Optimal Defaults for Corporate Law Evolution

Public corporations live in a dynamic and ever-changing business environment. This paper examines how courts and legislators should choose default arrangements in the corporate area to address new circumstances. We show that the interests of the shareholders of existing companies would not be served by adopting those defaults arrangements that public officials view as most likely to be value-enhancing. Because any charter amendment requires the board's initiative, opting out of an inefficient default arrangement is much more likely to occur when management disfavors the arrangement than management supports it. We develop a 'reversible defaults' approach that takes into account this asymmetry. When public officials must choose between two or more default arrangements and face significant uncertainty as to which one would best serve shareholders, they should err in favor of the arrangement that is less favorable to managers. Such an approach, we show, would make it most likely that companies would be ultimately governed by the arrangement that would maximize shareholder value. Evaluating some of the main choices that state corporate law has made in the past two decades in light of our proposed approach, we endorse some but question others. The arrangements we examine include those developed with respect to director liability, state antitakeover statutes, and the range of permitted defensive tactics.

Majority Control and Minority Protection

This chapter examines legal issues concerning majority control and minority protection in firms with concentrated ownership governance structures, with particular emphasis on the tradeoff between the goals of protecting minority shareholders and allowing controllers to pursue their vision and how corporate law should balance these conflicting goals. Focusing primarily on Delaware corporate law, it suggests that holding a control block allows majority shareholders to pursue their idiosyncratic vision in the manner they see fit, even against minority investors’ objections. Idiosyncratic vision refers to the subjective value that entrepreneurs attach to their business idea or vision, and this chapter considers its role in the value of control. It also discusses the perils of asymmetric information and differences of opinion, as well as the risk of agency costs for minority investors

Corporate Control, Dual Class, and the Limits of Judicial Review

Companies with a dual-class structure have increasingly been involved in high-profile battles over the reallocation of control rights. Google, for instance, sought to entrench its founders’ control by recapital­izing from a dual-class into a triple-class structure. The CBS board, in contrast, attempted to dilute its controlling shareholder by distributing a voting stock dividend that would empower minority shareholders to block a merger it perceived to be harmful. These cases raise a fundamental question at the heart of corporate law: What is the proper judicial response to self-dealing claims regarding reallocations of corporate control rights? This Article shows that the reallocation of control rights raises an inevitable tradeoff between investors’ protection from agency costs and the controller’s ability to pursue its idiosyncratic vision, making the value of different allocations of control rights both firm specific and individual specific. It is thus inherently impossible to create objective valuation mod­els for the reallocation of control rights. The impossibility of creating reli­able valuation models sets the limits of judicial review: The legal tools long used by Delaware courts to adjudicate conflicts over cash-flow rights, such as entire fairness review, are fundamentally incompatible with the adjudication of conflicts over reallocations of control rights. This Article explores the policy implications of this insight and suggests that courts treat reallocations of control rights as questions of charter interpretation as to who has the power to decide such reallocations and avoid reviewing the discretion to use that power. Courts should enforce the decision of the parties as to reallocations of control rights and apply the business judg­ment rule when the charter is silent

Rewarding Outside Directors

While they often rely on the threat of penalties to produce deterrence, legal systems rarely use the promise of rewards. In this Article, we consider the use of rewards to motivate director vigilance. Measures to enhance director liability are commonly perceived to be too costly. We, however demonstrate that properly designed reward regimes could match the behavioral incentives offered by negligence-based liability regimes but with significantly lower costs. We further argue that the market itself cannot implement such a regime in the form of equity compensation for directors. We conclude by providing preliminary sketches of two alternative reward regimes. While this Article focuses on outside directors, the implications of our analysis extend to other gatekeepers as well

Corporate Control and Idiosyncratic Vision

This Article offers a novel theory of corporate control. It does so by shedding new light on corporate-ownership structures and challenging the prevailing model of controlling shareholders as essentially opportunistic actors who seek to reap private benefits at the expense of minority shareholders. Our core claim is that entrepreneurs value corporate control because it allows them to pursue their vision (i.e., any business strategy that the entrepreneur genuinely believes will produce an above-market rate of return) in the manner they see fit. We call the subjective value an entrepreneur attaches to her vision the entrepreneur\u27s idiosyncratic vision. Our framework identifies a fundamental tradeoff, stemming from asymmetric information and differences of opinion, between the entrepreneur\u27s pursuit of her idiosyncratic vision and investors\u27 need for protection against agency costs. Entrepreneurs and investors address this inevitable conflict through different ownership structures, each with different allocations of control and cash-flow rights. Concentrated ownership, therefore, should not be viewed as an unalloyed evil. To the contrary, it creates value for controlling and minority shareholders alike. Our analysis shows that controlling shareholders hold a control block to increase the pie\u27s size (pursue idiosyncratic vision) rather than to dictate the pie\u27s distribution (consume private benefits). Importantly, when the entrepreneur\u27s idiosyncratic vision is ultimately realized, the benefits will be distributed pro rata to all investors. Our framework provides important insights for investor protection and corporate law doctrine and policy. We argue that corporate law for publicly traded firms with controlling shareholders should balance the controller\u27s need to secure her idiosyncratic vision against the minority\u27s need for protection. While the existing corporate-law scholarship has focused solely on the protection of minority shareholders, we show that it is equally important to pay heed to the rights of the controlling shareholders

Rewarding Outside Directors

While they often rely on the threat of penalties to produce deterrence, legal systems rarely use the promise of rewards. In this Article, we consider the use of rewards to motivate director vigilance. Measures to enhance director liability are commonly perceived to be too costly. We, however demonstrate that properly designed reward regimes could match the behavioral incentives offered by negligence-based liability regimes but with significantly lower costs. We further argue that the market itself cannot implement such a regime in the form of equity compensation for directors. We conclude by providing preliminary sketches of two alternative reward regimes. While this Article focuses on outside directors, the implications of our analysis extend to other gatekeepers as well