November 19, 2011
The question that won't go away: Are boards simply not up to the task?
It often strikes me as somewhat of an emperor-has-no-clothes moment when I explain to my students that, in this era of too-big-to-fail, we continue to entrust oversight of institutions that have the potential to cripple the entire global economic system to folks who are doing so on very much of a part-time basis, and with some minor distractions to boot (like running their own TBTF enterprise as CEO). I was reminded of this when I read Steven Davidoff's post, A Board Complicit in MF Global’s Bets, and Its Demise. After pointing out that the failure of oversight in this case was not due to lack of expertise or knowledge, Davidoff suggests that perhaps "boards are inherently unable to do the job we want of them: to oversee the company and counteract the influence of its chief executive." As a possible solution, Davidoff suggests that "[i]f the board members were to be penalized for their failures through forfeiture of their own compensation, perhaps directors would [be more] focused on creating a stronger risk management culture." I have my doubts that we could ever implement any such system that wouldn't be left as anything other than a shell after Delaware got done with it. Perhaps the answer lies in part in doing more of what some have suggested we do in the area of Securities Regulation--that is, stop pretending we have more oversight than we actually do and let the capital market discounting begin.
New Report on the S&P 500's Corporate Governance of Political Expenditures
Back in August, ten law professors, as the "Committee on Disclosure of Corporate Political Spending," submitted a petition to the SEC asking “that the Commission develop rules to require public companies to disclose to shareholders the use of corporate resources for political activities.”
The group includes Lucian Bebchuk, Bernard Black, John Coffee Jr., James Cox, Jeffrey Gordon, Ronald Gilson, Henry Hansmann, Robert Jackson Jr., Donald Langevoort, and Hillary Sale. The petition explains: “We differ in our views on the extent to which corporate political spending is beneficial for, or detrimental to, shareholder interests. We all share, however, the view that information about corporate spending on politics is important to shareholders—and that the Commission’s rules should require this information to be disclosed.”
I’ve been following with interest the comments to this petition. They’ve included statements from scholars like Ciara Torres-Spelliscy who has written extensively about corporate political spending, and this week the IRRC Institute has submitted a report on the S&P 500's corporate governance of political expenditures. In its submission cover letter, the IRRC Institute explains: “The report is the first to examine the governance policies of the full S&P 500; the first to report on spending of the full S&P 500; and the first to be part of a benchmarking time series, enabling trends to be examined robustly.”
Earlier this month, I posted about a recent report on the governance practices of the S&P 100, which the Center for Political Accountability and Wharton’s Zicklin Center for Business Ethics released.
I’m still digesting the new IRRC Institute report and may post more soon, but note for those interested in this area that it is well worth reading as it takes a broad and detailed approach, including information on topics such as governance about lobbying and whether companies provide public justifications for why they spend money on politics.
A few tidbits from the fascinating report:
On companies with “no spending” policies: “The overall number of companies that assert they do not spend money in politics has grown to 57, up from 40 a year ago. But a comparison of spending records and policy prohibitions shows that only 23 companies with ‘no spending’ policies actually did not give any money to political committees, parties or candidates in 2010 (though they may still lobby). Only 17 of these firms avoided all forms of political spending, including lobbying. (Another 57 companies have no policies about spending but also do not seem to spend.)”
On transparency: “Voluntary company disclosure of political spending remains limited and only 20 percent of S&P 500 companies report on how they spent shareowners’ money. Two‐thirds of the companies that appear to spend from their treasuries do not report to investors on this spending. The least transparent are Telecommunications and Financials firms; by contrast over 40 percent of Health Care companies explain where the money goes.”
On independent expenditures: “There has been a significant increase in the number of companies that discuss independent expenditures, which following Citizens United are allowed at the federal level for the first time in 100 years. Comparing companies in the index in both years (468 firms) shows that 19 more companies now say they will not fund campaign advertisements for or against candidates, generally will not do so, or are reviewing their policies—up from 58 last year. But only five companies now acknowledge in their policies that they make independent expenditures, even though careful scrutiny of voluntary spending reports adds a few firms to this tally.”
On the increasing adoption of indirect spending policies: “The proportion of companies that have adopted policies on indirect political spending through their trade associations has grown from 14 percent in 2010 to 24 percent. Half of the 100 biggest companies now disclose their policies on indirect spending through trade groups and other politically active non‐profit groups, but this commitment evaporates at smaller companies.”
On big companies spending big: “The top two revenue quintile companies were responsible for the vast majority of both federal lobbying and treasury contributions to national political committees and state political entities, with $915 million (93 percent) of the S&P 500’s total.”
On board oversight: “The 151 companies with board oversight of their spending disburse on average 30 percent more than their peers that do not have such oversight, when the latter comparison is controlled for revenue size. This may give some comfort to investors and others concerned about accountability and transparency, but not to those who think that corporate governance could be used as a lever to reduce spending.”
The report is also terrifically direct about information that is unknown, such as how much companies give indirectly through trade associations and other non-profit groups that spend in elections and on lobbying.
November 18, 2011
WarGames, DefCon 5, and Another Round on Chancellor Chandler
I have been thinking again about Chancellor Chandler's eBay v. Newmark decision, so I decided to take another look. I had been thinking about that quite a bit, because I have been having a hard time reconciling the Airgas and eBay decisions. (A quick summary of Airgas commentary is available here.) I think I figured out why. The overall feel I get from the Airgas decision is an embracing of director primacy. The feel of eBay feels more like shareholder primacy wrapped in director primacy language. Here's an example, from eBay, which I provide both to help make my point and to further illustrate the greatness of Chancellor Chandler's decisions:
n.23 For example, during negotiations, Price sent an email to eBay executives explaining that Jim and Craig understood that if they insisted eBay sign a non-compete agreement it would be “a defcon 5/deal breaker issue” for eBay. PTX-30 (email from Garret Price to eBay executives (June 24, 2004)). I include this email in the story (1) to illustrate how strongly eBay felt about maintaining the right to compete and (2) because we all appreciate a good reference now and then to the Defense Readiness Condition (“DefCon”) of the armed forces. A good DefCon reference, however, is even better when it makes use of the appropriate DefCon level. Accordingly, Price’s DefCon reference would have been more adept if he had used DefCon 1, which signals “maximum force readiness.” See Description of DefCon Defense Condition, Federation of American Scientists, http://www.fas.org/nuke/guide/usa/c3i/defcon.htm (last visited August 12, 2010); see also WARGAMES (Metro-Goldwyn-Mayer 1983) (Dr. McKittrick: “See that sign up here—up here. ‘DefCon.’ That indicates our current ‘def’ense ‘con’dition. It should read ‘DefCon 5,’ which means peace. It’s still 4 because of that little stunt you pulled. Actually, if we hadn’t caught it in time, it might have gone to DefCon 1. You know what that means, David?” David: “No. What does that mean?” Dr. McKittrick: “World War Three.”). Price, however, referenced DefCon 5, which merely signals “normal peacetime readiness.” I assume, therefore, that Price’s reference to DefCon 5 is not an accurate characterization of what eBay’s negotiation stance would have been had Jim and Craig fired a mandatory non-compete across eBay’s bow.
Chancellor Chandler seems to care quite a bit what eBay wanted here, but later in the opinion he gives very little deference to what the craigslist Board wanted. Chancellor Chandler determined that craigslist was wrong for not appropriately maximizing profits. He says:
The corporate form in which craigslist operates, however, is not an appropriate vehicle for purely philanthropic ends, at least not when there are other stockholders interested in realizing a return on their investment. Jim and Craig opted to form craigslist, Inc. as a for-profit Delaware corporation and voluntarily accepted millions of dollars from eBay as part of a transaction whereby eBay became a stockholder. Having chosen a for-profit corporate form, the craigslist directors are bound by the fiduciary duties and standards that accompany that form. Those standards include acting to promote the value of the corporation for the benefit of its stockholders.
As I have argued before, this is what eBay signed up for when they became craigslst stockholders. eBay wanted adamantly to be able to compete; craigslist wanted adamantly to keep their culture and business model. That's the contract, and both should be bound by it. Instead, though, this reads as though shareholders, at least big ones, should have the power to influence how a company conducts business. Note the allegation is not that the craiglist gives away too much money instead of issuing dividends. Instead, as I read it, it is that the company doesn't appropriately charge for its product. Is the Wal-Mart board violating their fiduciary obligations because it could charge more for potato chips? Of course not, but that's the same kind of question raised here. Recall -- craigslist is a market-leading, profitable company in its sector. Yet the Chancellor questions the board's decisionmaking here because a big shareholder squawked. (Admittedly, the were other actions of the craigslist board that merited review.)
Contrast this with the Airgas decision, as Gordon Smith et al. explain: "The Airgas case is the latest in a long line of Delaware cases in which a board of directors defied its own shareholders. Under modern corporation statutes, like Delaware’s, shareholders have few options in circumstances like these." In Airgas, a board rejected a "non-discriminatory, all cash, all-shares, fully financed offer" that shareholders wanted to accept. Chancellor Chandler said fine, under Delaware law, the board wins. In eBay, though, the board maintained their long-held business model, a shareholder complained, and Chancellor Chandler said nope, board loses.
The common sense part of this that bothers me is that, ultimately, these can be viewed a contract cases (at least, if buy Professor Bainbridge's nexus of contract theory). Airgas shareholders almost certainly thought that their agreement with the board meant that the board would try to maximize value and provide shareholders a chance to reap the return of their investment. eBay certainly knew that craiglist had no intention of shifting to a profits-first business model. And yet, in both cases, what I view as the terms of the contract aren't followed. If Delaware law trumps the shareholder-board agreement, then okay, but it seems to me that if that's the rule, either the shareholders or the board should have won both of these cases.
Nonetheless, Chancellor Chandler's opinions will be missed. I was hoping he'd follow up his WarGames citation with a reference to something like Ferris Bueller's Day Off. With Chancellor Chandler moving into the private sector, I'll bid him farewell from the court with this one: "Life moves pretty fast. If you don't stop and look around once in a while, you could miss it."
November 17, 2011
"[C]onstrained by Delaware Supreme Court precedent"?
Following up on both Elizabeth's post announcing that Chief Justice Myron T. Steele of the Delaware Supreme Court would be speaking at Stanford, and Josh's post on the Glom's Masters Forum on Chancellor William B. Chandler III's contributions to the Delaware Chancery Court, I note the following:
Over at the Glom, Afra Afsharipour discusses Chancellor Chandler's Airgas decision and notes that "like other commentators … I expected that Chancellor Chandler would uphold the pill. What I didn’t quite expect was Chancellor Chandler’s frank articulation of how decades of Delaware case law on the poison pill essentially gave him no choice but to reach the result that he did."
Meanwhile, a report from a recent panel discussion on cross-border issues in mergers and acquisitions notes that Chief Justice Steele interprets the case law differently:
Steele took issue with the view that the Chancery is constrained in its ability to remove a pill in the appropriate circumstances. He suggested that if the chancellor had found facts that were inconsistent with it being reasonable to keep the pill in place, an injunction against maintaining the pill could be issued under Delaware law. Where there is a battle of valuations, rather than the defence of a long-term strategy, a case can be made for removing the pill and letting the shareholders decide.
November 16, 2011
Musings on Chancellor Chandler at The Glom
Over at the Conglomerate, is hosting a "Masters Forum on William B. Chandler III's contributions to the Delaware Chancery Court. There are a series of posts discussing Chancellor Chandler's Disney decisions, M&A (and Airgas), his views on the practice of corporate law and more. I highly recommend taking a look.
I'd still like to hear more about his eBay v. Newmark decision, which I have posted about here and here. I, like the Masters who have written about Chancellor Chandler, think highly of his work and his decisions. That doesn't mean, though, as my views on his eBay and Airgas decisions indicate, that I necessarily agree with him in every case.
November 14, 2011
NFL Pundits Show Why We Need the Business Judgment Rule
The Atlanta Falcons lost to the New Orleans Saints in overtime in Sunday. The Falcons failed in a fourth-down attempt in their own territory, leading to a lot of second guessing on the NFL post-game shows. Here's the breakdown from Slate & Deadspin's NFL roundtable:
So arbitrary formulas aren't always the thing. But pure probabilities? Everyone's an expert today, thanks to the Falcons' decision to go for it in overtime on fourth and inches from their own 29-yard line. They were stuffed by the Saints, who slotted home a gimme field goal for a big division win. Here is a comprehensive list of every reason why Mike Smith's decision is being criticized: because it didn't happen to work.
. . . . A fourth-and-a-yard succeeds 74 percent of the time, and Michael Turner was not a yard away. . . . .
Brian Burke at Advanced NFL Stats has picked the perfect day to unveil the Fourthdownulator, a handy little application that allows you to plug in the situation and decide whether going for it makes statistical sense. Before running the fourth-down play, the Falcons' win probability stood at 47 percent (it would've risen to 57 percent if they had picked up the first down). Had they chosen to punt, that figure would've dropped to 42 percent. The difference is slight but undeniable, and becomes starker when you take into account both the Falcons' success at running the ball all day and the threat presented by the Saints' offense with decent field position.
. . . Maybe this is why coaches are so hesitant to go for it on fourth down: not because they might be unsuccessful, but because everyone's going to break down why.
Clearly, NFL pundits are paid to second-guess coaches and say what should have happened. That's their job. But notice that (in my highly unscientific and unreliable review of NFL commentators) no one seems to have thought it was the right call. [Update: Via the comment below (thanks), I know there's at least one who thinks the choice, if not the play call, was right.] If the numbers indicate it was a good call -- or even a reasonable call -- it would seem that 50% of the commentators would agree with the coach. But when we know how the decision turned out, that's highly unlikely to happen.
This is one key reason we have the business judgment rule (BJR) for corporate directors. That rule states that absent fraud, self-dealing or illegality, directors decisions cannot be judged. "Courts do not measure, weigh or quantify directors’ judgments. We do not even decide if they are reasonable in this context. Due care in the decisionmaking context is process due care only. Irrationality is the outer limit of the business judgment rule. " Brehm v Eisner, 746 A.2d 244 (Del. 2000)(emphasis added)(footnote omitted). As Smith v. Van Gorkom further explained, "The business judgment rule exists to protect and promote the full and free exercise of the managerial power granted to Delaware directors." 488 A.2d 858 (Del. 1985) Although there are times when the BJR seems to protect stupidity (and it does), the BJR or some similar rule is necessary to allow directors to take chances.
I realize that the comparison to NFL pundits and judicial review is a stretch given that both the charge and the authority of the judges is very different than that of NFL commentators. Still, I think that the inability to make rational post hoc assessments of decisions that turn out wrong is illustrative. As such, I am becoming more firmly convinced that Professor Bainbridge has it right when he says that the BJR is an abstenstion doctrine, and not a standard of review. As the good professor argues: "[C]orporate decisionmaking efficiency can be ensured only by preventing the board’s decisionmaking authority from being trumped by courts under the guise of judicial review."
The New York Times says Falcons' Coach Mike Smith's decision "backfired horribly and handed the New Orleans Saints a 26-23 overtime victory over the Falcons at the Georgia Dome." That's not what the numbers say. The numbers say he made a reasonable call, and it didn't turn out well. There was no "handing" the game to anyone. If I'm a Falcons fan (and I'm not), I'd hope my coach is making his decisions based on his own judgment and assessment of the situation, and not external noise. That's what he's been hired to do. Just like the members of a board of directors.
Small Business and Securities Law: Senate Version
I have previously written about the legislation in the House to free small businesses from some of the restrictions of federal securities law. See here and here. The Senate is now starting to play catch-up.
1. Crowdfunding. Senator Scott Brown has introduced a bill to add a crowdfunding exemption to the Securities Act. S. 1791, available here, would exempt from Securities Act registration securities sold through a crowdfunding intermediary if (1) the offering amount is less than $1 million during any 12-month period and (2) no investor invests more than $1,000. The issuer would have to file a notice with the SEC and "disclose to investors all rights of investors, including complete information about the risks, obligations, benefits, history, and costs of offering." State registration requirements would be preempted. Senator Brown’s bill would also exempt crowdfunding intermediaries from being treated as brokers if they meet certain requirements. Senator Brown's bill is similar to, but certainly not identical to, the crowdfunding bill passed by the House.
2. General Solicitation. Senator John Thune has introduced a bill to elimination the prohibition against general solicitation and general advertising from Rule 506 of Regulation D. Thune’s bill, S. 1831, is available here.
3. Exchange Act Reporting Threshold. Senators Pat Toomey,Tom Carper, Mark Warner, and Mike Johanns have introduced a bill to raise the threshold above which companies have to file Exchange Act reports. Their bill, S. 1824, is available here. Currently, reporting is required for companies that don’t trade on an exchange if the company has $10 million in assets and a class of equity securities held of record by 500 or more persons. The bill would raise the number of recordholders from 500 to 2,000 and would also exclude securities received pursuant to an employee compensation plan exempted from Securities Act registration.
Chief Justice Steele on Shareholder Empowerment vs. Board Authority
Chief Justice Myron T. Steele of the Delaware Supreme Court will be speaking at Stanford tomorrow on "Shareholder Empowerment vs. Board Authority."