Limits of Disclosure

Disclosure has its limits. One big focus of attention, criticism, and proposals for reform in the aftermath of the 2008 financial crisis has been securities disclosure. But most of the criticisms of disclosure relate to retail investors. The securities at issue in the crisis were mostly sold to sophisticated institutions. Whatever retail investors’ shortcomings may be, we would expect sophisticated investors to make well-informed investment decisions. But many sophisticated investors appear to have made investment decisions without making much use of the disclosure. We discuss another example where disclosure did not work as intended: executive compensation. The theory behind more expansive executive compensation disclosures was that shareholders might react to the disclosures with outrage and action, and companies, anticipating shareholder reaction, would curtail their compensation pre-emptively. But it was apparently not the reality and instead compensation spiraled higher. The two examples, taken together, serve to elucidate our broader point: underlying the rationale for disclosure are common sense views about how people make decisions — views that turn out to be importantly incomplete. This does not argue for making considerably less use of disclosure. But it does sound some cautionary notes. The strong allure of the disclosure solution is unfortunate, although perhaps unavoidable. The admittedly nebulous bottom line is this: disclosure is too often a convenient path for policymakers and many others looking to take action and hold onto comforting beliefs in the face of a bad outcome. Disclosure’s limits reveal yet again the need for a nuanced view of human nature that can better inform policy decisions

The Problem of Sunsets

An increasing percentage of corporations are going public with dual class stock in which the shares owned by the founders or other corporate insiders have greater voting rights than the shares sold to public investors. Some commentators have criticized the dual class structure as unfair to public investors by reducing the accountability of insiders; others have defended the value of dual class in encouraging innovation by providing founders with insulation from market pressure that enables them to pursue their idiosyncratic vision. The debate over whether dual class structures increase or decrease corporate value is, to date, unresolved. Empirical studies have failed to provide conclusive evidence as to the effect of dual class structures, and calls for regulators or stock exchanges to adopt prohibitions banning dual class structures outright have been unsuccessful, although several index providers have banned dual class stock from major indexes such as the S&P 500. As a result, some commentators have advocated a compromise position permitting corporations to go public with dual class structures but requiring that they include mandatory time-based sunset provisions. The sunset provisions would automatically convert the dual class structure to a single share structure after the passage of a pre-determined period of time. The Council of Institutional Investors has asked the New York Stock Exchange and Nasdaq to refuse to list the shares of dual class firms unless they contain a time-based sunset provision that would convert within seven years. This Article does not take a position on whether dual class structures are value-enhancing, but it does challenge the proposition that time-based sunsets are an appropriate response to the debate over dual class structures and that they should be imposed through regulation or stock exchange rules. To the extent that dual class structures are problematic, sunsets do not solve that problem. Moreover, time-based sunsets are an arbitrary response to the concern that developments such as the decline in a founder’s economic interest or the transfer of high-vote shares to third parties may reduce the attractiveness of the dual class structure. In addition, time-based sunsets create potential moral hazard problems. Further, because of their problematic incentives, minority shareholders cannot address the limitations of time-based sunsets through a retention vote. This Article observes that event-based sunsets, which have received less attention, focus on the specific developments that are likely to erode the potential value of dual class structures, and calls for market participants to explore them further through private ordering. Nonetheless, it argues that, at the present time, investors and policymakers lack sufficient information about either dual class or sunsets to justify using regulation, index requirements, or stock exchange rules to force companies into adopting sunsets. Last, it argues that, rather than relying on compulsory sunsets to evade the difficult policy issues raised by dual class, the debate should encompass a more thorough framing of the role and importance of shareholder voting rights

Should Corporations Have a Purpose?

Corporate purpose is the hot topic in corporate governance. Critics are calling for corporations to shift their purpose away from shareholder value as a means of addressing climate change, equity and inclusion, and other social values. We argue that this debate has overlooked the critical predicate questions of whether a corporation should have a purpose at all and, if so, what role it serves. We start by exploring and rejecting historical, doctrinal, and theoretical bases for corporate purpose. We challenge the premise that purpose can serve a useful function either as a legal constraint on managerial discretion or as a tool to promote the interests of stakeholders over those of shareholders. Instead, we identify an instrumental function for corporate purpose. Because a corporation consists of a variety of constituencies with differing interests and objectives, an articulated, measurable, and enforceable corporate purpose enables those constituencies both to select those corporations with which they wish to identify and to navigate the terms of that association through contract or regulation. We highlight the role of purpose in enabling a corporation to commit to core policies of its business model and for which the corporation has a comparative advantage. Critically, our instrumental view highlights the role of purpose as a voluntary tool to facilitate the goals of corporate participants rather than a regulatory instrument to promote specific public policies

The “Value” of a Public Benefit Corporation

We examine the “value” a PBC form provides for publicly-traded corporations. We analyze the structure of the PBC form and find that other than requiring a designated social purpose it does not differ significantly in siting control and direction with shareholders. We also examine the purpose statements in the charters of the most economically significant PBCs. We find that, independent of structural limitations on accountability, these purpose statements are, in most cases, too vague and aspirational to be legally significant, or even to serve as a reliable checks on PBC behavior. We theorize, and provide evidence, that without a legal or structural tool for binding a PBC to specific social objectives, the operational decisions of the publicly traded PBC may be subject to change according to the vision and preferences of individual officers, directors and shareholders. Our conclusions provide support for a more defined and enforceable PBC purpose statement for publicly-traded PBCs. Otherwise, publicly-traded PBCs are likely to operate no differently than traditional, publicly-traded corporations

The New Titans of Wall Street: A Theoretical Framework for Passive Investors

Passive investors — ETFs and index funds — are the most important development in modern day capital markets, dictating trillions of dollars in capital flows and increasingly owning much of corporate America. Neither the business model of passive funds, nor the way that they engage with their portfolio companies, however, is well understood, and misperceptions of both have led some commentators to call for passive investors to be subject to increased regulation and even disenfranchisement. Specifically, this literature takes a narrow view both of the market in which passive investors compete to manage customer funds and of passive investors’ participation in the capital markets.We respond to this failure by providing the first comprehensive theoretical framework for passive investment and its implications for corporate governance. To start, we explain that, to understand passive funds, it is necessary to understand the institutional context in which they operate. Two key insights follow. First, because passive funds are simply a pool of assets – their incentives are a product of the overall business operations of fund sponsors. Second, although passive funds are locked into their investments, their shareholders are not. Like all mutual fund investors, shareholders in index funds can exit at any time by selling their shares and receiving the net asset value of their ownership interest. Consequently, the sponsors of passive funds must compete on both price and performance with other investment options – including both other passive funds and actively-managed funds -- for investor dollars. As we explain, this competition provides passive fund sponsors with a variety of incentives to engage. Furthermore, the size of the major fund sponsors and the breadth of their holdings affords them economies of scale enabling them to engage effectively.An examination of passive investor engagement in corporate governance demonstrates that passive investors behave in accordance with this theory. Passive investors are devoting greater sophistication and resources to engagement with their portfolio companies and are exploiting their comparative advantages – their size, breadth of portfolio and resulting economies of scale -- to focus on issues with a broad market impact, such as potential corporate governance reforms, that have the potential to reduce the underperformance and mispricing of portfolio companies. Passive investors use these tools, as opposed to analyzing firm-specific operational issues, to reduce the relative advantage that active funds gain through their ability to trade.We conclude by exploring the overall implications of the rise of passive investment for corporate law and financial regulation. We argue that, although existing critiques of passive investors are unfounded, the rise of passive investing raises new concerns about ownership concentration, conflicts of interest and common ownership. We evaluate these concerns and the extent to which they warrant changes to existing regulation and practice

Do Social Movements Spur Corporate Change? The Rise of “MeToo Termination Rights” in CEO Contracts

Do social movements spur corporate change? This Article sheds new empirical and theoretical light on the issue through an original study of executive contracts before and after MeToo. The MeToo movement, beginning in late 2017, exposed a workplace culture seemingly permissive of high-level, sex-based misconduct. Companies typically responded slowly and imposed few consequences on perpetrators, often allowing them to depart with lucrative exit packages. Why did companies reward rather than penalize bad actors, and has the movement disrupted this culture of complicity? The passage of time since the height of the movement allows us to investigate these issues empirically, using the lens of executive contracts. Economic theory posits that CEO employment agreements are not negotiated at arm’s length and contain terms that strongly favor the executive. We hypothesize that these dynamics—typically associated with outsized compensation packages—resulted in pro-executive termination provisions that left room for executives to engage in sexbased misconduct without fear of reprisal. We argue that the MeToo movement represented a major shock to these bargaining dynamics and predict that, in the face of new reputational and liability risks, corporate boards will seek to reserve greater power to terminate CEOs for sex-based misconduct in post-MeToo agreements. We test—and substantiate—our hypotheses using a novel dataset of CEO employment agreements. We focus on changes to the contractual definition of a “forcause” termination. In the wake of MeToo, we find a significant and growing rise in the prevalence of what we call “MeToo termination rights”—definitions of cause that permit companies to terminate CEOs without severance pay in cases of harassment, discrimination, and violations of company policy. Such grounds for cause broadly capture most forms of sex-based misconduct. This documented rise in “MeToo termination rights” holds important lessons for corporate governance, executive contracting, and gender equity. First, our results show that external shocks can disrupt traditional corporate bargaining dynamics, bringing contract terms more in line with changing expectations. Second, our results provide insight into contract design, suggesting possible tradeoffs that companies make in structuring these novel termination rights. Finally, our results can be understood as reflecting a realignment of the treatment of top-level executives with the treatment of ordinary workers, who have long been subject to capacious sexual harassment policies. We conclude that the rise in “MeToo termination rights” offers evidence of increased corporate control of CEO behavior and greater institutional accountability for sex-based misconduct. We are therefore cautiously optimistic about the long-term effects of MeToo and the ability of powerful social movements to inspire change within private institutions

After the Deal: Fannie, Freddie, and the Financial Crisis Aftermath

This law review article is published in the Berkeley Law Scholarship Repository. To view this article in its entirety please see the related resources section above. Recommended Citation: Steven Davidoff Solomon, After the Deal: Fannie, Freddie, and the Financial Crisis Aftermath, 95 B.U. L. Rev. 371 (2015