Bainbridge has a take on the merits of activist shareholders for other investors here. His recommendation? He
"proposes managing shareholder interventions through changes to the federal proxy rules designed to make it more difficult for activists to effect operational changes, while encouraging shareholder efforts to hold directors and managers accountable."
It is the topic of the moment; in addition to the Bebchuk/Lipton debate, Penn just had in Dionysia Katelouzou, who had an interesting (and I think not yet published) paper arguing that, assuming shareholder activism is welfare-enhancing, it takes a shareholder-protective legal system for them to be able to perform their magic, meaning that campaigns were more likely to work in Japan, Canada, and the UK, than they might in continental Europe.
We've got a nice donnybrook going between Lucian Bebchuk and Marty Lipton on the positive long term returns to companies subjected to campaigns by activist shareholders. Lipton believes they do not exist, Bebchuk believes they do.
Our study empirically disproves the myopic activists claim that interventions by activist hedge funds are in the long term detrimental to the involved companies and their long-term shareholders. This post responds to the main criticisms of our work in Wachtell’s memos. Below we proceed as follows:
- First, we discuss the background of how our study meets a challenge that Wachtell issued several months ago;
- Second, we highlight how Wachtell’s critiques of our study fail to raise any questions concerning the validity of our findings concerning long-term returns, which by themselves are sufficient to undermine the myopic activists claim that Wachtell has long been putting forward;
- Third, we explain that the methodological criticisms Wachtell directs at our findings concerning long-term operating performance are unwarranted;
- Fourth, we show that Wachtell’s causality claim cannot provide it with a substitute basis for its opposition to hedge fund activism;
- Finally, we explain why Wachtell’s expressed preference for favoring anecdotal evidence and reports of experience over empirical evidence should be rejected.
It is all getting quite tasty indeed, and Bebchuk's memo is pretty compelling stuff. He's of course not alone, either. To name but one paper I've seen recently, Paul Rose and Bernie Sharfman have a new paper that also reviews the economic literature, and concluding that "Empirical studies have repeatedly shown that certain types of offensive shareholder activism lead to an increase in shareholder wealth."
The empirical question, it seems to me, is not a straightforward one - it is difficult to compare firms that activists do target with firms that they do not, and difficult of course to know what would have happened had a firm not been targeted. I take it that the case against activist shareholders is unimpeachably logical, and very Chicago. In efficient markets it should not be possible to realize long terms gains through management changes, for the companies targeted would be making said changes anyway. And for examples of studies along these lines, you can look at this or this case.
But this is not meant as a critique, rather as a scene setter - if you want critique, you'll have to read the papers themselves. As long as we see more tasty memos in this fight, you can expect to see them on this here blog.
Today's WSJ brings news of behind-the-scenes drama at the Dish Network, and it sounds way fishy to me. Dish's founder and controlling stockholder, Charlie Ergen, bought up the debt of competitor LightSquared on the cheap while the company was in bankruptcy. Then Dish cast its acquisitive eye on LightSquared. Prudently, it formed a special committee consisting of Stephen Goodbarn and Gary Howard, two of Dish's independent directors, because of the conflict of interest the situation posed. A Dish bid could net Ergen millions, after all. (The WSJ describes these 2 as the only independent directors out of the 8 member board, but that seems unlikely, given that the audit committee is required to be composed of 3 independents. The company's last proxy lists Tom A. Ortolf as the last audit committee member; presumably he is independent). Then things get interesting...
So here's the basic timeline: Ergen buys up LightSquared debt (unclear when). In July, a special committee consisting of Goodbarn and Howard is formed to consider a Dish bid for LightSquared. The special committee recommends a bid. But the members "expected the committee to have an ongoing role in the deal discussions." July 21, in a surprise move, the board disbands the committee. July 23, Dish bids $2.2 billion for LightSquared. July 25, independent director (and late special committee member) Howard resigns, without citing any specific reason for his departure.
What's left out of this account is what else was going on at Dish at the time. In June the company was fighting with Sprint to acquire Clearwire, and bowed out June 26th. And in June Dish also gave up on a bid for Sprint to SoftBank.
So, to review, Dish gives up on two major acquisitions in June. The next month it decides to buy a company Ergen owns a significant interest in. The acquisitions are of vastly different orders of magnitude, admittedly, but one possible inference is that Ergen wanted to have cash on hand to buy out a company that would enrich him personally. These negative inferences are just why it is wise to employ a special committee in these types of negotiations.
So why disband the special committee so quickly? One of the WSJ's sources explains "Mr Ergen stood to profit even if another company ended up buying LightSquared, which meant he wasn't motivated to force a Dish bid for personal gain." Um, yeah, that doesn't make any sense at all. There's no evidence that there were or are other companies sniffing around LightSquared, or at least willing to pay this much, so Ergen's motive for forcing a bid seems pretty potent. Even if the only effect of the Dish bid is to scare up a competing, higher bid, that's still good for Ergen. Particularly in light of the June happenings, these events just seem questionable.
Situations like these highlight how important the role of the board is and should be in conflict situations. The board shouldn't have the power to dissolve a committee; indeed, the role of the whole board should be to focus on these conflict-of-interest type situations.
So says Friend of Glom Lyman Johnson over at CLS Blue Sky. That's a title that's going to get the attention of some corporate types!
Lyman first objects to Chancellor Leo Strine's recent decision In re MFW S’holders Litig. to give bjr protection to a controlling shareholder in a self-dealing transaction when there's an independent committee and majority-of-the-minority shareholder approval (for more see here and here), calling this move "incoherent" because shareholders don't exercise business judgment in the way directors do.
But then, he says, let's call the whole thing off:
As just one law professor who has grappled with teaching this material to law students for almost thirty years, I can say that presenting students with a coherent and cogent understanding of fiduciary duties is made more difficult by Delaware’s current business judgment rule construct. Students – having studied the concept of legal duty in diverse curricular offerings such as torts, trusts and estates, agency and partnership law, and professional responsibility – understand the importance of legal duties, including the scope of duty and situations of no-duty. The concepts of care and loyalty, in all their manifestations, are relatively easy to grasp, if of somewhat surprising contours.
Analytically and doctrinally, the teaching could stop there – with fiduciary duties and their breach – and students would have a solid and workable understanding. Little but unnecessary complexity in the law and pedagogy is added by then filtering all of the above through the threshold of the business judgment rule construct as a standard of review, particularly with the Cede breach of duty/burden shift feature.
Go read the whole thing.
Hot off the presses comes a stimulating way to start the summer for corporate law professors. Cambridge recently published Christopher Bruner’s new book Corporate Governance in the Common-Law World. The book builds on his earlier law review work, including Power and Purpose in the “Anglo-American” Corporation and Corporate Governance Reform in a Time of Crisis.
Bruner lays patient, meticulous siege to functionalist accounts that have occupied center stage in comparative corporate law scholarship. The key moves in his gambit:
¶ Disaggregating the idea of “Anglo-American” corporate law by arguing that British, Australian, and Canadian systems give far more power to shareholders than does the U.S. approach;
¶ Arguing that a functional approach (which has led to predictions that differing social welfare and social democracy concerns explains a divergence between continental European systems and Anglo-American systems) fails to account for the differing approaches among these four common-law countries;
¶ Articulating the further differences among the U.K., Canadian, and Australian approaches; and
¶ Providing evidence that politics, not functional concerns, provides a better explanation for the diverging paths within the common-law world.
Bruner also looks at how the crisis has affected these four common-law countries to different degrees. Harder hit, the U.K. and United States have moved to increase shareholder power within corporations. Although in the introduction Bruner sets out to navigate middle course between “functionalism” and “contextualism,” the book hews much closer to the latter. In doing so, he stages a serious challenge to comparative scholarship that poses grander economic arguments to explain differences and similarities among corporate law regimes.
To my mind, the book also raises a challenge of whether a similar political approach might explain divergences within continental Europe. Moreover, might a politics focus provide an explanation for divergences and convergences well before the latter half of the 20th Century?
Bruner’s Introduction is available on ssrn.
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.
One of my colleagues said that my latest article (written with one of my excellent students, Jordan Lee) sounds like an R-rated movie. The title is Discretion, and here is the abstract:
Discretion is an important feature of all contractual relationships. In this Article, we rely on incomplete contract theory to motivate our study of discretion, with particular attention to fiduciary relationships. We make two contributions to the substantial literature on fiduciary law. First, we describe the role of fiduciary law as “boundary enforcement,” and we urge courts to honor the appropriate exercise of discretion by fiduciaries, even when the beneficiary or the judge might perceive a preferable action after the fact. Second, we answer the question, how should a court define the boundaries of fiduciary discretion? We observe that courts often define these boundaries by reference to industry customs and social norms. We also defend this as the most sensible and coherent approach to boundary enforcement.
I wrote an article about a decade ago called "The Critical Resource Theory of Fiduciary Duty" that still gets downloaded and cited a fair amount, at least for a fiduciary duty article. It is about the structure of fiduciary relationships, and I wanted to do a follow on article about how courts know when someone has breached a fiduciary duty. I actually had a fairly long draft of an article that was just horrible, and I never published it, but I kept thinking about and teaching about this problem. Earlier this year, I had a brainstorm about the subject, and the result is this new article.
By the way, interest in fiduciary law seems to have exploded in the past decade. Some of that interest stems from Tamar Frankel's book and the accompanying conference at Boston University. Some of the interest stems from the fact that fiduciary law is interesting in many countries outside the United States, where much of the best writing on this subject is found (see Paul Miller, for example). I look forward to a new surge in interest this summer, as Andrew Gold and Paul Miller have organized an excellent conference on The Philosophical Foundations of Fiduciary Law, to be held in Chicago. I am writing a paper entitled "True Loyalty" for that conference and very much looking forward to reading the other contributions.
Jesse Fried, Brian Broughman, and Darian Ibrahim have an excellent paper on Delaware's dominance in the market for corporate charters, arguing "that firms often choose Delaware corporate law because it is the only law 'spoken' by both in-state and out-of-state investors." Jesse described the paper in a recent blog post, and you can download it on SSRN. Jesse's summary of the evidence:
To test for a lingua-franca effect, we exploit a database of 1,850 VC-backed firms that provides precise information on the firm’s location, the identity and location of its investors, and changes in the firm’s domicile as its investor base evolves over time. We find, consistent with the lingua-franca effect, that the presence of out-of-state investors in each round of financing significantly increases the likelihood of Delaware incorporation or reincorporation. We also find that a startup is less likely to incorporate in Delaware if its out-of-state VC investors have already invested in firms incorporated in the startup’s home state, and thus have greater familiarity with home-state corporate law.
As attention moves rapidly towards comparative approaches, the research and teaching of company law has somehow lagged behind. The overall purpose of this book is therefore to fill a gap in the literature by identifying whether conceptual differences between countries exist. Rather than concentrate on whether the institutional structure of the corporation varies across jurisdictions, the objective of this book will be pursued by focusing on specific cases and how different countries might treat each of these cases. The book also has a public policy dimension, because the existence or absence of differences may lead to the question of whether formal harmonisation of company law is necessary. The book covers 10 legal systems. With respect to countries of the European Union, it focuses on the most populous countries (Germany, France, the UK, Spain, Italy and Poland) as well as two smaller Member States (Finland and Latvia). In addition, the laws of two of the world's largest economies (the US and Japan) are included for the purposes of wider comparison. All of these jurisdictions are subjected to scrutiny by deploying a comparative case-based study. On the basis of these case solutions, various conclusions are reached, some of which challenge established orthodoxies in the field of comparative company law.This is a very cool project, for which I am the U.S. contributor. Mathias and David were patient and longsuffering editors, and I believe they have produced something truly worthwhile for those of us interested in comparative company law. Thanks to the many collaborators who made this happen.
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.
This past February, I blogged about Chancellor Leo Strine's opinion in Auriga Capital Corp. v. Gatz Properties, LLC. The case was particularly interesting because Chancellor Strine expressed his view that a manager in a manager-managed LLC owes fiduciary duties, even if the participants in the LLC are silent about fiduciary duties. In other words, the manager has fiduciary duties by default.
But Chief Justice Myron Steele has expressed a different view in his article, Freedom of Contract and Default Contractual Duties in the Delaware Limited Partnerships and Limited Liability Companies, 46 Am. Bus. L.J. 221, 223-224 (2009).
So when the Delaware Supreme Court issued an en banc opinion in Auriga earlier this week, we were all curious what Chief Justice Steele would say. The result was a per curium decision and it was surprising. The Court affirmed Chancellor Strine's decision, then added:
[W]e pause to comment on one issue that the trial court should not have reached or decided. We refer to the court’s pronouncement that the Delaware Limited Liability Company Act imposes “default” fiduciary duties upon LLC managers and controllers unless the parties to the LLC Agreement contract that such duties shall not apply. Where, as here, the dispute over whether fiduciary standards apply could be decided solely by reference to the LLC Agreement, it was improvident and unnecessary for the trial court to reach out and decide, sua sponte, the default fiduciary duty issue as a matter of statutory construction. The trial court did so despite expressly acknowledging that the existence of fiduciary duties under the LLC Agreement was “no longer contested by the parties.” For the reasons next discussed, that court’s statutory pronouncements must be regarded as dictum without any precedential value.
First, the Peconic Bay LLC Agreement explicitly and specifically addressed the “fiduciary duty issue” in Section 15, which controls this dispute. Second, no litigant asked the Court of Chancery or this Court to decide the default fiduciary duty issue as a matter of statutory law. In these circumstances we decline to express any view regarding whether default fiduciary duties apply as a matter of statutory construction. The Court of Chancery likewise should have so refrained.
Third, the trial court’s stated reason for venturing into statutory territory creates additional cause for concern. The trial court opinion identifies “two issues that would arise if the equitable background explicitly contained in the statute were to be judicially excised now.” The opinion suggests that “a judicial eradication of the explicit equity overlay in the LLC Act could tend to erode our state’s credibility with investors in Delaware entities.” Such statements might be interpreted to suggest (hubristically) that once the Court of Chancery has decided an issue, and because practitioners rely on that court’s decisions, this Court should not judicially “excise” the Court of Chancery’s statutory interpretation, even if incorrect. That was the interpretation gleaned by Auriga’s counsel. During oral argument before this Court, counsel understood the trial court opinion to mean that “because the Court of Chancery has repeatedly decided an issue one way, . . . and practitioners have accepted it, that this Court, when it finally gets its hands on the issue, somehow ought to be constrained because people have been conforming their conduct to” comply with the Court of Chancery’s decisions. It is axiomatic, and we recognize, that once a trial judge decides an issue, other trial judges on that court are entitled to rely on that decision as stare decisis. Needless to say, as an appellate tribunal and the court of last resort in this State, we are not so constrained.
Fourth, the merits of the issue whether the LLC statute does—or does not— impose default fiduciary duties is one about which reasonable minds could differ. Indeed, reasonable minds arguably could conclude that the statute—which begins with the phrase, “[t]o the extent that, at law or in equity, a member or manager or other person has duties (including fiduciary duties)”—is consciously ambiguous. That possibility suggests that the “organs of the Bar” (to use the trial court’s phrase) may be well advised to consider urging the General Assembly to resolve any statutory ambiguity on this issue.
Fifth, and finally, the court’s excursus on this issue strayed beyond the proper purview and function of a judicial opinion. “Delaware law requires that a justiciable controversy exist before a court can adjudicate properly a dispute brought before it.” We remind Delaware judges that the obligation to write judicial opinions on the issues presented is not a license to use those opinions as a platform from which to propagate their individual world views on issues not presented. A judge’s duty is to resolve the issues that the parties present in a clear and concise manner. To the extent Delaware judges wish to stray beyond those issues and, without making any definitive pronouncements, ruminate on what the proper direction of Delaware law should be, there are appropriate platforms, such as law review articles, the classroom, continuing legal education presentations, and keynote speeches.
Parts of this passage surfaced on Above the Law and generated a story today in the NYT, but neither story mentioned the underlying dispute between Chief Justice Steele and Chancellor Strine on default fiduciary duties.
Those stories also didn't note that this was not the first time the Delaware Supreme Court had warned Chancellor Strine about dicta. Ironically, the issue in Gotham Partners, L.P. v. Hallwood Realty Partners, L.P., 817 A.2d 160, 167 (Del. 2002) was then-Vice Chancellor Strine's assertion that fiduciary duties could be eliminated in a limited partnership. On that occasion, the Court observed, "we are constrained to draw attention to ... the underlying general principle in our jurisprudence that scrupulous adherence to fiduciary duties is normally expected."
Finally, inspired by the reaction of Brett McDonnell when we discussed this story yesterday, I wonder what Ed Rock thinks of this opinion. See Edward B. Rock, Saints and Sinners: How Does Delaware Corporate Law Work?, 44 UCLA L. Rev. 1009 (1997).
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.