151 Corporate Law and Social Norms (Eisenberg, Melvin A.)
May 21, 1999
Corporate law serves both to facilitate and to regulate the conduct of the corporate enterprise. Insofar as corporate law is regulatory, it provides incentives and disincentives to the major actors in the corporate enterprise -- directors, officers, and significant shareholders -- through the threat of liability. In significant part, however, these actors are motivated not by the desire to avoid liability, but by the prospect of financial gain, on the one hand, and by social norms, on the other. Much work has been done on the way in which these actors are motivated by the threat of liability and the prospect of financial gain, but relatively little work has been done on the operation of social norms. In this Article, I examine the interrelation of social norms and law in corporate law. The purpose of this examination is to illuminate both corporate law specifically, and the interrelation of social norms and law generally, by studying ways in which that interrelation operates in a specific field. I focus on three kinds of social norms, which I call patterns, practices, and obligational norms.
The organization of the Article is as follows: I begin by describing and defining the kinds of social norms that are relevant to law. I then consider, in a preliminary way, the effects and origins of social norms. Finally, I examine the critical role of social norms in three central areas of corporate law: fiduciary duties (specifically, care and loyalty), corporate governance (specifically, board composition and the role of institutional investors), and takeovers. In the course of that examination, I apply and elaborate the introductory analysis concerning the kinds, origins, and effects of social norms, and consider some of the kinds of interrelations between social norms and law.
152 Financial Slack Policy and The Laws of Secured Transactions (Triantis, George G.)
Published in Journal of Legal Studies, Vol. 29, p. 35, 2000
A manager's discretion depends on the firm's internal funds and its capacity to issue low-risk debt (together "financial slack"). The optimal amount of financial slack is a challenging problem in corporate finance. Too much slack encourages managerial misbehavior and exacerbates corporate agency problems. Too little slack prevents the firm from exploiting profitable investment opportunities. The various features of financial leverage -- including the amount of debt, maturity, covenants and default rights, and collateral -- may be used to regulate the degree of slack in a firm. This paper demonstrates how (1) the priority rules and (2) the property rights in collateral and proceeds associated with security interests under each of U.C.C. Article 9 and the Bankruptcy Code contribute to optimal slack policy.
153 Japanese Corporate Governance: The Hidden Problems of the Corporate Law and Their Solutions (Shishido, Zenichi)
April 8, 1999
It has long been said that the Japanese corporate governance does not pay sufficient attention to shareholders as the owners of the corporation. And yet, despite this seeming lack of shareholder ownership, Japanese firms have performed quite well until recently. This paper seeks to solve this conundrum by developing the "Company Community" concept as a positive model of the Japanese corporate governance. This model is used to illustrate how the Japanese system of corporate governance solves the hidden problems of the corporate law. These hidden problems of corporate law are common to all developed economies and consist of the dual problems of balancing between monitoring and autonomy of management and balancing between money capital and human capital.
The company community concept solves these problems through an intricate system of monitoring consisting of three levels. The first level is the in-house monitoring by core employees who are quasi-residual claimants and monitor management as a participant in the Community. The second level is the monitoring by cross-shareholders in the firm, the main bank in particular. Cross-shareholding also has the effect of stabilizing the management position against outside control. The third level is the monitoring by exit of the outside shareholders. These multiple levels of monitoring have the effect of stabilizing management yet upholding shareholder ownership as the end game norm.
154 Shareholder Litigation Under Indeterminate Corporate Law (Kamar, Ehud)
Published in University of Chicago Law Review, Vol. 66, pp. 887-914, 1999
Insurance and indemnification of directors and officers for liability incurred in shareholder fiduciary claims presents a puzzling circularity, whereby shareholders protect directors and officers from suits that shareholders themselves bring. Nevertheless, liability insurance and indemnification can be efficient as a decoupling mechanism that allows courts to compensate plaintiffs for their litigation expenditures without overburdening defendants. The resulting combination of low sanctions and frequent enforcement can address the open-ended nature of fiduciary standards in two ways. First, it develops and clarifies the law through the creation of precedents and the accumulation of judges' and lawyers' experience. Second, it reduces the liability risk that directors and officers bear by making the occurrence of litigation more certain. That liability insurance and indemnification can be efficient does not mean, however, that it is efficient as practiced today. While current insurance and indemnification practices address indeterminacy by generating litigation, it is not clear that this indeterminacy is in itself desirable nor that it is addressed optimally.
155 Political Foundations for Separating Ownership From Corporate Control (Roe, Mark J.)
Published in Stanford Law Review, Vol. 53, December, 2000
The large public firm dominates business in the United States despite its critical infirmities, namely the frequently fragile relations between stockholders and managers. Managers' agendas can differ from shareholders'; tying managers tightly to shareholders has been central to American corporate governance. But in other economically-advanced nations ownership is not diffuse but concentrated. It is concentrated in no small measure because the delicate threads that tie managers to shareholders in the public firm fray easily in common political environments, such as those in the continental European social democracies. Social democracies press managers to stabilize employment, to forego even some profit-maximizing risks with the firm, and to use up capital in place rather than to down-size when markets no longer are aligned with firm's production capabilities. Since managers must have discretion in the public firm, how they use that discretion is crucial to stockholders, and social democratic pressures on managers induce them to stray from their shareholders' preference to maximize profits. Moreover, the means that align managers with diffuse stockholders in the United States—incentive compensation, transparent accounting, hostile takeovers, and strong shareholder-wealth maximization norms—are harder to implement in continental social democracies. Hence, public firms in social democracies will, all else equal, have higher managerial agency costs, and large-block shareholding will persist as shareholders' next best remaining way to control those costs. Indeed, when we line up the world's richest nations on a left-right continuum and then line them up on a close to diffuse ownership continuum, the two correlate powerfully. True, the effects on total social welfare are ambiguous; social democracies may enhance total social welfare, but if they do, they do so with fewer public firms than less socially-responsive nations. We thus uncover not only a political explanation for ownership concentration in Europe, but also a crucial political prerequisite to the rise of the public firm in the United States, namely the absence of a strong social democracy and the concomitant political pressures it would have put on the American business firm.
156 Class Action Accoutability: Reconciling Exit, Voice, and Loyalty in Representative Litigation (Coffee, John C. Jr.)
December 2, 1999 Published in Columbia Law Review, Vol. 100, No. 2, pp. 370-439, March 2000
This paper assesses the prospects for meaningful reform of the class action after Amchem Products v. Windsor and Ortiz v. Fibreboard Corp. It reads these decisions as viewing "class cohesion" as the essential rationale that legitimizes representative litigation. Although it agrees that a legitimacy principle must underlie representative litigation, it doubts that "class cohesion" can bear that weight, either as a theory of political representation or as an economic solution for the agency cost and collective action problems in representative litigation.
Instead, using the familiar terminology of "exit," "voice" and "loyalty," it suggests that "exit" should prove a superior remedy to voice, and can be implemented through procedures that use exit (much like the appraisal remedy in corporate law) to discipline unfaithful fiduciaries. More generally, it argues that the same accountability mechanisms that work in the field of corporate governance should work in this context as well.
Because Amchem and Ortiz may be read to require overly rigorous procedural requirements that could lead to what this article terms the "Balkanization" of the class action, this article further suggests that "exit" should sometimes constitute a functional substitute for "voice" or "loyalty." As a remedy, "exit" can be structured so as to maximize individual choice and promote competition between non-overlapping classes. Thus, the benefits of competition can be realized without increasing the risk of collusion or a "reverse auction."
On the normative level, a choice must be made between viewing the class as an entity and viewing it as an aggregation of individuals. This article argues for the latter view and posits that the basic fiduciary duty of the counsel in representative litigation should be to protect client autonomy.
157 The Price of Law: How the Market for Lawyers Distorts the Justice System (Hadfield, Gillian K.)
Forthcoming in Michigan Law Review, Vol. 98, No. 4, Feb. 2000
This paper begins with the question, Why do lawyers cost so much? The analysis is an investigation of the imperfections in the market for lawyers, imperfections that have been largely overlooked by focus on either the model of perfect competition or the impact of artificial barriers to entry into the provision of legal services. The paper catalogues multiple sources of imperfection: the nature of the incentives and mechanisms at work to determine the level of complexity in the system, the extent to which complexity and uncertainty make legal services into credence goods par exellence, the winner-take-all and tournament nature of the competition among lawyers, the sunk costs of lawyer-client relationships and hence the potential for opportunism and the limited potential for conventional market mechanisms to control opportunism, the incremental nature of legal fees—which structures legal expenditures as a sunk cost auction in which the cost of services can easily and rationally exceed the amount at stake, and three sources of monopoly: the familiar monopoly established by artificial barriers to entry, the "natural" monopoly arising from the limited supply of individuals in the economy with the cognitive skills necessary to engage effectively in competitive legal reasoning, and the state's monopoly over coercive dispute resolution.
The analysis uncovers deeply disturbing implications for justice from the economics of the market for lawyers. The price dynamics of the system operate within the framework of a unified profession/unified legal system that essentially puts individual clients—with justice interests at stake—into a bidding contest with corporate clients with efficiency (more generally, market) interests at stake. Corporations by definition are aggregations of individual wealth and as a consequence are able to bid for the resources; they also are a richer feeding ground for the wealth extraction generated by the imperfections/monopoly aspects of the market for lawyers. This is not an ethical critique of lawyers; it is the implication of ordinary economic response to incentives structured by a non-competitive market.
The economic dynamics of the market for lawyers operate like a vacuum, drawing the resources of the system into the corporate sphere, in the service (from a public perspective) of efficiency, and away from the individual sphere in the service of justice as in the relationships between the individual and the state, the market, the family, the community and so on. This stands on its head the lexicographic relationship between efficiency and justice: efficiency is of normative significance only to the extent it promotes individual welfare through just social relations.
The implications of the economic analysis in the paper are supported by the empirical evidence we have about the structure of the legal profession and the changes over the past several decades. The profession is roughly divided into two segments—one serving business clients and one serving individual clients. The business segment is populated by lawyers who graduated from elite institutions, who are well-connected and influential in the profession, who charge high fees and earn high incomes and who are perceived to be in short supply. These lawyers work in large firms or high-end boutiques and are increasingly likely to be specialized. Their work is perceived to be of the highest level of prestige by all members of the profession. The personal segment is populated by lawyers who graduate from lower-tier schools, charge lower fees and often flat fees set in apparently competitive fashion providing largely routine, non-contested legal services such as house closings, uncontested divorces and wills. Their work is perceived, by them and the rest of the profession, as low prestige. Lawyers in this segment tend to work in solo practice or small general practice firms. The supply of lawyers in this segment is perceived to exceed demand and there is evidence of un/underemployment and falling prices. The allocation of total hours spent by lawyers on legal work is increasingly skewed towards the business segment of the profession, and thus towards the efficiency and away from the individual justice goals of the justice system.
158 Privatization and Corporate Governance: The Lessons from Securities Market Failure (Coffee, John C. Jr.)
October 20.1, 1999 Published in The Journal of Corporation Law, Vol. 25, No. 1, Fall 1999
This paper analyzes the comparative experiences of Poland and the Czech Republic with voucher privatization. Because of a number of similarities between these two transitional economies, it finds their comparative experience to provide a useful natural experiment, with the critical distinguishing variable being their different approaches to regulatory controls. However, while their experiences have been very different, their substantive corporate law was very similar. The true locus of regulatory differences appears then to have been the area of securities market regulation, where their approaches differed dramatically.
Re-examining the work of LaPorta, Lopez-de-Silanos, Shleifer & Vishny, this paper submits that (1) the homogenity of both common law systems and civil law systems has been overstated; (2) common law systems in particular differ widely in terms of substantive corporate law, but have converged functionally at the level of securities regulation; (3) dispersed ownership will likely not persist under civil law systems that contemplate concentrated ownership and hence do not address or discourage rent-seeking corporate control contests or other forms of expropriation from minority shareholders; and (4) such "winner-take-all" control contests are probably most feasibly addressed through "self-enforcing" structural protections, such as (following the Polish model) the transitional use of state-created controlling shareholders. Reformulating the thesis originally advanced by LaPorta, et al., this article argues that civil law systems are not inherently unprotective of minority shareholders, but rather protect shareholders only against the forms of abuse that were well-known in systems of concentrated ownership (i.e., typically, abuse by a dominating parent) and not against the abuses that typically characterize systems of dispersed ownership (i.e., managerial expropriation and theft of the control premium). Ultimately, there is a conceptual mismatch between civil law systems and the dispersed ownership created by voucher privatization.
159 Does Delaware Law Improve Firm Value? (Daines, Robert)
November, 1999
Delaware corporate law rules are the nation's most important. They govern roughly 50% of Fortune 500 firms and more than 60% of all publicly held assets. However, scholars disagree about whether Delaware law improves or reduces firm value. Some claim that Delaware law increases firm value, others claim that it facilitates managerial rent seeking and still others argue that it is no different from other states'.
I present evidence consistent with the theory that Delaware law improves firm value. Using Tobin's Q as an estimate of firm value, I find that firms subject to Delaware corporate law are worth significantly more than similar firms in other jurisdictions. The result is robust to controls for firm size, diversification, profitability, investment opportunity and industry. Delaware firms also receive significantly more takeover bids and are more likely to be acquired. This suggests that Delaware law reduces the cost of acquiring Delaware firms, thereby facilitating the sale of the firm and improving firm value.
160 Privatization and Corporate Governance: Strategy for a Unified Korea (Milhaupt, Curtis J.)
December 1, 1999
About the Project: This paper will be part of a Handbook of Korean Unification designed to provide policymakers with a "blueprint" for a unified Korea. The project is sponsored by the Korean Economic Research Institute and the Columbia Law School Center for Korean Legal Studies. The project team is comprised of eighteen scholars from South Korea, the United States, and Germany with expertise in economics, law, political science, and sociology. The project team is charged with drawing on the German experience with unification to provide in-depth analysis and policy recommendations with respect to major aspects of Korean unification.
Abstract: Drawing on lessons from privatization experiences in Germany and Central Europe, the paper outlines a step-by-step approach to the privatization of North Korean state-owned enterprises. The strategy is designed to obtain the corporate governance benefits of a sales-only approach to privatization and the social and political benefits of voucher-based mass privatization programs. A central lesson from past privatization experience is that law matters: simply moving ownership from state to private hands in an institutional vacuum does not ensure that adequate corporate governance and supervisory mechanisms will develop spontaneously. Thus, assuming South Korean economic institutions will serve as the template for a unified Korea, continued reform of South Korean corporate and securities laws is a crucial component of any well-devised privatization strategy.
