ProfessorBainbridge.com

John Paul II

John Paul is one of my heroes. This makes me very sad:

Cardinal Joseph Ratzinger, who heads the Vatican's influential congregation on doctrine, told the German weekly magazine Bunte that the pope was probably taking on more than he should. "His health is bad. We should pray for the pope," he said Tuesday.

TypePad winning in blawgosphere; WSJ review

At the Conspiracy, Jacob Levy blogs:

Moving to Type: The former baude.blogspot.com, home to present and former U Chicago undergrads, lots of legal and political theory and entertaining commentary, is now http://www.crescatsententia.org/, with all the fancy Movable Type stuff that goes with it. Do the usual with your links and blogrolls... The number of blogs I regularly read that are still powered by blogger continues to dwindle: Oxblog, Mark Kleiman, and Josh Cherniss are the only ones I can think of offhand, except of course this one (and we're not hosted by blogspot anymore). [Ed.: I haven't been able to bring myself to ask him if my humble TypePad blog is on his regular reading list.]

Why is TypePad winning? Today's WSJ (sub. req'd) explains in a review of blogging tools:

The best service we tried was TypePad. We used the $14.95-a-month "Pro" version but recommend the simpler "Plus" version, which is only $8.95 a month; all you lose are some bells and whistles that a basic user probably won't miss. (Skip the $4.95-a-month version unless you don't want to create a photo album.) TypePad's photo software was some of the strongest, so if photos are going to be a centerpiece of your blog, it's a good choice. One downside: The instructions are cumbersome and require lots of clicking on buttons.

I switched from Blogger/Blogspot to TypePad about 3 weeks ago and have been very happy. I especially like TypePad's domain-mapping feature, which lets me take advantage of TypePad's many features and its hosting service, while still having my own unique top level domain. I could do much the same thing, of course, by using Moveable Type at an independent web hosting service, but my sense is that TypePad is easier to use than Moveable Type, while still having a ton of avdnaced features for those whose HTML skills exceed mine. So far, moreover, TypePad has proven to be a highly reliable hosting service. I haven't noticed any outages of any significance. Finally, as between the various TypePad options, if you think you will post a lot and aspire to generating the famous Instalanche, you'll want Pro to take advantage of the larger disk space allocation and bandwidth. (I've already used 1.5% of my allotted disk space and am running at about 50% of permissible bandwidth.) In sum, if you're thinking about starting a blawg, I strongly recommend TypePad.

Shareholder access again -- updated

Over at TheCorporateCounsel.net Blog, Broc blogs on the latest development in the shareholder access saga:

Readers of WSJ might have noticed a full-page advertisement on Thursday by a group of investors calling for the SEC to adopt a shareholder access rule. This ad followed a 9/23 press conference held by members of Calpers, AFSCME, CalSTERS, New York State Comptroller, New York City Comptroller and Connecticut State Treasurer on the same point. At the press conference, AFSCME released a survey showing that 84% of 1,030 individual investors stated that there should be a process to allow shareholders to nominate candidates for boards. The survey also showed that a majority of the respondents believed that management is not in the best position to determine who should be nominated. Many institutional investors have made clear that this rulemaking is their top priority right now.

My take? The SEC almost certainly has the authority to go forward with a shareholder access rulemaking (see here). But, on the merits, shareholder democracy is a very bad idea (see here and here). For those who want even more details, I discuss the scope of the SEC's reulmaking authority over the proxy statement at pp. 505-11 of my Corporation Law and Economics treatise, and provide an economic analysis of shareholder democracy at pages 512-17 thereof. (If you think that's a shamelessly self-serving plug, you're right.)

UPDATE: I'm reposting this discussion to move it up the scrolling order in light of this report from TheDeal.com:

The Securities and Exchange Commission is expected next month to issue draft rules that would allow a majority of shareholders to make a proxy proposal criticizing a public company's governance record and to seek investor approval to nominate their own board candidates. ... Under the SEC proposal, obtaining the right to nominate a board member by proxy would be a two-step process. First, a majority of investors must approve a shareholder measure nominating a board candidate. [Second, if] approved, that candidate would appear on the proxy ballot the following year. Only shareholders who own at least 3% to 5% of a company for a minimum of one year would qualify to nominate a candidate on the corporation's ballot. (Link via Corp Law Blog.)

My take remains as above. Corporations are not New England town meetings and shareholders are not owners (the corporation being a legal fiction representing a network of contracts incapable of being owned). If the links above do not persuade you, try my article Director v. Shareholder Primacy in the Convergence Debate. (Or, better yet, buy my book!)

Comparing Tyco's Kozlowski and Deutsche Bank's Ackermann

There is an interesting parallel set of prosecutions going on in the US and Germany. In the latter, the WSJ (sub. req'd) is reporting that Deutsche Bank CEO Josef Ackermann (and some other supervisory board members of Mannesmann AG) have been charged with approving bonuses for Mannesmann executives following approval of Mannesmann's acquisition by Vodafone. In the US, as CNNfn is reporting, the trial of former Tyco CEO Kozlowski began today.

The two cases illustrate a striking difference between US and German law. In US law, executive compensation typically is an issue for private litigation, typically involving shareholder derivative litigation charging waste of corporate assets. Kozlowski's case is a very rare exception to that rule, in which prosecutors are charging that Kozlowski stole from the corporation. The key charge in the indictment is that Kozlowski borrowed money from Tyco and then stole it by causing the "loans to be forgiven without the board's knowledge." If Kozlowski can prove that the board knew and approved the loan forgiveness, I don't see how the charges can stick. Indeed, I'm not convinced the charges will stick even if all Kozlowski can prove is that the loans were properly processed by corporate subordinates (specifically the firm's accounting department).

In contrast, under German law, criminal prosecutions over allegedly excessive executive compensation are a lot easier. The Economist explains that "Paragraph 87 of Germany's securities law says that [bonuses] to board members should bear a 'reasonable relationship to their duties'." I gather that such prosecutions are pretty rare in Germany and that this prosecution is especially controversial.

Personally, I think criminalizing the issue of excessive executive compensation is just nuts. But prosecuting not just the executives who got paid too much but also the board members who approve the payments is really crazy. Public corporations are finding it increasingly difficult to recruit and retain qualified independent directors. Relatively low pay, compensation in stock rather than cash, and increased time demands and liability exposure have all combined to render board service far less attractive than it once was. Criminalizing their executive compensation decisions, which are among the most controversial decisions a board makes, however, would make an bad situation almost impossible. What sane person would be willing to sit on a corporate board?

Eugene Volokh on choosing blogging topics

At the The Volokh Conspiracy, my friend and colleague Eugene Volokh explains how he picks topics for his incessant blogging:

My favorite hobby-horses are ones that (1) I know a lot about, so they require relatively little work for me (hence the not infrequent posts on various free speech issues); (2) I feel I have something new to say about (hence, for instance, the weird detour into the number of sexual partners that the median American male homosexual has), so that I feel my work would be worthwhile, and a pleasure; (3) require mostly armchair thinking based on stuff I already know; (4) strike me as unusually interesting; (5) come around when I've got relatively little real work to do, or a relatively great urge to procrastinate instead of doing that work; or (6) best yet, have as many of the above traits as possible.

I hadn't thought it through in that level of detail, but I'd say those factors also guide my decisionmaking. The end product differs, of course, because I don;t know much about free speech and it seems highly unlikely that I would even have anything new to say about the "weird detour" Eugene took. As with Eugene, however, applying these factors does explain why I am not going to blog about the current blogosphere brouhaha -- the Valerie Plame affair. In my casy, moreover, it also explains why I do not warblog (is that a verb or just a noun?).

More insider trading news

Several of my fellow corporate law blawggers have been writing about the case of attorney Arthur K. Bartlett who recently disgorged the whopping sum of $4,272 (plus $71 in prejudgment interest) and also paid a $4,272 civil penalty under ITSA. Corp Law Blog asks: "Does anyone think those penalties will deter future insider traders?," but goes point out that the private sanctions (loss of job and possible disbarrment) are much more severe. The oddly named, but always worth reading, By No Other blawg, uses this case to teach some worthwhile life lessons. Finally, Securities Litigation Watch comments:

$4,272? That has to be close to the record for "lowest insider trading gain subject to an SEC enforcement action." It is certainly a reminder that there really is no de minimis exception for persons who would engage in insider trading--if the SEC thinks they have the goods on you, they'll bring the case for deterrent value alone.

If Bartlett was the record, the SEC broke it almost immediately -- nay, shattered it! The Commission today announced that:

[California attorney Warren J.] Soloski has consented to the entry of a final judgment requiring him to pay disgorgement of $922.14, prejudgment interest of $288.83 thereon, and a one-time civil penalty of $922.14.

Maybe the SEC really wanted to drive home the point that there is no de minimis exception.

Speaking of insider trading, the website learnabout law.com says: "Professor Stephen Bainbridge of UCLA has authored a thorough and definitive summary of insider trading law entitled Securities Law: Insider Trading." You can buy it HERE.

Yes, the insiders are selling. But should you?

The headline of a NY Times article poses the titular question. Heavy insider selling is usually thought to be a bearish signal. The Times, however, relies on work by Nejat Seyhun, a finance professor at the University of Michigan to suggest that the current wave of selling is not necessarily pro-bear.

[Seyhun explains that] the new wave of insider selling has occurred while the stock market has been rallying. His research has found that such selling carries far less bearish significance than selling during a market decline.

To document this difference, Professor Seyhun looked at each publicly traded company on the New York and American stock exchanges and the Nasdaq market from the beginning of 1975 to the end of 2000, identifying all months when the company's insiders were net sellers.

Professor Seyhun found that when insiders sold during a decline, the stocks they sold lagged behind the overall market by an average of 5 percent over the next 12 months. ... In contrast, Professor Seyhun found no discernible pattern in the subsequent performance of stocks sold by insiders while the market was rallying.

As a result, he concludes, the current high level of insider selling provides no signal for the market's direction. He advises investors who base their equity exposure on the behavior of insiders to "sit tight and watch both stock prices and insider trading" in the coming months.

Sounds like good advice to me. (But I have my money, such as it is, parked in no-load low-fee passively managed index funds. Why? Because Malkiel told me to!) Anyway, while I have never met Prof. Seyhun, I have read much of his scholarly output. He is a very close and able student of insider selling patterns, who has done a lot of high quality empirical research on the subject. Seyhun's book Investment Intelligence from Insider Trading pulls that research together in a very effective way.

Reed to cut NYSE board

The WSJ (sub. req'd) is reporting that interim chief John Reed "favors much smaller boards [that the NYSE's current 27 members] as being more effective." He's right that a smaller board will be more effective, for reasons I have blogged previously. Apparently Reed also favors effecting the change by moving some or all of the Wall Street CEOs on the current board into a new advisory board that would lack any oversight of or involvement with the NYSE's regulatory function. IMHO, this is also the right call, as it made no sense for Grasso to be monitored by the very people he regulated. Long term, however, as I have argued before, the best solution is separation of the regulatory and trading functions followed by privitization of the latter.

Calistoga AVA?

The Wine Spectator Online is reporting on a push for a new Calistoga AVA:

Napa Valley is already divided into 13 subappellations, but the Calistoga area -- although as well-known nowadays for its Cabernets as for its hot springs -- is not among them. Chateau Montelena co-owner and winemaker Bo Barrett is trying to change that. ...

The proposed appellation would encompass about 7 square miles of land on the valley floor and in the adjacent mountains, with elevations ranging from 300 to 1,200 feet. The area is bordered on the west by the Mayacamas mountain range (which separates Napa from Sonoma) and on the east by the Vaca range. The appellation would be north of the St. Helena district, west of the Howell Mountain AVA, east of the Diamond Mountain AVA and just below Napa County's northern border.

AVAs do not yet have the viticultural significance of French AOCs, mainly because the rules governing the former are far more lax:

An AVA is defined strictly by a geographic area, whereas in France the parameters are much more precise. A French AOC identifies the grape varieties that may be grown in a geographic area, the maximum production per acre, the minimum level of alcohol required for wines produced in the area, and so forth.

Over time, however, market forces are accomplishing for the AVA system what regulation did not. Certain AVAs, perhaps most notably the sub-Napa Valley AVAs of Rutherford and Oakville, are becoming increasingly monocultural (Cabernet in both cases). To be sure, neither has achieved the singlemindness imposed by the French AOC system, as this list of the wildly diverse varieties grown in Rutherford demonstrates. Yet, markets work and thse AVAs are best-known for their fabulous Cabs, which creates incentives for growers to shift towards that variety. We see similar developments in parts of the Central Coast, where some of the AVAs around Santa Barbara are becoming known as Pinot Noir specialists.

What about the proposed Calistoga AVA? Viticulturally, Calistoga does have some unique characteristics. On our annual visits to the Napa Valley, Calistoga is always the warmest of the main wine towns (it is the furthest inland and thus least subject to maritime influences). The proposed AVA would cover vineyards that mostly specialize in warm climate varieties, especially Cabernet Sauvignon and Zinfandel. The better wines from this area have a distinctive fruitiness that easily tips to jammy in warm years. Chateau Montelena's Estate is probably the best example (very pricey, but their Calistoga Cuvee is more affordable, although still not cheap). IMHO, the poposed AVA would produce wines sufficiently distinctive from the generic Napa Valley type to warrant its own appellation.

More on behavioral economics

The new Law and Economics Blog criticizes my post Behavioral Economic Analysis of Law:

An uninformed reader would be greatly mislead in reading Professor Bainbridge's broad based criticism of legal decision theory, backed by what is simply a critique of one of its applications. Moreover, he largely ignores the descriptive power of legal decision theory by mentioning only one of its potential normative implications. To be fair, the blogosphere does not lend itself to comprehensive critiques. Professor Bainbridge may have good reasons in support of his seemingly over-broad introductory criticism. That the blogosphere is so situated, though, only speaks to why we should be careful when engaging in such a critique.

As to the complaint that I did not provide a "comprehensive critique," it would have been nice if the blogger had acknowledged that I included the following at the end of my post:

You can read an even more extended version of my argument, with application to the longstanding debate over mandatory disclosure in securities regulation, in my article Mandatory Disclosure: A Behavioral Analysis, 68 University of Cincinnati Law Review 1023 (2000).

If we're going to "be careful when engaging in ... a critique," let's include all the relevant facts.

Anyway, as for the complaint that I mention "only one of its [i.e., behavioral economics'] potential normative implications," the policymaking normative implications of behavioral economics strike me, at least, as the key question. In my article, I provide an example of one scholar who used generic behavioral economics claims to justify a prohibition of investor waivers of their rights under the securities laws, without showing that the various cognitive errors cited actually affect investor behavior in the context at hand. Behavioral economics, of course, can be relevant to legal issues other than policymaking. It might, for example, help lawyers and academics get a better handle on negotiations. Nothing in my post denies that. But my post was intended principally to suggest a limitation on the use of behavioral economics as a normative policymaking tool. If that wasn't clear enough, my bad; but, personally, I think it was clear enough.

UPDATE: Greg Goelzhauser of the Law and Economics blog responds here. Admittedly, I got a little testy in responding to his initial post. (In my defense, I hadn't had my morning coffee yet, although that's not much of an excuse, I admit.) But I stand by my substantive point that people are already using behavioral economics to make normative policy recommendations and that I am skeptical of doing so for the reasons developed in both the post and the article.

Ribstein on movies about business and why Hollywood hates capitalists

My friend University of Illinois law professor Larry Ribstein is best known as the leading expert on unincorporated business associations and a stalwart defender of the nexus of contracts theory of the firm. It turns out, however, that he is also a movie critic. At his home page, he has posted a new article: Art and Money in Movies: Why Hollywood Bashes Business. Very interesting. Here's the set of questions that prompted his interest:

Why does business look bad in movies? One writer (Anthony Chase, Civil Action Cinema, 1999 Law Review of Michigan State University Detroit College of Law 945, 957) explained that “[i]t is about money. And corporations have more money than everyone else. They can pay their attorneys more and last longer and usually win; certainly when they are dragged into court, kicking and screaming, by the powerless.”

But this general condemnation of business seems an unlikely explanation for films’ anti-business tone. Capitalism has brought vast wealth to a broad segment of U.S society, including most moviegoers and the writers, directors and stars who make the movies. One would not be surprised to see occasional criticism of capitalism, or to see moviemakers make good use of the drama inherent in the oppression and eventual triumph of economic underdogs. But why should capital always be the heavy? Why should filmmakers so rarely exploit the dramatic potential of business triumph, or of underdog businesspeople struggling against the tyranny of government? More importantly, films are themselves the product of large companies, many of which are parts of even larger conglomerates. Why would they attack themselves?

His answer: "the filmmakers’ main problem with capital being in control seems to be that the filmmakers are not." I'm not sure I buy that answer, but it is a provocative claim that is well-executed. But this article also raises a question of my own: How does Larry manage to be such a prolific producer of exceptionally high quality scholarship when he obviously spends so much time watching movies?

Field conservatives in So Cal academy

Following up on the blogosphere brouhaha over David Brooks' NY Times article on conservatives in the academy, my friend Tom Smith has a provocative post over at The Right Coast on the difference between house and field conservatives:

Brooks is a house conservative. He is careful never to say anything that would overly upset liberals. He is oh so nice on the Leher News Hour. For this reason, he is less interesting than Mark Shields, who really is knee-jerk liberal, but at least he's a two fisted one.

I like red meat as much as the next guy, especially from a polemicist, but the behavior of field conservatives often calls to mind the best line from the Brook's article:

"Conservatives are people who teach the value of prudence but are incapable of exercising any," says Mark Lilla, a politically unclassifiable professor at the University of Chicago.

There are times when being a firebreather is prudent and times when it isn't; if the trouble with house conservatives is that they never think its the right time to be a bomb thrower, the trouble with field conservatives is that they often seem to have no other mode of operation! Field conservatives, moreover, tend to devote at least as much time to squabbling with other conservatives as they do with liberals and moderates. This Taki column on David Frum is a hysterical example of the phenomenon, BTW. Hey, for that matter, so is this post!

BusinessPundit on business ethics

The BusinessPundit has an interesting post on business ethics:

If the only way you can stay in business is by lying, cheating, and manipulating your books, then you are a lousy capitalist and you will eventually get what is coming to you. Business schools need to step up and teach students more business philosophy. They need to know that they should play fair even when government regulators aren't looking, because otherwise earnings, stock price increases, or contract wins are meaningless. How can anyone be proud of their business accomplishments if they cheated?

Its not clear to me that ethics education at the post-graduate level can help all that much. Values and ethics education needs to start a lot earlier than that to take, I suspect: "Raise up a child in the way he should go. And when he is old he will not depart from it." On the other hand, it can't hurt.

One virtue of values and ethics education is suggested by the distinction between virtue and principle ethics. Principle ethics are most attractive to those who are tempted to propose a rule as a solution to a problem. In a principle-dominated ethical system, the moral life consists mainly of complying with society’s mandated code of conduct. In contrast, virtue ethics reject codes of conduct in favor of context-based judgment. In a virtues-based ethical system, the moral life consists mainly of the habitual private exercise of truthfulness, courage, justice, mercy, and the other virtues. Ideally, values-based education becomes one of those intermediating institutions that build what George Weigel calls “a citizenry regulating itself from within according to a shared public ‘language of good and evil.’”

In the wake of the Enron scandal, Congress and the SEC opted for a principle ethics-based approach. They mandated a host of new legal ethics rules. I supported these rules, but for reasons I’ve outlined in two recent law review articles (here and here) I doubt whether they’ll work in the absence of the sort of business and legal professionals who are capable of regulating themselves because they have internalized norms of honesty and justice.

Who was the Greatest US Supreme Justice? A Corporate/Securities Law Perspective

I was recently given a copy of Bernard Schwartz's entertaining book, A Book of Legal Lists, which includes lists of both the 10 greatest and 10 worst US supreme court justices. Those chapters reminded me of an article I wrote with my friend (and, regretably, former colleague) Mitu Gulati a few years ago, in which we had occasion to make an objective empirical evaluation of greatness on the part of modern supreme court justices.

As a proxy for the importance of cases decided by the Supreme Court, we looked at opinions that found their way into the casebooks. Specifically, we looked at thirty-eight currently used case books on Corporations, Business Associations, Securities Regulation, and Corporate Finance. For each casebook, we counted the number of securities and corporate opinions by the various Supreme Court justices. If the same case appeared in two casebooks, it was counted twice, and so on. We assumed more important cases would appear in more casebooks and that greatness would translate into a justice being assigned the most important (and most often reproduced) cases.

The table reveals a dramatic dominance effect for the late Justice Lewis Powell, both in terms of his overall number of securities and corporate cases in casebooks and his per year entry rate. In terms of total cases, Powell has sixty-one and only two other justices have more than 20 (White (22) and Blackmun (21); Marshall comes next closest with 19). A similar skew is present in the per year entry rates. Powell has an average of four securities or corporate cases entering the casebooks per year. The next closest number is 1.25. Finally, note that these are only comparisons for only those justices who have securities or corporate cases in the casebooks. Most have none. So, for our purposes, Lewis Powell ranks as the Greatest Supreme Court Justice. Your mileage, of course, may vary.

An alternate to the expertise/greatness hypothesis might be that Powell was simply a superior casebook opinion writer. While we did not test this alternate hypothesis, anecdotal evidence suggests that Powell did not having anything close to the same level of influence in other areas. He was an excellent opinion writer and among the more influential justices of his time. But his clear dominance was limited to the business areas. See Richard A. Posner, Cardozo: A Study in Reputation (1990) (commenting on Powell’s skill at opinion writing and comparing the influence levels of a set of different justices); Montgomery N. Koma, Measuring the Influence of Supreme Court Justices, 27 J. Legal Stud. 333 (1998) (ranking the justices according to influence levels as measured by citations).

Pine Ridge Cabernet Sauvignon Rutherford 2000

While the good wife has been under the weather, and abstaining per doctor's orders, the really good stuff apparently is off limits. Mind you, I am not saying she hid the key to the wine cellar. All I am saying is that she was the last one to see the key. And, that I vaguely remember something from criminal law about motive and opportunity. Luckily, however, some of the Pine Ridge was in the auxillary cellar, which has no lock. Hah!

I picked up a case of this wine last spring when we visited the Napa Valley. Fortunately, a Wine Spectator tasting note (subscription req'd) warned me that: "Intensity tails off on the finish, making this a good bet for near-term consumption." I tend to agree; this wine lacks the stuffing for long-term cellaring. In the short-term, however, wow!

Medium-deep purple-red shading to ruby at the rim. Big nose -- great blast of Napa cabernet fruit: currants, milk chocolate, and a whiff of the humidor. The palate follows the nose: smooth tannins, dark fruits, herbs, tobacco, lead pencil shavings. Short finish, though.

Coming clean for my readers: "What kind of conservative are you?"

After writing the prior post, I decided to have some fun. (It was either that or go tackle the ton of decorative rocks the good wife wants placed decoratively in the backyard.) So I Googled the following phrase: "what kind of conservative are you?" It kicked up a British online quiz for Tories:

My #1 result for the SelectSmart.com selector, What kind of Conservative are you?, is Libertarian Conservative.

Oh to have been a Tory in England when Lady Thatcher was in charge!

Turning to the US, on the well-known Kamber and O'Leary scale, I scored a 34, which slots me between Jack Kemp (30) and Bob Dole (35), but well-short of Ronald Reagan (maxing out the scale at 40). Bummer.

On the other hand, at the World's Smallest Political Quiz I scored as a "Centrist" and am told "Centrists favor selective government intervention and emphasize practical solutions to current problems. They tend to keep an open mind on new issues. Many centrists feel that government serves as a check on excessive liberty."

On yet another hand, however, at the distributive justice site (link via The Yin Blog), it was back to being a "right libertarian," which they describe as:

Right Libertarianism: "Theory that defends unlimited laissez-faire capitalism as the only morally justified regime. The main assumptions of this doctrine are twofold: the right of every individual to unlimited utilisation of his own person (self-ownership); and the right to unrestricted, or relatively mildly limited, appropriation of external resources. The first means that an individual has exclusive right to all the goods that are product of use of his talents and efforts. The second means that he has either the right to appropriate all natural resources which he finds and takes before others, or that such an appropriation is limited only by the fact that he must not put others in the position which is worse than the one in which they were before his acquisition of the resources. Furthermore, everything that an individual acquires with the help of his abilities, efforts, and use of thus appropriated resources, he can also freely exchange for the goods of others. If such a trade was voluntary, its results are just. This theory is interested only in this that the above procedures are satisfied and that nobody has used violence to take some goods from others. If things go that way, a distribution of resources is just regardless of its outcome, i.e. it is morally right no matter how much someone possesses at the end, and even if somebody does not have anything at all. Forceful intervention of the state for the sake of helping the poor is not allowed. The main representatives of this position are: F.A. Hayek, Jan Narveson, Robert Nozick."

Hmmm. Why no option for Tory with streaks of Catholic libertarian neo-conservative? With Russell Kirk and Michael Novak as "main representatives"? (One answer may be that the two strains co-exist only uneasily. Kirk had some very nasty things to say about neo-cons like Novak.)

Just in case my favorite corp law blawger Mike O'Sullivan gets worried again, I hasten to reassure my regular readers that this is still mostly a corporate law and economics blog, with a sideline in wine tasting. But, what the heck, its the weekend.

Conservatives in academia

In today's NY Times, newly-hired token conservative David Brooks writes of the absence of conservatives in the academy. The factual premise -- that libertarians and conservatives are under-represented on college and university campuses -- seems undeniable:

During the mid-1990's, for example, Professor James Lindgren of Northwestern University Law School conducted a survey of law professors, and concluded that of the faculties of the top 100 law schools, 80% of law professors were Democrats (or leaned left) and only 13% were Republicans (or leaned right). There is no reason to believe these numbers have changed.

Brooks identifies the problem as bias by those who do the hiring:

[T]here's one circumstance that causes [conservative faculty members] true anguish: when a bright conservative student comes to them and says he or she is thinking about pursuing an academic career in the humanities or social sciences. "This is one of the most difficult things," says Alan Kors, a rare conservative at Penn. "One is desperate to see people of independent mind willing to enter the academic world. On the other hand, it is simply the case they will be entering hostile and discriminatory territory." ...

... Will Inboden was working on a master's degree in U.S. history at Yale when a liberal professor pulled him aside after class and said: "You're one of the best students I've got, and you could have an outstanding career. But I have to caution you: hiring committees are loath to hire political conservatives. You've got to be really quiet."

Conservative professors emphasize that most discrimination is not conscious. A person who voted for President Bush may be viewed as an oddity, but the main problem in finding a job is that the sorts of subjects a conservative is likely to investigate — say, diplomatic or military history — do not excite hiring committees. Professors are interested in the subjects they are already pursuing, and in a horrible job market it is easy to toss out applications from people who are doing something different.

As a result, faculties skew overwhelmingly to the left.

If I may coin a phrase you'll dountless want to use yourself, it all sounds pretty fair and balanced to me. The gist is that there is a bias, but often not a conscious one.

Yet, Brooks' account prompted the following screed from UT law prof Brian Leiter, the gist of which seems to be that conservatives don't get hired because they're not smart enough, with the test of intelligence being faith in God. I'm paraphrasing, of course, so judge for yourself:

As usual, the possibility that conservatives are underrepresented because of intellectual or scholarly deficiencies isn't broached (how could that topic be broached by a journalist, after all?) (Surely it is relevant to an assessment of why Straussians who work on Plato have difficulty getting hired (except in departments already infested) is that they are viewed by all other Plato scholars as sloppy and philosophically inept scholars.)

Conservatives are usually keen to deny that the absence of, say, Blacks in academia doesn't signal bias; why are they so ready to infer bias from the absence of conservatives?

Only 7% of the members of the National Academy of Sciences believe in God, compared to 90% of the U.S. population. What should we infer?

I particularly don't get the point about "the absence of, say, Blacks in academia." Surely Leiter does not intend to ascribe the under-representation of minorities on university faculties to the same causal factor to which he ascribes the under-representation of conservatives! Perhaps all he means is that it is unfair for conservatives to use statistical evidence of bias in this context, because a number of conservatives criticize the use of statistical evidence of discrimination in disparate impact litigation. If so, I am inclined to be charitable both to Leiter and those he criticizes -- I like a little polemics in my blog reading and even the odd debater's trick. (I am puzzled, however, by a reference further down in Leiter's post that seems to claim courts have "largely rejected" statistical evidence of bias in employment discrimination litigation. That's not the way I learned it in law school, but its not a field I keep up with.) In any event, since Leiter apparently accepts as fact that both conservatives and minorities are under-represented in the academy, assessments with which I agree, we need to ask: who's doing the hiring? Only group left is white liberals. If Leiter wants to claim that white liberals are biased against both groups, that's a claim I'd be happy to concede.

Meanwhile, over at the Volokh Conspiracy (and was there ever a pack of smarter moderate and libertarian --albeit, not conservative -- academics?), Juan Non-Volokh has a more temperate commentary:

My experience in the academy ... confirms Brooks' account. Most of the hostility faced by conservatives (and libertarians) is not explicit, and often not conscious or deliberate. In many cases, the subject matter and methodology of conservative scholarship is simply of no interest to those on the left (and probably vice-versa). At schools where there are no tenured conservatives, job candidates and junior professors may be left without a "champion" to help them navigate the process. The lack of right-of-center views at some schools may also make even moderate conservatives appear "kooky" or extreme. By the same token, it is clear to me that many conservatives in academia cry "wolf," or seek to blame political opposition on their failure to succeed in a highly competitive environment. Contrary to what some believe, not every conservative's failure to get tenure is the result of politics.

The last point calls to mind a telling observation in Brooks' article:

"Conservatives are people who teach the value of prudence but are incapable of exercising any," says Mark Lilla, a politically unclassifiable professor at the University of Chicago.

Hmmm ... I wonder if this post is imprudent? Oh well, thank goodness for life tenure.

My own take is pretty close to that of Juan Non-Volokh. Personally, I have encountered very little overt discrimination in my career. On the other hand, I have spent enough time around law school hiring to know that it does happen. All too often, applicants with conservative lines on their resume -- an Olin fellowship, Federalist Society membership, or, heaven help you, a Scalia clerkship -- are passed over no matter how sterling the rest of their credentials may be. The problem is that at most law schools there is no critical mass of conservatives to act as "champions" for such candidates. (Leiter says "libertarians ... are well-represented at most of the top law schools (Yale, Harvard, Chicago, Virginia, Texas, UCLA, Northwestern, etc.)" He clearly has not met enough of our faculty.)

Law school hiring tends to be driven by the self-perpetuating network of left-leaning senior faculty. Nobody pulls the conservative candidate's AALS form out of the slushpile, while the latest left-leaning prodigy gets the benefit of phone calls from their mentors to buddies of the mentors and having their AALS form flagged or even hand carried around the building. It may not be deliberate bias, but there still is a disparate impact.

My advice to aspiring conservative legal academics? Stick to private law topics (business law is especially safe) and follow Juan's advice: "there are reasons some untenured professors blog under pseudonyms."

UPDATE: Over at Scrivener's Error, C.E. Petit blogs:

Professor Stephen Bainbridge (now at UCLA, but my professor for securities law when at his former institution) speculates on possible/perceived bias against conservative professors in his blawg. N.B. I have no doubt that Professor Bainbridge was, and is, a "conservative." I also have no doubt that, unlike some and perhaps many others of many political persuasions, he never allowed that to interfere with his teaching or grading.

My blushes. Petit then goes on to make some very interesting substantive points -- the post is well-worth reading.

UPDATE: Follow-up posts are

Law school hiring; the anti-conservative bias as institutional phenomenon

Conservatives in the academy: An update

Field conservatives in So Cal academy

Coming clean for my readers: "What kind of conservative are you?"

Hitching Post Pinot Noir Santa Barbara County 2000

(WS 87) The Hitching Post is a steakhouse in Buellton, CA, that runs a winery on the side. Or, maybe it's the other way around. Either way, they do a great job. HP is a pinor noir specialist, with a number of distinct bottlings. This is the basic wine -- a county level AVA label (Santa Barbara county). One notch up is the Santa Maria Valley AVA level, and above that are several single-vineyard lots. Personally, I don't find that much difference between the various labels. HP rarely knocks me off my feet, the way truly great pinot noir can. But they make fairly priced, highly reliable, early drinking, eminently quaffable wines. (The good wife is not a pinot noir fan; a small flaw in an otherwise estimable person, which has the upside of leaving more for your reporter.)

The 2000 started out pretty tannic for HP pinot, but is softening up nicely. I think it will hold until around 2006 or so. Good medium-light cherry color. (Kind of like cherry cola, but without the bubbles.) Strong nose of cola, game, earth, and dark cherries. Smooth on the palate, but still showing some tannins. A slightly syrah-like note of raw beef. Grape stems steeped in tea. Good grip on a medium-length finish.

Guttman v. Huang: Del VC Strine on audit committee due care standards

In recent years, increasing regulatory attention has been devoted to the role of the audit committee. In 1999, the major stock exchanges adopted new listing standards (after being prodded by then-SEC Chairman Arthur Levitt in a classic example of how the SEC uses (arguably, abuses) its “raised eyebrow” power) toughening the rules on audit committees. See generally 64 Fed. Reg. 71, 529 (Dec. 21,1999). Likewise, the SEC adopted new disclosure requirements, most notably requiring an annual Audit Committee Report in the proxy statement. Regulation S-K item 306; Schedule 14-A item 7(d)(3). Sarbanes-Oxley and the accompanying stock exchange listing standard amendments further ratcheted up the burdens on audit committees.

A (relatively) new Delaware chancery court opinion by Vice Chancellor Leo Strine sheds light on the state corporation law fallout from these developments. Guttman v. Huang, 823 A.2d 492 (Del. Ch. 2003). Strine is a very smart fellow, with a strong academic bent, who has written a number of important decisions of late. His opinion in Guttman is the best recent summary of the rules of audit committee liability. Because this is a very long post, I have dumped the legal analysis in the Extended Post below. (One of the main reasons for starting this blog was to provide an outlet for scholarly analysis of problems to which I don’t want to devote an entire law review article. This is a very good example of just what I had in mind.)

Generally, corporate directors and officers owe their firm and its shareholders three basic fiduciary duties: care, loyalty, and good faith. See, e.g., Cede & Co. v. Technicolor, Inc., 634 A.2d 345, 361 (Del. 1993). Of these, the duty of care is most relevant for present purposes. The duty of care requires corporate directors to exercise “that amount of care which ordinarily careful and prudent men would use in similar circumstances.” Graham v. Allis-Chalmers Mfg. Co., 188 A.2d 125, 130 (Del.1963). Central to the duty of care is an obligation for directors and officers to avail themselves, “prior to making a business decision, of all material information reasonably available to them.” Aronson v. Lewis, 473 A.2d 805, 811 (Del. 1984); see also Smith v. Van Gorkom, 488 A.2d 858, 872 (Del. 1985). Where the directors have so informed themselves, however, judicial review of their decisions and actions is precluded by the duty of care’s chief corollary—the business judgment rule. [NB: In addition to an informed decision, there are a number of other preconditions that must be satisfied in order for the business judgment to insulate a board’s decisions or actions from judicial review. See generally Stephen M. Bainbridge, Corporation Law and Economics 270-83 (2002) (discussing preconditions).]

The business judgment rule, of course, is a presumption that the directors or officers of a corporation acted on an informed basis, in good faith, and in the honest belief that the action taken was in the best interests of the company. Aronson v. Lewis, 473 A.2d 805, 812 (Del. 1984). “While it is often stated that corporate directors and officers will be liable for negligence in carrying out their corporate duties, all seem agreed that such a statement is misleading. . . . Whatever the terminology, the fact is that liability is rarely imposed upon corporate directors or officers simply for bad judgment and this reluctance to impose liability for unsuccessful business decisions has been doctrinally labeled the business judgment rule.” Joy v. North, 692 F.2d 880, 885 (2d Cir. 1982). See also Kamin v. American Express Co., 383 N.Y.S.2d 807 (Sup.Ct.1976), aff’d, 387 N.Y.S.2d 993 (App. div.1976) (holding that the duty of care “does not mean that a director is chargeable with ordinary negligence for having made an improper decision, or having acted imprudently”); Bayer v. Beran, 49 N.Y.S.2d 2, 6 (Sup. Ct. 1944) (stating that “although the concept of ‘responsibility’ is firmly fixed in the law, it is only in a most unusual and extraordinary case that directors are held liable for negligence in the absence of fraud, or improper motive, or personal interest”).

In the leading In re Caremark Int’l case, then-Delaware Chancellor William Allen opined that the directors’ duty of care includes an affirmative obligation to ensure “that appropriate information will come to its attention in a timely manner as a matter of ordinary operations.” In re Caremark Int’l Inc. Deriv. Litig., 698 A.2d 959, 970 (Del. Ch. 1996). Yet, it is critical to recognize the distinction drawn by Chancellor Allen between allegations involving lack of oversight by directors and mere inadequate oversight. The business judgment rule is relevant only where directors have actually exercised business judgment; in other words, there rule provides no protection where directors have made no decision at all. See, e.g., Aronson v. Lewis, 473 A.2d 805, 813 (Del. 1984) (stating that “the business judgment rule operates only in the context of director action”).

In Caremark, the corporation had no program whatsoever of internal controls to ensure that the corporation complied with key federal statutes governing its operations. When the corporation ran afoul of one of those statutes and was obliged to pay a substantial fine, a derivative suit was brought against the directors. In reviewing the merits of that claim for purposes of evaluating the settlement, Chancellor Allen noted that decisions made deep in the interior of an enterprise by relatively junior employees can have devastating consequences for the firm. Allen also noted two concurrent regulatory trends. On one hand, federal law increasingly uses criminal sanctions to ensure corporate compliance with various regulatory regimes. On the other, the federal criminal sentencing guidelines mitigate sanctions where the corporate defendant had law compliance programs in place. In light of these considerations, Allen rejected the defendants’ argument that “a corporate board has no responsibility to assure that appropriate information and reporting systems are established by management . . . .” Caremark, 698 A.2d at 969-70. Instead, as we have seen, he imposed an affirmative obligation for management and the board to implement systems of internal control. Because the Caremark directors had failed to take any action, the business judgment rule did not insulate them from (potential) liability for this failure. Instead, the duty of care controlled.

Where the board and management have established systems of internal control, however, the business judgment rule becomes the relevant standard of review. [NB: Indeed, it may be plausibly argued that the business judgment rule would insulate directors from liability even if the board considered the issue and then affirmatively decided not to adopt a system of internal controls relevant to the issue at hand. In theory, after all, a decision not to act does not differ from a decision to take action. In Caremark, moreover, Chancellor Allen made clear that directors who act in good faith through proper procedures are not liable even if, in retrospect, they made the wrong decision. Caremark, 698 A.2d at 967-68. The business judgment rule, as typically formulated, would seem to protect directors who rationally adopt either a minimal compliance program or even no program at all after weighing the costs against the benefits. Bainbridge, supra, at 296.

Hence, when reviewing how the directors have exercised their oversight function through an extant system of internal controls—as opposed to entirely failing even to create such a system—the standard of review becomes one that a plaintiff-shareholder can satisfy only with great difficulty. Plaintiff must show the traditional grounds on which the business judgment rule is set aside: fraud, illegality, or self-dealing.

Vice Chancellor Strine’s decision in Guttman v. Huang seems to blur this important distinction. In that decision, Vice Chancellor Strine opined that:

[T]he Caremark opinion articulates a standard for liability for failures of oversight that requires a showing that the directors breached their duty of loyalty by failing to attend to their duties in good faith. Put otherwise, the decision premises liability on a showing that the directors were conscious of the fact that they were not doing their jobs.

823 A.2d at 506. Guttman thus seems to establish a single standard of liability for cases involving negligent oversight through an extant system of internal controls and for failures to exercise oversight by failing to create such a system. If so, in my view, Guttman blurs a doctrinal distinction I regard as critical to understanding Caremark. (The two standards perhaps can be reconciled by arguing that directors who are “conscious of the fact that they were not doing their jobs” have “abdicated their functions,” which is not protected by the business judgment rule. Aronson v. Lewis, 473 A.2d 805, 813 (Del. 1984).)

Fortunately, even if Guttman is correct, the standard remains one which a derivative suit shareholder-plaintiff can satisfy only with great difficulty. Vice Chancellor Strine approvingly quoted a key passage from Chancellor Allen’s Caremark opinion:

Generally where a claim of directorial liability for corporate loss is predicated upon ignorance of liability creating activities within the corporation ... in my opinion only a sustained or systematic failure of the board to exercise oversight—such as an utter failure to attempt to assure a reasonable information and reporting system exists—will establish the lack of good faith that is a necessary condition to liability. Such a test of liability—lack of good faith as evidenced by sustained or systematic failure of a director to exercise reasonable oversight—is quite high. But, a demanding test of liability in the oversight context is probably beneficial to stockholders as a class, as it is in the board decision context, since it makes board service by qualified persons more likely, while continuing to act as a stimulus to good faith performance of duty by such directors.

Caremark, 698 A.2d at 971 (emphasis supplied), quoted in Guttman v. Huang, 823 A.2d 492, 506 (Del. Ch. 2003). Hence, the Vice Chancellor indicated that a Caremark claim must plead facts showing that, inter alia, “that the company lacked an audit committee, that the company had an audit committee that met only sporadically and devoted patently inadequate time to its work, or that the audit committee had clear notice of serious accounting irregularities and simply chose to ignore them or, even worse, to encourage their continuation.” Guttman, 823 A.2d at 507.

The bottom line thus seems to be that audit committees still receive substantial protection. Mere negligence still shpu;d not result in liability. Instead, a systemic breakdown in oversight or conscious disregard of clear problems is required. In my view, however, Vice Chancellor Strine would have done better to make clearer that the business judgment rule still applies in full force to an audit committee’s oversight functions. I have written a law review article entitled The Business Judgment Rule as Abstention Doctrine, forthcoming in the Vanderbilt Law Review, in which I explain in detail why courts generally should abstain from reviewing board decisions. In my view, those arguments carry over in full force to review of how an audit committee carries out its functions.

In brief, there is the problem of judging by hindsight. Decisionmakers tend to assign an erroneously high probability of occurrence to a probabilistic event simply because it ended up occurring. Christine Jolls et al., A Behavioral Approach to Law and Economics, 50 Stan. L. Rev. 1471, 1523 (1998). If a jury knows that the plaintiff was injured, the jury will be biased in favor of imposing negligence liability even if, viewed ex ante, there was a very low probability that such an injury would occur and that taking precautions against such an injury was not cost effective. Even where duty of care cases are tried without a jury, as in Delaware, judges who know with the benefit of hindsight that a business decision turned out badly likewise could be biased towards finding a breach of the duty of care. Cf. Chris Guthrie et al., Inside the Judicial Mind, 86 Cornell L. Rev. 777, 799-805 (2001) (discussing empirical evidence that judicial decisionmaking is tainted by the hindsight bias). Hence, there is a substantial risk that judges will be unable to distinguish between competent and negligent management because bad outcomes often will be regarded, ex post, as having been foreseeable and, therefore, preventable ex ante.

Second, business decisions are frequently complex and made under conditions of uncertainty. Accordingly, bounded rationality and information asymmetries counsel judicial abstention from reviewing board decisions. Judges likely have less general business expertise than directors. They also have less information about the specifics of the particular firm in question. To be sure, the old adage that “judges are not business experts” cannot be a complete explanation for the business judgment rule. Yet, many old adages have more than a grain of truth. So too does this one. Justice Jackson famously observed of the Supreme Court: “We are not final because we are infallible, but we are infallible only because we are final.” Neither courts nor boards are infallible, but someone must be final. Otherwise we end up with a never ending process of appellate review. The question then is simply who is better suited to be vested with the mantle of infallibility that comes by virtue of being final—directors or judges?

Corporate directors operate within a pervasive web of accountability mechanisms. A very important set of constraints are provided by a competition in a number of markets. The capital and product markets, the internal and external employment markets, and the market for corporate control all constrain shirking by directors and managers. Granted, only the most naïve would assume that these markets perfectly constrain director decisionmaking. It would be equally naïve, however, to ignore the lack of comparable market constraints on judicial decisionmaking. Market forces work an imperfect Darwinian selection on corporate decisionmakers, but no such forces constrain erring judges. As such, rational shareholders will prefer the risk of director error to that of judicial error.

Finally, judicial review could interfere with—or even destroy—the internal team governance structures that regulate board behavior. Research on relational teams –which are what boards and board committees are – shows that they are not only hard to monitor, but that they also are hard to discipline. Stephen M. Bainbridge, Why a Board? Group Decision Making in Corporate Governance, 55 Vand. L. Rev. 1, 49 (2002). Instead of external review, relational teams are best monitored by a combination of mutual motivation, peer pressure, and internal monitoring. As I have explained elsewhere in more detail, however, judicial review might well destroy the interpersonal relationships that foster these forms of internal board governance. Id. at 49-50.

In sum, Guttman is an interesting development, but one the Delaware courts should promptly clarify as incorporating the classic business judgment rule. The justifications for the business judgment rule apply in full force to the present setting.

Board size: Is there an optimum?

In the extensive commentary on the NYSE’s governance problems, a point I have not seen discussed very much is the sheer size of the NYSE board.

Board sizes vary widely. But most public corporation boards are much smaller than the NYSE’s 27 members. A 1999 survey by the National Association of Corporate Directors (NACD) found that slightly less than half of corporate boards had seven to nine members, with the remaining boards scattered evenly on either side of that range.

Is there an optimal board size? One meta-analysis of studies of board size in particular found a statistically significant correlation between increased board size and improved financial performance. Dan R. Dalton, Number of Directors and Financial Performance: A Meta-Analysis, 42 Acad. Mgmt. J. 674, 676 (1999). Given the potential influence of confounding variables, however, it does not seem safe to draw firm conclusions from that survey. Other studies, moreover, are to the contrary. See, e.g., Sanjai Bhagat & Bernard Black, The Uncertain Relationship Between Board Composition and Firm Performance, 54 Bus. Law. 921, 941-42 (1999) (summarizing studies); Theodore Eisenberg et al., Larger Board Size and Decreasing Firm Value in Small Firms, 48 J. Fin. Econ. 35, 36 (1998) (finding a significant negative correlation between board size and firm profitability in small and medium Finnish firms).

Up to a certain point, large boards can have a number of benefits. Larger size may facilitate the board’s resource-gathering function, since a larger number of directors will usually translate into more interlocking relationships with other organizations that may be useful in providing resources such as customers, clients, credit, and supplies. Larger boards with diverse interlocks are also likely to include a greater number of specialists—such as investment bankers or attorneys—who bring special expertise to the table.

On the other hand, a number of considerations suggest that small boards may be preferable. Large boards tend to be contentious and fragmented, which would reduces their ability collectively to monitor and discipline senior management. In such cases, the senior managers can affirmatively take advantage of the board through “coalition building, selective channeling of information, and ‘dividing and conquering.’ ” Jeffrey A. Alexander et al., Leadership Instability in Hospitals: The Influence of Board-CEO Relations and Organizational Growth and Decline, 38 Admin. Sci. Q. 74, 79 (1993). There seems to be plenty of evidence of this phenomenon at the NYSE under Grasso.

The social loafing phenomenon also suggests an upper limit on efficient group size. In a famous 1913 study which measured how hard subjects pulled a rope, members of two-person teams pulled to only ninety-three percent of their individual capacity, members of trios pulled to only eighty-five percent, and members of groups of eight pulled to only forty-nine percent. See David A. Kravitz & Barbara Martin, Ringelmann Rediscovered: The Original Article, 50 J. Personality & Soc. Psychol. 936, 938 (1986). This phenomenon is partially attributable to the difficulty of coordinating group effort as size increases. (Too many cooks spoil the soup.) Social loafing is also attributable, however, to the difficulty of motivating members of a group where identification and/or measurement of individual productivity are difficult—i.e., where the group functions as a production team. As group size grows, for example, the number of nonparticipants (loafers) likely increases. In addition, larger boards may inhibit the formation of the sorts of close-knit relationships by which groups constrain agency costs.

On balance, my guess is that 27 is way too big for optimal board functioning. A Korn/Ferry survey of corporate directors found: "According to respondents, the optimal board size is two inside directors and eight outside." So add this to the list of necessary NYSE reforms.

Blogs and blawgs briefly noted

A new group blog by 6 University of San Diego law professors can be found at The Right Coast. I know three of the six: Gail Heriot, Saikrishna Prakash, and Thomas Smith. All three are smart and interesting folks, so it should be a good blog (even if Sai's view of the misappropriation theory and Tom's view of fiduciary duties need improvement!). They promise a mix of "Law, Politics, and Culture." A word of advice, from all of my "vast" blogging experience: make the switch to TypePad sooner rather than later. You'll be much happier.

Venturpreneur on a difference between contracts and corporations law professors. He asks: "Perhaps contracts professors are smarter (or dumber?) than corporations professors?" The answer to that one seems pretty obvious to me.

Tyler at Marginal Revolution on the economics of the penny. Proposals to abolish the penny have been around forever (one even made it into a West Wing episode), but it'll never happen. Its all about the sales tax (scroll down to the article about the sales tax token). See also HERE.

Corp Law Blog on "the 'something must be done' syndrome" and regulation of financial markets. Also, ties in a recent insider trading case.

Volokh v. Leiter on campus free speech. I think Leiter is a bit rough on my friend and colleague Volokh, who not infrequently picks on innocent conservative polemicists and sticks up for left-wing terrorists (or, more accurately, the universities that allow them to speak on campus).

Tom Smith at the new Right Coast blawg blasts the Nature article on the ECMH; correctly, in my view: "So the folks at Santa Fe Institute have noticed there is more than one way to produce a random series. Well, duh."

Ernie on law firm websites, with some interesting quibbles in the comments section.

Jonah Goldberg at NRO Corner slams -- really slams -- Huffington.

Yet another example of why Al Bundy was right about the French.

Plainsman on Bashman; all blawggers stand in awe and envy (but not shock). On the same topic, D at Sub Judice predicts: "in one year, writing an email to Howard Bashman, hoping for a positive mention in the blog, will become part of what it means to zealously represent a client in a high profile appellate case. Yikes."

I don't know how Lawrence Solum of the Legal Theory Blog does it. This post is timed stamped 9/25/2003 12:03:01 AM; this post is time stamped 9/25/2003 12:03:40 AM; and 4 more posts in between with 12:03 time stamps! That’s 6 posts in under 40 seconds! Granted he's automating the posting process, but, even so, when does he write it all? BTW, did you notice that an anagram of Lawrence Solum is ME ONCE SLUR LAW? Also, LAW MEN SO CRUEL?

Watch this space for a post "Who was the Greatest US Supreme Justice? A Securities Law Perspective": Coming soon!

Taylor Fladgate First Estate Port NV; Cockburn Special Reserve Port NV

The Taylor Fladgate is a vintage character port I have had quite frequently. A deep impenetrable black-purple even at the rim. A hot, rustic nose of stewed fruits. Raisins and cigarettes on the palate. Sweet, but decent acidity to balance it. Previous bottles have been better; this one was ever so slightly cooked. Caveat emptor.

And so it was on to the Cockburn. There was a time when this was my regular everyday port; if the California economy continues going south, it may become so again. Much less impenetrable than the Taylor -- medium ruby edging to brick at the edges. Looks (and tastes) much more mature than the Taylor. Jammy nose of chocolate and prunes. Flavor profile ranges from dried red currants to chocolate. Violets(?). Simple but tasty. The finish cloys a bit, with mouth-coating tannins.

I think I'll stick to tawnys for a while.

Villa Antinori Chianti Classico Riserva 2000

Medium deep purple shading to ruby-red at the edge; not yet showing the typical Chianti orange-amber rim. Classic Chianti floral nose. Smooth tannins, strong acidity, medium body. Dried black fruits, oriental spice, earth, and leather. Doesn't yet have the barnyard element typical of mature Chianti. Good food wine; but not for spaghetti; try a classic bistecca pizzaiola or, even better, bistecca alla Fiorentina.

What is the appropriate motivation for director nominees?

Over at TheCorporateCounsel.net Blog, Broc poses the titular question, and comments:

One aspect of boardroom reform that has not been fully explored is what should be an acceptable motivation for someone who seeks to serve as a director. Historically, directors have agreed to serve principally for the prestige and clublike atmosphere. Some have done it for the money - although this is unlikely the case for those directors that earn big dollars as officers at other companies.

At the recent BRT Roundtable on Corporate Governance, Fannie Mae CEO Franklin Raines explained that he joined Pfizer's board to enhance his ability to be an innovator - which in turn would benefit his employer. This is an honest and understandable answer - but does it serve the needs of Pfizer's shareholders to whom he now owes fiduciary duties?

Personally, I think you want directors motivated by precisely what motivated Raines -- i.e., healthy self-interest. In The Wealth of Nations, Adam Smith famously remarked:

It is not from the benevolence of the butcher, the brewer, or the baker that we expect our dinner, but from their regard to their own interest. We address ourselves, not to their humanity but to their self-love, and never talk to them of our own necessities but of their advantages. [Book I, Chap.2.]

[In the course of conducting business, a business person generally] neither intends to promote the public interest, nor knows how much he is promoting it. [Instead, the business person] intends only his own gain, and he is in this, as in many other cases, led by an invisible hand to promote an end which was no part of his intention. Nor is it always the worse for the society that it was no part of it. By pursuing his own interest he frequently promotes that of the society more effectually than when he really intends to promote it. I have never known much good done by those who affected to trade for the public good. [Book IV, Chap. 2.]

Of course, Smith also famously railed against joint stock companies, which we now know to be error, but even mighty Homer nods.

Independent directors are not a panacea for the ills of corporate governance, as I have argued elsewhere, but independent directors motivated by a healthy concern for the self-interest do have considerable incentives to actively monitor management and to discipline poor managers. If the company fails on their watch, for example, the independent directors’ reputation and thus their future employability is likely to suffer. Those incentives are not perfect, of course, as demonstrated by the failures of independent directors at Enron and its ilk. But no motivation besides self-interest is more likely to elicit whatever benefits director independence can provide.

The fallout from Grasso? How about more worthless disclosure?

How will public corporations respond to the Grasso imbroglio? The New York Times speculates:

Directors of big companies, already under pressure to demonstrate independence from management, are now worried that they will be blamed for failing to explain not only how much but how they pay chief executives. ...

When companies send proxy statements to shareholders early next year, [Tom Wamberg, chief executive of Clark Consulting] said, they will be noticeably thicker, because directors feel compelled to spell out the terms of the deals they have struck with company officers.

"Our advice to our clients is overcommunicate, overexplain," Mr. Wamberg said. "For each required disclosure, what could have been four paragraphs is going to be eight paragraphs."

Wamberg's prediction strikes me as just about right. Risk averse lawyers will not want to be blamed by their clients if the firm gets bad PR for inadequate disclosure, let alone getting sued (successfully or not). Risk averse directors would rather provide excess disclosure than risk the sort of harm to their reputation that the NYSE's directors are currently experiencing. But is extra disclosure a good thing?

A rational shareholder will expend the effort to make an informed decision only if the expected benefits of doing so outweigh its costs. Given the length and complexity of SEC disclosure documents, the opportunity cost entailed in becoming informed before voting is quite high and very apparent. Moreover, most shareholders' holdings are too small to have any significant effect on the vote's outcome. Accordingly, shareholders assign a relatively low value to the expected benefits of careful consideration. (For a discussion of why rational apathy is a good thing, see HERE.)

The SEC has consistently ignored these textbook principles, insisting that shareholders want more and better disclosure of executive compensation. Ultimately, however, more comprehensible information doesn't help and greater volumes of information only makes the situation worse. For most shareholders, the investment of time and effort necessary to make informed voting decisions remains a game that is not worth playing. What then will shareholders do with the enhanced disclosure they will be getting post-Grasso? They will do what they always do with corporate disclosure: ignore it and simply vote for management's director slate and management compensation proposals.

Some believe that this shareholder passivity model no longer holds true in light of the growing importance of institutional investors. To be sure, institutional investors are an increasingly important force in the stock markets and, moreover, some institutions are playing a more active role in corporate governance. At the same time, however, the passivity model undoubtedly remains applicable even to most institutional investors. Participating in corporate governance is not a cost-less endeavor. Just as with any other shareholder, institutional investors must expend resources to make informed decisions. Most institutional investors therefore will probably seek to free-ride on the efforts of the few who are willing to expend such resources. As is typical of free-riding situations, this means that virtually no one will make informed decisions.

In sum, shareholders will want boards to make cost-effective disclosures. They will not want the board to spend a dollar on disclosure unless the shareholders get back at least $1.01 worth of additional value in the form of more informed decisions, greater accountability, and additional transparency. My guess is that Wamberg is right, and that many corporations will be spending a lot more on disclosure than the value the shareholders will get back.

Random stock traders and the ECMH; with a review of Malkiel's Random Walk

An article in Nature claims: "Stock market traders show signs of zero intelligence." It reports on research by J. Doyne Farmer, of the Santa Fe Institute, which purports to find that "that economic decision-making is so varied and complex that it is hard to distinguish it from random choices." They set up a theoretical model that assumes "traders place orders at random rather than on the basis of shrewd calculation and observation of economic trends." The results of running that model replicate many of the statistical features of a real world stock market (the London Stock Exchange in the period 1998-2000). Not being a fan of theoretical modeling, I find this result less persuasive than if it were backed by actual empirical data on ivestor behavior. (Link via Tyler at Marginal Revolution.)

The efficient capital markets hypothesis has long claimed that stock price movements are random. But in the ECMH model randomness refers not to trader behavior but to the proposition that stock price movements are serially independent. Randomness does not mean that the stock market is like throwing darts at a dart board. Stock prices go up on good news and down on bad news. If a company announces a major oil find, all other things being equal, the stock price will go up. Randomness simply means that stock price movements are serially independent: future changes in price are independent of past changes. In other words, investors can not profit by using past prices to predict future prices. Randomness in the ECMH thus is not inconsistent with the proposition that stock market actors are informed rational self-maximizers. In contrast, Nature claims that Farmer's research is inconsistent with that proposition: "by dispensing with even a restricted form of rationality, the new model is daring"

Like Tyler, I think Nature overstates the extent to which the standard ECMH model requires hard assumptions of rationality on the part of investors. Much recent work has been done on incorporating insights from noise theory and behavioral finance into the ECMH. (See also HERE.) Most economists simply do not believe in the extreme version of the ECMH that Nature lays out (as the Nature article itself acknowledges). To this extent, the article is arguing against a strawman. Instead, most economists and economically-minded lawyers who still adhere to ECMH now fall back on the old rule that "it takes a theory to beat a theory." In this view, the ECMH is a first approximation that does a better job of predicting market behavior than any other theory out there. When a theory comes along that generates profitable trading strategies inconsistent with ECMH that will be the day that the ECMH has been disproved. But this study is not that theory.

For more information on the ECMH, as well as a review of the best book ever written on using finance theory as an investment guide, see the extended post.

In RANDOM WALK DOWN WALL STREET, Burton Malkiel sets out the basics of modern corporate financial theory in a way accessible to the law reader. As a teacher of corporate finance to law students, I have recommended this book to my students for over 10 years. Numerous alumni have told me that was the best advise they got in law school (a sad commentary on American legal education, but that's another story).

Two basic theories are expounded here. First, modern portfolio theory (MPT), which elucidates the relationship between risk and diversification. Because investors are risk averse, they must be paid for bearing risk, which is done through a higher expected rate of return. As such, we speak of a risk premium: the difference in the rate of return paid on a risky investment and the rate of return on a risk-free investment. In the real world, we measure the risk premium associated with a particular investment by subtracting the short-term Treasury bill interest rate from the risky investment's rate of return. The risk premium, however, will only reflect certain risks. MPT differentiates between two types of risk: unsystematic and systematic. Unsystematic risk might be regarded as firm-specific risk: The risk that the CEO will have a heart attack; the risk that the firm's workers will go out on strike; the risk that the plant will burn down. These are all firm-specific risks. Systematic risk might be regarded as market risk: risks that affect all firms to one degree or another: changes in market interest rates; election results; recessions; and so forth. MPT acknowledges that risk and return are related: investors will demand a higher rate of return from riskier investments. In other words, a corporation issuing junk bonds must pay a higher rate of return than a company issuing investment grade bonds. Yet, portfolio theory claims that issuers of securities need not compensate investors for unsystematic risk. In other words, investors will not demand a risk premium to reflect firm-specific risks. Why? There is a mathematical proof, which relates to variance and standard deviation, but Malkiel explains it in a way that is quite intuitive. Investors can eliminate unsystematic risk by diversifying their portfolio. Diversification eliminates unsystematic risk, because things tend to come out in the wash. One firm's plant burns down, but another hit oil. Thus, even though the actual rate of return earned on a particular investment is likely to diverge from the expected return, the actual return on a well-diversified portfolio is less likely to diverge from the expected return. Bottom line? If you hold a nondiversified portfolio (say all Internet stocks), you are bearing risks for which the market will not compensate you. You may do well for a while, but it will eventually catch up to you (as it has recently for tech stocks).

The second pillar of Malkiel's analysis is the efficient capital markets theory (ECMH). The fundamental thesis of the ECMH is that, in an efficient market, current prices always and fully reflect all relevant information about the commodities being traded. In other words, in an efficient market, commodities are never overpriced or underpriced: the current price will be an accurate reflection of the market's consensus as to the commodity's value. Of course, there is no real world condition like this, but the securities markets are widely believed to be close to this ideal. There are three forms of ECMH, each of which has relevance for investors: **Weak form: All information concerning historical prices is fully reflected in the current price. Price changes in securities are serially independent or random. What do I mean by "random"? Suppose the company makes a major oil find. Do I mean that we can't predict whether the stock will go up or down? No: obviously stock prices generally go up on good news and down on bad news. What randomness means is that investors can not profit by using past prices to predict future prices. If the Weak Form of the hypothesis is true, technical analysis (a/k/a charting)-the attempt to predict future prices by looking at the past history of stock prices-can not be a profitable trading strategy over time. And, indeed, empirical studies have demonstrated that securities prices do move randomly and, moreover, have shown that charting is not a long-term profitable trading strategy. ** Semi-Strong Form: Current prices incorporate not only all historical information but also all current public information. As such, investors can not expect to profit from studying available information because the market will have already incorporated the information accurately into the price. As Malkiel demonstrates, this version of the ECMH also has been well established by empirical studies. Implication: if you spend time and effort studying stocks and companies, you are wasting your time. If you pay somebody to do it for you, you are wasting your money. ** Strong Form holds that prices incorporate all information, publicly available or not. This version must be (and is) false, or insider trading would not be profitable.

In the last section of RANDOM WALK, Malkiel distills all this theory into an eminently practical life-cycle guide to investing. As one may infer, it has two basic principles. First, diversification. Second, no one systematically earns positive abnormal returns from trading in securities; in other words, over time nobody outperforms the market. Mutual funds may outperform the market in 1 year, but they may falter in another. Once adjustment is made for risks, every reputable empirical study finds that mutual funds generally don't outperform the market over time. Malkiel's recommendation: put your money into no-load passively managed index mutual funds. You will see lots of anonymous reviews of RANDOM WALK claiming Malkiel is wrong. Odds are, most of those folks are have either been misled by the long bull market or, even more likely, are brokers or other market professionals who make a living selling active portfolio management. In sum, buy it, read it, believe it, and practice it.

Bleg re blogging in public during a conference or meeting

I'm curious to know what other academic bloggers (especially my fellow blawggers) think is proper conference/symposium blogging etiquitte. A google search turned up a lot of comments from tech bloggers, who seem mostly pro, but very little from blawgers. (The main exception was The Trademark Blog's crack: "At some point live blogging during conferences begins to resemble passing notes in class." In turn, that generated a link to an old Instapundit post that seems to take doing so as a matter of course, but that was a conference about blogging, so maybe its an exception.)

I would never blog (or do anything else computer related) while on the dais. I've seen people working on their laptops on the dais, and it always strikes me as unbelievably rude. But what about quietly sitting on the side of the room or in the back and blogging away? It's somewhat disrepectful to the other speakers, of course, but what if I'm blogging reactions to their remarks? Or they're just really boring? Should I be setting a better example for my students who use laptops during class? (Do student bloggers blog in class? Duh.) Thoughts?

UPDATE: A reader writes: "It would be interesting to see if conference organizers could somehow capture that immediate feedback and turn it in to part of the conference event. I can think of a lot of problems with attempting to do this, but some interesting trials could be done." Interestingly, when doing the preliminary research for this post, I found a discussion group thread in which one of the participants opined: "A slight variation has the organizers of the conference, projecting highlights of the blogs, projected on a screen and available for drilldown on a website. THAT would be a unifying force for the conference." See also HERE and, especially, HERE:

Here's the scenario. A traditional conference, with a stage, a speaker, panelists, and a moderator. People in the audience, with laptops, checking email, sending and receiving instant messages, and lately, posting publicly to their weblogs.

Once we reached the last stage, where publishing could be instantaneous and easy, the whole notion of an audience changes. We no longer have to line up at the microphones, nor are we limited to asking questions. Instead we can relate what's happening on stage to the whole world, or at least that part of the world that cares, and they can help us develop the story.

As noted in the original post, however, most of these discussions are by techies talking about tech conferences, where the relevant social norms are likely to be different than at law symposia.

[Sidenote: If it's ok to blog during a symposium, why can't I blog during a faculty meeting? (Of course, because I'm firmly convinced that every hour of faculty meeting time shaves a decade off my stint in purgatory, maybe I should skip it.)]

Blogs and Blawgs briefly noted

--ABA corporate governance task force releases final report (link via Broc)
--Corp Law Blog's long post recalling the Microsoft IPO
--CalPundit pans California's new anti-spam law; a classic piece of feel good legislation pushed through by politicians desperate to be seen to be doing something, but which is likely to have loads of unintended consequences
--Overlawyered posts: "Seattle's "5 Spot" restaurant offers a new $5.75 decadent dessert, but requires diners to sign a waiver before being served the fattening item." Also not to be missed is the post on the school bus lawsuit.
--My colleague Victor Fleischer notes the unfortunate nickname my course has acquired.

UPDATE:
--"How can you be named 'Lord High Chamberlain of the Blogosphere' when your site lacks trackback, comment sections, or even pemalinks," he asked knowingly. Methinks I detect special interests at work! Besides which, since when does Minnesota get to make these decisions?
--Southern Appeal remains on top of judicial confirmations.
--I wonder if it is an accident that my old Blogger site consistently racks 3-5 sites higher in Google search results than my new site? Nah, couldn't be ... could it?
--The eminent D. Gordon Smith of the Wisconsin law school and the Venturpreneur blog is blogging again after a several week hiatus. (What does that D stand for anyway?) The posts Vicarious and Limited Liability and Mall of America Dispute are especially worth reading.

The Recall and the Economy: Arnold Schwarzenegger in the WSJ

As part of our continuing coverage of the business and economic aspects of the California recall, we note that tomorrow's WSJ will include an op-ed by Arnold Schwarzenegger in which he does quite a nice job of diagnosing what's wrong with the California economy (available online now, but subscription required):

Over the past five years our state budget has grown nearly three times the pace of inflation. Our debt burden has risen by more than the other 49 states combined. The matrix of onerous regulations we impose on property owners and businesses has made the cost of doing business in California almost twice as high as in neighboring states. Our tax rates have become among the highest in the nation.

And perhaps worst of all our governor, Gray Davis, has created a counterproductive culture in Sacramento where businesses and entrepreneurs that dare make a profit are treated as if they are enemies of the state. Mr. Davis says he wants jobs, but he has done everything possible to chase away job creators. Thanks to the economic policies of this administration, for the first time in California history more native-born Americans are leaving this state than are moving here. No one would confuse the destructive economic policies of Gov. Davis and Lt. Gov. Cruz Bustamante with the pro-growth ideas of Milton Friedman or Adam Smith.

Exactly. But can he -- or Cruz or Tom -- do anything about it? With a set of die-hard Republicans in the legislature whose only platform seems to be standing athwart the tracks of history shouting no and a set of Democrats more than happy to run the nanny state locomotive right down their throats (with apologies to WFB, Jr.), I have become increasingly dubious that anything good can come out of Sacramento. But the right governor could at least keep things from getting worse by vetoing the most blatantly anti-business legislation, holding the line on taxes, and making the right bureaucratic appointments.

Review: A Theory of the Firm: Governance, Residual Claims, and Organizational Forms by Michael C. Jensen

Michael Jensen is one of the founders of the agency cost economics branch of the New Institutional Economics. A Theory of the Firm collects eight articles by Jensen and various co-authors that, collectively, represent the seminal body of work in this field. (I wonder how his various co-authors felt about being left of the spine of this book?) While his contributions to agency cost theory are the work for which he is best known, Jensen also figures prominently in the intellectual history of the nexus of contracts theory of the firm, as several of the articles collected here demonstrate.

U.S. public corporations are characterized by a separation of ownership and control: the firm's nominal owners, the shareholders, exercise virtually no control over either day to day operations or long-term policy. Instead, control is vested in the hands of professional managers, who typically own only a small portion of the firm's shares. The separation of ownership and control characteristic of U.S. corporations has costs: "The separation of ownership from control produces a condition where the interests of owner and of ultimate manager may, and often do, diverge . . . ." (Berle and Means, 1932). Modern scholars refer to the consequences of these divergences as agency costs, following Jensen and Meckling (1976), which are conventionally defined as the sum of the monitoring and bonding costs, plus any residual loss, incurred to prevent shirking by agents. In turn, shirking is conventionally defined to include as any action by a member of a production team that diverges from the interests of the team as a whole. As such, shirking includes not only culpable cheating, but also negligence, oversight, incapacity, and even honest mistakes. In other words, shirking is simply the inevitable consequence of bounded rationality and opportunism within agency relationships. The classic Jensen & Meckling article is reprinted herein.

Although agency cost theory undeniably is critical to understanding the modern corporate form, too many agency cost theorists have narrowly focused on agency costs to the exclusion of other institutional considerations, which easily can distort one's understanding. Corporate managers operate within a pervasive web of accountability mechanisms that substitute for monitoring by residual claimants. Important constraints are provided by a variety of market forces. The capital and product markets, the internal and external employment markets, and the market for corporate control all constrain shirking by firm agents. In addition, the legal system evolved various adaptive responses to the ineffectiveness of shareholder monitoring, establishing alternative accountability structures to punish and deter wrongdoing by firm agents, such as the board of directors. An even more important consideration, however, is that agency costs are the inevitable consequence of vesting discretion in someone other than the residual claimant. We could substantially reduce, if not eliminate, agency costs by eliminating discretion; that we do not do so suggests that discretion has substantial virtues. A complete theory of the firm thus requires one to balance the virtues of discretion against the need to require that discretion be used responsibly. Neither discretion nor accountability can be ignored, because both promote values essential to the survival of business organizations. Unfortunately, they are ultimately antithetical: one cannot have more of one without also having less of the other - the power to hold to account is the power to decide. Managers cannot be made more accountable without undermining their discretionary authority. Establishing the proper mix of discretion and accountability thus emerges as the central corporate governance question.

Jensen recognizes this tension in several of the articles collected here, which in general are less lex-centric than those of many of his intellectual progeny. In other words, Jensen is less likely to believe that regulation is an appropriate solution to a given problem. Instead, his work focuses on market solutions to agency cost problems. The articles on takeovers and leveraged buyouts are good examples.

As a practical criticism, I should note that newcomers and generalists may find the text heavy going in places, while us old-timers have already read all of these articles in their original publications. Yet, it still belongs on the shelf of any economically literate corporate lawyer.

The SEC's lobster trap

Mike O'Sullivan has an interesting post at Corp Law Blog on Rule 12h-3 and 12g5-1. The proposed changes he discusses would make it more difficult for corporations to extricate themselves from the SEC's periodic disclosure requirements, thereby perhaps also discouraging marginal firms from going public in the first place. If the securities laws are like a lobster trap, as some argue, these changes would further strengthen the analogy.

Hugh Hewitt and Weintraub and the Bee's business model

Hugh Hewitt observes: "why support with traffic the complacent and compliant time-servers [at the Sacramento Bee] while Weintraub remains in editorial chains?" This precisely illustrates the point I was trying to make in my earlier post. The Bee has to decide whether, as a business matter, it makes more sense to impose editorial control on blogs hosted on its site and written by its reporters, which gives them more control over their brand image, or to comply with the emergent norms of the blogosphere -- i.e., giving its bloggers free rein. As Hugh's exhortation to his readers suggests, taking the latter approach likely will maximize the number of referrals from gatekeepers like Hewitt, which in turn should drag the most eyeballs to the web site, which should generate more ad revenue. Which is precisely why I suggested the Bee made a mistake -- from a business perspective!

Sidenote: It would be nice if Hugh's site offered permalinks to particular posts (or, if it does, if I could find them).

UPDATE:Hugh Hewitt blogs my earlier post (I don't think he had seen this one when he wrote his post). According to Hugh, my analysis is:

Not persuasive, but better than the pablum the Bee has offered. [Ed.: Ouch. Doesn't even rise to the level of damning with faint praise! Hey, at least I have permalinks and a comment section!]

And since Professor B. knows of such things, I have to ask what is the duty, if any, owed the Bee's shareholders? The paper depends on readers because it depends on advertisers. Weintraub unbound was bringing them readers in large numbers. Now that the paper's new motto is "All the News That's Fit to Print, According to the Latino Caucus," isn't the product damaged? Doesn't management owe as many readers to the advertisers as possible? And if some enterprising competitor comes along and snags Weintraub with a promise of an unfettered web column, won't the old ladies in management have really lowered the value of the enterprise?

As the story goes, Ronald Dworkin was attending a conference at which many speakers critiqued his work. He got up and said: "once again, my critics have deliberately misunderstood me." (I've heard the story in various forms and ascribed to various famous academics.) I don't think either Glenn or Hugh are deliberately misunderstanding me, but its almost starting to feel that way.

To be clear, I'm saying that the Bee did make a mistake -- a business mistake -- by muzzling Weintraub. [Ed.: The first post explicitly stated: "As the sarcasm in the preceding paragraph should suggest to anyone but the most literalist reader, however, I think the Bee made a mistake."] I just thought the blogosphere was getting off track by framing the issue as one of political correctness, free speech, censorship, and so on. I think its a business issue. And, as a business issue, I agree with Hugh -- in the name of shareholder wealth maximization, unmuzzle Weintraub!

UPDATE 2: Jay Rosen at PressThink has a very good post in which he explains what the Bee should have done. The gist of it is that the Bee should provide its readers an opportunity to reply online in a "hard hitting and apt" was, so that Weintraub "learn[s] that he is edited by his readers, including the angry ones." Sounds like a plan to me.

UPDATE 3: Why do some people seem unable to understand that a decision motivated by political correctness is not necessarily a bad business decision?

Jeff Cooper on Iraqi Privatization

Jeff Cooper blogs at Cooped Up on news reports that "the Iraqi Governing Council is moving ahead with plans to privatize Iraq's state-owned industries":

Given the still-persistent effects of three decades of Ba'athist rule, there are really only two groups, at this point, who would have the resources to purchase Iraq's state-owned industries. The first is Ba'athist collaborators--those who grew rich under Saddam's regime--and I refuse to believe that these individuals would be viewed as a viable option. That leaves the second group: foreign investors.

At one level, this makes a certain amount of sense: foreign investors will have the business expertise to rebuild moribund industries. And yet the apparent decision to take this step now, at a time when the US continues to control the Iraqi government, is tone-deaf to the extreme. It's widely believed, in the middle east, in Europe, and even in this country, that the decision to invade Iraq represented an effort to take control of Iraq's resources. Moving ahead with privatization at this point--when buyers will almost certainly not be Iraqi and, indeed, will likely include a large component of Americans; when prices are likely to be depressed by the postwar disarray--will only reinforce the impression. The decision not to privatize the Iraqi oil industry stands as a counterweight, but how effective it will be remains to be seen.

I tend to agree more often with Prof. Cooper's wine tasting notes than his politics, but I think he nailed this one. In his book, The Politics of Prudence, the great conservative intellectual Russell Kirk argued that "a soundly conservative foreign policy, in the age which is dawning, should be neither 'interventionist' nor 'isolationist': it should be prudent." Exactly. And, for the reasons Cooper outlines, I think this strategy is most imprudent.

Daniel Drezner on John Edwards

Daniel Drener blogs on John Edwards:

Whatever the merits of Wesley Clark's decision to seek the Democratic nomination for President, Clark did succed in one area -- hogging the spotlight from John Edwards' formal announcement that he was also seeking the nomination. ... We here at DanielDrezner.com don't think that's fair. [We don't? Does this mean we're endorsing Edwards?--ed. Absolutely not. However, I've admired some of the things he's done during the past year, and I do think the Dems are prematurely slighting his candidacy.] In response, we bring you this cornucopia of John Edwards information:

Edwards has now set up a weblog. Not bad looking, mostly written by staff and volunteers....

Regular readers will recall that I blogged a while back on Edwards' campaign website; more specifically, discussing the page setting out his positions on corporate accountability. (See Presidential Politics and Corporate Governance: John Edwards and Shareholder Empowerment.) Edwards' weblog hasn't noticed this blog's existence, but it has blogged on Grasso, another topic on which this blog has had some thoughts.

NOTE: See also Corporate Governance and Presidential Politics and Kucinich for Federal Law of Corporations.

The NYSE Post-Grasso

Regular readers know I have been steadily blogging on the Grasso pay imbroglio and the governance problems the controversy unveiled at the NYSE. (See, e.g., Al Hunt on Grasso and the NYSE and Larry Kudlow on Dick Grasso on National Review Online.) Tonight, I want to tackle the question: what next? With Grasso out, Reed in for now, and Fisher on the horizon, what should the Exchange do next?

There are two issues that need to be addressed. First, the inherently defective governance resulting from the Exchange’s status as a privately held, more-or-less nonprofit corporation. As this space has argued before, the basic problems are two-fold: (1) the board composition – i.e., half ceremonial directors and half folks who are regulated by the Exchange; and (2) the absence of any constituency, such as shareholders, to whom the board is accountable. The obvious solution is privatization of the Exchange as a for-profit, publicly held corporation through a IPO.

Given the Exchange’s current responsibilities as a self-regulatory organization, however, privatization would exacerbate the second problem that needs to be addressed. At present, to the extent the Exchange is owned by anybody, it is owned by the specialists who are members of the Exchange. Yet, regulating those specialists is one of the Exchange’s key responsibilities under the securities laws. Most impartial observers believe that the Exchange has fallen down on that job. Although a SEC investigation is still pending, most informed and impartial observers suspect that “trading ahead” is a serious problem among Exchange specialists. Trading ahead is a violation of the specialists’ so-called “negative obligation.” Specialists make a market in specific stocks. Typically, they do so by conducting an auction among other floor members that matches buy orders with sell orders. When there is an imbalance between sell and buy orders, the specialist has an “affirmative obligation” to ensure orderly trading by buying or selling out of its inventory. If there are too many buy orders, for example, the specialist is obliged to match them by selling some shares it holds in the company in which it makes a market (the actual rules are pretty complicated, but you get the idea). The flip side of affirmative obligation is the negative obligation not to buy or sell out of its own inventory when an orderly market can be conducted by matching buy and sell orders from customers. (Front running is a somewhat related phenomenon in which specialists who have access to nonpublic information, such as where they benefit from selective disclosure by insiders or are aware of unusual trading activity or unusual orders, trade for their own account ahead of customers who lack access to that information. There are longstanding concerns about front running too.)

There is an obvious conflict of interest given that the Exchange is owned by the very people who it needs to investigate when there are concerns about trading ahead or front running. In some respects, that conflict of interest would be lessened if the Exchange were owned by public shareholders rather than the specialists. Yet, public ownership might just introduce a different set of conflicts. What if maximizing shareholder returns required the Exchange to overlook misconduct by specialists or others with floor trading privileges, for example?

The answer, it seems to me, is to follow the NASDAQ model. The NYSE’s roles as a regulator and a market should be separated. The regulatory functions could be assumed by the SEC, a new SRO, or maybe even the NASD (or some combination thereof). The market then could be spun off through an IPO. This solution addresses both the current governance problems and the longstanding conflicts inherent in the Exchange’s dual roles.

I am no fan of regulation for the sake of regulation or, especially, regulation just so that the regulator can be seen to be doing “something.” Yet, splitting the Exchange’s functions among at least two separate entities might actually have a deregulatory effect. Various news reports suggest that SEC Chairman Donaldson has been meddling heavily with the Exchange’s board, to the point of dictating the characteristics of the interim CEO, in ways he would never dare do with a true public corporation. Privatizing the NYSE thus might get the market out from under the worst of what the late Donald Schwartz called the "raised eyebrow" powers of the SEC. (Although I’m probably being too optimistic. Even a privatized Exchange would still be too central to the SEC’s mission to be allowed very far off leash.)

The NYSE is still the greatest capital market in the known universe. But it can be even better. Informed and impartial observers have known that there were problems at the NYSE for a very long time. The present controversy creates a space in which a more efficient system can be allowed to emerge.

Alex Tabarrok on Executive Compensation

Alex Tabarrok blogs at Marginal Revolution on executive compensation:

If workers are paid their marginal product its difficult to understand why some CEOs are paid such high wages. But think of the CEO's wage as a prize. Valuable prizes make everyone else work hard in order to become the CEO. With this model, the tournament model (JSTOR) of Lazear and Rosen, it may even make sense that CEO wages go up as profits go down. After all, shouldn't prizes be set highest when motivation is most required? No doubt, some will see this argument as more proof that economists are just shills for the capitalist class.

Good point. For my take on executive compensation, which some will also see as shilling for the capitalist oppressors, see Marginal Revolution on Grasso and Al Hunt on Grasso and the NYSE.

UPDATE: Corp Law Blog chimes in too, citing a study by two economists (non-Marginal Revolutionaries):

If you work at a bad firm, you are less likely to become a CEO because the firm is less likely to be around when you reach the finish line. Even if you become CEO, you should expect a shorter tenure than at a good firm, as your results are likely to be poor and as a result you're more likely to fired. Therefore, the bad firm has to pay its CEO more in order to induce you to shoot for its higher-risk CEO prize.

Sounds about right to me.

Cal Insider subject to editorial review: PC meddling or sound business plan?

Daniel Weintraub’s California Insider blog is essential reading for anybody interested in California politics (and who isn’t, given what a circus it is out here?). After a post on Cruz Bustamante got the legislature’s Latino caucus worked up, the Sacramento Bee announced that entries to Weintraub’s blog will now be reviewed by an editor before being posted. Predictably, the blogosphere is outraged. Hugh Hewitt, for example, blasts the Bee for political correctness in muzzling Weintraub:

Daniel Weintraub is the [Sacramento Bee's] best political columnist and reporter. ... Weintraub's blog ... was a genuine innovation in journalism, a decision to move one paper into the new century by equipping its best talent with a computer and a mission to report in real-time, thus moving an old-media dinosaur out of the swamp. Weintraub has consistently delivered scoop after scoop and most of his postings have shaped the news cycle that followed. Only Mickey Kaus has matched Weintraub for impact on the race and only the Bee has a web-based following because of original content on the web....

The Bee's powers have now decided to start supervising Weintraub. Why? Because the Latino Caucus complained about one of his entries.

It is a tough entry, one that blasts Cruz Bustamante and the Caucus. Weintraub is an opinion journalist, and in this particular posting his opinions on Cruz and his colleagues are not high. In fact, it deserves that classic phrase of journalistic approval: "hard-hitting."

So the Caucus blasted back. Usually an editor then stands up for the columnist and the paper's independence, citing a long tradition of press vigilance over entrenched political power and the glory of the First Amendment. Not this time.

Instapundit instantly jumped in too, to like effect, and most of the rest of the blogosphere has been quite exercised, as well.

Even though I’m coming to the party a little late (I’ve been out of reach of a computer all day), and even though I largely agree with Hugh’s assessment of the controversial post, my take on all of this differs from that of most of the big bloggers. The issues at stake here are quite different from those implicated by the Rasmusen controversy a few weeks ago. Indiana University is a taxpayer-funded public school. When it censors a faculty member, it is acting as an agent of the state, and is subject to the First Amendment. In addition, a university is supposed to value academic freedom, even when the academic in question is not politically correct. (Of course, if universities really did value academic freedom we wouldn’t need organizations like FIRE or blogs like Critical Mass!) In contrast, the Sacramento Bee is a business. Yes, I know it’s a newspaper. Yes, I know a lot of people (including journalists) blather on about newspapers being a quasi-utility vested with a public interest. But that’s just the nonsense they use to justify a unique constitutional privilege to libel people and invade their privacy. In the real world, newspapers are for-profit businesses.

The appropriate standard to apply to the Bee therefore is not the free speech standard applicable to a university but the emerging rules of business blogging. The California Insider is maintained on a corporate website. Weintraub has no more rights with respect to his blog than he does with respect to print articles. From this perspective, the right question is whether muzzling Weintraub was the right business decision. To answer that question, in turn, we need to think a bit about the relatively new phenomenon of corporate blogging.

Why does the Sacramento Bee host the Insider blog on their site? It seems unlikely that the blog translates into significant additional sales of the print newspaper. Instead, I’d guess the business case is grounded on attracting eyeballs to the Bee’s website, on which site they seem to be selling advertising space. In either case, as a high profile part of the Bee’s web business, the Insider blog has a substantial impact on the Bee’s brand.

The recent BBC imbroglio demonstrates that lack of editorial control of programming and even off-site editorializing by a media business’ reporters can adversely affect the business’ brand. The Economist’s Bagehot column last week opined:

To carry off the kind of scoop-driven journalism that the “Today” programme has aspired to recently needs not just aggressive reporters and news editors, but the guiding hand of a powerful senior editor too....

How should the BBC repair these defects? There are plenty of small things it could sensibly do, such as restricting the interviews between presenters and reporters—“two-ways” in the jargon—that often lead to stories being pumped up. It must also get a grip on staff correspondents who write opinion pieces in newspapers—an article by Mr Gilligan in the Mail on Sunday sprayed rocket fuel on the fire. But most of all, the BBC needs a powerful editor-in-chief, who, like the editor of a newspaper, would carry ultimate responsibility for news output and would therefore demand to be consulted over the handling of high-risk stories.

(Ironically, many of the Bee’s most vocal critics have also been vocal BBC critics!) If the brand the Bee wants to build is that of a left-leaning media outlet that caters to special interests, that is the Bee’s prerogative. If so, the Bee made the right call by putting in place a system of editorial review.

As the sarcasm in the preceding paragraph should suggest to anyone but the most literalist reader, however, I think the Bee made a mistake. [UPDATE: In light of Hewitt and Reynold's responsive posts (see below), I wanted to highlight this observation. Even though I've tweaked this post a bit as the evening went on, this comment has been in it since the outset.] Not a free speech mistake, but a business mistake. Corporate blogging is a relatively new phenomenon. In some cases, it is used to help promote specific products. In others, it is used to pull eyeballs to a corporate website. In either case, corporate blogging has a credibility problem. The blogosphere is dominated by highly skeptical folks (e.g., the self-proclaimed “anti-idiotarians”). I suspect most blog readers are predisposed to assume that corporate blogs are just paid shills and, accordingly, also predisposed to discount (if not outright ignore) corporate blogs. I doubt whether corporate blogs can be used successfully to shill a particular product (except where the corporate sponsorship is hidden, but imagine how that could backfire if the sponsorship comes to light!). Instead, the right business model is to pull eyeballs to the site, where they can be shown banner adds, pop ups, and the other detritus of web commerce. How many people outside Sacramento would surf to the Bee’s website if the Insider were not there, for example?

In order for this business model to work, however, the sponsor must adhere to the norms of the blogosphere. The blogosphere values immediacy, attitude, edge, and so on. The big referrers, like Hewitt, Volokh, Reynolds, and so on seem to especially value these attributes. If the Insider is perceived as having been muzzled by the Bee, the blog will get fewer referrals from the big guys and fewer readers will come to the corporate website.

The problem for the Bee and other news outlets with in-house blogs is to balance the need to have editorial control to avoid problems like those plaguing the BBC while still playing by the rules of the blogosphere. It’s a tough job, no doubt. It will probably be a while before anybody gets it right. At this point, however, it seems likely that the Bee has just given us a case-study of how not to do it.

UPDATE: Instapundit comments on my post:

[A]lthough Bainbridge is right that the Bee is perfectly within its legal rights to do whatever it wants to with things it publishes, the Blogosphere is perfectly within its rights to criticize the Bee and to point out that the Bee is behaving with all the commitment to public discourse that we'd expect from a big corporation like Enron or Disney. [Ed: Of course, the blogosphere is well within its rights to criticize. Where did I deny that, other than by being a bit snide about the 'sphere? Heck, I criticized the Bee.] Also, I think that Bainbridge is wrong to claim a contradiction between bloggers' criticism of the BBC's lax supervision of Andrew Gilligan with bloggers' criticism of the Bee's suddenly-intrusive supervision of Weintraub's blog. Weintraub is an opinion writer, who hasn't been accused of getting facts wrong. He's accused of stating political opinions that some people don't like.

Obviously, I think the BBC analogy has more merit to it than does Instapundit. Let me highlight a passage from the quote above from Bagehot: "It [i.e., the BBC] must also get a grip on staff correspondents who write opinion pieces in newspapers—an article by Mr Gilligan in the Mail on Sunday sprayed rocket fuel on the fire." That quote highlights a way in which I think Instapundit \missed my point. My point was not that Weintraud did anything wrong. My point was to comment about the business issue -- the business model when it comes to a corporation sponsoring a blog. Inflammatory op-eds can do just as much damage to a business' efforts to build its brand as factual errors in straight reporting. And that was my point. Well, actually my point was that the Bee could logiically think so, although observant readers will note I went on to suggest that the Bee erred by not adhering to the very blogosphere norms about which Instapundit opines.

UPDATE 2: The Instalanche has begun. For the benefit of new readers who came via that pointer, this blog focuses on corporate law and corporate governance, with a strong emphasis on current events implicating those topics (indeed, I see this post as a corporate governance post of sorts). Wine tasting notes are a favorite sideline, as are book reviews.

UPDATE 3: Instapundit responds:

Weintraub (like a lot of other print reporters and pundits) "represents" the Bee in TV and radio appearances all the time without a Bee editor being interposed, even though a lot more people see those appearances than read a blog, making the "danger to the brand" much greater. I continue to blame jealousy and discomfort with new technology.

I agree. But if I owned a newspaper, I would ride herd on reporters who serve as "talking heads," just as I would ride herd on their op-eds for other outlets (see BBC remarks above). If they got too out of line, they would hear about it, just like I suspect the BBC's Gilligan has been hearing about it. (If he hasn't heard about it, he is at least being set up by his bosses as the fall guy.)

Absolutely Final UPDATE: Hugh Hewitt has blogged a response to this post too. Because this post was already way too long, I've responded in a separate post.

A little remodeling

Return readers of this blog will note a new title and a more expansive description. I decided to roll out a more generic title for the blog for two reasons. First, I’ve registered a new domain www.professorbainbridge.com to which I’ve mapped my TypePad blog. It’ll be easier to remember and find than the TypePad URL, I hope. Second, the blog has tackled a more eclectic range of topics than I originally intended. Rather than stop blogging about off-topic stuff that interests me, I decided to broaden the scope of the blog a little bit (it'll still be mostly corporate law and current events in corporate governance, though). My apologies to anybody who feels obliged to update their blogrolls, but note that the old URL still works too.

Even though the description also changed, to reflect that more eclectic mix, the content won’t change much. If you like what you’ve been reading, keep coming back.

This seemed like an opportune time to roll out these changes because blogging probably will be light over the next several days as I attend to some pressing personal matters. Don’t give up, though. Y’all come back now, y’hear?

UPDATE: Corp law Blog noted this post and observed:

If you are concerned that Corp Law Blog may be tempted to follow Professor Bainbridge's lead, and veer off topic, rest assured I have no other interests.

Heh. I suspect Mike just has more discipline than I do (if I may take the liberty of referring to him so familiarly). But, since we're both in LA I hope to prevail upon him to buy me lunch one of these days, which will give me an opportunity to report back on his range of interests -- or lack thereof. [UPDATE to the update: And, anyway, on what other blog can you read about such hot topics as Outsider Reverse Veil Piercing?]

Review and Comment: Ronald Coase, The Firm, the Market, and the Law

Lawrence Solum has an excellent post today on Nobel laureate economist Ronald Coase and the famous Coase theorem. The Coase theorem is a principal foundation of modern neoclassical law and economics, of course; indeed, arguably the principal foundation. Solum's post is highly recommended.

Solum's post reminded me that I have been meaning to review Coase's book The Firm, The Market, and the Law. This is principally a collection of Coase's seminal works, although it does contain some useful new material. In particular, the opening chapter is entirely new and shows how a consistent theory of firms and markets, as well as a unique conception of economics and economically-oriented scholarship, runs through Coase's work from the 1930s to the late 1980s (when the book was published).

Coase is best known for two seminal articles. The earlier article "The Theory of the Firm" is the seminal work on the so-called nexus of contracts theory of the firm, as well as an early source for the transaction cost branch of the New Institutional Economics. The nexus of contracts model treats the firm not as an entity, but as an aggregate of various inputs acting together to produce goods or services. Employees provide labor. Creditors provide debt capital. Shareholders initially provide equity capital and subsequently bear the risk of losses and monitor the performance of management. Management monitors the performance of employees and coordinates the activities of all the firm's inputs. The firm is simply a legal fiction representing the complex set of contractual relationships between these inputs. Besides emphasizing the importance of examining the various contracts making up the firm, however, Coase's fundamental insight was that the contractual nature of the firm does not preclude an element of command and control absent from market transactions. If a corporate employee moves from department Y to department X he does so not because of change in relative prices, but because he is ordered to do so. In other words, markets allocate resources via the price mechanism but firms allocate resources via authoritative direction. The set of contracts making up the firm consists in very large measure of implicit agreements, which by definition are both incomplete and unenforceable. Under conditions of uncertainty and complexity, the firm's many constituencies cannot execute a complete contract, so that many decisions must be left for later contractual rewrites imposed by fiat. It is precisely the unenforceability of implicit corporate contracts that makes it possible for the central decisionmaker to rewrite them more-or-less freely. The parties to the corporate contract presumably accept this consequence of relying on implicit contracts because the resulting reduction in transaction costs benefits them all.

Even better known, and even more central to transaction cost economics, however, is Coase's later article "The Problem of Social Cost," which also is reprinted in full here. In that article, Coase laid a critical foundation of modern law and economics - the so-called Coase theorem. The Coase theorem has been formulated in various ways, but one useful statement might be that: "When the parties can bargain successfully, the initial allocation of legal rights does not matter." Suppose a steam locomotive drives by a field of wheat. Sparks from the engine set crops on fire. Should the railroad company be liable? In a world of zero transaction costs, the initial assignment of rights is irrelevant. If the legal rule we choose is inefficient, the parties can bargain around it. Put another way, according to the Coase theorem, rights will be acquired by those who value them most highly, which creates an incentive to discover and implement transaction cost minimizing governance forms.

The Coase theorem has been widely criticized. The second major set of new material in this book is a chapter entitled "Notes on the Problem of Social Cost," in which Coase answers the more serious criticisms. That essay provides a useful intellectual history of the Coase theorem, as well as a trenchant defense of its main claims. One of the less-well informed criticisms of Coase is that he assumes transaction costs are zero. He does not, as this new essay makes clear. Indeed, as Coase points out, the interesting cases are those in which transactions costs are non-zero. In a world of positive transaction costs, however, the parties may not be able to bargain. This is likely to be true in our example. The railroad travels past the property of many landowners, who put their property to differing uses and put differing values on those uses. Negotiating an optimal solution will all of those owners would be, at best, time consuming and onerous. Hence, the allocation of legal rights becomes quite important.

In any event, this is a book that clearly belongs on the shelf of any economically-minded lawyer or legal-minded economist.

UPDATE: Brian Leiter writes:

I've heard it said by various people, including, as I recall, Cooter, that Ellickson's book Order Without Law (1991) shows that the Coase theorem is false (or, more precisely, that the predictions that would be generated from the theorem are false). Comment? I'm genuinely curious about this.

Robert Ellickson’s book “Order Without Law” to which Brian Leiter refers is a deep and very important study of how ranchers and their neighbors in Shasta County, California, resolve disputes -- mainly territorial (such as cattle wandering onto a neighbor’s property, where they do damage. I do not think Ellickson regards his study as disproving the Coase Theorem. I don’t read Ellickson as denying that the Coase Thoerem holds under conditions of zero transaction costs. I read Ellickson as arguing that one important source of transaction costs is learning about one’s initial legal entitlements. For most residents of Shasta County, learning about the true law of property was too costly, let alone the cost of resorting to formal dispute resolution systems. (There is a dispute in the literature as to whether the relevant transaction costs are real or not. In other words, is the ranchers’ ignorance rational or a form of cognitive error?) So they resorted to informal common-sense norms to resolve disputes among themselves. Ellickson then summarizes his dispute with Coase as follows: "Coase overstates the influence of law. His error lies in his implicit assumption that people can effortlessly learn and enforce their initial legal entitlements, and that they confront transaction costs only when they attempt to bargain from their legal starting positions. In a world of costly information, however, one cannot assume that people will both know and honor law." (Order Without Law at 281.)

Actually, in an odd way, I think Ellickson reaffirms the Coase theorem. One implication of the Coase theorem is that, if transactions costs are zero, the actual content of legal rules does not matter. The usual move by law and economics scholars (and it is one I have made myself) is to recognize that transaction costs are often non-trivial. In such contexts, we typically argue that the government should facilitate private ordering by selecting the majoritarian default. As I read Order Without Law, however, Ellickson is saying that if parties face a high transaction cost barrier to learning what the formal rules of law are, the actual content of the rules again does not matter. People will just ignore the law and solve disputes by accepted community norms. The odd way in which this reaffirms the Coase Theorem is as follows: When transaction costs are high, the initial assignment of legal rights does matter, just as Coase predicts. Unlike Coase, however, Ellickson says that the relevant assignment of rights is effected by social norms rather than formal law. After which, bargaining occurs when the majoritarian default norm does not work for the particular parties in question. In sum, its just a question of whether law or social norms provides the relevant assignment of rights.

Finally, I should point you or interested readers to the Cooter-Ulen web site, where they assert: “In a result that comes down somewhere between the Coase Theorem and its critics, Ellickson’s study found that social custom, rather than the law, governed the relationships in Shasta County between farmers and cattlemen.” http://www.cooter-ulen.com/property.htm

UPDATE 2: Put another way, to the extent that the Coase theorem is understood to say that when transaction costs are high the content of formal law matters, Ellickson disproves it. To the extent the Coase theorem is understood to say that when transaction costs are high the content of the relevant rule -- whether law or social norm -- matters, he does not.

I should also note that part of the confusion is engendered by the so-called "Coasean parable" a.k.a. the "Parable of the Cattle." In The Problem of Social Cost, Coase told the following parable: A rancher's cattle wanders onto a farmer's land and harms some crops. Coase posited that, provided the parties could bargain with one other at low cost, the legal rule had only distributional consequences -- i.e., it affected who paid for the damages -- but not allocational consequences -- i.e., it did not affect whether the land was used for grazing or crops. Coase's parable, of course, tracks the situation Ellickson studied in Shasta County quite closely. Ellickson finds that the legal rule had neither allocational nor distributional consequences. Instead of being determined by the content of formal rules, the distributional issues were decided by social norms. Hence, the parable is "disproved" to that extent.

UPDATE 3: Reader JI writes:

For those concerned about Ellickson's "disproof" of the Coase Theorem, I would strongly recommend Daniel Farber, "Parody Lost/Pragmatism Regained: The Ironic History of the Coase Theorem", 83 Va. L. Rev. 397 (1998).

In short, Farber's point is thus: The so-called Coase Theorem was intended as a parody of neoclassical economics, and their assumptions of zero transaction costs. In case this pint was not clear from "The Problem of Social Costs", Coase explained this point at greater length in "Notes on The Problem of Social Costs" in his collection "The Firm, the Market and the Law". Guido Calabresi, among others, also makes this point in "The Pointlessness of Pareto: Carrying Coase Further", 100 Yale L.J. 1211 (1991). See also Jeanne L. Schroeder, "The End of the Market: A Psychoanalysis of Law and Economics", 112 Harvard L. Rev. 483 (1998-9). The list goes on, but back to Farber and Ellickson.

Neoclassical economics, following Arthur Pigou, felt that the ideal world that should exist, in which transactions will be most efficient, is a world without transaction costs. Their (influential) policy recommendations were therefore based on the premise that the government should strive to eliminate transaction, or "social", costs, thereby making the market more efficient by having it emulate, as much as possible, a market without transaction costs.

Coase attacked this position on two grounds. First, he argued that transaction costs are often reciprocal. Take the case of the sparks from the train burning wheat in the surrounding field. The typical neoclassical solution to this social cost would be to tax the train the amount of damage caused to the wheat farmer. But the more economic efficient outcome might be to have the farmer not plant wheat in such close proximity to the train tracks. In fact, forcing the railroad to reimburse the farmer for damaged wheat may encourage the farmer to plant surplus wheat, that would not otherwise be profitable for him to plant, in close proximity to the railroad in order to collect damages from the railroad.

Coase's second, and most important argument, is one of empiricism. He argued that neoclassical economics' "solution" to the problem of social costs, indeed economic analysis as a whole, was/is too theoretical. Pigou's solution to the problem of social costs was based completely on theory, and a one-size-fits-all theory to boot. Coase argued that economics and economic policy recommendations should be based on empirical, pragmatic observation fo the situiation at hand. To fruther the cause of empirical, pragmatic economics, he founded the Journal of Law and Economics, which is mostly devoted to such study (see, for example, Morrison, Winston and Watson, "Fundamental Flaws of Social Regulation: The Case of Airplane Noise", 42 J. Law & Econ. 723 (1999)).

Back to Farber. Since Coase was an advocate of empirical, pragmatic economics, he used the theorem later on dubbed the Coase Theorem as a parody of the neoclassical economic world of supposing no transaction costs. The outcome of such a model is ludicrous - legal entitlements don't matter, and the most efficient outcome is always attained. This is similar to physics without friction. However, since the hard-core neoclassicists were so engrosed in their own theories, they failed to notice the parody in the Coase Theorem. But since they did realize that accepting the Coase Theorem proved how ridiculous their models were, they set out to prove the Coase Theorem wrong. The way to prove the Coase Theorem wrong was to go out and show that in real life situations initial entitlements DO matter. So by failing to grasp the parody in the Coase Theorem (Parody Lost), these econmists inadvertently wound up engaging in pragmatic, empirical economic study (Pragmatism Regained) - which is the type of study Coase advocated - without adopting, or even understanding, Coase's arguments. What these neoclassical economists failed to realize is that it is impossible to empricially disprove the Coase Theorem, since it exists in a decidedly non-empirical world. In the real world, there will ALWAYS be transaction costs (see, for instance, Calabresi, "Transaction Costs, Resource Allocation and Liability Rules - A Comment", 11 J. Law & Econ. 67 (1968)).

One further point. Ironically, a correct understanding of the Coase Theorem can lead one towards libertarianism (Coase) or towards more advocacy of further governmental intrusion into the market (Calabresi). But on second thought, this isn't so ironic. Coase advocated empiricism and pragmatism - tools which are far less wont to lead to forgone conclusions than theory (witness the monotony of the academic eltie).

I think JI's comment is insightful, but I take issue with it in at least one respect. I tend to think that Farber (and JI) overstate the case in treating the Coase theorem as a "parody," at least to the extent they ascribe intentionality to Coase in that regard. Coase himself said in "The Firm, the Market, and the Law" that his intent "was not to describe what life would be like in such a world [i..e, one without transaction costs] but to provide a simple setting in which to develop the analysis and, what was even more important, to make clear the fundamental role which transaction costs do, and should, play in the fashioning of the institutions that make up the economic system." (13) Having said that, however, it is certainly true that Coase objected strenuously to the tendency among later economists to describe "the world of zero transaction costs ... as a Coasian world." (174)

Dow 20 Year Old Tawny Port NV

I love Port. Back in the days before Usenet was all spam all the time I was a regular player in the rec.food.drink newsgroup and even went so far as to do a Port FAQ. At that time, my regular post-dinner tipple was either a vintage character or LBV port, with the occasional vintage (Quinta do Noval being a favorite). Of late, however, I have become increasingly fond of tawny ports. A particular favorite is Dow's 20 year-old tawny (WS 89). Despite its years in cask, the Dow is still a relatively big wine, with lots of tasty stuff going on. A lovely reddish-brown color with strong legs. A powerful nose of vanilla, caramel, and roasted nuts. On the palate, the wine has good acidity to balance the residual sugar. As a result, it never cloys the way some ports do. The flavor profile is classic: caramel, English toffee, nuts. Excellent and highly recommended.

Advice to new bloggers I'm trying to take to heart

Julie Neidlinger blogged some great advice for new bloggers, of which I am still very much one. I was particularly struck by the following:

3. If it's in your head, in your life, write it even if you don't think it's "serious material". We can't all be David Frum. ... [Ed.: Check. See, e.g., HERE and HERE.]

7. Don't sell your soul for linkage and the hope of getting an Instalanche. Blog because you like to write. You shouldn't need any other reason. [Ed.: Why would you want a link from a guy who drives such a woefully underpowered car, anyway?]

8. Do link to other good posts. You may have some readers who aren't aware of them, and you have a responsibility to your readers to create a total reading experience. [Ed.: Taken together with #3, this is why I post about politics and wine, not just corporate law]

13. ... Everyone is an expert on something, even if it ends up being about your home town or community or school. Be the expert you that are. If all blogs wrote about Israel and Iraq, what a boring blogosphere it would be. ... [Ed.: This is not and never will be a warblog.]

Sounds right to me. On the topic of advice to new bloggers, Daniel Drezner's post from a few days ago is also well-worth reading. In particular, I think I need to do a better job on this score:

Yes, some bloggers have the ability to post in triple figures per day at a consistently high level. You, like me, are probably not one of those people. In baseball terms, you don't have to swing at every pitch -- wait for an issue or idea that's right over the plate.

Larry Kudlow on Dick Grasso on National Review Online

Lawrence Kudlow opines at NRO:

A kangaroo court of liberal-leaning journalists and Democratic state treasurers charged and convicted former New York Stock Exchange CEO Dick Grasso with an unpardonable sin -- success. This collection of class-envy warriors put such relentless pressure on the NYSE that Grasso was finally forced by his board to resign. Grasso, of course, was the man whose Herculean efforts were behind the reopening of the stock exchange only four business days after the terrorist bombing of downtown New York. But the so-called titans of finance who sit on the NYSE board were so mau-maued by the media and political onslaught that they actually sided against the man who inflicted the first major blow on Osama's terrorism.

There was no scandal here. Dick Grasso accepted a big pay package endorsed on two occasions by the NYSE board in return for 35 years of successful service. ...

Let's be very clear about this: Grasso has done nothing wrong. Nothing, that is, except believe his own board when they offered him a large pay package for his long-term service.

I share some of Kudlow's sentiments. A lot of the anti-Grasso furor was just agit-prop. And, he's right, there is a serious long-term problem with a system in which the power of massive investment funds like CalPers can be harnessed to the whims of ambitious political hacks. Finally, there was a lot of hypocrisy on the part of those Grasso critics who argued that he should be fired to still the controversy when they were the ones who stirred up the controversy in the first place.

Having said all that, however, Kudlow still is both over-reacting and, to be blunt, just plain wrong. Ironically, NRO's grand old man William F. Buckley gets it right when he asks: "Who authorized this gargantuan compensation?" First, Buckley's right and Kudlow's wrong about the size of Grasso's compensation. Granted, I think very high executive compensation can be defended. Yet, as this space has noted before, Grasso's lump sum payout was more than 10 out of 11 financial bosses got in the same period and more than anybody on Fortune's list of top executive salaries. The basic problem, as I've been arguing all along, is that the NYSE -- which regulates the corporate governance of listed companies with a haughty holier-than-thou arrogance -- itself had lousy governance. In fact, Kudlow gives the game away with the italicized phrase in the excerpt above: his own board. But that's the problem. It was Grasso's board. A corporate board is supposed to be the shareholders' board, not the CEOs (although, of course, too many boards are still captured by their CEOs). As one press report put it: "Grasso in fact had imperially handpicked members of the compensation committee that set his pay - ironically, while calling for corporate boards to be more independent of executives - and in turn sat on company boards whose shares were traded on the exchange." Most of those handpicked board members, moreover, were either ceremonial directors, CEOs of listed companies that Grasso regulated, or CEOs of financial institutions that Grasso also regulated. (Good summary HERE.)

In sum, Kudlow and I probably vote for the same people most of the time, but in this column he is just whacked.

Outsider reverse veil piercing

You all probably know Jeff Foxworthy’s signature routine: “If you [fill in the black], you might be a redneck.” Let’s paraphrase that: If you have an opinion on “outsider reverse piercing," you might be a corporate law geek. In outsider reverse veil piercing, a personal creditor of the shareholder seeks to disregard the corporation's separate legal existence. Unlike regular veil piercing, in which a creditor of the corporation is trying to reach the personal assets of a shareholder, in this situation a creditor of the shareholder wants to reach the assets of the corporation in order to satisfy the creditor's claims against the shareholder. A number of courts have recognized such a cause of action. I think it’s a pernicious and evil doctrine that should be cast into the outer darkness where there is weeping and gnashing of teeth.

This post is specifically prompted by C.F. Trust, Inc. v. First Flight L.P., 580 S.E.2d 806 (Va.2003), in which the Virginia supreme court recently recognized outsider reverse piercing as valid under Virginia law. How sad that the highest court of my home state – the state where my paternal unit still resides and from whose eponymous university I hold two degrees – should have made such a boner. (I still think of myself mostly as a mislaid Virginian rather than a Californian, although that is slowly changing.) To spare those of you who come here via Hugh Hewitt’s generous pointers the gory details, I’ll put the rest of my comments in the Extended Post below. (For those who want even more information on regular veil piercing, reverse veil piercing, and/or outsider reverse veil piercing, you can buy my Corporation Law and Economics text and flip to Chapter 4.)

The CF Trust court opined “that there is no logical basis upon which to distinguish between a traditional veil piercing action and an outsider reverse piercing action. In both instances, a claimant requests that a court disregard the normal protections accorded a corporate structure to prevent abuses of that structure.” Au contraire. The problem presented by outsider reverse veil piercing is reminiscent of the issues raised by the old "jingle rule" of partnership law. Section 40 of the UPA (1914) provides that personal creditors of a partner have priority with respect to the partner's personal assets and creditors of the partnership have priority with respect to partnership assets. The "jingle rule," however, has been superseded for all practical purposes by section 723 of the federal Bankruptcy Code. That section provides that the firm's creditors will be paid out of firm assets and then have equal rights to participate with personal creditors in dividing up personal assets. The rationale for this change seems to have been that prospective creditors of the partnership rely on the creditworthiness of the individual partners in making lending and contracting decisions. In response to the federal law, UPA (1997) section 807 de facto repealed the jingle rule.

UPA (1997) thus does not allow a personal creditor of a partner direct access to partnership assets. Section 502 limits the partner's "transferable interest" in the firm to "the partner's share of the profits and losses of the partnership and the partner's right to receive distributions." Section 504 then allows a "judgment creditor" of a partner to "charge the transferable interest of the judgment debtor to satisfy the judgment." In effect, the creditor thus gets a lien on the partner's interest. Although a creditor who has foreclosed on that lien may seek judicial dissolution of the partnership, a court will only grant dissolution if "it is equitable to wind up the partnership business." UPA (1997) section 801(6).

Corporate law does not contain comparable provisions, but essentially the same result obtains through application of the standard judgment collection rules. Courts that accept outsider reverse veil piercing, however, disrupt this scheme by allowing personal creditors of a shareholder direct access to corporate assets.

To the extent that outsider reverse veil piercing effectively gives priority to personal creditors in the corporate setting, it seems just as problematic as the old jingle rule, albeit for slightly different reasons. As with the jingle rule question, the issue is: whose creditors shall have priority with respect to which assets? Outsider reverse veil piercing allows the creditor to avoid the more demanding proof required by traditional theories of conversion or fraudulent transfer. Outsider reverse veil piercing also effectively bypasses the standard approach to collecting a judgment against a corporate shareholder, in which the creditor attaches the debtor's shares in the corporation rather than the assets of the corporation itself. Unsecured creditors who relied on firm assets in lending to the corporation are thus disadvantaged. Similarly, if there are other shareholders, their interests are adversely affected if the corporation's assets can be directly attached by the personal creditor of one shareholder. In contrast, in ordinary (i.e., forward) veil piercing cases, a creditor may reach only the assets of the controlling shareholder who is determined to be the corporation's alter ego.

Review: Mark Roe's "Strong Managers, Weak Owners"

In their 1932 classic, THE MODERN CORPORATION AND PRIVATE PROPERTY, Berle and Means brought to popular attention the separation of ownership and control in U.S. corporations: shareholders exercised virtually no control over either day to day operations or long-term policy; instead, control was vested in the hands of professional managers. Separation of ownership and control occurred, according to Berle and Means, because important technological changes during the 1800s, especially the development of modern mass production techniques, gave great advantages to firms large enough to achieve economics of scale, which in turn gave rise to giant industrial corporations. These firms could be financed only by aggregating many small investments. Modern corporate governance scholars refer to the consequences of separating ownership and control as agency costs, but Berle and Means had identified the basic problem over forty years before the current terminology was invented: "The separation of ownership from control produces a condition where the interests of owner and of ultimate manager may, and often do, diverge ...."

In STRONG MANAGERS, WEAK OWNERS, Mark Roe strikes out in a new direction, by attacking the origins of the agency cost problem. The question Roe poses is the foundational one of whether Berle and Means were correct in assuming that the separation of ownership and control is an inherent aspect of large public corporations. Roe contends that dispersed ownership was not the inevitable consequence of impersonal economic forces, but rather the result of a series of political decisions motivated by a fear of concentrated economic power. Investments could have been channeled to industrial enterprises through large financial intermediaries, such as banks, insurance companies, and mutual and pension funds. Put another way, while it was necessary to aggregate and tap the savings of large numbers of individual investors in order to fund major industrial corporations, such aggregation could have taken place in financial institutions specifically designed to provide savings opportunities. In turn, it would have been those institutions that invested in industrial corporations. American corporate governance did not evolve along these lines because the law created a series of obstacles to financial intermediaries. If those obstacles had not existed, ownership might not have fragmented and thus might not have separated from control. The implication of this thesis, of course, is that while economic forces shaped modern corporate governance, they did so within the parameters set by law. As such, the governance structure of U.S. public corporations may not be optimal in an absolute sense, but only relative to the set of possibilities defined by our legal system.

If I ever get around to working up the "Corporate Canon" blog "a reader" requested, Roe's book defintely would be on it. It is a major and important contribution to our understanding both of (a) how American corporate law/governance evolved, describing in detail the forces that affected that evolution, and (b) comparative corporate law analysis across diverse economic systems, especially the US, Germany, and Japan. This is not too say that I don't disagree with parts of Roe's analysis. I set out my critique in the extended post below. For even more gore details, you can download a law review article-length book review I wrote some years ago here. And, in the pursuit of capitalism, an Amazon "buy now" box is in the extended post too. Show your support for this blog today!

Roe focuses on legal rules preventing institutional investors from acting as financial intermediaries between the investing public and the management of public corporations. The first third of STRONG MANAGERS is devoted to a historical review of the rules that preclude institutions from playing a significant role in corporate governance. In the second third, he reviews recent developments, which perpetuated the legal obstacles to governance activism by institutions. In the final part, he addresses the essential policy implication of his analysis: should the legal system encourage institutions to take a more active governance role?

One can quibble with portions of Roe's historical argument. There is, for example, good evidence that ownership and control separated long before most of the rules Roe blames for the separation went on the books. At the very latest, ownership and control of large corporations had separated by the middle of the nineteenth century. In contrast, the rules with which Roe is concerned mostly came into existence only after 1900. Granted, banks fragmented in the first third of the 18th century, but a number of critical restrictions did not come into play until the New Deal. Insurers were largely unregulated until after 1906. Mutual funds, albeit long of little importance, likewise were essentially unregulated until the New Deal. Given this free market environment, why did these or other financial intermediaries not step into the economic niche opened when ownership and control separated during in the early and mid-1800s?

In other words, Roe has not proven that the Berle-Means corporation would not have evolved in the absence of the constraints on financial intermediaries he describes. But, at a minimum, Roe does demonstrate that politics did nothing to impede the development of the Berle-Means corporation, perhaps facilitated its evolution, and certainly helped sustain it by preventing financial intermediaries from taking active governance roles. In and of itself, that showing is a formidable accomplishment and a valuable contribution to the literature.

Although the first two sections of STRONG MANAGERS are notable in their own right, the book takes on importance mainly because of the significance of the policy questions to which the final section is addressed. Space does not permit one to do full justice to Roe's argument, which is nuanced and well-crafted. Suffice it to say that relatively little has changed since STRONG MANAGERS was published. Despite increased activism in recent years, institutions still are mostly passive. Even the most active institutional investors spend only trifling amounts on corporate governance activism. Institutions devote little effort to monitoring management, rarely conduct proxy solicitations, do not to try to elect directors, and rarely coordinate their activities. And, perhaps, this is a good thing. As Roe concedes, there is good evidence that bank-dominated finance has harmed that Japanese and German economies by impeding venture capital. Moreover, institutional investors may well abuse control by self-dealing. Even if institutional investors are entirely self-less, greater control on their part would still be undesirable if the separation of ownership and control mandated by U.S. law has substantial efficiency benefits. Here is where Roe and I part company-I suspect the Berle-Means corporation has significant economic advantages over its alternatives; he is skeptical. Perhaps only time will tell, as competition in increasingly global markets puts various systems of economic organization to the test. In the meanwhile, Roe's book belongs in the library of anyone interested in corporate law or governance.

A conversation at the United ticket counter, word-for-word

Me: “Why was my flight cancelled?”
Agent: “Mechanical”
Both: snicker

My guess is that “mechanical” –that one word was all she said – is code for “we didn’t sell enough tickets.” Granted, it could have been Isabel, but why didn’t she just say so?

Other random thoughts while traveling:

– Having your ride get rear-ended on the way to the airport is no fun.
– Having your flight cancelled is no fun.
– The ticket counter and gate agents at Northwest were a lot nicer than the ones at United, not to mention more efficient (special thanks to the Northwest gate agent in Detroit who scored me the exit row; she meant well, but see next entry).
– On a night flight when all you want to do is sleep, the only thing worse than two teenyboppers in the row ahead of you talking nonstop for four hours about Britney, Christina, and their appalling boyfriends is a baby behind you crying nonstop for four hours. When you have to contend with both, you begin to think very dark thoughts, indeed. (E.g., you wonder why they don’t make babies ride in cargo like they do dogs.)
–When United cancels a flight and books you on a different airline, why don’t they go ahead and give you frequent flyer miles?
– Why hasn’t help taking their airline to the brink of bankruptcy taught United’s customer service people to be (a) friendlier and (b) more helpful?
– If Northwest had more direct flights to more places out of LA, and I had fewer miles banked at United, I might switch main carriers.
–What wiseacre put the stack of Al Franken books in the Fiction rack at the Detroit airport bookstore?
–The folks at MSU could not have been nicer or run a smoother conference (special thanks to Mae, Elliot, and Will), but its always nice to come home.

Is the legal profession a den of credential snobs?

Scheherazade blogs at the Civil Procedure blog on "Why Are Lawyers Such Snobs?"

Any conversation about the future of the profession is incomplete if it doesn't acknowledge how pervasive and influential our profession's snobbery about pedigree is. I happen to think it's ugly and stupid, myself, but there is no arguing that it is there, and I think maybe older, well-pedigreed lawyers forget or don't recognize just how strong a pull it exerts on young people. ... [O]ur profession worships credentials. We assume people from big, fancy law firms are smarter, and we assume people from fancy expensive law schools are better. You're a big liar if you pretend it's not true.

No doubt, and no doubt it has a deleterious impact on the self-esteem of some young lawyers. Yet, even so, rankings of law schools still have a valid role. In his article In Praise of Law School Rankings: Solutions to Coordination and Collective Action Problems, 77 Texas Law Review 403-28 (1998), my colleague Russell Korobkin argued:

Students read and value rankings because they know that attending a highly-ranked school signals their quality to desirable employers, who also study the rankings in order to interpret these signals. This coordination function is served whether or not the rankings accurately measure the quality of law schools, however defined.

I think Russell's basically right, but I also think Scheherazade makes a valid argument that rankings have negative externalities that impact many young lawyers. I wish I knew how to get the benefits of rankings without creating snobs (the only snobs I like are wine snobs), but I don't. As always, there is no free lunch.

UPDATE: Ethical Esq., my former student at HLS John Palfrey, and the always-readable Ernie the Attorney have jumped in too.

Does state corporate law really race to the top?

The Michigan legislature recently amended the state’s control share acquisition statute to make it easier for the Taubman family to fend off the hostile bid for Taubman Centers from Simon Property Group and Westfield America Trust (I describe these statutes and the Michigan amendment in the Extended Post below). Several readers have written or used the comment feature to ask how I square these statutes with the race to the top hypothesis I have espoused in earlier posts (see, e.g., HERE). A fair question, indeed, but the two can be squared.

According to the standard race to the top account, investors will not purchase, or at least not pay as much for, securities of firms incorporated in states that cater too excessively to management. Lenders will not make loans to such firms without compensation for the risks posed by management's lack of accountability. As a result, those firms' cost of capital will rise, while their earnings will fall. Among other things, such firms thereby become more vulnerable to a hostile takeover and subsequent management purges. Corporate managers therefore have strong incentives to incorporate the business in a state offering rules preferred by investors. Competition for corporate charters thus should deter states from racing to the bottom. (The competing “race to the bottom” hypothesis argues that states compete in granting corporate charters. After all, the more charters the state grants, the more franchise and other taxes it collects. According to the race to the bottom theory, because it is corporate managers who decide on the state of incorporation, states compete by adopting statutes allowing corporate managers to exploit shareholders.)

The evidence on the race to the top versus race to the bottom dispute is not free from controversy, but I think the weight of the evidence clearly favors the race to the top. Roberta Romano’s event study of corporations changing their domicile by reincorporating in Delaware, for example, found that such firms experienced statistically significant positive cumulative abnormal returns. Roberta Romano, Law as a Product: Some Pieces of the Incorporation Puzzle, 1 J. L. ECON. & ORG. 225 (1985). In other words, reincorporating in Delaware increased shareholder wealth. This finding strongly supports the race to the top hypothesis. If shareholders thought that Delaware was winning a race to the bottom, shareholders should dump the stock of firms that reincorporate in Delaware, driving down the stock price of such firms. As Romano found, and all of the other major event studies confirm, there is a positive stock price effect upon reincorporation in Delaware. See generally ROBERTA ROMANO, THE ADVANTAGE OF COMPETITIVE FEDERALISM FOR SECURITIES REGULATION 64-73 (2002) (discussing the relevant studies and criticisms thereof).

The event study findings are buttressed by a well-known study by Robert Daines in which he compared the Tobin’s Q of Delaware and non-Delaware corporations. (Tobin’s Q is the ratio of a firm’s market value to its book value and is a widely accepted measure of firm value.) Daines found that Delaware corporations in the period 1981-1996 had a higher Tobin’s Q than those of non-Delaware corporations, suggesting that Delaware law increases shareholder wealth. Robert Daines, Does Delaware Law Improve Firm Value?, 62 J. FIN. ECON. 525 (2001). Although subsequent research suggests that this effect may not hold for all periods, Daines’ study remains an important confirmation of the event study data.

Additional support for the event study findings is provided by takeover regulation. Compared to most states, which have adopted multiple anti-takeover statutes of ever-increasing ferocity, Delaware’s single takeover statute is relatively friendly to hostile bidders. An empirical study of state corporation codes by John Coates confirms that the Delaware statute is the least restrictive and imposes the least delay on a hostile bidder. John C. Coates IV, An Index of the Contestability of Corporate Control: Studying Variation in Takeover Vulnerability (June 30, 1999). Given the clear evidence that hostile takeovers increase shareholder wealth, this finding is especially striking. See generally Stephen M. Bainbridge, Corporation Law and Economics 612-14 (2002). The supposed poster child of bad corporate governance, Delaware, turns out to be quite takeover-friendly and, by implication, equally shareholder-friendly. (Indeed, check out this headline: "Beware Delaware." The article goes on to argue that: "Since last summer, the Delaware Supreme Court has issued at least five decisions of great concern to the corporate bar. Each was remarkable not only because it found against directors and in favor of shareholders, but also because it reversed a lower court ruling that went the other way.")

This takes us to the Michigan anti-takeover statute. Given that state takeover regulation demonstrably reduces shareholder wealth but that most states have nevertheless adopted anti-takeover statutes, what are we to make of that data point? In my view, we must concede that state regulation of corporate takeovers appears to be an exception to the rule that efficient solutions tend to win out. But so what? Nobody claims that state competition is perfect. The question is only whether some competition is better than none. Delaware’s relatively hospitable environment for takeovers suggests an affirmative answer to that question.

In other words, the Michigan statute proves a central point of public choice theory. The incentives of legislators and regulators are driven by rent-seeking and interest group politics. In turn, the incentives of directors and managers who lobby state legislators vary by context. In most contexts, the financial incentives of directors and managers are aligned with those of shareholders for the reasons discussed above. In the hostile takeover context, however, the incentives of directors and managers deviate from those of the shareholders. Hostile takeovers are frequently followed by management purges, especially at the top management and board levels. Nobody likes to be fired, so it is hardly surprising that directors and managers try to use the legislative process to protect their jobs. Neither, however, does it disprove the race to the top hypothesis; it only shows that there is an exception to every rule.

Control share acquisition statutes rely on the states' traditional power to define corporate voting rights as a justification for regulating the bidder's right to vote shares acquired in a control transaction. A "control share acquisition" is typically defined as the acquisition of a sufficient number of target company shares to give the acquirer control over more than a specified percentage of the voting power of the target. The triggering level of share ownership is usually defined as an acquisition which would bring the bidder within one of three ranges of voting power: 20 to 33 1/3%, 33 1/3 to 50% and more than 50%. Most control share acquisition laws provide that shares acquired in a control share acquisition shall not have voting rights unless the shareholders approve a resolution granting voting rights to the acquirer's shares. See chapter 8 of my Mergers and Acqusitions text for more details.

Members of the Taubman family formed a group to pool their shares’ voting powers to oppose the Simon Property and Westfield hostile bid. Once aggregated, their combined shares exceeded the 33 1/3% threshold. Under the Michigan statute as then worded, the formation of the group constituted a control share acquisition as defined by statute (even though they did not acquire more shares in the usual sense of buying some), or so a federal court held back in May. Accordingly, the formation of the group required approval by Taubman Center’s other shareholders. The new bill amends the control share acquisition statute to permit shareholders to form such a group without triggering the voting requirement.

The stated purpose of control share statutes is providing shareholders with an opportunity to vote on a proposed acquisition of large share blocks which may result in or lead to a change in control of the target. These statutes are premised on the assumption that individual shareholders are often at a disadvantage when faced with a proposed change in control. If the target's shareholders believe that a successful tender offer will be followed by a purchase by the offeror of non tendered shares at a price lower than that offered in the initial bid, for example, individual shareholders may tender their shares to protect themselves from such an eventuality, even if they do not believe the offer to be in their best interests.

By requiring certain disclosures from the prospective purchaser and by allowing the target's shareholders to vote on the acquisition as a group, control share acquisition statutes supposedly provide the shareholders a collective opportunity to reject an inadequate or otherwise undesirable offer. For example, since control share acquisition statutes generally require the offeror to disclose plans for transactions involving the target that would be initiated after the control shares are acquired, shareholders presumably would be unlikely to approve a creeping tender offer or street sweep which would be followed by a squeezeout back end merger at a price less than or in a consideration different than that paid by the acquirer in purchasing the initial share block.

Vik Amar on recall and Bush v Gore

I blogged a while back on Einer Elhauge's excellent WSJ op-ed on the 9th Circuit's misreading of Bush v Gore. UC Hastings law Professor Vik Amar has an equally-insightful (if somewhat more skeptical of Bush v Gore) op-ed at Findlaw.com. He makes a key point that many proponents of the 9th Circuit opinion have overlooked; namely, the distinction between intentionally disregarding some votes due to political bias by human counters versus randomly disregarding some votes due to technological glitches:

It is hard to completely understand Bush v. Gore without appreciating the concern shared by many people in the country that Democratic and Republican county elections officials might try to take advantage of the unfettered discretion state law gave them to hand count votes to get to a particular result. Machine mistakes, even ones that are predictably skewed in favor of or against particular groups or parties, may be different than mistakes made by individual persons who are motivated to make those mistakes on purpose. Purposeful intent is often treated differently in the constitutional law of equal protection than is predictable disparate impact. And while many people alleged intentional manipulation in the Florida vote count nightmare, no one today alleges that the old-fashioned punch cards are used in urban populous counties in California because of a desire to disadvantage the causes or candidates who are most popular in those counties.

After reading Amar's column, you might also read Hugh Hewitt's Weekly Standard column on the 9th Circuit opinion, which focuses on Judge Harry Pregerson.

UPDATE: Drudge links to a Reuters breaking news story that the 9th Circuit will rehear the panel decision en banc.

On a personal note

I am blogging today from the Michigan State University - DCL Law Review Symposium "Sarbanes-Oxley: In the Wake of Corporate Reform," where I just finished presenting my paper on managerialism and legal ethics post-Sarbanes Oxley section 307 (shout out to my co-author and 2003 UCLA law grad Christina Johnson).

My thanks to Associate Dean Mae Kuykendall and Professor Elliot Spoon for making this blogging possible by arranging for an internet connection.

The best line of the day so far was a reference to the SEC - California Bar dispute, about which I've blogged before: "If you law students go to practice in California, don't worry about getting disbarred for complying with the SEC rule. If you get disbarred, you can always run for governor." Wish I'd said it.

Corp Law Blog on shareholder activism and shareholder proposals

Mike O'Sullivan at Corp Law Blog has a long but great post today on shareholder activism. Bottom line:

The unstated assumption behind the SEC's shareholder access initiative is that shareholders are best able to look out for the interests of a corporation and all its stockholders. I know of investors who exemplify this ideal, and I know of companies that would benefit from giving up some control to these investors. The problem is, I know of political activists who fall far short of this ideal, and I know these activists often target the best-performing companies. I doubt the SEC can craft a rule that would open the doors of the worst companies to investors while closing the doors of the best companies to the activists.

Exactly. Regular readers of this blog will know that I am similarly skeptical of shareholder activism. I strongly encourage you to go read Mike's whole post.

Federalist Society corporate governance conference

The Federalist Society will hold its 7th Annual Annual Corporate Governance Conference on Wednesday, September 24, 2003, at the New York Athletic Club in NYC. I was on the planning committee and had hoped to attend. Unfortunately, class and personal commitments will keep me here on the Left Coast that day. It should be a great conference, however. There will be two panels, with the morning panel discussing executive compensation and the afternoon session discussing director independence requirements. In between, there will be a debate on federalizing corporate law and a keynote address by Timothy Flanigan, former Deputy White House Counsel. The confirmed speakers include leading academics, prominent practitioners, and former SEC muckety mucks. You can register HERE.

Marginal Revolution on Grasso

Fabio Rojas at Marginal Revolution blogs:

Of course, the question is not how big [Grasso's pay] package was, but how much value did he add to the NYSE and was his fee competitive? Hard to say about the first since the NYSE is a non-profit corporation, but Grasso ($140M pay out) would be paid more than Jefferey Barbakow, who, according to Forbes' magazine ... was the highest paid executive of a publicly held firm in 2002 at $116M.

Exactly! The Wall Street Journal (subscribers only) similarly reports that "Grasso collected more cash between 1995 and 2002 than the heads of 10 of 11 financial-service firms included in benchmarking surveys used to set his pay." Again, it all goes back to bad governance -- directors who were either pets holding down a post they regarded as ceremonial or people who Grasso regulated. Garbage in, garbage out.

UPDATE: Actually, the comparison between Barbakow and Grasso is even more striking than Fabio claims. The NYSE actually paid Grasso $140 million in one lump sum, albeit including deferred compensation and so on. Whereas $111 million of Barbakow's "pay" came from exercising "stock gains, presumably by exercise of stock options, and thus didn't come directly from the corporate treasury.

Al Hunt on Grasso and the NYSE

Al Hunt’s op-ed in today’s Wall Street Journal (subscription req’d) uses the Grasso pay imbroglio to recycle virtually every grievance in the current left-liberal talking points guide, but lets stick to our knitting – i.e., corporate governance. Hunt complains that Grasso’s salary of $140 million is “indefensible” relative to what the “average worker” gets paid. (In a particularly invidious move, Hunt drags in the case of a wounded GI who had to reimburse the government for food during his hospital stay. While deplorable, its not clear what that case has to do with Grasso specifically or even executive compensation generally.) All of which raises the question: in thinking about executive compensation is the comparison to what average workers make a valid one or just a debater’s cheap shot?

If comparing what Grasso makes to the pay of an average worker is okay, then don’t we also have to compare what Shaquille O’Neal makes to that worker’s pay? If Hunt wants to argue that there is a dollar amount of annual earnings that nobody should be allowed to exceed, that’s one thing. But I doubt even Paul Krugman would go that far. Indeed, Hunt says that some folks – naming Tiger Woods, Kevin Costner, and Bill Gates – deserve their compensation, just not Grasso: "Most Americans are upwardly mobile and celebrate the riches of the truly successful and deserving, whether it's Michael Jordan, Kevin Costner, or Bill Gates. But in a time when sacrifices are being made by firefighters, schoolteachers and Marine staff sergeants, many of these same Americans resent the Dick Grassos." I don’t know why he thinks people resent Grasso's pay, but not Costner's. Has Hunt seen any of Costner’s recent movies? I mean, really. If any of the four he names should be joining firefighters et al. making sacrifices, it is Costner. Did you see "Waterworld"? or "The Postman"? Whereas nobody seriously doubts that Grasso was, at the very least, competent and most concede he was doing a good job.

But lets get serious about this for a minute. How much you get paid depends in large part on the thickness of the market for your services. In a thick market, wages tend to be low because there are many potential employees – all more or less fungible – competing for jobs. In a thin market, however, wages tend to be high because many employers are competing to hire a small number of eligible workers. The market for burger flippers is very thick. The market for law professors is relatively thick (so, for that matter, is the market for pundits -- if blogging has done nothing else, it has proven that people like Glenn Reynolds or Eugene Volokh can do punditry at a very high level even though they lacked access to a national medium until recently -- so maybe Hunt's mad because he's in for a paycut?). The market for CEOs of Fortune 500 companies (which is what the NYSE essentially is) is thin. I’d guess the number of people who have what it takes to run a Fortune 500 company isn’t much larger than the number of people who can run a NBA fast break. Its just supply and demand, folks.

Having said that, there are some important differences between Grasso’s and Shaq’s contracts, which do cut against the former. First, although I don't have the citations at the tip of my fingers, I have seen a couple of recent studies to suggest that boards erroneously believe the CEO market is thinner than it actually is, which tends to artificially inflate CEO salaries. Boards tend to want proven track records (picking an unproven CEO who tanks is bad for the board’s reputation), which limits the pool through the “Experience Required” phenomenon. Boards also tend to pick CEO candidates who resemble the prevailing demographics of the directors, which further artificially limits the pool.

Second, and more pertinent, Shaq is accountable in ways that Grasso was not. Shaq is subject to constant evaluation by Phil Jackson and Jerry Buss – neither of whom are shrinking violets. One has little doubt they make darn sure they are getting what they pay for. In contrast, although Grasso was nominally subject to evaluation by the NYSE board, that board was comprised in large part of ceremonial “public” directors who we now know did not take the job as seriously as they should have and representatives of the seat-holders who we have long known have various conflicts of interest. The board itself, moreover, was accountable to no one. So it all comes back to governance. In fairness to Hunt, he does devote a section in the middle of the screed to the governance issues. Contra the main thrust of Hunt’s column, however, the problem is not the dollar amount. The problem is that NYSE’s current governance structure had no mechanism for ensuring that the Exchange got back value commensurate with whatever amount it paid. Everything else is just so much populist agitprop.

Director primacy posting plan

University of Florida law professor Wayne Hanewicz has written a very interesting analysis of the Delaware supreme court’s controversial decision in Omnicare, Inc. v. NCS Healthcare, Inc., 818 A.2d 914 (Del. 2003). A draft is available online HERE. I found Wayne’s article particularly interesting in that much of the article is devoted to “evaluat[ing] the ‘director primacy’ model of corporate governance that Professor Stephen Bainbridge has advocated for in a series of recent articles.” (If you're interested, click on the "My Scholarship" link under the "Me and My Blog" header in the right sidebar and download anything with "director primacy" in the title.) Hanewicz says “there is much to like about director primacy” (my blushes), but purports to have identified “a weakness in the model. The weakness is that director primacy focuses too heavily on the board as the sole corporate decisionmaker.” You realize, of course, this means war!

Not really, of course. Actually, I like the article a lot and think Hanewicz makes a number of good points about both director primacy and Omnicare. In the old days, I would have had to write a responsive article (or, at least, stuck a bunch of extra footnotes into the next director primacy article), post it to SSRN, find a law review to publish it, and wait a year – or more – for it to come out in print. But now I can just blog my reactions. Actually I’ll probably do all the old-style stuff too, but blogging lets me get the core ideas out faster and perhaps to a wider, or at least different, audience. Indeed, the main reason I started this blog, besides needing to vent occasionally about the LA Times, was to disseminate my ideas about corporate law and governance to a new audience. Hence, Wayne’s article has set in motion a small flood of posts planned for the next few days and weeks. To whet your appetite, the current outline is as follows:

1. On the Necessity for a Model of the Firm in Economic Analysis of Corporate Law
2. The Big Three Models of Firm Governance, Plus One
3. The Contractarian Model of the Firm: Review of Coase’s The Firm, The Market, and the Law
4. Director Primacy Elaborated

September 18, 2003 in Corporation Law: Director Primacy | Permalink | TrackBack

September 17, 2003

Breaking News on Grasso

I was going to blog some thoughts on Holman Jenkins' well-worth reading op-ed in today's WSJ (subscription req'd). Key quotables:

Mr. Grasso, head of the exchange, is about to be fired for being paid too much, by the very board members who were responsible for paying him too much. ... In a real company, board members represent the owners. The NYSE's board, however, is that most ornamental of beasts, a "constituent" board, a collection of the great and commendable who supposedly represent the public good -- i.e., they don't know whom they represent. ... Today's troubles might well be traced back to 1999, when Mr. Grasso let floor traders talk him out of turning the Big Board into a shareholder-owned, for-profit business. You only have to look at the legal problems of Visa and MasterCard to notice that the NYSE is not the only important institution in need of transcending an obsolete form of "mutual" ownership. ...

Regular readers will know that I have been saying the same thing. But CNNfn is reporting:

The board of the New York Stock Exchange will hold an emergency meeting later Wednesday to discuss the future of embattled Chairman Richard Grasso, a person close to the situation told CNNfn.

So I think I'll hold fire for now. More later, probably.

UPDATE: Grasso's out. Fixing the structural problems -- lack of accountability, ceremonial directors, lack of transparency -- still needs prompt and thoughtful attention.

September 17, 2003 in Corporate Governance, Current Affairs, SEC: Securities Regulation and Litigation | Permalink | TrackBack

The Recall and Managing Bush v Gore

Rick Hasen, whose Election Law Blog is the gold standard of online election law resources and which I like a lot, has described Bush v Gore as setting out a "murky (or 'judicially unmanageable') standard." The Ninth Circuit managed to manage that "unmanageable standard" into an equal protection-based rule that, when you clear away all the smoke, seems to say that different counties in a given state may not use different ballot-counting systems. I'm just a lil ol' country corporate law professor, but this immediately struck me as a misreading of Bush v Gore. In a Wall Street Journal op-ed today (subscription required), Harvard law professor and constitutional/election law expert Einer Elhauge blows the Ninth Circuit's decision to smithereens:

Bush v. Gore never rested on such an equal protection theory. It couldn't have, because that decision sustained a machine recount despite the fact that some Florida counties used punch cards and others used optical scanners. As the Supreme Court stated, "The question before the Court is not whether local entities, in the exercise of their expertise, may develop different systems for implementing elections." Instead, Bush v. Gore expressly stated that the issue there was "whether the use of standardless manual recounts violates the Equal Protection and Due Process Clauses." It stressed that, there, the standards about whether to count a dimpled or partially perforated ballot varied not only between counties but within counties over time and between different counters.

If allowed to exercise such standardless discretion in ballot-counting, counters could engage in political discrimination by manipulating the standard to disfavor the ballots and candidates whose political viewpoints the counters disliked. But such discrimination would be hard to detect or prove precisely because there would be no standard against which to judge the counting. As Bush v. Gore stated, "The problem inheres in the absence of specific standards to ensure its equal application."

Sounds right to me. If so, however, the Ninth Circuit's result is clearly erroneous. Meanwhile, back at the the Election Law Blog, Hazen has a round up of recall op-ed links. The Bruce Ackerman link leads to an especially interesting post, in which vociferous Bush v Gore critic Ackerman takes the Ninth Circuit to task. Also noteworthy is the link to the NPR debate between Hasen and my friend Chapman University law professor John Eastman.

September 17, 2003 in Politics: California | Permalink | TrackBack

Ernie The Attorney's Pointer

Ernie The Attorney's Weekly Law Blog Roundup sends us a pointer:

Turning now to the academic sphere, we have Stephen Bainbridge a UCLA law professor and colleague of Eugene ('careful with that blog') Volokh. Stephen's blog is called Corporation Law and Economics. Wisely sensing the efficiencies of the market, Stephen moved his blog to a TypePad hosted site after a brief foray with this site at Blogger. An economics guy knows that when you get something for free it's worth every penny.

Exactly right. I don't want to knock Blogger, because it makes blogging available on a very wide scale. But the very first thing I learned in Econ 101 is "there is no such thing as a free lunch." TypePad is a significantly superior product, with much greater flexibility and a far wider array of features than Blogger. One of the coolest things I have just discovered, is that I can use Dragon NaturallySpeaking to dictate into the TypePad interface, which means I can blog faster and with less RSI concern.

September 17, 2003 in Weblogs | Permalink | TrackBack

September 16, 2003

Required Reading

John Hawkins blogs:

Yesterday, I did a twenty minute interview by phone with Milton Friedman. Of course, Mr. Friedman has an INCREDIBLE resume. He won the 1976 Nobel Memorial Prize for economic science, won the "Presidential Medal of Freedom in 1988 and received the National Medal of Science the same year".

The interview continues here.

Corp Law Blog blogs Sarbanes-Oxley overviews:

Having spent the past year immersed in the innards of SOX, I haven't spent much time with SOX overviews. I have, however, found "The Sarbanes-Oxley Act of 2002 and SEC Rulemaking" (PDF), a 200 page outline maintained by John J. Huber and Thomas J. Kim of Latham & Watkins LLP, to be a very useful SOX source. Although I have only skimmed it, "The Post-Enron Corporate Governance Environment: Where Are We Now?" (PDF), a 200 page SOX overview prepared by Fried Frank Harris Shriver & Jacobson, also looks to be a good source.

NRO's Jonah Goldberg (of "cheese eating surrender monkeys" fame -- or infamy, if you prefer, although I don't) blogs at the Corner on one of my favorite guilty pleasures: Highlander. Also, here. I hate to admit this publicly, but I even own the DVD for the infamous second film in the series, which Robert Ebert accurately called "the most hilariously incomprehensible movie ... almost awesome in its badness." Please come back anyway.

UPDATE:

Drudge headline: "Flashback: Brit General stops Wes Clark 'from starting WWIII'... " The original BBC story to which he links is HERE.

Quicken Brokerage - News Center reports:

Some New York Stock Exchange seat owners, frustrated at the furor over disclosure and governance at the exchange, are pushing for the Big Board to consider going public, resurrecting a popular idea that was championed by New York Stock Exchange Chairman Dick Grasso in 1999 but killed before members ever had a chance to vote on it, Tuesday's Wall Street Journal reported.

Regular readers will recall that I have argued privatization of the NYSE via a public stock offering is the bestavailable solution to the exchange's governance problems.

The Yin Blog, which I am starting to like a lot, comments on Christiane Amanpour's claim that the press was muzzled during the Iraq war:

Huh? ... But to complain that CNN was allegedly "intimidated" by the administration? Well, I suppose that's consistent with CNN's admitted character. As we've already seen, CNN has admitted that it concealed stories about the horrors of Iraq under Saddam Hussein. (I should note that CNN denies Amanpour's account.)

That's calling 'em the way you see 'em. After you stop by Professor Yin's blog a few times, you can try to guess his political affiliations and then vote in his reader poll. My vote was for "California liberal (pro-choice, pro-environment, otherwise moderate - model rep: Dianne Feinstein)," which is in second place with 30%. But, astonishingly enough, the runaway winner with 44% is "Watered down libertarian (model rep: Tom Campbell)." I guess I can see that. He seems like a pretty eclectic guy. UPDATE to the Update: Instapundit blogs the same story, but much less well. Go read Yin's whole post.

September 16, 2003 in Current Affairs, Weblogs | Permalink | TrackBack

More from Marginal Revolution on Student Evaluations

I blogged Tyler's earlier post on student evals, but then found this folllow-up post even scarier

:"...the correlation between Quality and Easiness is 0.61, and the correlation between Quality and Sexiness is 0.30. Using simple linear regression, we find that about half of the variation in Quality is a function of Easiness and Sexiness." The result is from three professors at Central Michigan University, reported by the SCSU Scholars blog.

It looks like I'm in deep doo-doo!

September 16, 2003 in Legal Education | Permalink | TrackBack

Presidential Politics and Corporate Governance: John Edwards and Shareholder Empowerment

John Edward's campaign website has the most detailed treatment of corporate governance and accountability issues than that of any of his competitiors. Among his key action items is "Empower[ing] Shareholders: Edwards will allow shareholders to nominate board members without waging a costly proxy fight." I like John Edwards. He did good work in pushing Sarbanes-Oxley section 307 over the objections of the pezzonovante at the ABA. If I were a Democrat, I would be deciding between Edwards and Lieberman. But I think he's demonstrably wrong here.

There is some anecdotal evidence that investors -- especially institutional investors -- are becoming more active, using the proxy system to defend their interests and influencing policy through negotiations with management. Yet, there is little concrete evidence that shareholder activism matters. Even the most active institutions devote little effort to monitoring management. They rarely conduct proxy solicitations or put forward shareholder proposals. They do not to try to elect representatives to boards of directors. See Bernard S. Black, Shareholder Activism and Corporate Governance in the United States, in The New Palgrave Dictionary of Economics and the Law 459 (1998).

U.S. public corporations are characterized by a separation of ownership and control: the firm's nominal owners, the shareholders, exercise virtually no control over either day to day operations or long-term policy. Instead, control is vested in the hands of professional managers, who typically own only a small portion of the firm's shares. This separation has costs, the most significant of which are referred to as agency costs, incurred to prevent shirking by managers. The agency cost model forces one to confront the question: who will monitor the monitors? In any team organization, one must have some ultimate monitor who has sufficient incentives to ensure firm productivity without himself having to be monitored. Shareholders, in theory, function as such ultimate monitors. Because institutional investors own large blocks, in particular, and have an incentive to develop specialized expertise in making and monitoring investments, institutional investors could hold management accountable for actions that do not promote shareholder welfare, which should lead to a reduction in agency costs.

The benefits of institutional control, however, may come at too high a cost. There is good evidence that bank control of the securities markets has harmed that Japanese and German economies by impeding the development of new businesses. Mark J. Roe, Strong Managers, Weak Owners: The Political Roots of American Corporate Finance 256 (1994). More importantly, there is a risk that institutional investors will abuse their control by self-dealing and other forms of over-reaching. If management becomes more beholden to the interests of large shareholders, it may become less concerned with the welfare of smaller investors. The U.S. experience with social investing by public pension funds, moreover, suggests that politicization of stockownership will be an economic drag. In general, the greater the extent to which a public pension fund is subject to direct political control, the worse its investment returns. Roberta Romano, Public Pension Fund Activism in Corporate Governance Reconsidered, 93 Colum. L. Rev. 795 (1993).

In my view, moreover, the separation of ownership and control is a highly efficient solution to the decisionmaking problems faced by large corporations. Separating ownership and control by vesting decisionmaking authority in a centralized entity distinct from the shareholders is what makes the large public corporation feasible. To be sure, this separation results in the agency cost problem described above. A narrow focus on agency costs, however, easily can distort one's understanding. Corporate managers operate within a pervasive web of accountability mechanisms that substitute for monitoring by residual claimants. Agency costs, in any event, are the inevitable consequence of vesting discretion in someone other than the residual claimant. We could substantially reduce, if not eliminate, agency costs by eliminating discretion; that we do not do so suggests that discretion has substantial virtues. See my article, Director v. Shareholder Primacy in the Convergence Debate, 16 Transnational Lawyer 45 (2002).

The root economic argument against shareholder activism thus becomes apparent. Large-scale shareholder involvement in corporate decisionmaking seems likely to disrupt the very mechanism that makes the modern public corporation practicable; namely, the centralization of essentially nonreviewable decisionmaking authority in the board of directors. Given the significant virtues of discretion, one ought not lightly interfere with management or the board's decisionmaking authority in the name of accountability. Preservation of managerial discretion should always be the null hypothesis. The separation of ownership and control mandated by U.S. corporate law precisely that effect. Empowering shareholders therefore may be good politics these days, but its bad public policy.

September 16, 2003 in Corporation Law: Director Primacy, Corporation Law: Proxies, Politics: Presidential Election | Permalink | TrackBack

Opt-in versus Opt-out Rules; With Application to Blogging Reader Emails

CS at the group blog SixFourteen.com writes:

A ... new ... blogger that I much like has quoted an e-mail I wrote to him here (I am "a reader"). The blog is Corporation Law and Economics, and basically deals with the substance underlying what I do all day (If y'all care). Extremely well done, and he has already caused me to buy a book--the mark of a good blog, if ever ther was one.

Thanks for the kind words, as always, but this post is prompted by his complaint (?) that I referred to him as "a reader." [UPDATE: Reader writes to the effect of no complaint, just comment.] Maybe there is blogosphere learning on this, but if not here is the question for discussion: "Should a blog's email policy be opt-in or opt-out?" My policy on quoting emails is opt-out: Unless you tell me not to do so, I will quote your email. My policy on identifying the emailer is opt-in: Unless you tell me to name you, I will refer to you as "a reader."

Rationale: An opt-in rule requires consent of responding readers before the information they have sent you can be disclosed to other readers. Opt-in thus essentially stops the free flow of information blogging is designed to promote. In contrast, an opt-out rule promotes free flow of information while still alllowing privacy sensitive readers to prevent personal information and communications from being shared. Many privacy surveys, however, suggest that consumers view opt-out consent as appropriate only if the opting-out provision is effectively brought to the customer's attention, the policy is clear and detailed, and the system makes opting-out easy to execute. Assuming correspondents are more likely to have privacy concerns with respect to identity rather than the substance of their remarks, I adopted opt-in for the former and opt-out with respect to the latter. The difficult of my solution, of course, is that is a non-obvious one that, unless adopted as a network standard, may only serve to raise transaction costs. Which leads back to the starting question of whether there is in fact a blogosphere standard?

September 16, 2003 in Weblogs | Permalink | Comments (0) | TrackBack

California Joins Washington on SEC Legal Ethics Preemption Fight

TheCorporateCounsel.net Blog reports:

It looks like California has joined the jurisdictional flap over the SEC's new "reporting up" rule. In response to the SEC's General Counsel's letter to the State of Washington, the Corporations Committee of the State Bar's Business Law Section has sent a letter to the SEC notifying it that new Rule 205.3(d)(2) conflicts with California law.

The Corporations Committee also notified the SEC that - in the absence of an appellate judgment in favor of the SEC's pre-emption claim - the California State Bar may not refuse to enforce Section 6068(e) of the California Business and Professions Code. Under Section 6068(e), California attorneys have an ethical obligation to maintain client confidences "at every peril to himself or herself."

As you may recall, back on July 23, the SEC's General Counsel publicly released a letter stating that state bar associations were pre-empted from disciplining an attorney who made voluntary disclosure of client confidences to the SEC in reliance on its rules. This letter was in response to a proposed action by the Washington State Bar Association Board of Governors. On July 26, the Washington State Bar Association Board of Governors took its action notwithstanding the SEC's position.

Corp Law Blog has a very good post on why the SEC may have a harder time preempting state legal ethics rules than conventional wisdom would assume:

Preemption isn't meant to be easy. The California letter details exactly how hard it will be in California, which has a statute (Bus. and Prof. Code Sec. 6068(e)) specifically requiring attorneys to maintain client confidences: "It is the duty of an attorney . . . [t]o maintain inviolate the confidence, and at every peril to himself or herself to preserve the secrets, of his or her client."

As you would expect, California does not permit bar associations or anyone else to ignore California statutes based on a letter from the SEC's general counsel. California's Constitution (Art III, Sec. 3.5), specifically requires California agencies, such as its bar association, to enforce California statutes in the face of any Federal law purporting to preempt it unless and until an appellate court determines that the Federal law does, indeed, validly preempt the California law. California attorneys are well-advised to consider this when deciding whether to follow Prezioso's lead and ditch California's attorney conduct rules for the SEC's new rules.

Indeed, for the California State Bar makes clear that it intends to continue disciplining lawyers who disclose client confidences, even though SEC Rule 205.3(d) purports to authorize an attorney appearing before the SEC to disclose client confidences without client consent where "the attorney reasonably believes [it to be] necessary." The letter also makes clear that the California State Bar will not give effect to SEC Rule 205.6(c), which purports to insulate from liability a lawyer who complies in good faith with the SEC's legal ethics rules. Hence, compliance with the SEC rules -- indeed, even the necessity to do so to avoid SEC disciplinary action -- apparently will not be a defense to a California disciplinary proceeding, at least until a federal appeals court orders otherwise.

September 16, 2003 in Corporation Law: Federalism, Corporation Law: Sarbanes-Oxley, Current Affairs | Permalink | TrackBack

September 15, 2003

Briefly Noted

Corp Law Blog on the question: "If you were shopping in the M&A; market for an entire company, would you pay more for a public company or a private company?"

9th Circuit enjoins recall and blogosphere goes nuts; selected highlights: Jack Balkin, vociferous Bush v. Gore critic, neverthless pans Circuit decision. Hugh Hewitt is now madder at 9th Circuit than Tombots. Mickey Kaus has a plethora of links and opinion. Ditto the California Insider. Ditto Howard Bashman at How Appealing, in multiple posts covering both the blogosphere and mainstream media (start and the top and just keep on scrolling). UPDATE: Hugh Hewitt links to Iowa law professor Tung Yin's blog for "wild speculation on the recall," which is definitely worth reading, and throws in a link to this blog for wine (or something), sending a slew of Hugh fans my way. Thanks Hugh! I'll work on the "color" for you.

Solum v Volokh on intellectual property. Volokh rebuts.

WSJ (subscription required) on "Starting a Blog" discusses Typepad:

"TypePad charges for its services but offers a lot of features. For those who want to shape every detail of their Web logs without knowing a thing about programming, TypePad allows users to change colors, typefaces and font sizes for just about every part of the Web log through easy click-through menus. It "pings" sites that track Web logs, telling the world you've added a new entry. As for photos, TypePad lets users create photo galleries and can post photos from cellphones. Users can also post cover art from the CDs and books they're currently listening to or reading.TypePad's parent is Six Apart Ltd., a San Mateo, Calif., start-up that until this summer was based in the spare bedroom of co-founders and spouses Mena and Ben Trott. The Trotts wanted a product that was customizable but didn't require a knowledge of the intricate workings of the Internet."

That's a great description of the product I wanted too -- which is why I switched. I'm pretty happy too, except I can't figure out how to make TrackBack work.

A reader emails to "ask with some trepidation because it will end up costing me money (Amazon will shortly get an order for the Easterbrook/Fischel book from me). Could you blog on list of books and/or law review articles that you view as instrumental/fundamental in the corporate law field (Something akin to A Taxing Blog's "Tax Canon Post")? It would be much appreciated ...." Hmmm, that's a good idea, but it may take me awhile. In the meanwhile, I will be posting book reviews (mostly law-related) with some regularity. Keep clicking on the "Books" link in the Categories list in the left side-bar. (In the interests of full disclosure, a subject that should be near and dear to the heart of all corporate lawyers, I should note that I participate in the Amazon Associates program. Accordingly, buying a book after clicking on its title here may end up supporting this blog.)

My friend UNLV law professor Bob Lawless has a great website, which includes a remarkably detailed compilation of corporate and securities law links. In the spirit of relentless self-promotion, I can't resist also pointing you to his syllabus, especially the part that says: "A recent text that I find highly useful is Stephen M. Bainbridge, Corporation Law and Economics (Foundation Press 2002). Professor Bainbridge does a good job of weaving the underlying economics into various rules that affect the business firm. It is an excellent reference." And they say they can't "find a great legal treatise for corporate lawyers."

You can buy Corporation Law and Economics here:

Thus ends today's shamelessly self-serving plug.

September 15, 2003 in Current Affairs, Weblogs | Permalink | TrackBack

Applied Economic Analysis: Can a Board Meet Online?

The Wall Street Journal (subscription required) has a good article in Monday's technology section on how corporations are using dedicated board of directors websites to let directors communicate with management and each other. But here's the part that caught my eye:

The main functions of a directors' Web site are simple enough: easy online access to briefing papers and internal company data, so directors can do their homework at home or on the road a few days before board meetings and show up fully informed; the ability to fine-tune a document online, so directors can hold a brief but urgent committee meeting online from different locations; and an exclusive e-mail system.

Can they really meet online? It depends on whether they use Internet telephony or a real-time text-based mechanism (like a chat room). Delaware General Corporation Law sec. 141(i) provides that directors may conduct a meeting:

by means of conference telephone or other communications equipment by means of which all persons participating in the meeting can hear each other....

Web-based supplements to a telephone conference call thus are fine, but real-time text based messaging is OUT. To conduct a meeting exclusively online, in a Delaware corporation at least, you must use Internet telephony. I wonder if any Delaware corporations have held invalid text-based board meetings online? I emailed this post to the reporter who wrote the story and asked him. I'll report back if he answers. In the meanwhile, I once wrote an article motivated by DGCL section 141(i)'s requirement that directors be able to hear one another. Why a Board? Group Decision Making in Corporate Governance, 55 VANDERBILT LAW REVIEW 1 (2002). To be clear, the article's not about online meetings -- its a theoretical inquiry (neoinstitutional and behavioral economics with a dose of social norms theory) into why corporations are run by a board rather than an individual autocrat (of course, in practice, many CEOs are individual autocrats). But section 141(i) was what got me thinking about the theory issues. I excerpt the relevant discussion, which explains why I think section 141(i) is correct, in the extended post below for those interested in more information.

UPDATE: The WSJ reporter (Geroeg Anders) have given me permission to blog his response: "As far as I can tell, boards (either deliberately or inadvertently) are staying within the bounds of the Delaware code as currently written. Even when computer-to-computer interactions are a meaningful part of a remote board/committee meeting, there usually are parallel phone lines that are open, so that people can ask questions the old-fashioned way."

The requirement that members be able to “hear” one another seems quaint in an era of electronic mail, instant messaging, and internet chat capabilities. Yet, when Delaware recently amended its corporation statute to permit much greater use of electronic forms of communication, it retained the requirement that board meetings be conducted in such a way that all members may hear one another. As it turns out, this appears to have been the right choice. Research on decision making has found that groups linked by computer make fewer remarks and take longer to reach decisions than do groups meeting face to face. Kiesler and Sproul, for example, not only found that meetings conducted through computers result in greater delays, but also that the decisions made in such meetings were more likely to exhibit the risky shift phenomenon. Sara Kiesler and Lee Sproul, Group Decision Making and Communication Technology, 52 Org. Beh. & Human Decision Processes 96 (1992). They also found that time-constrained groups exchanged much less information when meeting electronically than when meeting face-to-face.

Electronic communication takes place mostly through text-based mediums. For many people reading and typing are slower and require greater effort than verbal communication. Text-based communication also deprives participants of social cues, such as body language and tone of voice, that may be important signals. Social norms constraining behavior apparently function less well in text-based communication, as illustrated by the flame wars that plague Usenet newsgroups.

As with other aspects of the rules governing board meetings, accordingly, there seems to be a legitimate basis for otherwise formalistic rules. Even such housekeeping rules as notice requirements prove to be consistent with the research on group decision making. Unless the articles of incorporation require otherwise, no notice of regularly scheduled board meetings is required. Special meetings require at least two days notice. As a matter of statutory law, the requisite notice need not announce the purpose of the meeting. Because the directors’ duty of care requires them to make an informed decision, however, it is advisable whenever possible to provide directors of advance notice of the reason for calling a meeting and any relevant documentation. As with other requirements relating to board meetings, the notice rules are intended to ensure that the board functions as a collegial body, all of whose members participate and get the benefit of the participation by all other members. MBCA § 8.23 cmt.

That notice requirements effectively carry out that function is suggested by research on group performance. Michaelsen et al. conducted a study in which individuals were pre-tested and then re-tested as members of a group. Under those conditions, groups outperformed individuals. Michaelsen et al. analogize this testing order to organizational decision-making processes in which “group members prepare a position paper and circulate it to other group members prior to problem-solving discussions.” Larry K. Michaelsen et al., A Realistic Test of Individual Versus Group Consensus Decision Making, 74 J. App. Psych. 834, 834 (1989). A board meeting conducted after meaningful notice likewise replicates this testing order.

September 15, 2003 in Corporate Governance, Corporation Law | Permalink | TrackBack

Can you be a Competitive Federalist and still want Spitzer to shut the #@!% up?

Elliot Spitzer, the attorney general of New York, whom the Economist calls “publicity hungry,” recently ramped up his crusade of suing financial institutions by going after the mutual fund industry. (Relatedly, in a move that irked federal prosecutors, the Oklahoma attorney general indicted a slate of ex-WorldCom executives.)

I am an unabashed proponent of competitive federalism – i.e., the idea that having corporate law regulated at the state level promotes competition between states seeking to attract corporations to incorporate in their state, which competition tends to lead to efficient legal rules. Does this mean I am ideologically constrained to support Spitzer’s crusade even if I think he is more concerned with raising his profile for a widely-predicted future gubernatorial campaign than cleaning up the corporate swamp exposed by Enron et al.? I’ve been puzzling about that question for a while, and have finally concluded I can be a competitive federalist and still want Spitzer to shut down. I explain why in the Extended Post below.

The basic idea behind competitive federalism is that both efficiency and liberty are promoted when jurisdictions compete for the opportunity to regulate you. According to the high priestess of competitive federalism (Roberta Romano) and its elder statesman (Ralph Winter), this condition is satisfied with respect to corporate law. Corporations pay franchise taxes to the state that incorporated them. The more corporations a state incorporates, the more the state earns in franchise taxes. (Delaware, which is the run away winner of state competition in corporate law, historically earned 15-20% of its annual revenues from corporate franchise taxes.) As I have explained before, this competition leads to a race to the top in drafting corporate law rules. Rational investors will not pay as much for securities of firms incorporated in states that do not protect investor interests. As a result, those firms' cost of capital will rise, which gives corporate managers an incentive to incorporate in a state offering rules preferred by investors. Accordingly, competition for corporate charters leads states to adopt efficient corporate laws so as to attract incorporations.

What then are we to make of Elliot Spitzer’s hyperactive enforcement regime? Must we conclude that Spitzer has raced to the top? NO! A thousand times no! Competitive federalism only works when the entity being regulated has an exit option. So long as firms may freely select among multiple competing regulators, the power of each regulator is limited by the right of exit. In such an environment, if a particular regulator gets eager, firms can exit that regulator’s jurisdiction and move to one that is more laissez-faire. In contrast, when there is but a single regulator, such that exit by the regulated party is no longer an option, this check on excessive regulation is lost. The problem we face today is that Spitzer has not limited himself to businesses incorporated in New York. Instead, Spitzer (like the Oklahoma attorney general who went after the WorldCom execs) has assumed jurisdiction over purported wrongdoers without regard to the state in which their firm was incorporated. If his sweeping assertion of regulatory jurisdiction goes unchallenged, Spitzer will have eliminated the exit option that makes competitive federalism work.

Accordingly, even a competitive federalist could (and should) prefer federal to state regulation in this context (bear in mind that arguments for competitive federalism should not be equated with “states rights”). As the Supreme Court plurality in MITE explained, a state has "no legitimate interest in protecting non resident shareholders." Edgar v. MITE Corp., 457 U.S. 624 (1982). For example, what do we do if Spitzer thinks a corporation’s board harmed a Delaware corporation’s shareholders, but the Delaware courts think otherwise? Who wins? Because Spitzer claims national jurisdiction, there is no exit option and, accordingly, no state competition. Entities cannot escape to a more laissez-faire jurisdiction. In the absence of state competition, federal regulation seems preferable. After all, did not the Founding Fathers adopt a Constitution in large part to avoid the economic Balkanization threatened by the Articles of Confederation?

When firms may freely select among multiple competing regulators, oppressive regulation becomes impractical. If one regulator overreaches, as noted above, firms will exit its jurisdiction and move to one that is more laissez-faire. In contrast, when a single regulator can reach all firms, such that exit by the regulated is no longer an option, the essential check on excessive regulation provided by competitive federalism is lost.

Of course, a hard core competitive federalist would prefer a regime in which firms could choose not only their corporate governance regime but also their securities regulation rules by incorporating in a specific jurisdiction. This is, for example, the argument made by Roberta Romano in her book The Advantage of Competitive Federalism for Securities Regulation. But that is, perhaps, a subject for another day. In the meanwhile, can’t we at least get Spitzer to shut up?

September 15, 2003 in Corporation Law: Federalism, SEC: Spitzer | Permalink | TrackBack

September 14, 2003

Behavioral Economic Analysis of Law

Law and economics remains the most successful example of intellectual arbitrage in the history of corporate jurisprudence. It is virtually impossible to find serious corporate law scholarship that is not informed by economic analysis. Even those corporate law scholars who reject economic analysis spend much of their time responding to those who practice it.

As with any model claiming predictive power, law and economics rests on a theory of human behavior. Specifically, neoclassical economics is premised on rational choice theory, which posits decisionmakers who are autonomous individuals who make rational choices that maximize their satisfactions. Critics of the law and economics school have long complained that rational choice is, at best, an incomplete account of human behavior. The traditional law and economics response to this complaint is that rationality is simply an abstraction developed as a useful model of predicting the behavior of large numbers of people and, as such, does not purport to describe real people embedded in a real social order. Until quite recently, moreover, empirical research tended to confirm that the rational choice model of human behavior is a good first approximation of how large numbers of people are likely to behave in exchange transactions.

Over the last 10-15 years, however, a new school of economic analysis has emerged that challenges the rational choice model precisely on its predictive power. Empirical and laboratory work by cognitive psychologists and experimental economists has identified a growing number of anomalies in which behavior appears to systematically depart from that predicted by rational choice. A good example is the so-called status quo bias: All else being equal, decisionmakers favor maintaining the status quo rather than switching to some alternative state. The status quo bias can lead to market failure where decisionmakers’ preference for the status quo perpetuates suboptimal practices.

My thoughts on this topic were prompted by hearing my colleague Russell Korobkin -- a member of the Volokh Conspiracy (albeit a rarely seen one) -- give a presentation to a faculty workshop on behavioral economic analysis of form contracts; his presentation was based on an excellent paper, by the way, which he has posted to SSRN. (Strongly recommended.) I got to thinking some more about behavioral economics after having lunch last Friday with my colleague Victor Fleischer of A Taxing Blog. Behavioral economics is something of the flavor of the month in legal education, especially on the part of those with an ideological disposition against the free market connotations of neoclassical economic analysis. After a brief flirtation with it myself, I have become much more skeptical, for the reasons developed at length in the Extended Post below.

Empirical demonstrations of this decisionmaking bias have focused on the so-called endowment effect. Subjects commonly place a higher monetary value on items they own than on those that they do not own, even if the two items have the same market value. Accordingly, subjects must be paid more to give up something than they would be willing to pay to acquire the same object. The classic demonstration of the endowment effect variant of the status quo bias was a laboratory experiment in which students were initially endowed either with a coffee mug or six dollars cash. Mug holders were asked to identify the minimum amount they would accept to sell the mug, while cash holders were asked to specify the maximum amount they would be willing to pay to purchase a mug. Subjects were told that a market-clearing price would be determined and trades executed between mug holders willing to accept that amount and cash holders willing to pay that price. It turned out that the price demanded by mug holders was about twice that cash holders were willing to pay, so that very few trades took place.

I do not deny that there is considerable empirical evidence for the endowment effect and the status quo bias. More generally, I also do not deny that behavioral economics is a potentially useful tool that any legal scholar should have in his toolkit. As the Economist explained:

[I]f the endowment effect is real, people's economic decisions are fundamentally different from what economists have assumed. The implications of this are profound. To take one example, the Coase theorem, which argues that initial allocations of wealth do not matter as long as markets allow people to trade their stakes—the rationale for government auctions of everything from radio spectrum to mobile-telephone licences—would no longer be valid. To take another, although economists have shown that you need only a few sharp traders for prices in financial (and other) markets to become efficient, the volume of trade with an endowment effect will be below what it might be without one.

But it is one that must be used cautiously; too many legal scholars are using it far too glibly. Consider, for example, the evidence that the endowment effect appears to vanish when people do not physically possess the commodity in question. Subjects trading tokens or vouchers demonstrate only a weak endowment effect. Because capital market transactions more closely resemble the token or vouchers context then experiments involving physical possession of a tangible commodity, for example, these results call into question the extent to which one can rely on the endowment effect as evidence of a capital market failure. [Update: Korobkin passed on one of his articles, which presents a more nuanced account of this evidence. The money quote is "Money itself does not create an endowment effect, but the effect does appear to exist for financial instruments that are valued only for the money they are worth (i.e., have no intrinsic value themselves) if the value of the instrument is uncertain. These results suggest that securities and other financial instruments can create an endowment effect even though they are held as stores of wealth rather than for their intrinsic or 'use' value." The Endowment Effect and Legal Analysis, 97 Northwestern University Law Review 1227, 1236-37 (2003). Is not clear to me, however, why the results Korobkin discusses are not better characterized as mere risk aversion as opposed to an endowment effect.]

More important, in light of the above update, as the Economist also reported, there is emerging evidence that market actors can learn their way out of biases like the endowment effect:

John List, an economist at the University of Maryland, recently tested the existence of the endowment effect in a new way. Instead of using callow students, he went to a real market with traders of varying degrees of experience: a sports-card exchange, one of many such, where Americans trade pictures of their favourite athletes. There, traders dealing in hundreds of cards mix with browsers who might buy only one.

List found:

[E]vidence for an endowment effect—but also that long experience as a card trader spilled over into his experimental mug-and-chocolate market. Only novices, like the students in earlier experiments, tended to be swayed by what they had been given. This implies that prospect theory can capture the behaviour of inexperienced people, of which the world has many in all sorts of markets. But experienced buyers or sellers in well-established markets get over their psychological “flaws”. They can even transfer their trading skills from one market to another. The neoclassicals, it seems, have scored a point.

I would add a different, but I think equally significant reservation: The claim that law can correct market failures caused by decisionmaking biases or cognitive errors treats regulators as exogenous to the system. Once the state is endogenized, however, regulators must be treated as actors with their own systematic decisionmaking biases. It thus becomes evident that behavioral economics loops back on itself as a justification for legal intervention. Public choice theory provides still another reason market failure is not a sufficient justification for government intervention. Again, the problem is one of treating an endogenous factor as exogenous. A welfare economics model that posits legal intervention as a solution to market failure ignores the fact that regulators are themselves actors with their own self-interested motivations.

In sum, there is a strong temptation to use behavioral economics too glibly. Advocates of government intervention are akways tempted to jump from positing the status quo bias, citing the coffee mug experiments, to an assertion that the government needs to shake up the status quo, without demonstrating that the bias is truly valid in the specific setting at hand. In addition, a certain degree of skepticism about the power of law to effect social change seems warranted. Indeed, behavioral economics itself offers additional reasons to doubt the capacity of law as agent for social change. Finally, one cannot justify government intervention without asking whether the case for it survives endogenizing the state.

You can read an even more extended version of my argument, with application to the longstanding debate over mandatory disclosure in securities regulation, in my article Mandatory Disclosure: A Behavioral Analysis, 68 University of Cincinnati Law Review 1023 (2000).

September 14, 2003 in Legal Education | Permalink | TrackBack

Review: Michael Novak's The Spirit of Democratic Capitalism

Michael Novak is probably the foremost Christian thinker on the economy. Any of his books reward study, but The Spirit of Democratic Capitalism is undoubtedly his magnum opus. In this classic text, which has now been updated and revised, Novak joins issue with theologians like Paul Tillich who contend that "any serious Christian must be a socialist." It appeared in a samizdat (underground) edition in Poland during the 1980s and had an obvious impact on the Solidarity movement. Its reasoned defense of democratic capitalism as being grounded in the humane values of the Judeo-Christian tradition also helped give a moral center to the neo-conservative movement.

In "Democratic Capitalism," Novak addresses the consistency of capitalism with church teachings on wealth. Novak recognizes that church teaching has been hostile to capitalism, as with much else of modernity. Yet, Novak contends that arguments against capitalism serve mainly to give aid and comfort to the Leviathan state. Indeed, Novak persuasively (if controversially) attributes Christian opposition to capitalism to two main sources: ignorance and antique world views. Church leaders and theologians tend to have either a pre-capitalist or a frankly socialist set of ideals about political economy.

To be clear, Novak does not believe that faith should be subordinated to capitalism. To the contrary, he recognizes that the divine plan was that we should enjoy the fruits of the earth and of our own industry. He simply contends that capitalism is the best way Fallen humans have yet devised to obey the Biblical command that we are to be stewards of God's world. Novak never loses sight of the basic proposition that it was equally the divine plan that God should be worshiped, obeyed, and feared. The fear of the Lord, he would argue, is the beginning of capitalist wisdom, just as it is of any other kind of wisdom. Not surprisingly, therefore, Novak's analysis has begun to impact the way the church thinks about capitalism. Pope John Paul II's most recent encyclicals on work and the economy, for example, such as Centesimus Annus, contain obvious marks of Novak's influence. In sum, very highly recommended.

September 14, 2003 in Books, Religion | Permalink | TrackBack

Even on Wall Street, It Seems, the Fine Print Goes Unread

The NY Times (registration req'd) reports:

How did successive boards of the New York Stock Exchange, filled with senior executives from every major Wall Street firm and such companies as Viacom, Ford, Philip Morris and AOL Time Warner, allow the exchange to pay its chief executive, Richard A. Grasso, a king's ransom? The answer seems to be that most board members saw the post as an honor, but not one that required much attention. Last week, board members were angrily saying that they had no idea that Mr. Grasso had been owed $48 million over the next four years, in addition to the $139.5 million lump-sum payment he took in deferred compensation, savings and retirement benefits a week earlier. Unfortunately for their reputations, those payments had been spelled out in the employment contract with Mr. Grasso that the board had authorized only weeks earlier. But not even H. Carl McCall, the former New York State comptroller, who is the chairman of the board's compensation committee, had understood how much money was involved. And he had signed the contract on behalf of the board.

Have they not read Van Gorkom? Granted, I don't think even Delaware supreme court Justice Randy Holland (author of, inter alia, Omnicare) expects directors to slog through a 100+ page contract of dense legalese -- thats what boards pay lawyers like us to do -- but the Delaware courts have been steadily ratcheting up the pressure on directors to make informed decisions, especially in high profile matters like executive compensation (see, e.g., Chancellor Chandler's opinion in the Walt Disney litigation). Directors must be able to document that they knew and understood the key terms of the contracts they approve, which requires (at a bare minimum) guidance by legal counsel and, if appropriate, other experts (like compensation consultants). Not for naught was Van Gorkom termed the "Investment Banker and Lawyer Full Employment Act." The problem here, of course, on which I have blogged before, is that the NYSE is neither fish nor fowl -- neither a public corporation nor a government agency. I'm not saying that becoming a public corporation is a panacea for all corporate governance ills, but I am saying that if the NYSE were a private-sector publicly-held for-profit business corporation, whose directors were subject to market discipline and the threat of being hauled into Delaware chancery court, they would be less likely to ignore their responsibilities. And wouldn't that be a good thing?

September 14, 2003 in Corporate Governance, Current Affairs, SEC: Securities Regulation and Litigation | Permalink

Ridge Mazzoni Home Ranch 2000

Ridge long has been one of my favorite wineries. This Sonoma County wine was part of Ridge's Advanced Tasting Program, which is their program of limited release wines available only by joining their mailing list. The Mazzoni is a blend of 47% zinfandel, 47% carignane, and 6% petite sirah. The color is a deep purple shading to ruby. Strong legs. Hot and spicy nose, with jammy dark fruits. On the palate, the wine is big, brawny, firm, somewhat rustic with flavors of rysty iron and brambly blackberry jam. Was pretty tough when first tasted last year, but is mellowing nicely. Will hold.

September 14, 2003 in Food and Drink, Wine Tasting Notes | Permalink | TrackBack

Review: Gettysburg: A Novel of the Civil War

Growing up as an Army brat whose father was mainly stationed in the South, it was perhaps inevitable that I should be fascinated by military history and, in particular, the Civil War. One of the best recent Civil War novels I have read is Gettysburg: A Novel of the Civil War by Newt Gingrich and William Forstchen. Newt Gingrich as novelist? Revolutionary? Sure. Ideologue? You bet. But novelist? Surprisingly enough, Gettysburg turns out to be one of the best alternative military history novels I've read in ages. Sure, the "what if Lee had won at Gettysburg?" is the oldest cliche in alternative history but Gingrich and Forstchen have turned in a winning variant. After day one at Gettysburg, Lee is persuaded by Longstreet to pull out and do a long march around Meade's flank to get astride Meade's line of communications with Washington. It is Second Manassas all over again. I will refrain from any additional spoliers, except for noting that Westminster, Md., burns. As someone who went to college in that burg, I always thought it could stand a good burning!

The writing style is clear, if a bit MTV-ish in its rapid scene cuts, and maps make the action easy to follow. (Harry Turtledove, please take note of the utility of maps!) It's impossible to know how much credit to give Gingrich as opposed to Forstchen (or a third contributor, one Albert Hanser, who is identified merely as a "contributing editor"). But it works, which is what really matters. The old cliche "un-put-downable" is really true here -- I stayed up until 1:30 am reading it.

This is the first book in a planned trilogy. The obvious comparison is with Harry Turtledove's civil war series. (Not Guns of the South, which is entirely separate, but rather the series that started with How Few Remain.) Its been pretty easy to spot where Turtledove is going: he's just rewriting the First and Second World Wars on American soil. In contrast, it is hard to tell where Gingrich and Forstchen are going. In real history, the North had such an overwhelming superiority in manpower, industrial output, and railroad lines that the South had no real chance. All Lincoln had to do was find a general who "understood the mathematics." Gingrich and Forstchen clearly know this: several characters make reference to these advantages at several points in the novel. But why write three books of alternative history to get to the same point as real history -- a Union victory -- by a different route? Anyway, it should be an interesting ride.

September 14, 2003 in Books | Permalink

Review: Mercuro and Medema's Economics and the Law

What is law and economics? It is the school of jurisprudence in which the tools of microeconomic analysis are used to study law. Those of us who practice economic analysis have a deceptively simple task. We translate some legal doctrine into economic terms. We then apply a few basic principles -- cost-benefit analysis, collective action theory, decision-making under uncertainty, risk aversion, and the like -- to the problem. Finally, we translate the result back into legal terms.

Law and economics unquestionably is the most successful form of intellectual arbitrage in the history of jurisprudence. Why? Traditional forms of legal scholarship were mostly backward looking. One reasoned from old precedents to decide a present case, seemingly without much concern (at least explicitly) for the effect today's decision would have a future behavior. Yet, law is necessarily forward looking. To be sure, a major function of our legal system is to resolve present disputes, but law's main job is to regulate future behavior. The law and economics movement succeeded because it recognized that judges cannot administer justice solely retrospectively. They must also consider what rules their decisions will create to guide the behavior of other actors in the future. Even more important, however, law and economics gives judges systematic mechanisms for predicting how rules will affect behavior.

Mercuro and Medema's Law and Economics offers a comprehensive overview of law and economics. Unlike many texts, it is not limited to the Chicago School (as exemplified by such stalwarts as Manne, Easterbrook, and Posner). They also describe the New Haven school (classically exemplified by Calabresi), the public choice theory of Arrow, Buchanan, and others, as well as both the traditional and new institutional economics. By reminding us that law and economics is not a homogeneous field, and providing a fair commentary on each of the major traditions within the larger discipline, they offer an excellent introduction to this important area of jurisprudence.

One nice touch, which makes the text useful for a wide audience, is that it does not assume familiarity with either economics or law. The introduction offers a brief historical overview of basic jurisprudence, as well as an appendix explaining basic economic principles. Consequently, the book will serve well the interests both of lawyers who need to brush up on economics and economists interested in law.

Criticisms: There is little in the way of critical evaluative judgment. Indeed, Mercuro and Medema disavow any effort at criticism. As a result, the reader is left to his own devices. Second, I am not persuaded by Mercuro and Medema's decision to include a rather lengthy chapter on critical legal studies. Criticism of law and economics has been a major project of CLS scholars, but CLS scholarship has had no influence of any significance on any of the dominant strains of law and economics thinking. In this case, moreover, the failure to exercise critical evaluative judgment means that the generalist reader may have difficulty assessing the (bogus) claims made by CLS. In general, while maintaining facial neutrality on their own part, Mercuro and Medema give far more attention to CLS and Marxist critiques of law and economics than they do to conservative critiques thereof or to law and economics criticisms of CLS.

September 14, 2003 in Books | Permalink

Review: Williamson's The Mechanisms of Governance

Oliver Williamson is one of the seminal figures of New Institutional Economics. The Mechanisms of Governance is the third book in which Williamson has collected his principal writings, while working them into a coherent whole. The earlier volumes, Markets and Hierarchies and The Economic Institutions of Capitalism, are justly regarded as the foundational texts of the transaction costs economics school of institutional economics. The Mechanisms of Governance seems certain to join them as essentials for any legally literate economist or economically literate lawyer.

Transaction cost economics focuses on institutions, in contrast to neoclassical economics' focus on individuals, providing simple models that help us understand how institutions function and how they will respond to regulation. We can analogize transaction costs to friction: they are dead weight losses that reduce efficiency. They make transactions more costly and less likely to occur. Among the most important sources of transaction costs is the limited cognitive power of human decisionmakers. Unlike the Chicago School of law and economics, which posits the traditional concept of rational choice, Williamson asserts that rationality is bounded. Put another way, he assumes that economic actors seek to maximize their expected utility, but also that the limitations of human cognition often result in decisions that fail to maximize utility. Decisionmakers inherently have limited memories, computational skills, and other mental tools, which in turn limit their ability to gather and process information. As he demonstrates, this phenomenon, known as bounded rationality, has pervasive implications for understanding how institutions work.

Accordingly, Williamson's approach provides an analytical framework that is useful not only to economists, but also to lawyers and policymakers. Among other subjects, Williamson tackles such subjects as vertical integration, corporate governance, and industrial organization.

In sum, highly recommended. My only hesitation is Williamson's unfortunate writing style. Although The Mechanisms of Governance is largely free of the recreational mathematics that plagues much modern economic writing, which is useful for those of us who flunked Differential Equations, it is very jargon-intensive. Worse yet, much of the jargon is self-created. All of which makes reading Williamson an effort-intensive project. Usually the cost-benefit analysis nevertheless comes out in his favor, but sometimes one puzzles out the jargon to find a rather obvious point that could have been conveyed far more simply.

September 14, 2003 in Books | Permalink | TrackBack

Review: Easterbrook and Fischel's Economic Structure of Corporate Law

Easterbrook and Fischel collected a series of law review articles into the classic text on the contractarian theory of corporate law: The Economic Structure of Corporate Law. During the 1980s, Easterbrook and Fischel were two of the corporate law academy's enfants terribles. Their articles were provocative, yet insightful. They raised a lot of hackles, yet did ground-breaking work. Both went on to bigger and better things. Easterbrook is now a judge on the US 7th Circuit. Fischel was a prominent expert witness/consultant and dean of the UChicago law school. The Economic Structure of Corporate Law stands as their legacy for corporate law.

Like other contractarians, Easterbrook and Fischel model the firm not as an entity, but as an aggregate of various inputs acting together to produce goods or services. Employees provide labor. Creditors provide debt capital. Shareholders initially provide equity capital and subsequently bear the risk of losses and monitor the performance of management. Management monitors the performance of employees and coordinates the activities of all the firm's inputs. The firm is simply a legal fiction representing the complex set of contractual relationships between these inputs. In other words, the firm is not a thing, but rather a nexus or web of explicit and implicit contracts establishing rights and obligations among the various inputs making up the firm.

The nexus of contracts model has important implications for a range of corporate law topics, the most obvious of which is the debate over the proper role of mandatory legal rules. As a positive matter, contractarians contend that corporate law in fact is generally comprised of default rules, from which the parties to the set of contracts making up the corporation are free to depart, rather than mandatory rules. As a normative matter, contractarians argue that this is just as it should be. Easterbrook and Fischel devote the bulk of this text to tweaking out these implications across an array of important topics, such as limited liability and insider trading.

Their analysis is not flawless. As but a single example, they consistently opt for the so-called majoritarian default. Their basic thesis is that by providing the rule to which the parties would agree if they could bargain, society facilitates private ordering. Majoritarian defaults are not always desirable, however, even if a potentially dominant one can be identified. Sometimes penalty defaults are preferable. Penalty defaults are designed to impose a penalty on at least one of the parties if they fail to bargain out of the default rule, thereby giving at least the party subject to the penalty an incentive to negotiate a contractual alternative to the penalty default. They force the parties to choose affirmatively the contract provision they prefer. Penalty defaults are appropriate where it is costly for courts to determine what the parties would have wanted. In such cases, it may be more efficient for the parties to negotiate a term ex ante than for courts to determine ex post what the parties would have wanted.

Having said that, however, this remains one of the most significant monographs on corporate law. I highly recommend it for any corporate lawyer's bookshelf.

September 14, 2003 in Books, Corporation Law | Permalink

September 13, 2003

Louis M Martini Cabernet Sauvignon 1978

At a recent dinner, a good friend opened a bottle of 1978 Louis M. Martini cabernet sauvignon. Until a downturn in the 1980s, Martini was one of the Big 5 Napa Valley producers, known for producing wines of gentle grace but with the ability to age. Candidly, however, I was not expecting much, since my impression was that the bottle had had less than ideal storage conditions, but I was very pleasantly surprised -- it had held up quite well and was quite good. I don't make tasting notes in mixed company (i.e., around non-wine geeks), but my recollection is quite strong. To be sure, the cab showed signs of oxidation. Indeed, were maderized not a term mainly applied to whites and roses, it would be the mot juste. Yet, despite what some purists might term a fault, it was eminently drinkable -- indeed, quite tasty . The flavor profile was that of a tawny port: mostly nuts and dried fruits -- prunes, figs and dried apricots -- on a caramel base. It was an honor and a privilege to have been invited to share in this taste of California's rich viticultural heritage.

September 13, 2003 in Wine Tasting Notes | Permalink | TrackBack

The Port FAQ and the Old Usenet Posts

Back in the days before the usenet was all spam all the time, I was a regular contributor to the rec.food.drink group. Using the Google Groups page, I've searched for my old posts so as to post some to the blog. Most of them are too dated to bother with, but I did find one long post proposing a draft FAQ on port wine. I've stuck that post in the Extended Posts area.

Contents:
1) Introduction: What is Port? Where does it come from?
2) What are the various styles of Ports?
3) Serving suggestions.
4) What vintages should I be buying for current consumption and what vintages should I be buying to lay down? (With an aside on the economics of buying port.)
5) What are "single-Qunita" ports?
6) Where should I go for additional information?
*******
1) Introduction: What is Port? Where does it come from? True port comes from the Douro river valley in Portugal. The Douro is in the northern third of the country and runs pretty much straight from east to west (at least within Portugal). Although the Duoro originates in Spain, where it is called Ribera del Duero, all port comes from Portugal. Over 40 varieties of grapes are grown in the Douro region. Most of the best are named "Tinta [something]." There is no such thing as a varietal port.

Port is a sweet wine. It is also a fortified wine. Most port is red, although there is a small trickle of white port. White port tends to be a bit dryer and much of it goes to France where it is used as an aperitif. The making of port is quite unique. The grapes are crushed as one would to make a normal red wine. Most houses now use mechanical crushers, although a few still use foot-trodden grapes for their best wines. In either case, the wines are allowed to ferment normally until they reach about 6% alcohol. At that point, the wine will still have a lot of residual sugar (usually about 10%). [Recall that dry table wine will ferment to 10-14% alcohol.] The wine is then run off into vats holding brandy (or, more often, neutral spirits fermented and distilled from wine). The usual ratio is four parts wine to one part spirits. The brandy raises the alcohol content to 19-21%. Yeasts cannot function at that high percentage of alcohol. (It is an odd fact, and perhaps one worth meditating upon, that alcohol is toxic even to the beasties that produce it.) Accordingly, fermentation stops. The residual sugar therefore remains in the wine, leaving the raw young port a naturally sweet wine. Once made the wine is transported down river to the city of Oporto (actually to a suburb across the river from Oporto), where it matures in barrels called pipes. The pipes hold slightly more than twice the volume of wine held by the French barrels used in Bordeaux, Burgundy and California. Unlike most French or California wines, however, wood flavors are not desired. Port shippers thus use old barrels for their port, which impart little if any flavor to the wines aged in them.

Sometime within the first 2 years of the wine's life, the Port producer has to decide whether to bottle it as true vintage Port or to keep it in cask for later use in a ruby, tawny, or late-bottled vintage Port. Port producers generally consider vintage Port to be their top wine, so they reserve only their best casks for it and only bottle it in the best years (usually no more than 3 years a decade). When a Port producer decides to bottle a vintage Port, they're said to "declare the vintage". Not all producers declare the same years. People familiar with vintage champagne will recognize that roughly the same process is being used here. Vintage Port is released for sale when it's 3 years old, after it's been in the bottle for 6 months to a year. It can be very rough stuff, highly tannic and very heady (due to the brandy). It usually takes at least 10 years for a vintage Port to settle down, and in general 20 years for the top vintages to really approach maturity. (During the maturing process the wine and brandy are said to "marry," with the result being a smoother and much more pleasant wine.) All other ports (w/ the exception of some "crusted" ports) are ready to drink when they're released. BTW: In pre-EC days, "port" was legally defined in England as wine that had been shipped over the bar at Oporto. Some say that a fair bit of Australian and South African wine stopped off in Oporto on its way to England, and then was sold as port therein! "Port" is also made in most New World countries, especially California, Australian and South African. In general, I recommend staying away from New World "ports." There are some good ones, but most of them are pure dreck. And the good ones aren't as good value as the Portuguese ones -- IMHO. I don't even cook with the things. Having said that, Ficklin is pretty good. Quady's Starboard wine (get it?) is also pretty good, although I mostly like the name. You can spot a true port by looking at the country of origin on the label; also true ports are actually labelled "Porto," rather than "port." Somebody (I've lost track of who) posted the following: "For Aussie Port, the Yalumba "Gallway Pipe" is an outstanding tawny, as good as most upper-tier Oporto producers 20-year tawnies, at half the price ($15)."

2) Styles

a) Ruby. Young, fruity, flavorful, dare I say frivolous. Not regarded by connoisseurs as a serious wine. But usually the cheapest category and perhaps not a bad place to start. Vintage character, however, doesn't cost that much more and is usually a lot better. The name comes the color, which is pretty accurate. Generally gets 3-4 years of barrel age, with little if any bottle age. Always a blend of vineyards and years.

b) Tawny. Tawny is aged for many years in large wood barrels (called pipes). Tawny is a blend of wood-aged ports from many years. The houses blend for at least three reasons. First, blending helps smooth out variations from vintage to vintage, which enables the house to maintain a consistent style from year to year. Presumably this is thought to enhance brand loyalty. Second, by blending, you obscure the flaws of a particular vintage. Third, blending means that you get the benefit of several different ages of port. Younger wines contribute some freshness and tannin, while older wines contribute smoothness and character. The name "tawny" comes from the fact that the wine is kept in barrel long enough that the wine has turned from the bright red/purple of young wine to a tawny shade. (Cheap tawnies are made by blending ruby and white port.) Tawnies are usually sold under with an indication of the average age of the wines in the blend (thus, 20-year-old Tawny will have an average age of 20 years for the wine) [NB: These days, this is my usual tipple.]

c) Vintage. In contrast to the preceding, vintage port all comes from a single year. It also does most of its aging in bottle. Typically, vintage ports get only a couple of years in barrel, while Tawny may get 10 to 30 or even more. The difference between wood and bottle aging is quite dramatic. Tawny and vintage port are totally different drinks, due to their different aging processes. Tawny develops rancio, a flavor caused by oxidation, that for many people is an acquired taste. On the other hand, tawny is ready to drink upon release because it did its aging in barrel. Ditto for ruby. In contrast, vintage port desperately needs age in bottle. The amount of time needed in bottle differs from house to house. 10 years is probably the minimum needed for light houses in a light year. 15 is more typical. Tawny and ruby generally will not improve in bottle, and may in fact deteriorate. (Caveat: some contend that so-called late bottled vintage ports improve in bottle. I don't find this to be the case. See below.)

Paul Winalski writes: Vintage port "throws a very heavy sediment as it ages. Fully mature vintage Port usually has a brick-reddish color (not as tan-colored as a tawny), an extremely complex and full bouquet, and complex flavors in which the fruit, brandy, and sweetness components of the Port have married in a harmonious balance." All true, except that I don't like to let my port get too far to the brick end of the spectrum.

d) Vintage Character: If you don't like tawny, and find vintage too expensive for frequent drinking, then you should turn to "vintage character" ports. Vintage character (VC) ports are really ruby ports (essentially wood-aged ports that don't stay in barrel long enough to become tawnys). Usually, the house's VC port will be it's best ruby port.

I drink Warre's Warrior, Sandeman's Founder's Reserve, and Cockburn's Special Reserve on a regular basis. [NB: These days Dow’s 10 year old tawny is my main tipple.] None are particularly special, but all are quite acceptable. NB: port snobs will turn up their noses at VC ports, but most of them have a bottle or two hidden in their liquor closet. They're cheap (compared to vintage and tawny), they last up to a week once opened, and they're fine for mid-week drinking. (They also go quite well with cigars. I'm loath to drink vintage port with a cigar, lest I obscure the wonderful taste and aroma that I've waited so long and paid so much to savor.)

e) Late-bottled vintage (LBV) port is port from a single year's harvest that has been kept in cask longer than the 2 years required for true vintage port. In general, LBVs get 4-6 years in barrel. It is usually ready to drink upon release, although many port connoisseurs believe it improves in bottle. A variant on this theme is "crusted port," which is similar to LBV but likely to throw a heavy sediment in bottle. Crusted port is more likely to improve in bottle than is LBV, IMHO.

3) Serving suggestions. Most people drink port after dinner (because its sweet). I find it works well with Stilton, nuts (not too salty, e.g., walnuts), and cigars. (But see my remarks above w/r/t to cigars with vintage port.) It doesn't work very well with sweet desserts. The French (God love 'em) drink Port as an aperitif. I don't know why, other than their national sweet tooth, and I'm certainly not going to try it myself.

Vintage port *MUST* be decanted. Because of the volume of sediment it throws, you can maximize the amount of available wine by passing it through a filter. There are some very nice pewter and silver decanting funnels available, some of which have built- in filters and some of which are designed to hold a piece of muslin or cheesecloth that will act as a filter.

It is traditional for the host to pass the port clockwise at table (i.e., right to left). In olden days, the women would leave the table for the sitting room, while the men would move up to the head of the table to drink port and smoke cigars for a period before rejoining the ladies. Those days are of course gone. In my house, the port is nevertheless still consumed primarily by the men of the party. If we are smoking cigars, however, we do so in the detached garage!

(4) Vintage information: Paul Winalski writes: "1963 and 1977 have won almost universal praise as great years for vintage Port. 1955, 1970, 1983, 1985, and 1991 are all widely-declared years of top quality. 1960, 1966, 1975, 1978, 1980, and 1982 are less widely declared and not on the same quality plateau." This is generally true, so long as you define "widely" to mean "virtually all." Most houses declared 60, 66 and 75. NB: I can get exact figures and will do so before my next posting.

An aside on the economics of buying port to lay down: A recent contributor to r.f.d. urged that we all run out and buy the '91 ports. To which I responded as follows: "The great trouble with port is time value of money. Are you better off buying port to lay down for 20 years or investing your money wisely and then buying the port 15 years or so from now from a reputable auction house? I suspect the latter will often be the case. Bear in mind that when you buy newly released port to hold to maturity, you are incurring two sets of opportunity costs: (1) the income you forego by not investing those funds; and (2) the loss of storage space for an extended period of time. "Example follows: [The prior poster wrote:] 'I was telling Dave in Denver about my baby, a '66 Graham's that I picked up at Justerini & Brooks for 49 quid (75 of your earth dollars) [snip]' "Let's use present discounted valuing to see whether you're better off buying this port today at $75 than you would have been if you had bought it on release. "1966 value equals 1994 value divided by the discount factor, which is (1 + r) raised to the nth, where n is the number of years we're discounting for and r is the discount rate. Assume a discount rate of 6% and that the '66 was released 25 years ago today. On that basis, the 1966 value should have been about $17.50. In other words, if the 1966 port cost more than $17.50 on release it made economic sense for you to buy the port back then (disregarding the opportunity cost of giving up the storage space for 25 years). "Another example. Suppose you buy the 1991 port today for $20. What is the implicit interest rate that is necessary for that bottle to be worth $75 in 25 years? 5.4%. In other words, it makes economic sense for you to buy the 1991 port today only if you have no investment opportunity that can pay you an annual rate of return of more than 5.4% for the next 25 years. (If you don't, send me your money and I'll pay you 5.4% for the next 25 years. Just kidding.) "None of which is to denigrate the 1991 vintage. But I'm buying and drinking '70, '77, '78, and '82 ports right now at a much lower cost than I would have incurred if I had bought them on release. So a little attention to economics gives one a better perspective on the need to run out and buy the 1991 vintage."

To which Paul Winalski responded as follows: "On the other hand, if I lay down the port myself, I (1) know that 15+ years from now, I'll be sure of having it, rather than having to rely on maybe finding it at auction somewhere, and (2) I'll be sure it was kept correctly, rather than taking a gamble that whoever is putting it up for auction stored it properly." Paul has proven himself to be a person to be taken seriously on wine questions, especially relating to port. But I disagree with him on this issue. I have had little difficulty getting adequate supplies of my favorite ports at auction. Nor have I had any problems w/ bottles that were improperly stored (by which I mean bottles stored in conditions worse than those I can provide). This is a key point: few of us really have the proper conditions to store port for 15+ years. Does your wine cellar really never get above say 60 degrees? Does your wine cellar really never get below say 50% humidity? Unless you've got perfect (or at least excellent) storage conditions, aging port becomes quite a gamble. I'd rather buy it from an auction house whose reputation for checking the wine's provenance is well- established. In any case, my main point was that the economics are more complicated than some would suggest. What Paul did is to further complicate the economics, which in facts supports my main point that the decision to buy vintage port requires a more thoughtful analysis than simply saying "Great vintage, good price, have at it."

5) "Single-Quinta" ports are essentially comparable to a French or California single-vineyard wine. Quinta is the term used in the Douro for a farm, i.e., a specific vineyard site. The Port shippers own (or buy from) vineyards located all over the Douro area. The wines they bottle are usually a blend from several quintas. Sometimes one quinta will produce excellent wine, worthy of vintage treatment, but the conditions aren't right for the producer to declare a vintage. The producer may opt to bottle the wine from this single quinta as vintage Port. It's the same as regular vintage Port, except it all comes from one vineyard site and bears the quinta name as well as the producer's name (regular vintage Port only has the producer's name and the vintage date). Examples include Dow's Quinta do Bomfim, Graham's Quinta dos Malvedos, Symington's Quinta do Vesuvio, and Quinta do Noval's Nacional.

Paul Winalski writes: "General wisdom is that, while these single quintas generally form the backbone of the producer's vintage Port in declared vintage years, they miss some nuances and complexity contributed by the wines from the other vineyard sites, and thus the single-quinta vintage Ports aren't as complex or complete as regular vintage Ports from declared years. The ones I've had (Malvedos and Vesuvio) have been damn good Ports." The general wisdom to which Paul refers is true in my experience, BUT the Quinta do Noval Nacional port has consistently been the greatest port I've ever drunk. (The 1931 Nacional also has the distinction of having brought the highest price ever paid for a port at auction: something like $30,000. It's a goal.) Nacional is notably for being the only remaining port to be made from ungrafted vines: the vineyard has never been infested with phylloxera. Other than the Nacional, single-quinta ports strike me as being mostly a marketing device.

6) Additional information: James Suckling's "Wine Spectator Guide to Vintage Ports">Wine Spectator Guide to Vintage Ports" is undoubtedly the leading reference, although it is now somewhat dated. Michael Broadbent's "Vintage Book" also has a good bit of information, although it too is rather dated. Robert Parker's "Wine Buying Guide">Wine Buying Guide" has a decent section on vintage ports, mostly focusing on recent vintages.


September 13, 2003 in Food and Drink | Permalink

Ridge Langtry Zinfandel 1973

Very little fading or browning, still quite a deep red, albeit with some brick at the edges. The flavor was staggering: lush dark fruits, with virtually no sign of drying out. A subtle impression of sweetness, although there was no indication on the verbose label of any RS. Perhaps the slightest residual hint of pepper and bramble, but really tasting more like a 20 year old claret than a zinfandel.

September 13, 2003 in Food and Drink, Wine Tasting Notes | Permalink

Sarbanes-Oxley Winners and Losers

Dwight Klingenberg, a business journalist, writes:

A little over a year ago, Congress passed the most sweeping legislation affecting businesses since the creation of the Securities and Exchange Commission in the '30s. Although the Sarbanes-Oxley Act - we'll call it Sarbox from here on - itself is a scant 66 pages, the subsequent implementation rules and regulations will fill numerous hard drives over the next few years. At this stage, who are the winners and losers?

66 pages is scant? Anyway, go read the whole thing. To whet your appetite, here's a summary of winners and losers:

Winners
Treadway Commission
The SEC
Law firms
Software vendors
Outsourcers

Losers
Research analysts
The AICPA
Private companies and agencies

Too close to call
In-house counsel
Public companies [This was the one I was prepared to question, leaning towards putting public companies into the loser category for the reasons stated in thefirst sentence that follows, but I am semi-persuaded by the second sentence. I'll need more data before making up my mind on that one.]

Public firms are now strapped with significant new costs: whistleblower hotlines, expanded internal audit departments, extensive control documentation, higher director compensation, shocking increases in directors' and officers' insurance and bigger fees from their auditors. However, most CFOs we speak to will admit privately that the documentation effort resulted in finding control issues and shortcomings they are fixing.

CPA firms
Directors

September 13, 2003 in Corporation Law, Corporation Law: Sarbanes-Oxley | Permalink

Recall and the Economy

Daniel Weintraub blogs an interview with Arnold about the worker's compensation bill that just passed in Sacramento. The Insider is not impressed:

We know by now that Schwarzenegger is not a policy wonk. He intends to lead with broad strokes while delegating the nitty-gritty to others. And I don’t expect him, or any candidate, to be able to recite chapter and verse on every issue discussed in the Legislature. But Schwarzenegger has chosen to make this issue the centerpiece of his economic plan. I would expect his staff to follow the negotiations, compare them to his proposals, and find at least one specific, major reform that he wants to see adopted and then brief him on that issue so he can respond to a question like this. And I would expect the candidate to insist on it.

The basic problems with this bill are (1) you can't trust the numbers and (2) it did nothing to rein in the plaintiff's trial bar. Why didn't Arnold just say that?

September 13, 2003 in Politics: California | Permalink

New Posting Starts Now

Readers of Corporation Law and Economics in the earlier Blogger version will note that the posts that follow appeared at blogspot. New posts start now.

September 13, 2003 | Permalink

Provenance Rutherford Cabernet Sauvignon 2000

Provenance 2000 Rutherford cabernet sauvignon (WS 90). It was infanticide — nowhere near ready to drink — but with promise for the future. Firm with smooth tannins, deep color, but almost no nose. The flavor profile included currants and cassis, leathery beef, and oriental spices; not much Rutherford dust. Needs time. Interestingly, Provenance is run by Duckhorn’s longtime winemaker Tom Rinaldi. At Provenance he is pursuing the same blending philosophy he championed at Duckhron. This wine, for example, is 15% merlot.

September 13, 2003 in Food and Drink, Wine Tasting Notes | Permalink

Why the Problem at the NYSE is the same as the Problem at Freddie and Fannie

The Wall Street Journal editorializes today (subscription required) on Treasury Sec'y Snow's testimony yesterday on Freddie Mac and Fannie Mae:

Arguing that publicly traded companies should have only private directors, he suggested the time had come for Fan and Fred to eliminate the directors on their boards who are now appointed by the President. Good corporate governance, he crisply noted, requires that the people who are running companies serve the stockholders.

Apropos of that point, a reader writes:

My opinion is that Freddie Mac's board [mild expletive deleted] its shareholders by ordering an investigative law firm to try to pin blame on senior management (and therefore not on the Board) for an accounting scandal. The result may have covered the board's posterior, but it damaged the company both internally and externally. Is there any solution for this in terms of corporate governance? My guess is that shareholder lawsuits are a lousy tool for creating Board accountability, but is there a better tool that would not have the side effect of giving board such a strong incentive to cover itself that it hires a hit squad investigator to go after management and trash the entire company?

How does this tie into the on-going Grasso pay imbroglio? The trouble with all three entities is that they are neither fish nor fowl. Their government connections insulate them from discipline by markets and investors. The NYSE is part of a trading market oligopoly with very high barriers to entry, some of which are attributable to SEC rules. (The SEC, for example, long let the NYSE get away with listing standards making it almost impossible for a firm to de-list.) In the case of Freddie and Fannie, though, its even worse: the markets believe (with some justification) that the federal government has (implicitly) guaranteed their debts, which allows them to avoid by market discipline by borrowing at below-market rates. Moreover, because their board includes political appointees, both are further insulated from investor discipline. The solution for all three is privatization. Let them run as for-profit corporations in competitive markets, with full disclosure (none of them are very transparent as to either governance or finances).

UPDATE: Broc on Grasso:

And don't get me started about the NYSE's governance structure. True, its not a public company but it does have all the earmarkings of a poster child for bad governance. A CEO who handpicks the board - and the compensation committee. A compensation committee who approves CEO compensation arrangements that it doesn't understand. A compensation committee comprised of CEOs from companies that have inherent conflicts of interest with the CEO by virtue of him being their regulator.

Check.

UPDATE 2: Gregg Easterbrook blogs:

Turns out the compensation board that approved Grasso's grotesque bonus contained executives from big companies that had a keen interest in insuring that the NYSE did not act against stock-market manipulation. Citigroup, Morgan Stanley and Merrill Lynch--the key offenders who admitted in the recent $1.4 billion Securities and Exchange Commission settlement that they deliberately misled investors--all had seats on the committee setting Grasso's pay. So did AOL Time Warner which, during the period Grasso was being assigned the grotesque bonuses, was engaged in the most determined campaign to wipe out shareholder value in American business history. These tainted companies were in effect offering Grasso huge amounts of money if he played along and made sure the NYSE did nothing to expose them--and Grasso, a faithful water-carrier, made sure the NYSE did absolutely nothing. There's a word for all this, and the word is "corruption."

Check again.


September 13, 2003 in Corporate Governance, Current Affairs, SEC: Securities Regulation and Litigation | Permalink

Estancia Meritage Alexander Valley 1999

Denise Howell of the Bag and Baggage blog gave us a very nice pointer. She writes: "Professor Bainbridge blames his blog on Hugh Hewitt, who wants 'less corp law, more politics;' I'll chime in with my own typical request for 'more wine!'" Your wish, etc....

Estancia Meritage Alexander Valley 1999 (WS 87). A cabernet/merlot blend. A modest nose that is, unfortunately, reminiscent of cherry-flavored cough syrup. Tannic and acidic on the palate, with notes of red cherries and mocha java. I wonder if they acidified it, although I don’t think they used citric acid the way some cheapskates do (the lemon flavor usually gives it away in reds). Not bad for a mid-week wine, albeit a bit pricey for that purpose (MSRP $30, although I paid a lot less), but not one I would buy again. On the other hand, the other bottle in the cellar will get drunk rather than just going into the stock pot. And, I should note, the good wife liked it better than I did. My main problem with this wine is that it’s not really ready to drink, but I’m also not sure it will age that well. I’ll cross my fingers, give the other bottle a couple of years, and report back (assuming I’m still doing this then).

September 13, 2003 in Food and Drink, Wine Tasting Notes | Permalink

Student Evaluations

Marginal Revolution is blogging on the question of whether student evaluations are a good idea. Tyler cites a study, which concludes (among other things) that: "Cosmetic factors such as appearance have a big influence on evaluations." This reminded me of my all-time favorite student evaluation: "Professor Bainbridge is my favorite professor. Please tell him to go on a diet, because right now he's heading for an early heart attack." I thought about that one for a while, ordered a pizza, opened a bottle of Chianti, and lit a cigar.

September 13, 2003 in Legal Education | Permalink

Kucinich for Federal Law of Corporations

Democratic presidential candidate Dennis Kucinich is advocating a federal law of corporations:

We need a new relationship between corporations and our society. Just as our founders understood the need for separation of church and state, we need to institutionalize the separation of corporations and the state. This begins with government taking the responsibility to establish the conditions under which corporations may do business in the United States, including the establishment of a federal corporate charter which describes corporate rights and responsibilities.

Federal incorporation is a perfectly legitimate idea, with a distinguished intellectual pedigree. Personally, however, I'm a competitive federalism kind of guy. In my view, the state-based system of regulating corporate governance is one of the main strengths of the U.S. capital markets -- as Professor Roberta Romano famously claimed, state regulation and the resulting regulatory competition between jurisdictions is the “genius of American corporate law.”

The basic case for federalizing corporate law rests on the so-called “race to the bottom” hypothesis. States compete in granting corporate charters. After all, the more charters the state grants, the more franchise and other taxes it collects. According to the race to the bottom theory, because it is corporate managers who decide on the state of incorporation, states compete by adopting statutes allowing corporate managers to exploit shareholders. As the clear winner in this state competition, Delaware is usually the poster-child for bad corporate governance. Interestingly, the two main poster-children for reform, Enron and WorldCom, were not Delaware corporations. (They were incorporated in Oregon and Georgia, respectively.)

Basic economic common sense tells us that investors will not purchase, or at least not pay as much for, securities of firms incorporated in states that cater too excessively to management. Lenders will not lend to such firms without compensation for the risks posed by management’s lack of accountability. As a result, those firms’ cost of capital will rise, while their earnings will fall. Among other things, such firms thereby become more vulnerable to a hostile takeover and subsequent management purges. Corporate managers therefore have strong incentives to incorporate the business in a state offering rules preferred by investors. Competition for corporate charters thus should deter states from adopting excessively pro management statutes. The empirical research bears out this view of state competition, suggesting that efficient solutions to corporate law problems win out over time.

But even if you could prove that state competition is a race to the bottom, basic federalism principles would still counsel against federal preemption of corporate law. The corporation is a creature of the state, “whose very existence and attributes are a product of state law.” States have an interest in overseeing the firms they create. States also have an interest in protecting the shareholders of their corporations. Finally, a state has a legitimate “interest in promoting stable relationships among parties involved in the corporations it charters, as well as in ensuring that investors in such corporations have an effective voice in corporate affairs.” In other words, state regulation not only protects shareholders, but also protects investor and entrepreneurial confidence in the fairness and effectiveness of the state corporation law. (The quotations are from CTS Corp. v. Dynamics Corp., 481 U.S. 69, 91 (1987))

According to the Supreme Court’s CTS decision, the country as a whole benefits from state regulation in this area, as well. As Justice Powell explained in that case, the markets that facilitate national and international participation in ownership of corporations are essential for providing capital not only for new enterprises but also for established companies that need to expand their businesses. This beneficial free market system depends at its core upon the fact that corporations generally are organized under, and governed by, the law of the state of their incorporation. This is so in large part because ousting the states from their traditional role as the primary regulators of corporate governance would eliminate a valuable opportunity for experimentation with alternative solutions to the many difficult regulatory problems that arise in corporate law. As Justice Brandeis pointed out many years ago, “It is one of the happy incidents of the federal system that a single courageous State may, if its citizens choose, serve as a laboratory; and try novel social and economic experiments without risk to the rest of country.” (New State Ice Co. v. Liebmann, 285 U.S. 262, 311 (1932) (Brandeis, J., dissenting)) So long as state legislation is limited to regulation of firms incorporated within the state, as it generally is, there is no risk of conflicting rules applying to the same corporation. Experimentation thus does not result in confusion, but instead may lead to more efficient corporate law rules.

In contrast, a uniform federal law would preclude experimentation with differing modes of regulation. As such, there would be no opportunity for new and better regulatory ideas to be developed—no “laboratory” of federalism. Instead, we would be stuck with rules that may well be wrong from the outset and, in any case, may quickly become obsolete.

The point is not merely to restate the race to the top argument. Competitive federalism promotes liberty as well as shareholder wealth. When firms may freely select among multiple competing regulators, oppressive regulation becomes impractical. if one regulator overreaches, firms will exit its jurisdiction and move to one that is more laissez-faire. In contrast, when there is but a single regulator, such that exit by the regulated is no longer an option, an essential check on excessive regulation is lost.

How I square all of this with my earlier post on Spitzer will be the subject of a future post, tentatively entitled "Can you Be a Competitive Federalist and Still Want Spitzer to Shut the %!*# Up?" Stay tuned.

September 13, 2003 in Corporation Law: Federalism, Politics: Presidential Election | Permalink

Corporate Governance and Presidential Politics

Being a corporate law kind of guy, I decided to check whether the main presidential candidates had said anything about corporate governance in their web sites. As far as I can tell, so far only Kucinich (see above) and John Edwards have done so. Edward's position paper has a lot more detail than did Kucinich's, with more action items. Kucinich was also easier, because competitive federalism is something I've written a lot about, so there was plenty of stuff in the file to adapt for that post. I'll get back to you on Edwards, probably over the weekend.

In the interests of equal time, I should note that Bush's official site apparently doesn't have a position paper on corporate governance issues either. Nor, for that matter, do any of the California recall gubernatorial candidates. (Does Bustamante have a campaign web site? I couldn't find one for the recall campaign -- just his official state site and Lt. Gov. campaign site, the latter of which seemed to be down.)

Anyway, blogging about presidential candidates should generate some hate mail, if nothing else does. (I don't plan on blogging about "you know who" though. I don't need that much hate mail.)

September 13, 2003 in Corporate Governance, Current Affairs | Permalink

New Article on Sarbanes-Oxley Section 307

The Social Science Research Network is a site for legal, economic, management, and accounting scholars to post working papers before they are formally published in a professional journal. All of my articles since 1998 are collected there, along with most of the ones published before that date. SSRN just released to its data base my newest article, co-written with UCLA grad Christina Johnson, entitled "Managerialism, Legal Ethics, and Sarbanes-Oxley Section 307. This article was prepared for a conference on the Sarbanes-Oxley Act (a.k.a. the 'Public Company Accounting Reform and Investor Protection Act' of 2002), this Article focuses on the professional responsibility rules promulgated by the Securities and Exchange Commission under Section 307 of the Act. According to the theoretical model of corporate governance espoused by all business corporation statutes, a corporation is to be run by its board of directors for the benefit of its shareholders. In practice, however, corporations frequently are run by their top managers for the benefit of those managers.

A number of recent trends have empowered boards of directors vis-a-vis management. As this Article's review of the statutory text and its legislative history demonstrates, Congress intended the Sarbanes-Oxley Act to further that trend. We further demonstrate that Section 307 should be understood as part of the Act's overall anti-managerialist intent. Congress sought to enlist legal counsel in strengthening the board. Specifically, Congress directed the SEC to create an up the ladder reporting requirement pursuant to which a firm's legal counsel would report evidence of misconduct to the board of directors, thereby redressing one of the information asymmetries between boards and managers.

This Article argues that, as a normative matter, Sarbanes-Oxley Section 307 was well-intentioned. As a practical matter, however, Section 307 seems unlikely to effect significant changes in corporate governance. In our view, the nature of legal practice, the largely unchanged relationship between lawyers and managers, and the problematic approach taken by the SEC to implementing Section 307 suggest that the new legal regime is unlikely to result in significantly better information flows within the corporate hierarchy. You can download the full paper HERE.

September 13, 2003 in Corporation Law, Corporation Law: Sarbanes-Oxley | Permalink

Sarbanes-Oxley Ethics Codes

Kansas city corporate attorney Arthur Chaykin sends along the following observations:

I had been hopeful that the Sarbanes-Oxley Act would have one saving virtue: I thought, perhaps, that CEO's would do what they could to improve business decision making in their companies if only to avoid immediate disclosure through anonymous "hotline" directly to the Board. I reasoned that such calls could, at the very least, become an annoyance for CEO's and, at worst, could give the Board the impression that the CEO did not know how to run the company. Therefore, I thought it was at least possible that CEO's would "pump up" corporate ethics codes and programs in an earnest attempt to reduce the number of "bad acts" within the company.

However, on further reflection, I am concerned that the Sarbanes-Oxley Act may have the exact opposite impact. As you know, the Act requires an ethics code, at least for financial officers, or an explanation as to why no ethics code is presented (and no company will want to explain that). Furthermore, the Act requires a company to explain any "deviation" from its ethics code. As I read it, that means that anytime a company decides to make a reasonable exception to a conflict of interest policy, it has to do a public filing. In order to avoid that, I am sure companies will try to (a) obfuscate their codes so that it will be hard to know whether a violation has occurred or not (thus defeating the entire purpose) or (b) attempt to reserve discretion in some body within the corporation so that they do not have to report the exception as a deviation (but it is not clear that will work). So, I expect a lot of companies to select (a). I have had one general counsel indicate that she had just written the new code and made sure that it only did the bare minimum because she did not want to incur additional disclosure obligations.

Can you believe it?

Yes, I can believe it. Arthur is exactly right that no company in its right mind will want to explain the absence of an ethics code (in the trade we call this therapeutic disclosure, about which I will be posting soon). He's also exactly right that no company will want to be put in the position of disclosing deviations from the code. Hence, we're going to get bare bones ethics codes, which is exactly what seems to be happening.

September 13, 2003 in Corporate Governance, Corporation Law: Sarbanes-Oxley | Permalink

A Review of "The Company"

The Company: A Short History of a Revolutionary Idea. John Micklethwait & Adrian Wooldridge. New York, The Modern Library, 2003. Although I recommend this text to generalist readers seeking a (remarkably) concise introduction to history of the business corporation, personally I came away somewhat disappointed. There is little doubt Micklethwait and Wooldridge are correct in their claim that the corporation is now the key economic institution in Western nations. Yet, it did not have to turn out that way. As Micklethwait and Wooldridge usefully remind us, two centuries ago, leading business and economic thinkers (including the great Adam Smith) derided the joint stock company. What explains the relatively rapid development in the mid-19th century of a recognizably modern corporation and, in turn, that entity's emergence as the dominant form of economic organization?

Micklethwait and Wooldridge offer a fairly conventional answer to that question, based largely on new technologies -- especially the railroad -- requiring vast amounts of capital, the advantages such large firms derived from economies of scale, the emergence of limited liability that made it practicable to raise large sums from numerous passive investors, and the rise of professional management. Readers familiar with the work of business historian Alfred Chandler will find relatively little new in this part of the story, although Micklethwait and Woolridge's treatment has the advantage for generalist readers of being considerably more accessible than is most of Chandler's work. Instead of offering any novel historical analysis, Micklethwait and Wooldridge's principal potential contribution (albeit one they failed adequately to realize) is the normative thesis to be derived from the historical account.

In their introduction, Micklethwait and Wooldridge lay out a claim that will be familiar to readers of Michael Novak's work (surprisingly, however, they seem unaware of his seminal work). Like Novak, Micklethwait and Wooldridge argue not only that the corporation is one of the West's great competitive advantages, but also that the number of private-sector corporations a country boasts is a relatively good guide to the degree of political freedom it provides its citizens. Unfortunately, this insight goes nowhere.

The normative claim is entirely plausible. The rise of modern corporations did more than just expand the economic pie. The legal system that facilitated their rise necessarily allowed individuals freedom to pursue the accumulation of wealth. Economic liberty, in turn, proved a necessary concomitant of personal liberty -- the two have almost always marched hand in hand. In turn, the modern public corporation has turned out to be a powerful engine for focusing the efforts of individuals to maintain the requisite sphere of economic liberty. Those whose livelihood depends on corporate enterprise cannot be neutral about political systems. Only democratic capitalist societies permit voluntary formation of private corporations and allot them a sphere of economic liberty within which to function, which gives those who value such enterprises a powerful incentive to resist both statism and socialism. As Michael Novak has observed, private property and freedom of contract were indispensable if private business corporations were to come into existence. In turn, the corporation gave liberty economic substance over and against the state. Regrettably, after laying it out, Micklethwait and Wooldridge fail to pursue this thesis. Instead, their book lapses into mere narrative history.

Having said that, however, it is exceptional narrative history. As journalists for the Economist, which I regard as the best-written magazine around, they write clearly yet powerfully. There are numerous insights, cleverly turned phrases, and interesting anecdotes. All of which makes for a compelling read, if not a compelling normative argument.

September 13, 2003 in Books, Corporate Governance | Permalink | TrackBack

Donaldson tells Congress action on shareholder access to proxy coming soon

Reuters is reporting that:

U.S. Securities and Exchange Commission Chairman William Donaldson told lawmakers on Tuesday that the agency will consider, as early as this month, proposals to give shareholders access to proxy statements. The commission has been moving toward adopting a rule to allow shareholders to nominate some company directors using the corporate proxy statement, a pamphlet distributed to shareholders annually.

Mike O'Sullivan has been blogging at Corp Law Blog about why this is such a bad idea. I tend to agree with him on the merits, and will post later explaining why.

Tonight I'm commenting solely on whether the SEC has authority to adopt this rule. I am leaning towards concluding (albeit reluctantly) that the SEC probably has authority to do most of what they are talking about. In particular, consider the distinction the Business Roundtable court drew between rule 19c-4 and rule 14a-4(b)(2)'s requirement that proxies give shareholders an opportunity to withhold authority to vote for individual director nominees. Business Roundtable v. SEC, 905 F.2d 406 (DC Cir. 1990). In the court's view, the latter "bars a kind of electoral tying arrangement, and thus may be supportable as a control over management's power to set the voting agenda, or, slightly more broadly, voting procedures," while "Rule 19c-4 much more directly interferes with the substance of what shareholders may enact." In an article I wrote on 19c-4, I concluded that the shareholder proposal rule would pass muster under the Business Roundtable approach. Absent rule 14a-8, shareholders have no practical means of initiating action in the voting process or otherwise affecting the agenda. As such, rule 14a-8 presumably is supportable "as a control over management's power to set the voting agenda." Director nomination rules would seem to fall into that category as well.

September 13, 2003 in Corporation Law: Proxies, SEC: Shareholder Access Rule | Permalink

Corporate Governance Rant

Mike O'Sullivan at Corp Law Blog has a great post -- nay, rant -- on the on-going saga of corporate governance reform. Money quote:

"Any corporate governance reform looks great when viewed through an Enron or WorldCom lens. Many of these reforms look less attractive when viewed through a GE lens, a Berkshire Hathaway lens or a [FILL IN YOUR FAVORITE PUBLIC COMPANY] lens. Instead of asking "Would this reform stick it to Ken Lay?" you should ask "Would this reform hobble Jeffrey Immelt, Warren Buffett or [FILL IN YOUR FAVORITE CEO]?"

Exactly! Go read the whole thing. After which, you might want to read my article on the federalism implications of corporate governance reform. In it, I note that there has been a creeping - but steady - federalization of corporate governance law. Taken together, these developments constitute the most dramatic expansion of federal regulatory power over corporate governance since the New Deal.

No one seriously doubts that Congress has the power under the Commerce Clause to create a federal law of corporations if it chooses. The question of who gets to regulate public corporations thus is not one of constitutional law but rather of prudence and federalism. In this essay, I advance both economic and non-economic arguments against federal preemption of state corporation law. Competitive federalism promotes liberty as well as shareholder wealth. When firms may freely select among multiple competing regulators, oppressive regulation becomes impractical. If one regulator overreaches, firms will exit its jurisdiction and move to one that is more laissez-faire. In contrast, when there is but a single regulator, exit is no longer an option and an essential check on excessive regulation is lost.

September 13, 2003 in Corporate Governance | Permalink

Abolishing Veil Piercing: A Review

PROF UNTANGLES CORPORATE WEB WITH LAW AND ECONOMICS: "Lawyers who have no recollection of hearing or seeing the words 'law' and 'economics' in the same sentence at any time during law school might have a vague notion that 'law and economics' is something the 7th U.S. Circuit Court of Appeals does when Judge Richard A. Posner or Judge Frank H. Easterbrook is on the panel. This veil of ignorance is pierced by a new article on piercing the veil. Using law and economics analysis, Stephen Bainbridge (a professor at UCLA Law School and visiting professor at Harvard) concludes that courts should abolish veil piercing when it comes to holding individual shareholders liable for corporate debts. Yet Bainbridge also believes courts should keep a variation of veil piercing for use against affiliated corporations. Stephen M. Bainbridge, 'Abolishing Veil Piercing,' 26 Journal of Corporation Law 479."

It's actually a very good summary of both the law and economics methodology and the doctrinal analysis used in that article. As they correctly summarize my conclusion: "So law and economics analysis condemns veil piercing against individuals but -- on what Bainbridge considers a "close question" -- blesses the remedy in appropriate cases against affiliated corporations."

September 13, 2003 in Corporation Law: Limited Liability | Permalink

Silver Oak Cabernet Sauvignon 1993 Horizontal Tasting

Last weekend we held a small horizontal tasting of the 1993 Silver Oak cabernets. The Napa Valley (WS 88; RMP 90) was big, rich, and still quite tannic. For most of the tasters, this was their favorite. On the nose, one got a good blast of cedar, earth, and dark fruits. On the palate, the wine is surprisingly reticient for a 10-year old California cabernet, especially for Silver Oak, which is usually quite forward. I'm worried it will dry out before it's really ready. In contrast, the Alexander Valley (WS 90; RMP 90) was clearly my favorite of the two. The Alex has an immense nose of lead pencil, herbs, chocolate, and spicy fruit. The Lafite-like bouquet filled the room! (Not that I have all that much experience with Lafite, to be sure, but dropping the Lafite name seems to be the first rule of wine blogging.) On the palate, the Alex shows dill, currant, and cassis, with a long finish. The wine is mature, but still has a lot left -- I'd guess at least 5 more years.

September 13, 2003 in Food and Drink, Wine Tasting Notes | Permalink

Venturpreneur on Blogs as a marketing tool for lawyers

Gordon Smith, a University of Wisconsin law professor who runs the excellent Venturpreneur blog, offers the following observations on lawyers who use a blog as a marketing tool:

Venturpreneur: "I just received a call from Jan Pribeck, who is writing a story about blogging for the Wisconsin Law Journal, a practitioner's journal here in the Badger state. I have noticed a fair degree of interest in blogging among practicing lawyers. The promise of blogging is that it can promote the lawyer or law firm to a large potential audience. The obstacles, however, are many. In particular, blogging is a time consuming enterprise, and it is a pretty indirect method of reaching potential customers. Lawyers complain often about their stressful schedules. Add blogging to an already stressed life, and you are not going to like the results. More importantly, perhaps, the best blogs have a point of view. An attitude. Many lawyers are rightly skeptical of taking firm public positions, not only because they may drive away potential clients, but because they find those positions used against them in litigation or negotiations. Blogging can be a fairly effective marketing tool for personalities -- how many of you would know Glenn Reynolds from his law review articles? -- but most lawyers are not selling their personalities. Quite the opposite, in fact, they are often selling their ability to assume a client's personality (or at least embrace a client's cause). In that context, blogging sends the wrong message."

I suspect he's right. A former colleague of mine (from back when I was teaching at Illinois) once described being a law professor as a "loophole on life." The academic lifestyle thus lends itself to blogging a way that practice does not. Law professors have time to blog and, moreover, already get paid for having an ax to grind. Or, at least, so I hope. My scholarship has a definite point of view, which is reflected in the title of this blog, and this blog is an alternative way of getting that point of view out there for public consumption.

My colleague Victor Fleischer, one of the authors of the group blog "A Taxing Blog," has co-authored an interesting essay on academic blogging, in which he observes:

As bloggers, we enjoy an excuse to keep up on what’s current in the tax world and to read more widely than we might otherwise. We also hope to make a connection with an audience that we might not otherwise reach with traditional legal scholarship. ... [W]e think of blogging as a supplement to – not a substitute for – our more traditional scholarship. And blogging might even enhance our scholarship by giving us access to and feedback from a broader, more diverse audience than, say, the readers of the Harvard Law Review. Moreover, as shameless tax nerds, we feel a right – nay, a solemn duty – to introduce the world of tax policy to the blogosphere.

Substitute corporate law for tax in the foregoing and that roughly captures what I'm trying to do in "Corporation Law and Economics."

September 13, 2003 in Weblogs | Permalink

Shamelessly self-serving plug

My new book Mergers and Acquisitions is now available at Amazon. It also can be ordered directly from the publisher, Foundation Press. A summary table of contents is available here. The publisher's blurb reads as follows: "This law school textbook is designed for advanced business law courses, such as Mergers & Acquisitions or Corporate Finance, with a primary emphasis on corporate and securities law issues. The text has a strong emphasis on the doctrinal issues taught in today's Mergers & Acquisitions classes, and also places significant emphasis on an economic analysis of the major issues in such a course." Doesn't make it sound like a John Grisham novel does it? But, as I said in the preface, while the primary audience for this text is law students taking an advanced corporation law course, I hope that judges and lawyers will also find it helpful.

September 13, 2003 in Books | Permalink

September 12, 2003

The corporate canon

A reader once asked me to suggest a canon of corporate law works analogous to my colleague Vic Fleischer's Tax Canon. Here are my nominees for books every corporate lawyer, especially every economically-minded corporate lawyer should own (with links to Amazon):

Corporation Law: Modern Texts
ALI: Principles of Corporate Governance
Berle and Means: Modern Corporation and Private Property
Butler and Ribstein: The Corporation and the Constitution
Clark: Corporate Law
Easterbrook and Fischel: The Economic Structure of Corporate Law [review here]
Klein and Coffee: Business Organization and Finance
Manning: Legal Capital
Roe: Strong Managers, Weak Owners [review here]

Corporation Law: Classic Texts
Conard: Corporations in Perspective
Wormser: Disregard of the Corporate Fiction and Allied Corporation Problems


Corporation Law: Law Review Article Collections
Gevurtz: Corporate Law Anthology
Romano: Foundations of Corporate Law

Corporate Governance and Economics
Coase: The Firm, the Market, and the Law [review here]
Chandler: The Visible Hand: The Managerial Revolution in American Business
Davis: Corporations: A Study of the Origin and Development
Jensen: A Theory of the Firm: Governance, Residual Claims, and Organizational Forms [review here]
Malkiel: A Random Walk Down Wall Street [review here]
Micklethwait and Wooldridge: The Company: A Short History of a Revolutionary Idea [review here]
Williamson: The Economic Intstitutions of Capitalism [review here]
Williamson: The Mechanisms of Governance [review here]

Shameless self-serving plug for my books
Corporation Law and Economics
Mergers and Acquisitions
Securities Law: Insider Trading

September 12, 2003 in Books, Corporate Governance, Corporation Law | Permalink | TrackBack

Publish or perish: new business judgment rule article

My article The Business Judgment Rule as Abstention Doctrine has been accepted for publication by the Vanderbilt Law Review. Anyway, in this article, I observe that the business judgment rule is corporate law's central doctrine, pervasively affecting the roles of directors, officers, and controlling shareholders. Increasingly, moreover, versions of the business judgment rule are found in the law governing the other types of business organizations, ranging from such common forms as the general partnership to such unusual ones as the reciprocal insurance exchange. Yet, curiously, there is relatively little agreement as to either the theoretical underpinnings of or policy justification for the rule. This gap in our understanding has important doctrinal implications. As this paper demonstrates, a string of recent decisions by the Delaware supreme court based on a misconception of the business judgment rule's role in corporate governance has taken the law in a highly undesirable direction.

Two conceptions of the business judgment rule compete in the case law. One views the business judgment rule as a standard of liability under which courts undertake some objective review of the merits of board decisions. This view is increasingly widely accepted, especially by some members of the Delaware supreme court. The other conception treats the rule not as a standard of review but as a doctrine of abstention, pursuant to which courts simply decline to review board decisions. The distinction between these conceptions matters a great deal. Under the former, for example, it is far more likely that claims against the board of directors will survive through the summary judgment phase of litigation, which at the very least raises the settlement value of shareholder litigation and even can have outcome-determinative effects.

Like many recent corporate law developments, the standard of review conception of the business judgment rule is based on a shareholder primacy-based theory of the corporation. This article extends my recent work on a competing theory of the firm, known as director primacy, pursuant to which the board of directors is viewed as the nexus of the set of contracts that makes up the firm. In this model, the defining tension of corporate law is that between authority and accountability. (See HERE, HERE, HERE, and especially HERE.) Because one cannot make directors more accountable without infringing on their exercise of authority, courts must be reluctant to review the director decisions absent evidence of the sort of self-dealing that raises very serious accountability concerns. In this article, I argue that only the abstention version of the business judgment rule properly operationalizes this approach.

The article will not be out in print for several months, at the very least, but you can download my final draft HERE. (Scroll down to the download buttons.)

September 12, 2003 in Corporation Law: Business Judgment Rule | Permalink | TrackBack

Bush (43) as big government conservative

Several bloggers (e.g., Sullivan) and commentators (e.g., Barnes) have noted that despite President Bush’s reputation as a conservative the federal government has grown dramatically during his tenure in office, not all of which can be explained by post-Sept. 11 homeland security initiatives. As a corporate law guy, I would add to this set of reservations President Bush’s seemingly approving comment that Sarbanes-Oxley enacted “the most far-reaching reforms of American business practices since the time of Franklin Delano Roosevelt.” Odd praise, indeed, coming from a purportedly conservative President. Especially odd praise coming from a former state governor with a track record of stated respect for basic federalism principles, because, taken together, Sarbanes-Oxley’s various provisions constitute the most dramatic expansion of federal regulatory power over corporate governance since the New Deal.

September 12, 2003 in Politics: Presidential Election | Permalink | TrackBack

September 11, 2003

McKesson HBOC, Inc. v. New York State Common Retirement Fund, Inc.

2003 WL 21920240 (9th Cir. 2003):

The corporate form protects shareholders by limiting their liability and their direct control over the corporation. See Japan Petroleum Co. (Nigeria) Ltd. v. Ashland Oil, Inc., 456 F.Supp. 831, 838 (D.Del.1978) ('One of the major features of the corporate form of organization is that it insulates shareholders from personal liability for the debts of the corporation.'); see also Stephen M. Bainbridge, Abolishing Veil Piercing, 26 J. Corp. L. 479, 482 (2001) ('Shareholders of public corporations are effectively immune from veil piercing claims.').

Heh.

September 11, 2003 in Corporation Law: Limited Liability | Permalink | TrackBack

September 10, 2003

Policy on reader emails

I try to respond to most reader emails, but will ignore spam, obscenity, ad hominem attacks, or general incivility. My policy on quoting emails is opt-out: Unless you tell me not to do so, I will quote your email. My policy on identifying the emailer is opt-in: Unless you tell me to name you, I will refer to you as "a reader."

Rationale: An opt-in rule requires consent of responding readers before the information they have sent you can be disclosed to other readers. Opt-in thus essentially stops the free flow of information blogging is designed to promote. In contrast, an opt-out rule promotes free flow of information while still alllowing privacy sensitive readers to prevent personal information and communications from being shared. Many privacy surveys, however, suggest that consumers view opt-out consent as appropriate only if the opting-out provision is effectively brought to the customer's attention, the policy is clear and detailed, and the system makes opting-out easy to execute. Assuming correspondents are more likely to have privacy concerns with respect to identity rather than the substance of their remarks, I adopted opt-in for the former and opt-out with respect to the latter.

September 10, 2003 in Weblogs | Permalink | TrackBack

Reserving the right to tweak posts

I reserve the right to correct spelling errors and make stylistic changes without notice and, more important, without so indicating. Ditto minor tweaking. When I wish to correct factual errors or change a substantive opinion, however, I will provide an Update notice (like this one). Who gets to decide into which category a given change falls? Me -- hey its my blog!

September 10, 2003 in Weblogs | Permalink | TrackBack

Introduction

This blog's main focus is U.S. corporation law and corporate governance. I'll also be posting my wine tasting notes, since most corporate lawyers I know also have a healthy interest in wine. (By "healthy interest" I mean anything up to, but not including, the English Lord to whom it was said: "My Lord, I understand you drank three bottles of Port last night unassisted." The Lord responded: "My dear sir. That is a lie. I had the assistance of a bottle of Madeira.") I'll probably touch on politics and general news occasionally, although this is definitely not a war blog, but mainly when the news relates to business.

When not working on the blog, I teach corporate law at UCLA. On the side, I write books and articles about corporate law. Indeed, one of the main functions of this blog is to disseminate the ideas in my books and articles to another audience.

And now for the fine print: This web site is not intended to be, and you should not rely on any materials on this blog as, a source of legal advice. Postings to this web site have been prepared for informational purposes only. Transmission or receipt of information contained in this web site does not create an attorney-client relationship. No assurance is given that any correspondence, via e-mail or otherwise, between you and the author of this blog resulting from your receipt of information from this web site will be secure or treated as confidential or privileged. The transmission or delivery of any correspondence will not create an attorney-client relationship between you and the author of this blog. Please do not send the author any confidential information. Legal advice must be tailored to the specific circumstances of each situation, so nothing in this blog should be used as a substitute for the advice of qualified legal counsel familiar with your particular situation.

The author assumes no responsibility for the accuracy or timeliness of any information contained in this web site.

This blog is not intended to serve as an advertisement or solicitation of legal or any other business. In particular, the author does not intend or desire to wishes to solicit through this blog the business of anyone in any state or other jurisdiction where this web site, or the use thereof, may not be in compliance with any law or ethical rule.

I am not a practicing lawyer. I cannot and will not represent you or provide legal advice. I also am not a legal referral service. I cannot and will not refer you to legal counsel.

In general, I very much like Corp Law Blog's Ground Rules for Using this Web Site and hereby adopt them and incorporate them herein by reference.

September 10, 2003 in Weblogs | Permalink