Corporate Law


New Demands, Better Boards: Rethinking Director Compensation in an Era of Heightened Corporate Governance

Katherine M. Brown

Sarbanes-Oxley and the accompanying era of heightened corporate governance dramatically changed the composition, role, and responsibilities of corporate boards. As a result of these changes, many of the justifications for traditional director compensation plans no longer apply. As directors struggle with their new responsibilities as independent corporate monitors, the manner in which they are compensated must reflect these changes. A director compensation plan in which directors receive compensation primarily in the form of cash, coupled with finely tailored equityholding requirements, strikes the right balance of director independence and director accountability. It also facilitates the creation of corporate boards drawn from a more diverse pool of talent.

Layovers and Cargo Ships: The Prohibition of Internet Gambling and a Proposed System of Regulation

Ryan S. Landes

Since its emergence in the 1990s, Internet gambling has grown into a $12-billion-per-year industry. In October 2006 Congress passed the Security and Accountability for Every Port Act, which includes a provision that prohibits domestic financial institutions from moving funds to and from online casinos, all of which are located overseas. While the new law has certainly caused a major stir in the Internet gambling community, users and overseas companies are continuing to find new ways to circumvent it. In this Note, the author first gives an overview of the gambling industry and the problems it poses to gamblers and communities. The author then reviews the tactics Congress attempted to use over the last decade in fighting Internet gambling—criminalizing the operation of a gambling website, criminalizing individual gambling, and criminalizing funds transfers to and from casinos—and explains why each method fails to address, and often exacerbates, the very problems the legislation seeks to resolve. The author then proposes a new method of regulation and explores how that system could significantly reduce the problems of Internet gambling.

Internal Poison Pills

George S. Geis

Corporate law largely addresses three basic relationships: shareholder versus manager, shareholder versus non-equity investor, and majority shareholder versus minority shareholder. Ever since the pioneering work of Adolf Berle and Gardiner Means, a great deal of scholarly attention has been directed toward the first relationship. The second relationship earned its share of the limelight with the leveraged buyout trend of the 1980s. It is only in this decade, however, that the third relationship has taken center stage—in the wake of several incongruous Delaware cases and a flood of post-Sarbanes-Oxley freezeout mergers.

This scrutiny is certainly warranted, as the tension between majority and minority shareholders presents thorny concerns and has the potential to erode considerable social welfare. In essence, lawmakers must walk a tightrope between two alternative hazards. On the one hand, assigning too much power to minority shareholders can lead to a holdout problem where recalcitrant dissenters demand private tribute before blessing a decision (such as a merger). On the other hand, granting the majority untrammeled discretion to freeze out minority owners can promote tunneling or other abuses of power that will depress the ex ante value of a firm. Thus far, the law has addressed these concerns with disclosure obligations, special committees, judicial review of fiduciary duties, and appraisal rights. But the results are far from satisfying.

This Article offers a novel idea for governing the tension between majority and minority shareholders: an “internal poison pill.” Borrowing conceptually from the famous shareholder rights plans created in the 1980s to address bullying external bidders, I show how an analogous (though economically distinct) financial instrument might be used by shareholders to navigate the twin internal governance tensions of holdout and expropriation. Two key features of this proposal distinguish it from alternative reforms: (1) It focuses on a privately enacted solution with room for contextual customization; and (2) it uses embedded option theory to construct an intermediate legal entitlement (as opposed to an extreme property or liability rule) for both majority and minority shareholders. If successfully scoped and swallowed, these internal poison pills could facilitate efficient freezeouts, chill coercive ones, supplant the awkward remedy of appraisal, and, ultimately, increase the ex ante value of firms by mitigating agency problems between majority and minority shareholders.

The Reach of State Corporate Law Beyond State Borders: Reflections Upon Federalism

The Honorable Jack B. Jacobs

Brennan Lecture

In this speech, delivered for the annual Justice William J. Brennan, Jr., Lecture on State Courts and Social Justice, the Honorable Jack B. Jacobs demonstrates that state corporate law sometimes acquires an extraterritorial reach. The federalist model of corporation law assumes that each state’s law only reaches to that state’s border, but reality has diverged from that model through state anti-takeover statutes, the internal affairs doctrine, and state “corporate outreach” statutes that impose internal governance requirements on companies incorporated in other states. Anti-takeover statutes are essentially grounded upon the internal affairs doctrine, which holds that such affairs are governed by a company’s state of incorporation. But the corporate outreach statutes attempt to supersede the law of the state of incorporation, exposing companies to conflicting internal governance requirements. The Supreme Court could resolve this conflict by deeming the internal affairs doctrine either a choice-of-law rule or a rule of constitutional law. The former choice could lead to economic disruption, while the latter would increase interstate competition for incorporation business and sustain the current diversity of legal choices available to corporations.

The Politics of Shareholder Voting

Lee Harris

Economic theory that suggests underperforming boards of directors should be fearful of an ouster vote by shareholders underappreciates the complexity of shareholder voting decisions. Skill at enhancing firm value has less to do with whether directors win votes and stay at the helm of public companies than previous commentators have presumed. Instead, like incumbent politicians, managers of some of the largest U.S. firms tend to stay in charge of firms because they understand—and take advantage o —the political dynamics of corporate voting. This Article presents a competing theory of shareholder voting decisions, one that suggests that shareholder voting in corporate elections is not dissimilar from citizen voting in political elections. Next, the Article presents the evidence. Using a hand-collected dataset from recent board elections, the Article compares the explanatory power of a standard economic variable (long-term stock price returns) and a political variable (money budgeted for campaigning) on election outcomes. Based on the data, directors’ ability to enhance firm value (as measured by stock price returns) is not significantly related to whether they win reelection. Rather, the likelihood of being returned to office appears to be a function of typical election politics—how much was spent by challengers to persuade shareholder voters. These findings have at least two implications. First, the theory that shareholder voting may be politicized helps point the way to how the SEC ought to craft reforms—and, just as important, how not to craft them. Recent SEC reform efforts have the laudable goals of creating new conduits for shareholders to participate in firm affairs, increasing shareholder-nominated candidate success, and disciplining incumbent managers.

The results of this study suggest that these reforms will not achieve the stated goals. Even with these reforms, the board continues to have an important political advantage, which likely translates into real votes. As the research here shows, the outcome of elections depends on persuasion and, not simply, as the SEC contends, on shareholders’ director nominees being presented alongside those of management. Second, the evidence and theory about shareholder voting presented here has significant implications for understanding mergers and acquisitions, particularly hostile acquisitions. The theory is that acquirers have steep incentives to target firms with poor performance. In most cases, however, such acquisitions depend on winning a vote from shareholders. Thus, if there is any disciplinary effect created by the prospect of takeovers, it depends crucially on understanding what motivates shareholder voting behavior. If voting shareholders respond to political motivations, not economic ones, then the performance of target board members might not be as relevant as takeover theorists had previously surmised.

A Modified Caremark Standard to Protect Shareholders of Financial Firm from Poor Risk Management

Alec Orenstein

The recent collapse of the world financial system exposed excessive risk taking at
many of the largest financial services firms. However, when shareholders of
Citigroup sued the board of directors alleging that the board failed to adequately
monitor the firm’s risk exposure, the Delaware Chancery Court dismissed the suit
under the famous Caremark case. Caremark held that a board’s failure to monitor
will not result in liability unless there was a failure to implement a monitoring
system or a “sustained or systematic” failure to use that monitoring system. This
deferential standard is premised on an assumption that managers are risk averse
and the law should encourage risk taking. However, certain characteristics of financial
firms make such firms more prone to risk taking and more susceptible to catastrophic
losses resulting from that risk taking than other firms. In this Note, I argue
that Caremark should be reworked in cases involving managers of financial firms
in order to deter the excessive risk taking that caused such massive losses to shareholders
of these firms recently. This standard should take the form of a gross negligence
standard that allows the court to take a close look at whether management
took the necessary steps to prevent their firm from being exposed to excessive risk.

The Government as Shareholder and Political Risk: Procedural Protections in the Bailout

Matthew R. Shahabian

In the wake of the fall of Lehman Brothers and the surrounding financial instability, Congress passed the Emergency Economic Stabilization Act of 2008, giving the Treasury Department unprecedented power to intervene directly in the financial markets and the economy at large. Though the original intention of the bill was for Treasury to purchase “toxic” assets from financial institutions in order to bring immediate relief to the financial sector, the Treasury Department instead purchased equity from such institutions and became the largest shareholder of corporations like Citigroup, A.I.G., and Bank of America. As a shareholder, the government possessed great informal influence over corporate policy—influence that it did not hesitate to exercise. This influence, paired with the lack of judicial review in the bailout bill, created a new kind of political risk for investors uncertain of whether the government would use its shareholder position to advance its own political goals. This Note analyzes and evaluates this political risk created by government control and explains why neither administrative law nor corporate law constrained the government as shareholder in the financial crisis following Lehman’s failure. Given that the recently enacted Dodd-Frank Wall Street Reform and Consumer Protection Act fails to address what the government should do in the event of a future financial crisis, this Note suggests a clearer outline for the government’s role in corporate management when it acts as a shareholder and argues for judicialreview to provide procedural protections to shareholders, thereby reducing political risk.

Grading Regulators: The Impact of Global and Local Indicators on Vietnam’s Business Governance

Trang (Mae) Nguyen

International indicators are widely used as diagnostic tools for global governance. For the developing world, with scarce resources and complex social problems, indicators can help businesses, donors, and policymakers identify issues, tailor solutions, and measure impacts. This Note studies the dynamics between global and domestic indicators in Vietnam, particularly the ways they influence Vietnam’s policy processes. It finds that while global indicators have advanced the notion of competitiveness and made it a priority of the national government, sub-national indicators—here, a ranking of Vietnam’s provinces—play a significant role as a more tailored and focused tool to motivate internal competition for pro-business reforms. This Note therefore confirms the dominant viewpoint that global indicators influence a country’s development agenda, but concludes that this effect is even more pronounced in the presence of robust local indicators.

Foreign Investment Restrictions in Coastwise Shipping: A Maritime Mess

Daniel Michaeli

A federal law known as the Jones Act imposes citizen ownership and control requirements on owners and operators of ships that transport goods between U.S. ports. Scholars have consistently presumed that these requirements are enforceable. This Note demonstrates, however, that limiting foreign ownership in companies with widely dispersed shareholders has become legally and practically infeasible in modern U.S. securities markets. It sheds light for the first time on the Seg-100 program of the Depository Trust Company, which aims to resolve this problem but would ultimately, even with substantial changes, be unable to discern the citizenship of entities that are not natural persons—a vast majority of shareholders. After considering the Jones Act’s ownership and control restrictions in the context of U.S. national security and economic interests, the Note finds that both practical considerations and U.S. interests support elimination of the citizen ownership and control requirements. Recognizing that Congress may be unwilling to invite unrestricted foreign investment in coastwise shipping, it also proposes more limited reforms to foreign ownership limitations and administrative actions that could reduce, but not eliminate, unnecessary costs of the current system.

Durbin’s Defect: The Impact of Post-Recession Legislation on Low-Income Consumers

Arin H. Smith

In 2010, the economy was reeling from an economic recession that particularly affected low-income consumers. One law, known as the Durbin Amendment, sought to protect consumers by regulating the fees that financial institutions charge merchants each time a customer uses a debit card. This Note examines the amendment’s effects, arguing that it has ultimately raised the costs of banking for low-income consumers. Due to complex banking disclosures and the structure of the regulations, these increased costs have not been offset by increased transparency or lower retail prices. This Note recommends specific changes to the Durbin Amendment that will better support its stated goals. However, because these changes cannot entirely mitigate the negative effects, this Note recommends that Congress also pass legislation to improve access to banking for low-income consumers.