Unintended Agency Problems: How International Bureaucracies are Built and Empowered

The ground underneath the entire liberal international order is rapidly shifting. Institutions as diverse as the European Union, International Monetary Fund, United Nations, and World Trade Organization are under major threat. These institutions reflect decades of political investments in a world order where institutionalized cooperation was considered an essential cornerstone for peace and prosperity. Going beyond the politics of the day, this Article argues that the seeds of today’s discontent with the international order were in fact sown back when these institutions were first created. We show how states initially design international institutions with features that later haunt them in unexpected ways. In the worst cases, states become so dissatisfied with the institutions they build that they threaten to abandon or dissolve them, shaking the foundations of the international order. Our central argument is that two cooperation problems intersect in unanticipated ways. The first problem – the horizontal conflict – involves the distribution of benefits among states. When states first create an international organization, they seek to capture a big share of the benefits and protect their interests vis-à-vis other states. They do this by demanding voting rules that allow them to block unfavorable decisions, requiring leadership positions for their own nationals, and lobbying to include their priority issues on the organization’s agenda. We argue that this initial effort to resolve distributional conflicts is short-sighted, ultimately leaving states dissatisfied with the international organizations they build. The second problem – the vertical conflict among states collectively, on the one hand, and international organization bureaucracies and tribunals, on the other – is worsened by the compromises reached to resolve the horizontal conflict. For example, when states agree that key decisions must be reached by consensus, it becomes difficult to roll back the actions of a wayward secretariat or tribunal down the line. Or, when states place their own nationals in key positions, a multi-national body with an international agenda emerges. Such an international organization can become detached from the national concerns of its creators. Moreover, when states put their key issues on the organization’s agenda, a broad mandate results. In turn, a broad mandate empowers the organization’s staff to set its own priorities, making state control difficult. Contrary to prior isolated studies on horizontal and vertical conflicts, we are the first to identify how the two conflicts intersect in important and unexpected ways. To find possible solutions, we draw on analogous intersections in corporate law literature, which have been examined more thoroughly

Collaborative Gatekeepers

In their efforts to hold financial institutions accountable after the 2007 financial crisis, U.S. regulators have repeatedly turned to anti-money-laundering laws. Initially designed to fight drug cartels and terrorists, these laws have recently yielded billion-dollar fines for all types of bank engagement in fraud and have spurred an overhaul of financial institutions’ internal compliance. This increased reliance on anti-money-laundering laws, we argue, is due to distinct features that can better help regulators gain insights into financial fraud. Most other financial laws enlist private firms as gatekeepers and hold them liable if they knowingly or negligently engage in client fraud. Yet, as long as gatekeepers maintain deniability, they can accommodate dubious client requests. Instead, anti-money-laundering laws require gatekeepers to report to regulators suspicions of misconduct, even without clear proof of fraud. Because suspicions arise early in the gatekeeper–client relationship, conflicts of interest are not likely to be as strong. Moreover, the task of identifying suspicious cases can be more readily outsourced to compliance departments, lessening dependence on front-line employees whose future might be tied to specific clients. Finally, suspicions may arise even in gatekeepers who only have partial access to clients’ transactions and, thus, cannot come to full knowledge of the fraud. Inspired by the collaborative relationship between gatekeepers and enforcement authorities in anti-money laundering, we develop a theoretical framework that explains why this approach could operate as a general template for financial regulation. We then investigate the implementation of the collaborative model in practice. Starting from anti-money-laundering laws’ history, we present new evidence from recently released archival materials to illustrate that, rather than fighting proposals for expanding their regulatory obligations, private industry embraced them. Turning to the present, we discuss how the collaborative model has reshaped banking oversight in money laundering: It has leveraged the power of big data, encouraged the creation of dedicated compliance departments, and spearheaded one of the biggest inter-agency collaborations in the United States. Finally, we discuss how the collaborative model could work in the future in two other areas of financial activity: broker-dealer regulation and equity issuance

Comment on the Definition of Eligible Organization for Purposes of Coverage of Certain Preventive Services Under the Affordable Care Act

This comment letter was submitted by U.C. Berkeley corporate law professors in response to a request for comment by the Health and Human Services Department on the definition of eligible organization under the Affordable Care Act in light of the Supreme Court\u27s decision in Burwell v. Hobby Lobby. Eligible organizations will be permitted under the Hobby Lobby decision to assert the religious principles of their shareholders to exempt themselves from the Affordable Care Act\u27s contraceptive mandate for employees. In Hobby Lobby, the Supreme Court held that the nexus of identity between several closely-held, for-profit corporations and their shareholders holding “a sincere religious belief that life begins at conception” was sufficiently close to justify granting such corporations an exemption from the Affordable Care Act\u27s contraceptive mandate pursuant to the Religious Freedom Restoration Act of 1993. More specifically, the Court ascertained that the overall interests of the corporations and their natural-person shareholders were sufficiently identical to warrant ascribing the religious commitments of the shareholders to their corporations. Notably, the Court stopped short of articulating a diagnostic test for determining when a sufficient overlap of interests exists; instead, it concluded that well-established principles in state corporate law should provide such guidance. We believe that state corporate law does in fact provide the diagnostic test the Court desires for determining when it is appropriate to disregard the distinct identity of a corporation for the identity of its shareholders. This test is rooted in the long-standing case law that constitutes the alter ego doctrine (commonly referred to as “veil piercing”). To sustain a claim of veil piercing, state corporate law uniformly requires there to be “unity of ownership and interest” between the corporation and its shareholders. If a corporation is operated as the effective alter ego of its shareholders to such an extent that its separate corporate existence ceases to exist as a practical matter, then a veil piercing claim can be established that effectively attributes the corporation’s legal rights and obligations to its shareholders, and vice versa. A veil piercing conclusion effectively holds that there is no practical difference between the corporation and the shareholders themselves. We therefore propose that for purposes of defining an “eligible organization” under Hobby Lobby, the HHS and other federal organizations should follow the corporate law doctrine of veil piercing. Indeed, to make this doctrine administratively feasible, we further suggest that shareholders of a corporation should have to certify that they and the corporation have a unity in identity and interests, and therefore the corporation should be viewed as the shareholders’ alter ego

The Global Dominance of European Competition Law Over American Antitrust Law

The world’s biggest consumer markets – the European Union and the United States – have adopted different approaches to regulating competition. This has not only put the EU and US at odds in high-profile investigations of anticompetitive conduct, but also made them race to spread their regulatory models. Using a novel dataset of competition statutes, we investigate this race to influence the world’s regulatory landscape and find that the EU’s competition laws have been more widely emulated than the US’s competition laws. We then argue that both “push” and “pull” factors explain the appeal of the EU’s competition regime: the EU actively promotes its model through preferential trade agreements and has an administrative template that is easy to emulate. As EU and US regulators offer competing regulatory models in domains as diverse as privacy, finance, and environmental protection, our study sheds light on how global regulatory races are fought and won

Corporate Law and Social Risk

Over a quarter of total assets under management are now invested in socially responsible companies. This turn to sustainability has gained solid ground over the last few years, earning the commitment of hundreds of CEOs and dominating the global business agenda. This marks an astounding repudiation of Wall Street’s get-rich-quick mentality, as well as a direct challenge to corporate law’s reigning mantra of profit maximization above all. But corporate law scholars are skeptical about the rise of sustainability. Some scoff at companies’ promises to “do the right thing” as empty rhetoric. But companies are revisiting core business practices and adjusting central governance mechanisms, such as executive compensation, to reward improvements in sustainability performance. For other theorists, directors and officers beholden to shareholder primacy can opt for sustainability only as long as it also maximizes profits. While doctrinally straightforward, this approach is highly problematic in practice. The wide range of issues nurtured under the sustainability movement—ranging from environment and climate, to diversity and other workplace concerns, to privacy and supply chain management—do not always lend themselves readily to a profit-maximizing logic and are often costly in the short term. We offer a new solution to this quandary. We argue that, through their sustainability initiatives, companies are looking primarily for safeguards against downside risks, and not simply for opportunities to increase their profits. Social risk has proven highly destructive for corporate value even when the company’s key failure is not violating laws, as the recent crises at Facebook and Uber demonstrate. Sustainability can help avoid such crises because it provides corporate boards with input from stakeholders such as employees, NGOs, local authorities, and regulatory agencies. These stakeholders are uniquely placed to register the impact of company policies on the ground and can communicate concerns early. Contrasting sustainability with compliance, the only risk monitoring mechanism sanctioned in our laws, we note distinct advantages. While compliance’s scope is tethered to legal violations, sustainability encourages intervention even when laws have not caught up. Compliance’s emphasis on detection and punishment distorts management’s incentives and incites fears of retribution in stakeholders. Rather than dwelling on the past, sustainability builds a new vision for the future hoping to inspire and gain trust. We base our account of sustainability on interviews and roundtable discussions with over three hundred participants, including leading public and private companies, large asset managers, investors and pension funds, shareholder advisory firms, and sustainability standard setters and data providers. Our conversations confirm that it was investors who pushed hard for environmental and social initiatives, putting pressure on more reserved managers and boards. We argue that investors’ support for sustainability is precisely because it helps fight risks that are otherwise hard to diversify. Asset managers, in particular, who own significant positions in every U.S. public company, are exposed to industry-wide and market-wide risk and may suffer externalities from a company’s reckless behavior. While investors have been early supporters, CEOs and executives are only recently opening up to sustainability, which continues to face some resistance in corporate boardrooms. We argue that directors’ and officers’ unwillingness to address social risk is a manifestation of agency conflicts. Averting crises is a thankless task, and boards have few incentives to undertake action without external pressure. Moreover, the intractability of many sustainability concerns, combined with management’s confidence in the company’s success, leads to systematically downplaying social risk. But by failing to establish an appropriate sustainability function, directors and managers are unnecessarily exposing their shareholders to increased risk. Boards should ensure that their company has a well-running sustainability function with proper board oversight that reaches out to stakeholders relevant to the company’s business. This governance reform, we conclude, is essential to allow sustainability to reach its full potential

The ESG Information System

The mounting focus on ESG has forced internal corporate decision-making into the spotlight. Investors are eager to support companies in innovative “green” technologies and scrutinize companies’ transition plans. Activists are targeting boards whose decisions appear too timid or insufficiently explained. Consumers and employees are incorporating companies sustainability credentials in their purchasing and employment decisions. These actors are asking companies for better information, higher quality reports, and granular data. In response, companies are producing lengthy sustainability reports, adopting ambitious purpose statements, and touting their sustainability credentials. Understandably, concerns about greenwashing and accountability abound, and policymakers are preparing for action. In this Essay, we show how the ESG information system modeled itself after the key corporate governance innovations of the last fifty years. We start with the introduction of the monitoring board in the 1970s, which paved the way for the rise of independent directors in overseeing company activity, providing a counterweight to management, and increasing responsiveness to investor concerns. We argue that ESG’s insistence on board oversight, diversity, and expertise reflects a similar intuition that board members with special expertise can have valuable contributions to decision-making.19 We then turn to the next wave of corporate governance reform, formalized in the Sarbanes-Oxley Act of 2002 (SOX), which made practices already common in the market mandatory and introduced others. With its emphasis on disclosure accuracy, SOX served as the prime archetype for the ESG information system. The global effort to standardize ESG echoes SOX’s emphasis on standardization, either through market-led initiatives like the Sustainability Accounting Standards Board (SASB) or through government-supported bodies. Similarly, SOX’s reliance on auditor certifications of internal controls a measure heavily criticized by many as overly costly is reproduced through market demands and regulatory mandates for assurance. Finally, the buildup of sustainability departments emulates SOX’s efforts to boost the independence of internal controls. Finally, by examining ESG disclosure in practice, we show that it offers managers and directors vital information about the social impact of their decisions. This perspective sheds light on the ESG disclosure debate, highlighting it as a logical evolution of (rather than a threat to) traditional corporate governance systems that enhance information flow to managers and the board