October 13, 2006
The Ultimate Blog Post: Backdating, Instrumentalism, the Good, Executive Compensation, the Right, Paris Hilton, and Delaware Law
Posted by Jeff Lipshaw
The front page of Thursday's Wall Street Journal features two stories as to which the horse is probably not only beaten (apologies to Ani Satz for this insensitve figure of speech) but has been sent to the knackers (why am I thinking of poor old Boxer? "I will work harder" and "Napoleon is always right"): a redux of the general discussion of executive pay and the more specific discussion of backdating.
The debates continues to interest me, not so much for the specific criticisms and defenses of either, but for the gap between town and gown (with lawyers generally falling into a variant of gown). While much in "town" values leave nothing to write home about (otherwise why would there be a Paris Hilton?), there's an underlying good sense out there somewhere. Indeed, I wondered, looking at Brian Tamanaha's posts on his new book, whether his perception of "the spread of an instrumental view of law within the legal culture, concomitant with a loss of faith in the social good" is a thesis of intellectual history or social history. I'd argue that Warren Buffett's use of the front page test to judge practices like backdating points to some shared notion of social right, if not social good. The distinction here is between (a) the idea there is communal agreement on what makes all better off, and (b) the idea there is communal agreement on what is right, regardless of consequence.
More on this below the fold.
Let's look at the two juxtaposed articles on the front page of the October 12 Wall Street Journal. The first was a story about how the effort to cause the market to limit executive pay through proxy disclosures backfired. Instead of shaming executives into reduced pay packages, "[a]s it turns out, disclosure can push pay higher by revealing to CEOs what their peers receive. Limiting one type of compensation often encourages new types of pay, such as stock options, which were pushed as a solution only to become tainted by scandal." Even more interesting were comments from Charles Munger, the vice-chairman of Berkshire Hathaway, and long-time associate of Warren Buffett. (Full disclosure: I don't know Mr. Munger, but he and his wife Nancy have donated $45 million to my alma mater, the Stanford Law School, for new law student housing.) Mr. Munger described executive compensation as "wretched excess" and says "he hears complaints from 'Republicans who grumble on the country-club porch' about the resulting political turmoil over the pay question."
The second was a report on more CEOs taking a fall over backdated options: most recently, the CEOs of CNET Networks and McAfee, Inc. have stepped down after option backdating has been discovered. More relevant to our little piece of the world here, GCs are taking the fall as well.
What does this have to do with "town versus gown" and instrumentalism?
It seems to me there is, out in the world beyond the academy, some shared notions of the social right that are more than mere instrumentalism, even though those shared notions may be buried in the otherwise unsightly moshpit of popular culture.
On one hand, the rich people on Main Street don't worry about the paradox or contradictions of a country club sensibility about taking care not to be too showy with one's wealth (either because it's just not right, because of some recognition that luck plays a role in the accumulation of wealth, hence noblesse oblige, or fear of unleashing just the kind of populist backlash we see now). It's okay to be rich, but not too rich. Or, it's okay to be rich, but not tastelessly rich. The not-so-rich people on Main Street don't care about the contradictions. I've said before that I think what passes for moral outrage on this is really a political argument about wealth distribution, and good old American populism. In either case, nobody is seriously suggesting hugely radical solutions (we never get too close to killing the golden egg laying goose) - it's a debate about how much is too much.
A less reflective Main Street may be more willing than academia to accept good old fashioned horse sense (whether populist or country-club), because no expression of the social right ever really stands up to the kind of intense epistemology inquiry we find in the academy. The same basic arguments have been circling around since Plato and Aristotle, and at some point we find ourselves back in the consequentialist/empiricist versus deontological/rationalist dew loop. A few of us in the legal academy muddle around, furtively and surreptitiously, in metaphysics, but the rest of us conclude that scientism/pragmatism/instrumentalism is the only productive use of our time and intellects.
As I have already blogged over at PrawfsBlawg on the compensation and backdating issues, I'm fairly well persuaded by Larry Ribstein and others (see Truth on the Market) of the scientific view that there's no economic harm in backdating the options, but I'm also not willing to discount the moral sense out there on Main Street that something is wrong, particularly when the sense is coming from all quarters. If markets are efficient, if lying on the option about the date of its issuance is "no harm, no foul," if everything comes out in the disclosure wash, why is it still a story?
I'm continuing to work on a thesis sparked by blog discussion about business environments and the right to lie, albeit in the context of acquisition agreements, disclaimers, and damage limitations. (The Tulane faculty will hear it on October 25, and the Texas Wesleyan faculty on October 30.) It's fascinating to see how the various schools of thought deal with the lie. Judge Posner has a quick and dismissive conclusion that a lie is somehow different from mere non-disclosure. "The liar makes a positive investment in manufacturing and disseminating misinformation. This investment is completely wasted from a social standpoint, so naturally we do not reward him for his lie." (Posner, Economic Analysis of Law, 6th ed., p. 111). I'm not so sure that's the case. Investment in white lies may not be wasteful at all. Or consider Vice-Chancellor Strine's struggle with the deliberate contractual misrepresentation in the Abry case (the subject of the above thesis) under Delaware law:
I use the plain word "lie" intentionally because there is a moral difference between a lie and an unintentional mis-representation of fact. This moral difference also explains many of the cases in the fraus omnia corrumpit strain, which arose when the concept of fraud was more typically construed as involving lying, and thus it is understandable that courts would find it distasteful to enforce contracts excusing liars for responsibility for the harm their lies caused.
Something more than mere instrumentalism is at work here. I will suggest that, as much as Vice Chancellor Strine would like to be able to justify this moral conclusion in science (he cites the Posner quote above as the only authority for the inefficiency of lying), there is a notion of social right - a product of town rather than gown - that nevertheless creeps back into the law.
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Very interesting post. I'd like to ask the many defenders of backdating options: all right, maybe it's legal, but is it morally justifiable? Was the United Health Board right to throw out its CEO (McGuire) today? Or was that decision simply an epiphenomenon of misguided press outrage?
Posted by: Frank Pasquale | Oct 16, 2006 9:22:42 AM