Never Trust a Corporation

I would like to start by noting multitudinous objections to assertions made in Larry Mitchell\u27s Corporate Irresponsibility: America\u27s Newest Export. But I waive these points for purposes of this Symposium. I would prefer to take the occasion to celebrate the book. So I will make two points on the subject of corporate social responsibility on which the book and I stand in complete accord

Venture Capital on the Downside: Preferred Stock and Corporate Control

This Article takes the occasion of the simultaneous collapse of the high technology stock market and the failure of the dot-coin startups, along with the subsequent retrenchment of the venture capital business, to examine the law and economics of downside arrangements in venture capital contracts. The subject matter implicates core concerns of legal and economic theory of the firm. Debates about the separation of ownership and control, relational investing, takeover policy, the law and economics of debt capitalization, and bankruptcy reform, all grapple with the downside problem of controlling and terminating unsuccessful managers for the benefit of outside debt and equity investors (and the related upside problem of incentivizing effective but fallible managers). The factors motivating these debates also bear on venture capital contracting. But venture capital presents a special puzzle for solution. Convertible preferred stock is the dominant financial contract in the venture capital market, at least in the United States. This contrasts with other contexts in corporate finance, where preferred stock is thought to be a financing vehicle long in decline. The only mature firms that finance with preferred, which once was ubiquitous in American capital structures, tend to be firms in regulated industries having little choice in the matter. Tax rules favoring debt finance provide the primary explanation for preferred\u27s decline. But many corporate law observers would suggest dysfunctional downside contracting as a concomitant cause. Simply, preferred performs badly on the downside, where senior security contracts supposedly are at their most effective. Preferred stockholders routinely have been victimized in distress situations by opportunistic issuers who strip them of their contract rights, transferring value to the junior equity holders who control the firm\u27s management. The cumulation of bad experiences adds impetus to a wider trend in favor of debt as the mode of senior participation

Shareholder Value and Auditor Independence

This Article questions the practice of framing problems concerning auditors\u27 professional responsibility inside a principal-agent paradigm. If professional independence is to be achieved, auditors cannot be enmeshed in agency relationships with the shareholders of their audit clients. As agents, the auditors by definition become subject to the principal\u27s control and cannot act independently. For the same reason, auditors\u27 duties should be neither articulated in the framework of corporate law fiduciary duty, nor conceived relationally at all. These assertions follow from an inquiry into the operative notion of the shareholder-beneficiary. The Article unpacks the notion of the shareholder and tells a particularized story about the shareholder interest. The exercise complicates the agency description, highlighting multiple and unstable shareholder demands that displace the unitary model of the shareholder usually brought to bear. This fragmented and volatile model of the shareholder provides neither a basis for articulating a coherent set of instructions respecting aggressive accounting nor for imposing conservative accounting. The Article concludes that legal positivism provides a more appropriate conceptual framework. Auditor duties should be conceived in formal rather than relational terms, with fidelity going to the rules and the system that auditors apply rather than to a client interest

Pari Passu and A Distressed Sovereign\u27s Rational Choices

Part I describes the disruptive role the pari passu clause plays in sovereign debt compositions, stating the case favoring the narrow reading. Part II reconsiders the economic incentives in play at the time lenders close loans to sovereigns, stating a case for the broad reading. Part III works the competing readings through the legal framework of bond contract interpretation. The exercise shows that the matter comes down to a choice between an ex ante reading, conducted as of the time the contract is executed and delivered, and an ex post reading, conducted as of the later time of distress. The Article concludes that the ex post reading legitimately may be attached to the clause, not because it is correct at all times and in all contexts, but because this is in fact a time of distress

Gaming Delaware

Back in 2000, at the World Trade Center in Portland, Oregon, Time Belden and other Enron electricity traders carefully studied the regulations governing California\u27s new electricity market. Belden thought that the complex rules were prone to gaming. And game them he did. Under one strategy, Enron filed imaginary transmission schedules, creating nonexistent congestion, so as to draw on the rules\u27 provision of payment to alleviate congestion. They called it Death Star. Then there was Ricochet, or megawatt laundering, under which Enron circumvented price caps by exporting power out of California, only to bring the power back later, when the State, desperate for supply, had to pay a premium price. Eventually, with an energy-starved California up in arms and the Federal Energy Regulatory Commission investigating energy sales to the State, Enron\u27s lawyers paid the traders a visit. The traders walked the lawyers through the transactions, demonstrating legality under what must have been highly technical applications of the rules. The lawyers, expecting litigation, said, Alright, but is it too late to change the names? Can\u27t you just call the strategies Puppy Dog and Mama\u27s Cooking ? Enron\u27s North American trading desk made a profit of $2.2 billion in 2000, much of it due to activities in Western region electricity and natural gas. The crisis in California implied political scrutiny of Enron\u27s results, and the firm did not want the public to see the extent of its profits. So, still gaming the system, it booked$1 billion of pot as a reserve against potential liability, without actually showing the reserve in its published financials. In a legal regime of form without substance, an opportunistic actor can exploit the system in much the same way as Enron\u27s traders and accountants. In such a world, all law is rules-based and literally interpreted, and there are no backstop interpretive controls in the form of principles (to use the accountants\u27 term) or standards (to use the lawyers\u27 term)

Welfare, Dialectic, and Mediation in Corporate Law

Bill Klein extends an idealistic and progressive invitation with the Criteria for Good Laws of Business Association (the Criteria). The structure of our debates, he says, prevents us from joining the issue. The discourse will move forward if we can isolate core components on which we agree and disagree. The invitation, thus directed, is well-constructed. To facilitate engagement, each criterion is set out as pari passu with each other. And there is a good reason for the inclusion of each listed criterion. Each has an established place in public and private law jurisprudence. Each has influenced results, coming forth as salient in one or another area of law, in one or another regulation or case. We can, then, agree in the abstract to take each criterion seriously. Klein bids us then to cull, modify, and restate, so as to identify more clearly the goals we hold out for corporate law. The remainder of this essay takes up that invitation, taking our debates to the Criteria, taking the Criteria to our debates, and taking both to the law itself. It suggests that the criteria on which we can agree lie at a higher level of generality than the Criteria: corporate law makes us all welfare consequentialists who agree that good corporate law is about encouraging productivity. We differ over the means to that end in debates that have over time evolved away from the ideological and toward the functional. Absent an ex ante set of empirically verifiable formulas for productive business organization, we are left to our debates

Corporate Finance in the Law School Curriculum

Review of: Corporate Finance: Cases and Materials. By Robert W. Hamilton: West Publishing Co., St. Paul, Minnesota, 1984

Sovereign Debt Reform and the Best Interest of Creditors

In April 2002 the International Monetary Fund introduced a sovereign bankruptcy proposal only to be rebuffed by the United States Treasury. Where the IMF wanted a mandatory bankruptcy regime, the Treasury wanted to solve distress problems with contractual devices. Sovereign bondholders and sovereign issuers themselves flatly rejected both proposals, even though they were nominally the beneficiaries of both proponents. This Article addresses and explains this bondholder reaction. In so doing, it takes a highly skeptical view of the IMF\u27s proposal even as it shows that the incentive structure surrounding sovereign lending renders untenable the Treasury\u27s contractarian proposal. The Article\u27s analysis follows from a review and restatement of the economic learning on sovereign debt relationships. The IMF and the Treasury share the objective facilitating restructuring by substituting a regime of collective action for the prevailing practice of requiring unanimous bondholder consent to significant amendments of bond contracts. In so doing they follow a conventional wisdom respecting bond contracts under which standard unanimity provisions are inefficient and irrational. The Article shows that this dismissal of the unanimity requirement comes too quickly. Under our analysis of the problem the debtor distress, bondholders rationally may prefer to make compositions harder to conclude. There is no first best equilibrium bond contract; instead bondholders select from a menu of second best forms, making trade offs between unanimous action and collective action provisions in an imperfect world. One factor leading lenders to favor unanimous action is the need to self protect. In a world without a good faith backstop, creditors motivated by side deals can take advantage of majority rule to impose suboptimal compositions. Holding out is the only weapon available to the minority creditor. The Article argues that, given such side deals, a stable majoritarian regime cannot be achieved as a matter of free contract. Mandate will be necessary. It follows that the Treasury\u27s contractarian approach is implausible absent a backstop regime of intercreditor good faith duties. The Article draws on the history of corporate reorganization prior to the enactment of the section 77B of the Bankruptcy Act of 1934 to show that courts have grappled with these questions before, intervening aggressively on equitable principles