expressed public support for the PBC. Whether B Lab is completely supportive of the PBC and all its deviations from the Model is not entirely clear.
Below, I compare and contrast some of the key provisions of the Delaware’s PBC and the Model.
- Benefit Director. PBC – not mentioned. Model – required for public companies. (§302(a)).
- Benefit Officer. PBC – not mentioned. Model – optional (§304(a)).
- Benefit Report (Preparing). PBC – no less than biennially (§366(b) & (c)). Model – annually (§401(c)).
- Benefit Report (Public Posting). PBC - optional (§366(c)). Model - required to post benefit report on company website; if no website must provide the benefit report for free to anyone who asks for a copy (§402).
- Identification of Specific Public Benefit Purpose(s). PBC – required (§362(a)). Model – optional (§201(b)).
- Minimum Ownership for Shareholder Standing in Derivative Lawsuits. PBC – 2%; or if the PBC is publicly traded then the lesser of 2% and $2 million in market value (§367). Model – 2% (§305(b)(2)(i)).
- Third Party Standard. PBC – optional (§366(c)). Model – mandatory (§§102 & 402).
- Third Party Certification. PBC – optional (§366(c)). Model – optional (§401(c)).
The only area above where the PBC is less flexible than the Model is in requiring the identification of specific public benefit purpose(s), which will be discussed in the next post on director guidance.
A little Friday reading:
Via CLS Blue Sky Blog, Lawrence Cunningham on the wily Oracle of O vs. Modern Finance Theory:
Threatened by Buffett’s performance, stubborn devotees of modern finance theory resorted to strange explanations for his success. Maybe he is just lucky—the monkey who typed out Hamlet— or maybe he has inside access to information that other investors do not. In dismissing Buffett, modern finance enthusiasts still insist that an investor’s best strategy is to diversify based on betas or dart throwing, and constantly reconfigure one’s portfolio of investments.
Buffett responds with a quip and some advice: the quip is that devotees of his investment philosophy should probably endow chaired professorships at colleges and universities to ensure the perpetual teaching of efficient market dogma; the advice is to ignore modern finance theory and other quasi-sophisticated views of the market and stick to investment knitting. That can best be done for many people through long-term investment in an index fund. Or it can be done by conducting hard-headed analyses of businesses within an investor’s competence to evaluate. In that kind of thinking, the risk that matters is not beta or volatility, but the possibility of loss or injury from an investment.
And NYT's Deal Professor, Steven Davidoff, tells a gripping tale of hedge fund vs family hegemony playing out in Maryland's courts. CommonWealth REIT is controlled by the Portnoy family, which has made a pretty penny in the process, and 2 hedge funds are trying to get it to change its ways.
First, the story has implications for the future of shareholder arbitration provisions. I knew the SEC objects to these puppies at IPO, but didn't think that a board might turn around post-IPO and and adopt amend the bylaws to require arbitration to resolve disputes with shareholders. Shady. But apparently that's what happened at CommonWealth REIT.
And there's more to the story.
On March 1, CommonWealth’s board passed a bylaw amendment that purports to require that any shareholder wishing to undertake a consent solicitation must, among other things, own 3 percent of the company’s shares for three years. This is an extremely aggressive position that if upheld would stop Corvex and Related in their tracks.
Not satisfied with this attempted knockout blow, CommonWealth appears to have lobbied the Maryland Legislature to amend the Maryland Unsolicited Takeover Act. This law allows companies to have a mandatory staggered board.
CommonWealth already has such a board, but the company has also reportedly lobbied the legislature to make a change that companies opting into this statute would now be unable to have their directors removed by written consent. Again, this would kill Corvex and Related’s campaign. When the two funds got wind of this, they fought back, and the Maryland legislature adjourned without adopting CommonWealth’s proposal.
CommonWealth still announced this week that it had opted into the act. The REIT is claiming that even though the Maryland Legislature did not adopt any amendment, the law still implicitly has this requirement. The funds will now have to sue CommonWealth to force them to change their interpretation.
Go read the whole thing. Some wacky shenanigans from my home state. If it does come down to arbitration I'd love to see CommonWealth's arbitrator, allegedly a friend of its controlling family, go toe to toe with the hedge funds' choice-- former Delaware Chancellor Bill Chandler.
Thanks to Usha for asking me to guest blog about the proposed Public Benefit Corporation amendments to Delaware’s General Corporation Law. This summer one of my planned projects is writing an article tentatively entitled Governing Public Benefit Corporations, and I will be floating some of my early ideas here. Comments will be appreciated.
On March 20, I mentioned the proposed Delaware Public Benefit Corporation (“PBC”) amendments on the Social Enterprise Law Blog (“SocEntLaw”)* shortly after I received word from Professor Brian Quinn and some of my friends in Delaware. Last week, both Usha and Stephen Bainbridge added thoughtful posts about the PBC.
For this guest blogging stint, I plan on authoring three additional posts, starting next week. Each post will compare and contrast the proposed PBC amendments with the model benefit corporation legislation. The twelve states that currently have benefit corporation statutes follow the structure and main provisions of the model legislation without too much variation. (The variations can be seen in my chart that Usha mentioned). Delaware, however, cuts its own path. In the three posts, I will focus on private ordering, director guidance, and brand strength.
* I will cross-post my guest posts on the Conglomerate at my permanent blogging home over at SocEntLaw. Last year, Cass Brewer (Georgia State), Deborah Burand (Michigan), Alicia Plerhoples (Georgetown), Dana Brakman Reiser (Brooklyn), a handful of practicing attorneys, and I (Regent) joined social enterprise lawyer Kyle Westaway (who is a Regent Law alum and a Lecturer on Law at Harvard Law School) at his blog. We welcome any and all readers.
From yesterday's Deal Professor comes Steven Davidoff on the "newest trend in activist investing": hedge funds incentivizing their directors by paying them extra if they win a seat and the company takes off. For example, Elliott Management has nominated 5 directors for the Hess Corporation. If any win a seat and Hess stock outperforms a peer group, the directors could make $9 million over 3 years. Jana Partners is offering its nominees a similar deal for serving on Agrium's board, again for a potential of millions if it profits. Plus both funds offer a $50,000 retainer, over and above whatever the directors collect from the companies themselves, likely a six-figure director fee.
In John Steinbeck's East of Eden (Go out and read it if you haven't already. Now. Go), one character says "You can't make a race horse of a pig." "No," replies another, "but you can make a very fast pig." For my money, these hedge funds are trying to make a faster pig. I know this is activist hedge fund's m.o.: get seats on the board, make quick changes, see stock rise, sell. But today's public company board, composed of independents who are by definition part-timers, shouldn't be making managerial calls at all. They should only take action when there's a conflict with management. Or so I argue in A Conflict Primacy Model of the Public Board.
Allowing boards to manage gives hedge funds an in, and creates problems like, in Davidoff's words:
this kind of pay arrangement sets up two classes of directors doing the same job but being paid very different amounts. It could not only create resentment, but disagreement over the path of the company.
Creating a subclass of directors focused on the short term doesn't sound like a particularly good way to run a company, at least to me.
A recent report from Wilson Sonsini on venture-backed IPOs has lots of interesting tidbits, for example:
- Almost all of the companies are incorporated in Delaware (94%).
- More companies separated the chairman and CEO roles than combined them.
- Board committees at these companies frequently included venture capitalists who had invested in the companies (counting the VCs as independent," despite their share ownership).
- Almost all of the companies (98%) had adopted a code of business conduct.
- Over 80% of the companies implemented a classified board in connection with the IPO.
Lots more in the report. Thanks to Richard Blake for the tip.
Here are a few gift suggestions culled from books published this year if your special someone is a lawyer who associates Modigliani and Miller with capital structure and not paintings with elongated faces and the Tropic of Cancer:
- Tamar Frankel’s The Ponzi Scheme Puzzle;
- Steve Bainbridge’s Corporate Governance after the Financial Crisis (for a point of comparison, see his former colleague Lynn Stout’s The Shareholder Value Myth: How Putting Shareholders First Harms Investors, Corporations, and the Public);
- Research Handbook on the Economics of Corporate Law, a collection edited by Claire Hill & Brett McDonnell.
Even the non-lawyers and non-academics in your life might enjoy Frank Partnoy’s Wait: The Art and Science of Delay. Of course, the target audience might never get around to buying the book.
A few links to tide you over during your tryptophan-induced torpor:
- Many law faculty dream (or so I’ve heard) of splitting their school in two and separating themselves from various colleagues (mimicking the good bank/bad bank model). Well Penn State is doing just that with its two campuses. (See the Dan Filler’s short post at the Faculty Lounge and the comments thereto);
- In the NY Review of Books, Elaine Blair reviews Every Love Story is a Ghost Story, D.T. Max’s bio of David Foster Wallace. It’s fascinating discussion of how Wallace drew on his own experience in addiction recovery, to create not only characters but a map out of the intellectual wilderness of “self-consciousness and hip fatigue” in American culture high and low;
- David Nasaw has slices of his new book, The Patriarch: The Remarkable Life and Turbulent Times of Joseph P. Kennedy at Slate;
- In the New Yorker, Nick Paumgarten explores the eternal musical afterlife in the Grateful Dead tape archives;
- Steve Bainbridge on vino for Thanksgiving (what about post-Thanksgiving?) and shareholder empowerment and banks.
- Track grandma’s flight home at FlightRadar24.
- Here's a ton of guidance from the SEC and DOJ on Foreign Corrupt Practices investigations, the new boom area for DC practitioners, and principal headache of the multinational. JPMorgan is the latest firm to be ensnared; my sense is that financial firms have generally had a better run than most when it comes to avoiding prosecution. HT
- And here's ISS's new approach to 2013 votes. It isn't going to go entirely for labelling the pledging of stock to be a problematic company pay practice; it is also going to wait before recommending a vote against boards that ignore shareholder proposals that pass with a majority vote. But both look like they're in the offing. HT
Interesting stuff. I favor the proposed rule because I believe that information about corporate spending on politics is important to shareholders, and although some of that spending is currently disclosed, the proposal rule would provide more coherent and easily accessible disclosure.
I recently blogged about my new corporate governance article, A Conflict Primacy Model of the Corporate Board. Bernie Sharfman posted a thoughtful comment, asking "how do you get around DGCL 141(a) and its judicially interpreted requirement that the board participate in all significant decisions of the corporation?" The short answer is that "by or under the direction of the board of directors" statutory language, and the longer one is that, after some agonizing, I decided to defer questions of implementation for now. I often try to cram too much into one article, and rethinking the public board's role as centering on dealing with areas of managerial conflict seemed, upon reflection, to be a lot to bite off in one symposium piece.
Which leads me to the genesis of this particular piece, which I'll explain using a personal anecdote. I sometimes exasperate my husband with my acceptance of the world as it is. Our classic example involves soon after we started dating, when he visited my parents' house. There was a wall lamp in the basement that had been hanging from wires for years--indeed, since we had moved in 8 years earlier. It had been broken during the move-in, but the Rodrigues take was: it still works, so why fix it? Nathan was horrified, went to a hardware store, and replaced the light fixture in about half an hour.
My attitude towards the supermajority independent board stems from my familial tendency to accept the world as it is. Independent public boards aren't going away. That means that most directors are outsiders, and we have no guarantee that they know anything about the company or even the industry. So what should we do? Keep expecting them to manage the corporation in a strategic sense? I say no, instead use the independent board for what it's good for: areas of conflict with management. That's where its outsider status serves a useful purpose. This first piece represents an argument about the ends that we can realistically ask such a board to serve. Implementation is an important, but separate question.
So it was with sympathy and gratitude that I read Steve Bainbridge's post this summer, explaining his starting point and first premise when articulating his director primacy model (I hereby out myself as the friend whose misreading inspired the post). Despite what I thought was my familiarity with Steve's position, in the draft I sent to him earlier this summer I mischaracterized the overall nature of his inquiry. As he put it in his post:
Like most legal theorists who write about the board, both Eisenberg and Blair/Stout are concerned with the uses to which the board puts its powers. Eisenberg wants the board to monitor. Blair/Stout want the board to mediate.
In contrast, I did not approach the board of directors from a perspective framed by the question “what does the board do?” Instead, my inquiry started differently. I looked at the language of the DGCL and the MBCA, which both state that the business and affairs of the corporation shall be managed by or under the direction of the board of directors. And I asked, why? Why a board? Why not shareholders? Or employees? Or an imperial CEO?...Hence, like the statutes, director primacy is about the allocation of power within the firm, and has little to say about how that power is to be used (other than requiring that it be used to maximize shareholder wealth)...
The statutes are indifferent as to how specific boards allocate their time amongst those functions. And so am I.
Steve and I had a fruitful (from my perspective, at least) email discussion about my draft, which I look forward to continuing at the end of this week, at the UCLA Junior Business Law Faculty Forum. I'm also looking forward to seeing Lisa, Gordon and and some friends of the Glom there, too.
I've been a bit light on the blogging this semester. Mea culpa. In my defense, I have been busy, working on 2 writing projects and one other matter. I've finally posted the first article, the fruits of a terrific conference at Illinois Law earlier this year. I took full advantage of the "safe space" a symposium affords and the piece is a bit...ambitious. Here's the abstract:
The board of directors is the theoretical fulcrum of the corporate form: Statutes task the board with managing the corporation. Yet in the twentieth century, CEOs and other executives came to dominate the real-world control of the corporation. In light of this transformation, in the 1970s Melvin E. Eisenberg proposed reconceiving the board as an independent monitor. Eisenberg’s monitoring board is now the dominant regulatory model of the board. Recently two different visions of the board of directors have emerged. Stephen Bainbridge’s “director primacy” model calls directors “Platonic guardians,” and Margaret Blair and Lynn Stout’s “team production model” characterizes them as “mediating hierarchs.” Each of these models involves different conceptions of the board, but both theories presume that boards should play a central role in corporate governance.
The reality of today’s public corporate board, however, is one of limited information, constrained time, and uncertain ability. The reforms of the past three decades have left us with supermajority independent boards — boards, that is, composed mostly of outsiders. There is no guarantee that the directors populating these boards have any knowledge of the corporation in general or of the particulars of the business they serve. With one exception (the financial expert), they need not have advanced degrees or a minimum level of experience in business or management. The only quality they must have is independence, defined as a lack of ties to the corporation. This chief strength of the board is also a weakness, because it means that most members of the board rely on the CEO for knowledge of the corporation and its business.
The centrality of independence to modern boards requires us to rethink their essential role. I do so here by articulating and defending a “conflict primacy” model of the public company board. In my view, expecting a group dominated by outsiders to make substantive managerial decisions about the corporation – about the proper approach to labor disputes, when to expand the corporation, how to expend corporate resources – simply does not make sense. What does make sense is for the board to police situations in which the self-interest of the corporation’s day-to-day managers impedes their ability to function effectively. The board’s central role, then, should concern monitoring CEO performance and pay (including the removal power and succession planning), overseeing the audit function, and dealing with takeovers and derivative suits. In such areas of conflict of interest the board’s lack of ties to management becomes a strength, and so it is on these subjects that the board should focus. Perhaps controversially, the conflict primacy model would reduce the CEO’s role on the board, demoting him to nonvoting, ex officio status. Reconstituted in this manner as a more fully independent body, the board of directors would have a clear but circumscribed mandate that comports with its modern character. Part-timers are not well situated to second-guess executives, but are well equipped to manage conflicts of interest.