Incentivizing Credit Rating Agencies under the Issuer Pay Model Through a Mandatory Compensation Competition

Credit rating agencies are important institutions of the global capital markets. If they had performed properly, the financial crisis of 2008-2009 would not have occurred. This article offers the simplest fix proposed thus far, and it is contrarian. This Article accepts the central role of rating agencies in the regulation of bond investments, the realities of a duopoly, and the issuer-pay model of compensation. The status quo is the baseline. The role of regulation should be to create the conditions necessary to induce competition. This article proposes that a small, recurring portion of revenue earned by the largest rating agencies should be ceded to fund a pay-for-performance bonus, and that the agencies should compete for this bonus on a periodic winner-take-all basis. This modest, at-the-margin bonding mechanism would significantly affect incentives and outcomes: conflict of interest and implicit coordination would be minimized; competition would increase; the quality of ratings would improve. Since regulation would only be required to assess performance and would not change the fundamental industrial organization, this proposal has the advantage of simplicity and feasibility

The Terrorism Risk Insurance Act: Time to End the Corporate Welfare

The terrorist attacks of September 11, 2001, inflicted enormous losses on the insurance industry and businesses. In the wake of the disruptions occurring in the insurance market at the time, the government enacted the Terrorism Risk Insurance Act of 2002 to create a “temporary” federal backstop against catastrophic losses. This program subsidized private risk with public funds through a cost-sharing program for which the government does not receive any compensation. The compelling need for the program was unclear even in the smoldering aftermath of 9/11. Yet in response to effective lobbying by the insurance industry and business interests, Congress has twice extended the program. The program is now scheduled to sunset at the end of 2014, 12 years after this supposedly temporary program was instituted. If there was some ambiguity about the program’s need before, there is none now. Terrorism risk is not more severe than other insurable risks such as natural catastrophes, and a federal backstop stakes public money to protect the insurance industry, and subsidize the terrorism risk insurance premiums for commercial policyholders. The private market is capable of underwriting this risk. This policy analysis suggests that the program should sunset as scheduled in 2014, thus ending this form of corporate welfare

The Tort Foundation of Duty of Care and Business Judgment

This Article corrects a misconception in corporation law – the belief that principles of tort law do not apply to the liability scheme of fiduciary duty. A board’s duty of care implies exposure to liability, but the business judgment rule precludes it. Tort law finds fault; corporation law excuses it. The conventional wisdom says that the tort analogy fails. This dismissal of tort prinicples is wrong. Although shareholder derivative suits and ordinary tort cases properly yield systemically antipodal outcomes, they are bound by a common analytical framework. The principles of board liability are rooted in tort doctrines governing duty, customs, and pure economic loss. Properly applied, they produce a duty “to care” (vis-à-vis duty of care), based on a good faith undertaking of care, but upon such undertaking no liability for negligently inflicted economic loss – the exact result achieved by the fiduciary duty of care and the business judgment rule. A sound tort analysis not only theorizes the enigmatic relationship between the duty of care and the business judgment rule, but it also explains Delaware’s puzzling procedural-substantive divide. Fiduciary duty in corporation law rests on a tort foundation. Lastly, the thesis of this Article has a broader implication. The contractarian view of corporation law seeks to relegate the role of courts to passive custodians of the corporate contractual terms provided by the legislature and the corporation’s constituents. However, this view is constrained by a tort framework wherein courts do and should play a robust, albeit reserved, role in regulating important aspects of corporate governance through the continued common law process of doctrinal development of the idea of a wrong

Catastrophic Risk and Governance after Hurricane Katrina: A Postscript to \u3ci\u3eTerrorism Risk in a Post-9/11 Economy\u3c/i\u3e

This essay inquires into the political economy and system of governance that have made catastrophes more frequent and severe. The system of governance that is designed to mitigate risk and respond to catastrophes can be ineffective, or worse, increase the risk of harm through unintended consequences. Human influence must be considered a source of collateral risk, the kind that leads to a systemic crisis or exacerbates one. This essay concludes with some brief proposals, discussion topics more than completed ideas, which may facilitate further academic and political dialogue on effective governance and public risk management. They include a catastrophe tax, the elimination of subsidies for bad risks, reduction of coordination costs, and a clearer understanding of a public-private partnership

Loss of Chance, Probabilistic Cause, and Damage Calculations: The Error in \u3ci\u3eMatsuyama v. Birnbaum\u3c/i\u3e and the Majority Rule of Damages in Many Jurisdictions More Generally

This short commentary corrects an erroneous understanding of probabilistic causation in the loss-of-chance doctrine and the damage calculation method adopted in Matsuyama v. Birnbaum. The Supreme Judicial Court of Massachusetts is not alone. Many other common law courts have made the same error, including Indiana, Nevada, New Mexico, Ohio, and Oklahoma. The consistency in the mistake suggests that the error is the majority rule of damages. I demonstrate here that this majority rule is based on erroneous mathematical reasoning and the fallacy of probabilistic logic

Employee Say-on-Pay: Monitoring And Legitimizing Executive Compensation

This Article proposes the adoption of employee say-on-pay in corporate governance. The board would benefit from an advisory vote of employees on executive compensation. This proposal is based on two considerations: firstly, the benefits of better monitoring and reduced agency cost in corporate governance; secondly, the link between executive compensation and income inequity and wealth disparity in the broader economy. If adopted, shareholders and employees would monitor executive performance and pay at different levels. Shareholders through the market mechanism can only monitor at the level of public disclosures and share price. Employees can leverage private information. Non-executive managers in particular can better monitor the company and senior executives, based on inside knowledge and a longer term horizon, than diffuse, diversified, and short durational shareholders. Employees collectively possess the corporation’s entire information content; the assessment derived there from would be relevant to the board’s assessment of executive performance and pay. On the level of political economy, employee approval would legitimate executive pay in the current social, economic, and political environment in which executive compensation and income disparities have touched public consciousness. Executive compensation is no longer purely a matter of private contracting. Prominent economists have linked excessive pay to economic inequity, a pressing issue of public consciousness today. Employees are a major constituent of the corporate system and our political society. They can act as surrogate public monitors and perform a gatekeeping function of good corporate governance. Structured properly and achieved fairly as to the executive, employee say-on-pay would politically legitimate executive compensation and income disparity at both the firm and political levels