This comprehensive case book sheds light on the complicated regulatory framework and the dynamic nature of laws on corporate governance in the United States. Chapters typically cover regulations promulgated by federal, state, and self-regulatory organizations. Corporate governance is examined through case law with ample discussion to provide context concerning evolving practices and normative concerns. In that regard, the authors give voice to a wide variety of perspectives, including their own. Corporate Governance: Cases and Materialsby J. Robert Brown, Jr., Professor of Law, University of Denver Sturm College of Law; Lisa L. Casey, Associate Professor of Law, Notre Dame Law School.
Corporate governance involves a complicated regulatory construct, “a byproduct not of reason but path dependency.” The framework is in considerable flux, as are the participants. Institutional investors now own two thirds of the outstanding shares in US public companies and have demanded an increased role in corporate governance, likewise corporate directors have become more independent. Still, power resides mostly with boards.
What is corporate governance? Generally, corporate governance refers to the host of legal and non-legal principles and practices affecting control of publicly held business corporations. Most broadly, corporate governance affects not only who controls publicly traded corporations and for what purpose but also the allocation of risks and returns from the firm’s activities among the various participants in the firm, including stockholders and managers as well as creditors, employees, customers, and even communities. However, American corporate governance doctrine primarily describes the control rights and related responsibilities of three principal groups:
- the firm’s shareholders, who provide capital and must approve major firm transactions,
- the firm’s board of directors, who are elected by shareholders to oversee the management of the corporation, and
- the firm’s senior executives who are responsible for the day today operations of the corporation.
As the Delaware Supreme Court has stated, “the most fundamental principles of corporate governance are a function of the allocation of power within a corporation between its stockholders and its board of directors.”
At over 800 pages, this tome cannot be easily summarized, other than to say it provides the best guidance and insight into many of the most important laws and cases on corporate governance that I have seen. What follows are my own notes. It isn’t a review in the traditional sense, so much as it is a file I can reference in the future to help me find some of the many important references in the book., including some page numbers. Yes, the book also includes a substantial index, so I’m more likely to consult that than I am this post but the sheer act of writing a few points down helps me better understand them and remember. I’m sure, if you were taking a few notes, your list will be different but no matter who you are, if you are interested in corporate governance, you’ll find much to be fascinated by and much to digest.
Traditionally owned by their members (brokers and dealers), stock exchanges have converted into for-profit companies. The structure raises concerns about the relationship between their regulatory responsibilities and their fiduciary obligations to shareholders. Stock exchanges initially had substantial regulatory powers , for example requiring an annual stockholders meeting. Brown and Casey explain what concerns arose when exchanges converted to profit status. The exchanges now have an obligation to act in the best interest of their own shareowners, including the need to maximize profits. I’m not sure this is really a need but the mythology drives reality.
Since this obligation is potentially inconsistent with the NYSE’s regulatory function, to take one example, they set up a separate subsidiary to handle regulatory functions. NYSE will not be able to use any assets or any regulatory fees, fines or penalties collected by NYSE for commercial purposes. These obscure provisions are also covered under provisions of Sarbanes-Oxley and Dodd Frank. The authors go into cases where NYSE was alleged to self-deal, neglecting its regulatory and oversight duties. The court found there is no private right of action for violations of the rules of the stock exchange. Yikes!
The book contains a good discussion of where the lines are drawn between Delaware and federal law. National opinion on executive compensation does, for example influence Delaware decision-makers and we see indirect federal influence at work with Delaware suppressing its local contractarian model.
It is important to note that no regulatory agency in Delaware makes forward-looking rules. No Delaware prosecutor scrutinizes corporate America to throw wrongdoers in jail. The Delaware bar draws the boundaries between the powers of managers and investors. In contrast, policymakers in Washington see themselves as custodians for the overall health of the American economy.
As Forbes and Milliken opine, “The very existence of the board as an institution is rooted in the wise belief that the effective oversight of an organization exceeds the capabilities of any individual and that collective knowledge and deliberation are better suited to this task.” (p. 97)
(p. 107) Jeffrey Gordon. Independent boards solve three problems: First they enhance the fidelity of managers to shareholder objectives. Second, they enhance the reliability of the firm’s public disclosure. Third, they provide a mechanism that binds the responsiveness of the firm to stockmarket signals in a bounded way. He sees the board as a “visible hand” needed to “balance the tendency of markets to overshoot.”
Interesting discussion (p. 109) on the 1996 IRS criteria for “outside directors” who can approve performance-based pay above the $1 million deductibility cap established by section 162(m) of the Internal Revenue Code. This is an important benchmark that I personally think we need to revisit. Unfortunately, independent directors may not have the information necessary to discover self-dealing, nor do they have significant incentive, since they are likely to, as Nell Minow puts it, dance with the ones who invited them. Some good statistics here (p. 125) on the evolution of nominating practices.
Page 129 discusses that in 2003 the SEC adopted disclosure rules with the objective of encouraging nominating committees to consider shareholder recommendations for nominations. Companies must disclose whether the committee had received a recommended candidate from shareholder groups or shareholders holding 5% of the stock of the company within 120 days of the data the proxy statement and whether the committee chose to nominate such candidates. A 2006 survey by Spencer Stewart shows “no shareholder nominations three years after the effective date of the disclosure rules.” As I recall, the Corporate Library helped me find a few cases where companies placed such nominees on their proxy but most did so because they missed procedural deadlines. I tried to get more groups to use this vehicle, largely to show that most such submissions were ignored. Good discussion of proxy access.
Unlike the vast majority of states which have codified model standards of conduct for directors and officers, Delaware’s General Assembly has declined to enact statutory duties for corporate fiduciaries. Instead, judge-made law regulates the behavior standards for managers of firms incorporated in the state. This means, of course, that Delaware’s fiduciary law is subject to interpretation and modification on a case-by-case basis. (p. 143)
Good discussion of Smith v Van Gorkom where the Delaware Supreme Court held business judgment rule did not protect defendant directors liability. Of course corporate directors complained, so the legislature responded a year later in 1986 by amending the State’s General Corporation law to enable corporations to exculpate their directors from such liability through provisions in their certificate of incorporation. (p. 162) Soon, almost all corporations amended their charters to include exculpatory provisions, sometimes called “raincoat provisions,” shielding company directors from liability for violating their duty of care. The case provides a good example of the type of critical thinking about such issues displayed throughout the book.
Under the nexus-of-contracts conception of law, shareholders are not conceived to own the corporation. Rather they are conceived to have only contractual claims against the corporation. Therefore, corporate representatives (managers) favor enabling provisions where parties can opt-in or opt-out rather a one-size-fits-all approach of categorical rules. Delaware builds on that desire with its commitment to maintaining a climate of private ordering.
The opt-in approach used by Delaware places exclusive authority is in the hands of management to institute a waiver of liability provision and to draft the appropriate language. Only the board can initiate such a change, thus barring shareowners from opting back into a default regime. According to Brown, “there is little evidence in practice that the relationship between shareholders and managers can be accurately characterizes the process of private ordering. Instead, when the law defers to private ordering, the result is that management is allowed to impose on shareholders a categorical rule embodies its self-interest.” (p. 173)
The evidence is consistent with a race to the bottom. The waiver of liability provisions were not designed to solve corporate governance problem, but were intended to benefit management. Shareowners need authority equal to that of management to initiate an opt-in or opt-out process or to change a prior decision. Shareowners need to be given far broader authority to propose changes to the arrangements that constitute the nexus of contracts at any particular company. Liberal access to the company’s proxy would reduce the cost of collective action for shareowners.
The book does an excellent job of covering landmark decisions, such as Caremark, where causes of actions alleging the board’s systematic failure to monitor legal compliance caused injury to the corporation. Directors must make good faith efforts to assure their firm not only has adequate information and reporting system but that it is designed and operates to bring failures to their attention in timely manner.
Although we normally speak of a triad of fiduciary duties that includes good faith, care and loyalty, the obligation to act in good faith doesn’t rise to the same level. Only violation of the duties of care and loyalty can directly result in liability, whereas failure to act in good faith must take an indirect route. The duty of good faith is not really a separate duty, but is rather as an element of the duty of loyalty. (p. 187)
As I read the book, I become concerned about some of the reforms that we have been able to win for shareowners over the years, such as all the requirements that a large number of directors be independent. Yes, I’ve seen studies that find independent directors are often uninformed, since they have to play catch up. However, I hadn’t realized that Delaware courts have all but eliminated meaningful limits on self-interest transactions by corporate officers. As long such transactions are approved by a”neutral” decision-making body, such as independent disinterested directors, they are subject to review under the business judgment rule… a standard that is rarely overcome. Indeed, interested directors can sit in on the discussion, participate in the debate and even vote on the transaction without the board losing it’s “neutral” status as long as the majority is disinterested. (p. 229) It makes me wonder what the courts will assume when some directors are elected through proxy access. Will decisions requiring shareowner consent be deemed so if directors nominated by shareowners sit on the board?
The authors point to another example on p. 271. “The need to ensure substantive fairness in the area of executive compensation has been replaced by process.” The duty of loyalty is essentially replaced by the duty of care.
Interesting law review article by Richard Posner discussing excessive CEO compensation. One of the problems is that boards are usually dominated by other CEOs who have a financial stake in all companies paying high salaries. They have a natural psychological tendency to believe the salaries of corporate executives reflects their intrinsic worth and they are strongly inclined to exaggerate the merits of their own value along with the value of all CEOs. While many people feel underpaid, virtually none feels overpaid, including CEOs. Additionally, a board can shield themselves from criticism by pointing out they paid top dollar for the CEO. The generosity of the compensation package thus becomes evidence that he was indeed the best choice ex ante. (p. 283)
Good discussion of the SEC’s Proxy Voting Rule, which requires mutual funds disclose to clients how they can obtain information about their proxy voting policies and how they voted. (p. 357) Unfortunately, it is not detailed enough to help me work through the chain of responsibilities for my own 401(k) plan.
I also found a good discussion of the mechanics of voting and how the Court of Chancery came to a new interpretation of the Cede breakdown of the stock ledger as equivalent to DTC issuing the omnibus proxy. Although mentioned as a possible issue, the use of voter information forms (VIFs), as something of a substitute for legal proxies, is not explored… probably because there haven’t been any court cases discussing how the system takes away the legal rights of shareowners. (p. 388). For examples, see my letter to the SEC’s Investors Advisory Committee of September 20, 2012 and the discussion of blank votes going to management, as well as my 2009 petition to the SEC.
Blasius Industries v Atlas Corp. worth noting for future reference (p. 405)
A board’s decision to act to prevent the shareholders from creating a majority of new board positions and filling them does not involve the exercise of the corporation’s power over its property, or with respect to its rights or obligations; rather it involves allocation, between shareholders as a class and the board, of effective power with respect to governance of the corporation… The theory of our corporation law confers power upon directors as the agents of the shareholders; it does not create Platonic masters… [the board’s action] constituted an unintended violation of the duty of loyalty that the board owned to the shareholders.
Good discussion of proxy contests, requirements for challengers re filing (p. 469), several cases, and on proxy access. Good discussion of the role of disclosure, particularly Brown’s insights on its limitations in changing actual behavior (p. 554) and social responsibility through private ordering (p. 685). Also of importance to me were chapters on comparative corporate governance (yes, we can learn from others) and “How Does Corporate Governance Matter?, which mostly looks at the impact of governance reforms on corporate performance.
Any student lucky enough to have this textbook assigned will be in for one of the most informative courses of their life. After providing excellent coverage of the foundations corporate governance in corporate law, the authors delve into a discussion of the “hottest” topics in corporate governance at publicly traded companies. There should be no need for coffee to stay awake in such classes. For the rest of us, we can be glad that Jay Brown is on the SEC’s Investor Advisory Committee, which is to advise the Commission on regulatory priorities, the regulation of securities products, trading strategies, fee structures, the effectiveness of disclosure, and on initiatives to protect investor interests and to promote investor confidence and the integrity of the securities marketplace. It is nice to have such a well-informed Committee member making recommendations to the Commission.