Corporate Governance

Jon Macey on Corporate Governance (Part 3)

By J Robert Brown Jr et al.

We are discussing Corporate Governance, Promises Kept, Promises Broken, the provocative book by Jon Macey, Deputy Dean and Sam Harris Professor of Corporate Law, Corporate Finance, and Securities Law at Yale. 

As we have noted, Macey views corporations as a nexus of contracts.  This is a theoretical framework that allows managers and shareholders to agree to the terms of their relationship.  In other words, it elevates private ordering over mandatory corporate law provisions. 

While the approach has interesting theoretical implications and arguably results in an approach to governance that favors activist shareholders (at least those who want to change the "contract" by limiting compensation or requiring reimbursement of expenses for proxy contests), the approach breaks down in practice.  In Opting Only In: Contractarians, Waiver of Liability, and the Race to the Bottom, we studied the waiver of liability provisions in the top 100 companes to see if there was any evidence of private ordering. After all, theory behind them was that, as amendments to the articles, both directors and shareholdes had to approve them. This would, therefore, result in some negotiations between the two groups.

In fact, nothing of the kind occurred. All of the publicly traded companies in the top 100 (there were a few mutual companies) had waiver of liability provisions, excepting only Pepsi. (Come companies did not have them because of statutory provisions that effectively waived liability. In those cases, none of the companies "opted out."). In other words, they were universal. Even more revealing, every one of them waived liability to the furthest extent permitted.

There are only two explanations for this data. Either waiver of liability provisions that waive liability to the maximum extent permitted are inherently efficient in all circumstances or there is no actual bargaining between the two groups and the corporate contract merely reflects the interests of management. It is, of course, the latter that makes the strongest case (as the article goes on to show).  In fact, management dominates the contracting process.  To have anything even resembling a negotiation process, existing state law would require dramatic revision, including acceding to shareholders the authority to initiate amendments to the articles of incorporation.

In fairness to Macey's view, he would likely recognize this reality.  Instead, he relies on the market for corporate control to police inefficient arrangements.  If management relentlessly enters into unfair arrangements with shareholders, it will suffer at the capital markets and eventually be taken over by someone with a more efficient approach.  We will deal with this later.  For now, it is enough to note that reliance on the market still leaves the choice in the hands of management, which is not real bargaining, and would only penalize management to the extent the "inefficiency" was great enough to justify the high costs of a hostile acquisition.  In other words, reliance on hostile takeovers does not ensure a meaningful role for shareholders in the bargaining process.

Full post as published by The Race to the Bottom on December 03, 2008 (boomark / email).