The Separation of Voting and Control: The Role of Contract in Corporate Governance

The default rules of corporate law make shareholders’ control rights a function of their voting power. Whether a director is elected or a merger is approved depends on how shareholders vote. Yet, in private corporations shareholders routinely alter their rights by contract. This phenomenon of shareholder agreements—contracts among the owners of a firm— has received far less attention than it deserves, mainly because detailed data about the actual contents of shareholder agreements has been lacking. Private companies disclose little, and shareholder agreements are thought to play a trivial or nonexistent role in public companies. I show that this is false—fifteen percent of corporations that went public in recent years did so subject to a shareholder agreement. With this dataset in hand, I show the dramatic extent to which these shareholders redefine their control rights by contract. Shareholders restrict the sale of shares and waive aspects of the duty of loyalty. Above all, however, shareholders use their agreements to bargain with each other over votes for directors, and to bargain with the corporation itself for other control rights, such as vetoes over major corporate actions. In essence, while statutory corporate law makes control rights a function of voting power, shareholder agreements make control rights a function of contract instead, separating voting and control. Studying this phenomenon raises new questions of doctrine, theory, and empirics that go to foundational issues in corporate law. Is it desirable to let shareholders redesign corporate control rights wholesale by contract? What law should govern their contracts when they do so? I provide a novel account of shareholder agreements’ use in public firms, before offering preliminary views on their welfare effects, implications for corporate theory, and on their governing law, which remains strikingly underdeveloped

Assessing Transnational Private Regulation of the OTC Derivatives Market: ISDA, the BBA, and the Future of Financial Reform

For the last twenty years, the dominant narrative of the over-the-counter derivatives market has been one of absent regulation, deregulation, and regulatory conflict, predictably resulting in disaster. This Article challenges this narrative, arguing that the global derivatives market has been subject to pervasive and harmonized regulation by what should be recognized as transnational private regulators. Recognizing the reality of widespread transnational private regulation of derivatives has significant implications, which this Article explores. Appreciating the actual regulatory status quo is essential if policymakers are to correctly diagnose problems, avoid past regulatory errors, and plan effective remedies. There are also advantages to relying on private transnational regulation, as increased governmental effort to regulate the OTC derivatives space may undermine and fracture existing regulation. To be sure, private transnational regulation carries risks that have sometimes materialized, such as the manipulation of LIBOR. Thus, this Article also evaluates best practices in regulating through transnational private governance

Is Corporate Law Nonpartisan?

Only rarely does the United States Supreme Court hear a case with fundamental implications for corporate law. In Carney v. Adams, however, the Supreme Court had the opportunity to address whether the State of Delaware’s requirement of partisan balance for its judiciary violates the First Amendment. Although the Court disposed of the case on other grounds, Justice Sotomayor acknowledged that the issue “will likely be raised again.” The stakes are high because most large businesses are incorporated in Delaware and thus are governed by its corporate law. Former Governors and Chief Justices of Delaware lined up to defend the state’s “nonpartisan” approach to its judiciary. The case raises the question of why nonpartisanship is taken to be an advantage for Delaware and whether the processes by which corporate law is made are generally politically partisan or not. Despite these developments, however, the place of political partisanship in corporate law has been largely overlooked. This Article offers a framework for analyzing the role of political partisanship in corporate law. It begins by showing that there is suggestive evidence of a relationship between political partisanship and the substance of corporate law at the state level. When corporate law materially differs across states, those differences are often predicted by which party controls the state’s government. Political party entrepreneurs also agitate for corporate law reforms at the state level. Yet, Delaware adopts a conspicuously nonpartisan approach to corporate law. As is widely observed, how Delaware makes corporate law, from its constitution, to its legislature, to its judiciary, is unusual. It is designed to insulate that law from political partisanship. More surprisingly, this began when Delaware first became a leading home to incorporations a century ago. In fact, the same thing was true of New Jersey during its brief period of prominence before Delaware. Why? We suggest that the answer relates to corporate law’s central debate regarding the “market for corporate law.” In the United States, the internal affairs doctrine allows corporations to choose the state whose corporate law governs them by incorporating in the jurisdiction of their choice. This doctrine produces a form of regulatory competition that is structurally biased to produce a winner that favors “demand-side” interests, i.e., the interests of corporate decision-makers themselves. Understanding this dynamic has been one of corporate law’s foundational concerns. We complement that literature by arguing that nonpartisanship provides a competitive advantage in Delaware’s quest to appeal to these interests. Delaware’s approach enables it to afford great weight to the interests of nationally diverse and heterogeneous shareholders and makes it less likely that the state will sacrifice shareholders’ interests to please local constituents. The internal affairs doctrine thus indirectly works to favor incorporations to a state with a nonpartisan approach. Our framework also offers new insights into the debate on the federalization of corporate law and the Supreme Court litigation. Specifically, we argue that within First Amendment jurisprudence, the Supreme Court can and should carefully consider its ruling’s effects on Delaware nonpartisanship

What is the Law’s Role in a Recession?

The last two years have seen astonishing changes to how fiscal and monetary authorities in the developed world manage the economy. In the face of the largest global economic contraction since World War II, governments embarked on massive campaigns of economic stimulus, far outpacing the response to the Global Financial Crisis. Central banks similarly engaged in financial intervention on a scale not seen in eighty years. Over roughly a year, the Federal Reserve alone doubled its asset holdings from around $4 trillion to$8 trillion, making for arguably the most aggressive expansion of the United States’ money supply since the Federal Reserve’s founding in 1913. The three largest central banks in the developed world - the Bank of Japan, the European Central Bank, and the Fed now hold almost $25 trillion in assets - more than the total assets of the United States’ commercial banking sector. In this Review Essay, we explore the idea of “expansionary legal policy” - the use of courts, administration, and regulation to stimulate overall demand for goods and services during recessions. The dramatic financial market events of 2020 and innovations in the practice of fiscal and monetary policy provide a fertile ground for exploring this idea in the context of the regulation of commercial banking. In particular, we argue that perhaps the single legal institution with the greatest ability to use discretion to stimulative effect are banking regulators. The most obvious way to do this is through the exercise of discretion to loosen capital requirements on banks, allowing them to grow in size and activity during recessions. This practice has a checkered history, however. As a result, we sketch an analytical framework for when banking regulators should use their administrative discretion to loosen capital requirements on banks during recessions and thus stimulate the economy. We suggest that both the nature of a crisis (as economic, rather than financial), and the nature of capital forbearance (based on riskless, rather than risk-sensitive assets) are essential preconditions for sound “expansionary banking policy.” We also highlight how developments in macroeconomic management should invite us to rethink basic issues of institutional design in central banking

The Regulation of Trading Markets: A Survey and Evaluation

This chapter was prepared for a conference exploring the desirability and structure of a new special study of the securities markets. Our objective is not to resolve all of the questions that commentators have raised about the new equity markets, but to lay the groundwork for a new special study by surveying the state of market regulation, identifying issues, and offering preliminary evaluations

The New Public/Private Equilibrium and the Regulation of Public Companies

This Symposium Article examines how the public/private divide works today and maps out some of the potential implications for major issues in securities law. Classic debates in securities law were often predicated on the idea that public companies are a coherent class of firms that differ markedly from private companies. For more than fifty years after the adoption of the federal securities laws, this view was justified. During that period, the vast majority of successful and growing private firms eventually accepted the regulatory obligations of being public in order to access a wider and deeper pool of capital, among other benefits. This was a descriptive reality, but it had important normative implications as well. An identifiable class of large, growing firms went public, and they generally went public for a reason they shared: raising capital. As a result, regulatory interventions imposed on the category of “public companies” had a coherent target. We argue that firms’ going public decisions are now shaped by a much larger and more varied set of factors. These factors are complex, cross-cutting, and impact firms considering going public in very heterogeneous ways. This complexity results from several developments and we emphasize two. First, it is a result of the fact that while the public/private divide was created by securities law, public and private markets now provide two widely different ecologies for firms, which profoundly shape firms’ governance as well as the issuance and trading of their shares. Second, long-term advances in the ease of capital raising in private markets have made it possible for firms to remain private indefinitely and have diminished or eliminated the capital-raising advantages of public markets. The result of this latter change has been rightly called a “new equilibrium.” In that equilibrium, fewer and older firms go public, while other successful firms remain private indefinitely. In this equilibrium, capital raising is no longer the primary reason firms go public. Rather, we argue, firms go public due to one or more of the many other features of the public market’s ecology. The normative implication of this new equilibrium is to reduce the coherency of the regulation of public companies. The benefits and costs of being public (or private) apply unevenly to firms eligible to go public. Instead, to a greater degree firms now face idiosyncratic, company-specific tradeoffs between being public or private, and they often go public for reasons unrelated to the original design of the public/private divide. Regulations imposed on public firms are likely to not only be increasingly under- and over-inclusive, but also to apply to a class of companies whose coherency as an economic phenomenon may be increasingly suspect

A Machine Learning Classifier for Corporate Opportunity Waivers

Rauterberg & Talley (2017) develop a data set of “corporate opportunity waivers” (COWs) – significant contractual modifications of fiduciary duties – sampled from SEC filings. Part of their analysis utilizes a machine learning (ML) classifier to extend their data set beyond the hand-coded sample. Because the ML approach is likely unfamiliar to some readers, and in the light of its great potential across other areas of law and finance research, this note explains the basic components using a simple example, and it demonstrates strategies for calibrating and evaluating the classifier

Learning to Manipulate a Financial Benchmark

Financial benchmarks estimate market values or reference rates used in a wide variety of contexts, but are often calculated from data generated by parties who have incentives to manipulate these benchmarks. Since the London Interbank Offered Rate (LIBOR) scandal in 2011, market participants, scholars, and regulators have scrutinized financial benchmarks and the ability of traders to manipulate them. We study the impact on market welfare of manipulating transaction-based benchmarks in a simulated market environment. Our market consists of a single benchmark manipulator with external holdings dependent on the benchmark, and numerous background traders unaffected by the benchmark. We explore two types of manipulative trading strategies: zero-intelligence strategies and strategies generated by deep reinforcement learning. Background traders use zero-intelligence trading strategies. We find that the total surplus of all market participants who are trading increases with manipulation. However, the aggregated market surplus decreases for all trading agents, and the market surplus of the manipulator decreases, so the manipulator’s surplus from the benchmark significantly increases. This entails under natural assumptions that the market and any third parties invested in the opposite side of the benchmark from the manipulator are negatively impacted by this manipulation

High‐Frequency Trading and the New Stock Market: Sense And Nonsense

The stock market has been transformed during the last 25 years. Human suppliers of liquidity like the NASDAQ dealers and NYSE specialists have been replaced by algorithmic market making; stocks that once traded on a single venue now trade across twelve exchanges and a multitude of alternative trading systems. New venues like dark pools, and new participants like high‐frequency traders, have emerged to take on prominent roles. This new market has had more than its share of controversy and regulatory scrutiny, particularly in the wake of Michael Lewis’s bestseller Flash Boys. In this article, the authors analyze five of the most controversial new market practices, including various high‐frequency trading strategies and dark pool activities. They set out a simple conceptual framework based on adverse selection and agency problems, and apply that framework to assess the welfare effects of each of the five practices. While much that is criticized is indeed objectionable, other controversial practices are much more complex than popularly imagined and may in fact be socially desirable. They conclude by evaluating a range of potential reforms to equity market structure