Heterogeneous-Expectations Model of the Value of Bonds Bearing Call Options

This paper develops a dynamic programming model of the optimal refunding strategy and the corresponding value of a callable bond. The model differs from previous work on this subject primarily in that it explicitly admits the possibility of differences between the issuer's expectations of future interest rates and an investor's corresponding expectations. This generalization facilitates the application of the model to determine what a specific bond (issued, for example, by a particular corporation) is worth to any given investor. Additional analytical features of the model, which differ from corresponding aspects of some previous models, include the use of a stochastic discounting rate and the use of continuous distributions to characterize the relevant interest rate expectations. For the bond issuer, his own expectations (together with the bond's coupon and call features) suffice to indicate the critical refunding yield as well as the expected value of the bond in each time period until the bond matures. For an investor, however, the analytical solution of the model and the illustrative numerical examples presented in the paper show that the issuer's expectations and the investor's own both matter if the two differ.

One Share, One Vote and the False Promise of Shareholder Homogeneity

Shareholder democracy has blossomed. The once moribund shareholder franchise is now critical in takeover contests, merger decisions, and board oversight. However, the mechanisms of this vote remain largely undertheorized. In this Article, we use voting rights and social choice theory to develop a new approach to the corporate franchise. Political democracies typically tie the right to vote to the level of a person\u27s interest in the outcome of the election. Corporate democracies, on the other hand, tend to define the requisite institutional interest quite narrowly, and thus restrict the right to vote to shareholders alone. This restriction has found its justification in the assumption that shareholders have a homogeneous interest in corporate wealth maximization. Such homogeneity, it is argued, maximizes efficient preference satisfaction. This assumption of shareholder homogeneity is false. It is becoming increasing clear, for example, that shareholders have many different types of interests in a corporation. In addition, stakeholders such as employees, consumers, and creditors also have interests in corporate governance that are not currently captured through existing contractual regimes. Moreover, many of the conclusions drawn from the assumption of shareholder homogeneity are either based on dated understandings of Arrow\u27s Theorem or, in some cases, are flat out inconsistent with the standard economic theory that they purport to embody. As a result, corporate voting schemes are sterile reflections of their more robust political counterparts. The Article argues that corporate law scholars should acknowledge the weaknesses of shareholder voting theory and should examine new ways of translating the preferences of corporate participants into a governance structur

The Uncorporation and the Unraveling of \u27Nexus of Contracts\u27 Theory

This is a review of The Rise of the Uncorporation, by Larry E. Ribstein (Oxford University Press 2010). The Rise of the Uncorporation gives a compelling account of the increasing reliance on business forms other than the corporation. These new organizational forms - such as limited liability companies, limited liability partnerships, partnerships, and the like - give businesses greater freedom to structure themselves in ways that best facilitate their particular needs. And this, according to Ribstein, is an unqualified good, for it allows firms to operate more efficiently than if they were forced to assume an intensely regulated form. Like most stories, though, this one has a heavy, and here it is the corporation. The corporate form, which dominated the landscape for much of the twentieth century, is contrasted with the uncorporation and presented as the product of forced, not free, choice. This is, perhaps, the most surprising (and welcome) aspect of the book, for the corporation has long been theorized as a product of contractual freedom and championed for its resulting efficiency. Now that we (with Ribstein’s help) have dispensed with the myth that the corporation is merely a nexus of contracts, we can focus our attention on the significant role that government plays in all forms of organizational form, corporate and otherwise

The Bizarre Law & Economics of \u27Business Roundtable v. SEC\u27

Corporations are legal entities designed to foster certain kinds of collective economic activity. The decisionmaking power within a corporation ultimately rests with a board of directors elected by shareholders. Shareholders, however, do not use anything like a conventional ballot in these elections; instead, they fill out a “proxy ballot,” delivered to them by the incumbent board. This proxy ballot lists only the incumbent board’s chosen nominees, very often the board members themselves. If a shareholder wants to run for director or propose another nominee for the board, she needs to provide all other shareholders with a separate proxy ballot — an expensive and complicated proposition. For over seventy years, the Securities & Exchange Commission has considered various means of wresting exclusive control of the proxy ballot from corporate boards. In 2010, pursuant to direct Congressional authorization, the agency finally succeeded, enacting Rule 14a-11. The rule should have given shareholders access to a corporation\u27s proxy ballot for director nominations, thereby reducing the costs for shareholders and diminishing the longstanding barriers to a more robust corporate democracy. But within a year of the rule’s enactment, and to the surprise of almost every observer, the D.C. Circuit struck down the rule in Business Roundtable v. SEC as an arbitrary and capricious exercise of agency power. The court’s ruling relies upon perceived failings in the Commission’s economic analysis. But it is the court\u27s economic analysis that is open to scrutiny and criticism. Over the past few decades, corporate law and economics scholarship has become adept at containing and eliding certain contradictions of its basic principles. The reasoning in Business Roundtable represents a facile reflection of these principles — a reflection that thereby magnifies the underlying flaws. As a result, the D.C. Circuit’s decision to strike down Rule 14a-11 rests on a false version of shareholder democracy, one that undermines the very market principles that it purports to advance. It ignores the benefits of true shareholder democracy and focuses instead on costs that are routine for any functioning electoral system. By drawing distorted conclusions from certain tropes of corporate law and economics scholarship, the court essentially codified a strange new set of requirements for administrative agencies like the Commission. We fear that, unless it is corrected over time, this bad law and economics will cow regulatory agencies, particularly the SEC, into adhering to a crabbed and inchoate vision of corporate governance. And we hope that substantive criticism of the opinion, such as that represented in this article, will demonstrate that the court’s errors need not be replicated by others

The Uncorporation and the Unraveling of \u27Nexus of Contracts\u27 Theory

This is a review of The Rise of the Uncorporation, by Larry E. Ribstein (Oxford University Press 2010). The Rise of the Uncorporation gives a compelling account of the increasing reliance on business forms other than the corporation. These new organizational forms - such as limited liability companies, limited liability partnerships, partnerships, and the like - give businesses greater freedom to structure themselves in ways that best facilitate their particular needs. And this, according to Ribstein, is an unqualified good, for it allows firms to operate more efficiently than if they were forced to assume an intensely regulated form. Like most stories, though, this one has a heavy, and here it is the corporation. The corporate form, which dominated the landscape for much of the twentieth century, is contrasted with the uncorporation and presented as the product of forced, not free, choice. This is, perhaps, the most surprising (and welcome) aspect of the book, for the corporation has long been theorized as a product of contractual freedom and championed for its resulting efficiency. Now that we (with Ribstein’s help) have dispensed with the myth that the corporation is merely a nexus of contracts, we can focus our attention on the significant role that government plays in all forms of organizational form, corporate and otherwise

Shareholder Democracy and the Curious Turn Toward Board Primacy

Corporate law is consumed with a debate over shareholder democracy. The conventional wisdom counsels that shareholders should have more voice in corporate governance, in order to reduce agency costs and provide democratic legitimacy. A second set of theorists, described as “board primacists,” advocates against greater shareholder democracy and in favor of increased board discretion. These theorists argue that shareholders need to delegate their authority in order to provide the board with the proper authority to manage the enterprise and avoid short-term decision making. In the last few years, the classical economic underpinnings of corporate law have been destabilized by a growing recognition that shareholders are not a homogeneous group of wealth maximizers. This recognition has, among other things, undercut the arguments made in support of the typical corporate structure where shareholders alone possess the right to vote in corporate elections. Board primacy seems well-positioned to retheorize corporate law to adapt to this new reality. In their analyses of the issue, however, board primacy theorists have conflated two very different aspects of group decision processes: the responsiveness of the governance system and the composition of the electorate. This confusion ends up putting many board primacy theorists in the curious position of moving away from the public choice emphasis on preference aggregation toward a more civic republican model of less responsive, more deliberative decision making. By restricting the franchise, board primacists have detached their governance structures from the underlying desires of their constituents without substituting anything in their place. We argue, however, that the breakdown of this particular distinction between shareholders and other constituents could mean that we should investigate treating other constituents more like shareholders, rather than the other way around

Reconstructing the Corporation: A Mutual-Control Model of Corporate Governance

The consensus around shareholder primacy is crumbling. Investors, long assumed to be uncomplicated profit-maximizers, are looking for ways to express a wider range of values in allocating their funds. Workers are agitating for greater voice at their workplaces. And prominent legislators have recently proposed corporate law reforms that would put a sizable number of employee representatives on the boards of directors of large public companies. These rumblings of public discontent are echoed in recent corporate law scholarship, which has cataloged the costs of shareholder control, touted the advantages of nonvoting stock, and questioned whether activist holders of various stripes are acting in the company’s best interests. Academics who support stronger shareholder rights are accused of pandering to special interest groups or naively seeking a panacea in a plebiscite. As critical theorists have documented over time, the foundations of the shareholder primacy model have always been compromised. In particular, the arguments for a core feature of the modern corporation — the exclusive shareholder franchise — have been revealed as the product of flawed assumptions, misapplied social choice theory, and a failure to hold true to the fundamental precepts of standard economics. It is time to look at such governance features anew, and reorient the literature around the basic purpose of corporations: to provide a legal mechanism for business firms to engage in the process of joint production. In this article, we demonstrate how the prerogatives of corporate governance have been improperly limited to shareholders. We then present a new mutual-control model of corporate governance, one that builds on the longstanding theory of the firm as well as a novel theory of democratic participation. These twin arguments, economic and political, both counsel in favor of extending the corporate franchise to employees as well as shareholders, and, importantly, provide a way to distinguish these two constituencies from other corporate stakeholders when it comes to governance rights. We conclude by assessing the current status of a shared governance system in Germany and advocating for further theoretical and empirical inquiry into organizational governance structures that provide for joint shareholder and employee participation

The False Promise of One Share, One Vote

Shareholder democracy has blossomed. The once moribund shareholder franchise is now critical in takeover contests, merger decisions, and board oversight. However, the mechanisms of this vote remain largely under theorized. In this Article, we use voting rights and social choice theory to develop a new approach to the corporate franchise. Political democracies typically tie the right to vote to the level of a person\u27s interest in the outcome of the election. Corporate democracies, on the other hand, tend to define the requisite institutional interest quite narrowly, and thus restrict the right to vote to shareholders alone. This restriction has found its justification in the assumption that shareholders have a homogeneous interest in corporate wealth maximization. Such homogeneity, it is argued, maximizes efficient preference satisfaction. This assumption of shareholder homogeneity is false. It is becoming increasing clear, for example, that shareholders have many different types of interests in a corporation. In addition, stakeholders such as employees, consumers, and creditors also have interests in corporate governance that are not currently captured through existing contractual regimes. Moreover, many of the conclusions drawn from the assumption of shareholder homogeneity are either based on dated understandings of Arrow\u27s Theorem or, in some cases, are flat out inconsistent with the standard economic theory that they purport to embody. As a result, corporate voting schemes are sterile reflections of their more robust political counterparts. The Article argues that corporate law scholars should acknowledge the weaknesses of shareholder voting theory and should examine new ways of translating the preferences of corporate participants into a governance structure

The Bizarre Law & Economics of \u27Business Roundtable v. SEC\u27

Corporations are legal entities designed to foster certain kinds of collective economic activity. The decisionmaking power within a corporation ultimately rests with a board of directors elected by shareholders. Shareholders, however, do not use anything like a conventional ballot in these elections; instead, they fill out a “proxy ballot,” delivered to them by the incumbent board. This proxy ballot lists only the incumbent board’s chosen nominees, very often the board members themselves. If a shareholder wants to run for director or propose another nominee for the board, she needs to provide all other shareholders with a separate proxy ballot — an expensive and complicated proposition. For over seventy years, the Securities & Exchange Commission has considered various means of wresting exclusive control of the proxy ballot from corporate boards. In 2010, pursuant to direct Congressional authorization, the agency finally succeeded, enacting Rule 14a-11. The rule should have given shareholders access to a corporation\u27s proxy ballot for director nominations, thereby reducing the costs for shareholders and diminishing the longstanding barriers to a more robust corporate democracy. But within a year of the rule’s enactment, and to the surprise of almost every observer, the D.C. Circuit struck down the rule in Business Roundtable v. SEC as an arbitrary and capricious exercise of agency power. The court’s ruling relies upon perceived failings in the Commission’s economic analysis. But it is the court\u27s economic analysis that is open to scrutiny and criticism. Over the past few decades, corporate law and economics scholarship has become adept at containing and eliding certain contradictions of its basic principles. The reasoning in Business Roundtable represents a facile reflection of these principles — a reflection that thereby magnifies the underlying flaws. As a result, the D.C. Circuit’s decision to strike down Rule 14a-11 rests on a false version of shareholder democracy, one that undermines the very market principles that it purports to advance. It ignores the benefits of true shareholder democracy and focuses instead on costs that are routine for any functioning electoral system. By drawing distorted conclusions from certain tropes of corporate law and economics scholarship, the court essentially codified a strange new set of requirements for administrative agencies like the Commission. We fear that, unless it is corrected over time, this bad law and economics will cow regulatory agencies, particularly the SEC, into adhering to a crabbed and inchoate vision of corporate governance. And we hope that substantive criticism of the opinion, such as that represented in this article, will demonstrate that the court’s errors need not be replicated by others

The Uncorporation and the Unraveling of \u27Nexus of Contracts\u27 Theory

A corporation is not a contract. It is a state-created entity. It has legal personhood with the right to form contracts, suffer liability for torts, and (as the Supreme Court recently decided) make campaign contributions. However, many corporate law scholars have remained wedded to the conception-metaphor, model, paradigm, what have you-of the corporation as a contract or nexus of contracts. The nexus of contracts theory is meant to point up the voluntary, market-oriented nature of the firm and to dismiss the notion that the corporation owes anything to the state. It is also used as a justification for preserving the corporate law status quo. Since the corporation is contractual in nature, the argument goes, corporate structure reflects what the participants have freely chosen. The basic corporate structure-shareholders vote for the board of directors, who then appoint the officers-is seen not as the decision of state legislatures, but as the free choice of investors, directors, boards, and indeed all of those who are involved with the corporation. To question this structure is to dispute the market choices of those who are, presumably, in the best position to make these decisions. In The Rise of the Uncorporation, Larry Ribstein paints an alternative picture. It is a picture not of organizational perfection but of political intermeddling. Rather than claiming that the corporation is the efficient result of market forces, Ribstein depicts it as a large, insensate beast, blundering about the business landscape and leaving destruction in its wake. For most of the twentieth century, the corporate form was the only option for firms looking for limited liability, and as a result it was used far more frequently than it should have been. It was not until the birth of the limited liability company ( LLC ) that a new era-that of the uncorporation -came into being. Now that businesses are truly free to choose amongst business organizational firms, Ribstein argues, the uncorporation will continue to gain popularity, and the corporation\u27s presence will shrink down to a more appropriate size