Engineering a venture capital market: lessons from the American experience

The venture capital market and firms whose creation and early stages were financed by venture capital are among the crown jewels of the American economy. Beyond representing an important engine of macroeconomic growth and job creation, these firms have been a major force in commercializing cutting edge science, whether through their impact on existing industries as with the radical changes in pharmaceuticals catalyzed by venture-backed firms commercialization of biotechnology, or by the their role in developing entirely new industries as with the emergence of the internet and world wide web. The venture capital market thus provides a unique link between finance and innovation, providing start-up and early stage firms - organizational forms particularly well suited to innovation - with capital market access that is tailored to the special task of financing these high risk, high return activities

The Political Ecology of Takeovers: Thoughts On Harmonizing the European Corporate Governance Environment

Economic policy debate in the United States during the 1980s focused on the dynamics of bidder and target tactics in hostile takeovers. Confronted with the largest transactions in business history, financial economists took advantage of developments in econometric techniques to conduct virtually real time studies of the impact on firm value of each new bidder tactic and target defense. For courts and lawyers, hostile takeovers subjected standard features of corporate law to the equivalent of a stress x-ray, revealing previously undetected doctrinal cracks. Congress held seemingly endless hearings on the subject, although managing to enact only relatively innocuous tax penalties on particular defensive tactics the public found especially offensive. State legislatures, closer to the political action, acted more substantively, if less wisely. Whether or not takeovers created new wealth they did result in its transfer, and at least one of the parties from whom wealth was transferred – target management – had remarkable influence in state legislatures. When labor also came actively to oppose hostile takeovers, the coalition was virtually unstoppable. The decade saw some thirty-four states pass more than sixty-five major laws restricting corporate takeovers, including states discouraging partial offers and front-end loaded offers. The 1980s have now closed transactionally as well as chronologically. The first quarter of 1991 marked the lowest level of merger and acquisition activity since the first quarter of 1980. The passing of this remarkable decade invites a broader perspective, which can be helpfully thought of as the political ecology of takeovers. An ecological perspective builds on the proposition that phenomena are embedded in interactive systems – a rich web of mutually dependent relationships. Thus, a seemingly independent event cannot be fully evaluated without understanding how it relates to the environmental forces to which it was a response and which, in turn, respond to it. What the narrow focus of the 1980s debate missed was an appreciation of the complex economic corporate governance and political environments in which hostile takeovers are embedded. Corporate acquisitions are a response to real conditions in the economic environment. The choice among acquisition techniques, most importantly between friendly and hostile transactions, depends both upon the economic motivation for the transaction and upon conditions in the corporate governance environment. Finally, conditions in the corporate governance environment are directly influenced by politics; both what is allowed and prohibited is defined, in the first instance, by legislation. My goal in this article is two-fold. I begin by sketching the political ecology of takeovers in the United States – the interaction of economics, corporate governance and politics that shaped the experience of the 1980s. I then make a tentative effort at applying the insights gained from an ecological perspective to the current endeavor to change dramatically the European corporate governance environment through the harmonization of takeover and company law in the European Community. Sheltered by the cloak of political naivete commonly allowed those attempting comparative analysis from a distance, I will argue that an ecological understanding of takeovers suggests a different approach than that reflected so far in the debate over the terms of harmonization. This approach is based on what I term the mutability principle

Controlling Family Shareholders in Developing Countries: Anchoring Relational Exchange

The Law and Finance account of the ubiquity of controlling shareholders in developing markets is based on conditions in the capital market: poor shareholder protection law prevents controlling shareholders from parting with control out of fear of exploitation by a new controlling shareholder who acquires a controlling position in the market. This explanation, however, does not address why we observe any minority shareholders in such markets, or why controlling shareholders in developing markets are most often family-based. This paper looks at the impact of “bad law” on shareholder distribution in a very different way. Developing countries typically provide not only poor minority protection, but poor commercial law generally. Specifically, the paper considers the impact on the distribution of shareholders of conditions in the product market, where the driving legal influence is the quality of commercial law that supports the corporation’s actual business activities, and where the presence of a controlling family shareholder may help support reputation-based trading in a bad commercial law environment

The Devolution of the Legal Profession: a Demand Side Perspective

Economic analysis has not played a significant role in the increasingly intense debate over the decline of professionalism among lawyers.Economists\u27 lack of interest in the issue may be understandable. The lawyers\u27 lament is that the legal profession is devolving into the business of law. That this concern has not captured the economists\u27 attention may reflect only that economists do not view the label business as a pejorative. If becoming a business means efficiently rendering an important service in a competitive environment, then of what is there to complain? Lawyers, more directly concerned with maintaining their professional status, would find little comfort in this explanation for the economists\u27 inattention. From the lawyers\u27 perspective, economists lack appreciation for what is lost in the gap between a business and a profession: the grand Brandesian vision of a public role for lawyers that contemplates a broader professional obligation than to act only in the client\u27s (or the lawyer\u27s) self-interest. Both views – economists\u27 indifference to the lawyers\u27 public oriented vision of professionalism and the disdain students of the legal profession often display for economic analysis – are incomplete in important respects. By applying economic analysis to highlight the critical role of professionalism in the market for legal services, it is possible to demonstrate the importance of both professionalism as a concept and economics as a means to analyze it. To be sure, nothing special is gained from translating standard sociological analyses of the functions of professionalism into economese unless the translation results in new insights.But such insights are in fact available here. An economic perspective suggests an important function of professionalism that has gone largely unobserved under traditional modes of analysis. Additionally, an economic perspective on professionalism helps identify the sources of the quite real pressures on the legal profession\u27s continued ability to perform this function and the quite real limits on the profession\u27s ability to do very much about it. My thesis is that important elements of what have been traditionally understood as professional standards operate not as freerstanding statements describing appropriate behavior by lawyers, or even as paternalistic proclamations concerning lawyers\u27 treatment of clients. Rather, important elements of professional standards serve to cast lawyers in the role of enforcers of agreements among clients. And if this is right, then the continued viability of these elements of professionalism depends not only on the attitude of lawyers, but, more importantly, on the attitude of clients: Will clients still allow lawyers to play the role of enforcer? From this perspective, the threat to professionalism comes from the demand side, not the supply side. The good news for lawyers is that economic analysis of legal professionalism provides some solace – the devolution of the profession may not be our fault. The bad news is that, for precisely the same reason, there may be very real limits on what the profession alone can do to arrest the decline

The Case Against Shark Repellent Amendments: Structural Limitations on the Enabling Concept

The tactical history of the tender offer movement resembles an unrestrained arms race. Faced with offeror assaults in the form of Saturday night specials, various types of bear-hugs, godfather offers, and block purchases, target management responded with equally intriguing defensive tactics: the black book, reverse bear-hug, sandbag, show stopper, white knight, and, drawing directly on military jargon, the scorched earth. But however varied the labels given particular defensive strategies, they share the common characteristic of being responsive: They are available only after an offer is made and the battle for the target\u27s independence joined. From the target\u27s perspective, what was missing from the defensive arsenal was a deterrent – a tactic that would convince a potential offeror not even to attempt the attack, thereby not only saving the target the substantial costs associated with tender offer conflicts but, more importantly, eliminating the not insubstantial risk that all defenses would fail and the offer prove successful. Shark repellent amendments are intended to fill this gap in a prospective target\u27s defenses. The idea is to amend the target\u27s articles of incorporation to make it a less desirable or more difficult acquisition, and thereby to encourage the shark to seek a more appetizing or more easily digested alternative. If successful, however, the tactic is not without cost. To the extent that shark repellent amendments deter potential offerors, they also have the unavoidable effect of preventing shareholder access to offers made at substantial premiums over market price, and at the same time insulating incumbent management from the principal mechanism by which they might be dislodged unwillingly from their positions

A Structural Approach to Corporations: The Case Against Defensive Tactics in Tender Offers

Tender offers present an obvious and inherent conflict of interest between management and shareholders. On the one hand, an offer provides shareholders with the opportunity to sell their shares for a substantial premium over market price. On the other hand, the tender offer is the principal mechanism by which management can be forcibly unseated from control. It should thus come as no surprise that management often resists outsiders\u27 efforts to direct tender offers at its shareholders. The form of that resistance, however, is somewhat surprising. Because the tender offer is the only form of corporate acquisition addressed directly to the target\u27s shareholders, one might expect defensive tactics initiated by management to focus on persuading shareholders that the proffered transaction was not in their best interests. An offer would then fail because target shareholders found it unattractive. Reality, however, differs from expectation. Major forms of defensive tactics achieve success not because they convince target shareholders to retain their shares, but because they prevent the offer from being made, or if made, consummated, and thereby ensure that shareholders cannot make, from management\u27s perspective, the wrong decision. Courts and regulatory authorities have long recognized this conflict between management\u27s wish to retain control and the shareholders\u27 wish to have access to -the highest price for their stock. Responding to cases arising out of the first postwar acquisition wave, the Delaware Supreme Court first confronted the conflict more than 20 years ago, and the Securities Exchange Commission, in settings where a defensive tactic requires shareholder approval, has since 1969 required explicit disclosure of the potential foreclosure of shareholder access to desirable offers. But despite this long-standing recognition, state corporation law\u27s resolution of the conflict continues to turn on management\u27s motive in defeating the tender offer and thereby preventing a shift in control. In this article I will argue that emphasizing managerial motives cannot resolve the conflict and, indeed, does no more than offer a pretense for believing that the conflict does not exist. The difficulty with the traditional approach, however, goes beyond the uncertainties of motivational analysis. It is not the reason for management\u27s action which creates the conflict, but the fact that management acts at all. Resolving the conflict unavoidably requires delineating the appropriate roles of management and shareholders in control transactions. This effort, in turn, is possible only by expanding the sources which courts have traditionally considered relevant in developing corporation law. I will argue here that an appropriate allocation of authority between management and shareholders in the modern public corporation and, therefore, resolution of the conflict of interest inherent in the tender offer process, can be achieved only by carefully examining the entire structure of the modern corporation. And while the broad outline of this structure is sketched by the typical state enabling statute, its picture is completed by nonlegal forces deriving from the markets in which the corporation and its participants function. Part I of this article critically examines the traditional approach to regulating management efforts to prevent changes of control. Having argued that the traditional approach is incapable of resolving the conflict of interest presented by management defensive tactics, I will then offer in Part II what I term a structural approach to the problem. This approach exposes the invalidity of defensive tactics in tender offers and delineates a general principle governing management\u27s appropriate role in the tender offer process. In Part III I address the various arguments used to justify management discretion to block a tender offer, and in Part IV describe the role which remains for management, a role substantially more limited than that management currently assigns to itself. Finally, in Part V I suggest a rule which implements the structural approach and then consider anticipated criticism of the rule

Separation and the Function of Corporation Law

I am delighted to participate in taking up Professor William Klein\u27s suggestion that we could learn something by attempting a functional typology of corporation law. As a starting point, any typology must be animated by an underlying theory whose terms dictate the lines the typology draws. I want to focus my contribution at the level of the theory that might animate the architecture of this grid. To see what I mean by this, think of the Sesame Street version of Edward Levi\u27s classic, An Introduction to Legal Reasoning. The character points at a board on which there are pictures of a number of objects and sings: One of these things is not like the other; one of these things just doesn\u27t belong. The idea is to teach the children (and law students) to distinguish between categories based on a principle. My concern here is with the principle that might allow us to choose among Bill Klein\u27s litany of potential criteria of good corporate law. In particular, I will focus on the separation theorem, which states the implications of complete capital markets on shareholder preferences concerning corporate investment policy. My proposition is that the presence of markets in the list of characteristics that determine equity value makes a radical difference in the function played by corporate law. In these circumstances the criteria for good corporate law are limited to a single overriding goal: facilitating the maximization of shareholder wealth. I will illustrate the usefulness of a unicriterion view of corporate law by briefly taking up two familiar issues that span the corporate law domain: the idea of a stakeholder-oriented board of directors in public corporations and the role of the courts in enforcing the reasonable expectations of private corporation shareholders. This emphasis on the link between markets, asset pricing, and legal institutions has been a familiar theme in my work. For example, I have argued that business lawyers function to make up for market failures in asset pricing. Similarly, Reinier Kraakman and I have stressed that familiar institutions operate to alleviate failures in the information market and thereby operate to support price efficiency. I am convinced that the benefit of working out this interaction between the structure of institutions, including here the structure of corporation law, and the efficiency and completeness of related markets, results in a good deal more than what my friend Bob Mnookin refers to as cute theory – that is, theory which appears elegant at first glance, but whose simplicity results not from deep insight but from surface facility

The Poison Pill in Japan: The Missing Infrastructure

The fact of a small number of hostile takeover bids in Japan the recent past, together with technical amendments of the Civil Code that would allow a poison pill-like security, raises the question of how a poison pill would operate in Japan should it be widely deployed. This paper reviews the U.S. experience with the pill to the end of identifying what institutions operated to prevent the poison pill from fully enabling the target board to block a hostile takeover. It then considers whether similar ameliorating institutions are available in Japan, and concludes that with the exception of the court system, Japan lacks the range institutions that proved to be effective in the United States. As a result, the Japanese courts will have a heavy responsibility in framing limits on the use of poison pills

Reflections in a Distant Mirror: Japanese Corporate Governance through American Eyes

For the last ten years, Japanese corporate governance has served as a distant mirror in whose reflection American academics could better see the attributes of their own system. As scholars came to recognize that the institutional characteristics of the American and Japanese systems were politically and historically contingent, other countries\u27 approaches became serious objects of study, rather than just way stations on the road to convergence. One learned about one\u27s own system from the choices made by others. As it came to be conceived, the Japanese corporation of the 1980s represented quite a different method of organizing production. Styled the J-form by Masahiko Aoki, the Japanese corporation combined an interlocking set of governance arrangements that supported a different kind of industrial organization. The main bank relationship, coupled with cross shareholdings, supported a management commitment to lifetime employment for an important subset of employees who, in turn, had the proper incentives to invest in the firm specific human capital necessary for a production system geared to horizontal coordination and information sharing. Central to the J-form was a commitment to organizational stability, consistent with what was said to be a Japanese focus on process technologies