Agency Costs in Law-Firm Selection: Are Companies Under-Spending on Counsel?

A growing body of literature examines whether corporate clients derive sufficient value from the law firms that they engage. Yet little attention has been paid to whether clients optimally select among law firms in the first place. One entry-point is to identify discrepancies in the quality of counsel selected by different corporate clients for the very same work. Using a large sample of loans, this Article finds that major U.S. public companies select lower-ranked law firms for their financing transactions than do private equity-owned companies, controlling for various deal characteristics. While some of this discrepancy can be attributed to value-maximizing behavior, agency and other information problems within public companies may distort their choice of counsel. Contrary to the thrust of existing commentary, U.S. public companies may well be spending too little on outside counsel

Law Firm Selection and the Value of Transactional Lawyering

Following the contraction in demand for law firms’ services during the Great Recession, “Big Law” was widely diagnosed as suffering from several maladies that would spell its ultimate demise, including excessive fees, excessive size, increased competition from in-house counsel, the commoditization of legal work, and the decline in demand for “relationship firms.” While each of these market pressures is only too real for certain segments of the law-firm population, their threat to the most elite U.S. law firms has been largely misunderstood. Even as many firms reduce their fees and contract in size, we should expect certain firms to continue to charge more and grow bigger. The current prescriptions for fixing Big Law fail to recognize that the top-tier firms within the group serve a unique market function. Focusing on a particular type of legal work – major corporate transactions – this Article proposes a novel theory of the value created by elite law firms: their private information about “market” deal terms, acquired through repeated exposure to the same types of transactions, provides clients with a significant bargaining advantage in deal negotiations. By aggregating expertise in the ever-changing and ever-increasing set of deal terms for certain transactions, law firms help their clients price such terms more accurately and thereby maximize their surplus from the deal. This pricing function – traditionally thought to be limited to investment banks – is one that cannot be replicated or subsumed by in-house counsel, other service providers, or commoditized contracts

Individual Autonomy in Corporate Law

The field of corporate law is riven with competing visions of the corporation. This Article seeks to identify points of broad agreement by negative implication. It examines two developments in corporate law that have drawn widespread criticism from corporate law scholars: the Supreme Court\u27s recognition of corporate religious rights in Burwell v. Hobby Lobby and the Nevada legislature\u27s decision to eliminate mandatory fiduciary duties for corporate directors and officers. Despite their fundamental differences, both resulted in expanding individual rights or autonomy within the corporation-for shareholders and managers, respectively. The visceral critiques aimed at these two developments suggest a broadly shared view that the corporation is a device that should be optimized for collective action of a particular type-namely large-scale economic activity. As such, once one has opted into the corporate form, little room remains for the exercise of individual rights and autonomy ex post. Corporate law permits shareholders and managers to act only in limited and highly formalized ways. In this view, the strong assertion of shareholder and managerial autonomy in Hobby Lobby and Nevada\u27s corporate law is problematic fbr three reasons. First, it conflicts with longstanding principles underlying the corporate form. Second, it is arguably inefficient, even where it comports with the parties\u27 private ordering. Third, despite its liberalizing aims, it is likely to foster even greater regulatory complexity or involvement in the long run. While there are no easy answers to how one should weigh individual rights against economic efficiency, advancing personal autonomy by altering the corporate form may ultimately provide little autonomy bang for one\u27s buck. From both a rights and an efficiency perspective, there are better means to champion the individual over the group

Market Information and the Elite law Firm

As a subcategory of contract negotiations, corporate transactions present information problems that have not been fully analyzed. In particular, the literature does not address the possibility that parties may simply be unaware of value-increasing transaction terms or their outside option. Such unawareness can arise even for transactions that attract many competing parties, if the bargaining process is such that (1) the price terms are negotiated and fixed prior to the non-price terms, contrary to the standard assumption; and (2) some of the non-price terms remain private for some period of time. A simple bargaining model shows that, when such unawareness is reasonably probable, each transaction party will maximize its expected payoff by acquiring current market information about non-price transaction terms. Because they have unique access to it, law firms with a significant share of transactional advisory work play an important role in aggregating and selling such market information. The implication is that, absent shocks to transactional practice, the volume advantage of high-market-share law firms should be self-perpetuating. This result is consistent with the observation that the legal advisory market for major corporate transactions is highly concentrated, and that the top firms earn substantial and persistent rents

The Deregulation of Private Capital and the Decline of the Public Company

From its inception, the federal securities law regime created and enforced a major divide between public and private capital raising. Firms that chose to “go public” took on substantial disclosure burdens, but in exchange were given the exclusive right to raise capital from the general public. Over time, however, the disclosure quid pro quo has been subverted: Public companies are still asked to disclose, yet capital is flooding into private companies with regulators’ blessing. This Article provides a critique of the new public-private divide centered on its information effects. While regulators may have hoped for both the private and public equity markets to thrive, they may instead be hastening the latter’s decline. Public companies benefit significantly less from mandatory disclosure than they did just three decades ago, because raising large amounts of capital no longer requires going and remaining public. Meanwhile, private companies are thriving in part by free-riding on the information contained in public company stock prices and disclosure. This pattern is unlikely to be sustainable. Public companies have little incentive to subsidize their private company competitors in the race for capital--and we are already witnessing a sharp decline in initial public offerings and stock exchange listings. With fewer and fewer public companies left to produce the information on which private companies depend, the outlook is uncertain for both sides of the securities-law divide

Private Equity\u27s Governance Advantage: A Requiem

Private equity’s original purpose was to optimize companies’ governance and operations. Reuniting ownership and control in corporate America, the leveraged buyout (or the mere threat thereof) undoubtedly helped reform management practices in a broad swath of U.S. companies. Due to mounting competitive pressures, however, private equity is finding relatively fewer underperforming companies to fix. This is particularly true of U.S. public companies, which are continuously dogged by activist hedge funds and other empowered shareholders looking for any sign of slack. In response, private equity is shifting its center of gravity away from governance reform, towards a dizzying array of new tactics and new asset classes. Large private equity firms now simultaneously run leveraged buyout funds, credit funds, real estate funds, alternative investments funds, and even hedge funds. The difficulty is that some of the new money-making strategies are less likely to be value increasing than governance and operational improvements. Moreover, they introduce conflicts of interest and complexities that alter private equity’s role in corporate governance. Private equity’s governance advantage has always been to ensure that companies are the servant of only one master. Yet today the master itself may have divided loyalties and attention. With few gains left to be had from governance reforms, private equity is quietly distancing itself from the corporate governance revolution that it helped bring about

The Myth of the Ideal Investor

Critiques of specific investor behavior often assume an ideal investor against which all others should be compared. This ideal investor figures prominently in the heated debates over the impact of investor time horizons on firm value. In much of the commentary, the ideal is a longterm investor that actively monitors management, but the specifics are typically left vague. That is no coincidence. The various characteristics that we might wish for in such an investor cannot peacefully coexist in practice. If the ideal investor remains illusory, which of the real-world investor types should we champion instead? The answer, I argue, is none. The corporate finance ecosystem evolves at such a rapid pace that interventions specifically designed to encourage particular types of investors are increasingly likely to be ineffective or even counterproductive: we are destined to place our bets on the wrong horse, time and again. To illustrate the difficulty, this Article briefly sketches the evolution of three types of shareholders frequently advanced as exemplars based on their time horizons: major mutual fund groups, activist hedge funds, and private equity funds. Based on their behavior to date, there is little support for policies aimed either at favoring or penalizing such investors’ participation in the capital markets generally, and corporate governance specifically

Private Equity Firms as Gatekeepers

Notwithstanding the considerable attention private equity receives, there continues to be substantial confusion about what private equity does and whether this creates value. Calls for more aggressive regulation of the industry reflect a skeptical view of private equity as—at best—a zero-sum game, in which profits are generated only at the expense of other constituencies. The standard defense of private equity points to its corporate governance advantages as a source of value. This Article identifies an overlooked and increasingly important way in which private equity creates value: private equity firms act as gatekeepers in the debt markets. As repeat players, private equity firms use their reputations with creditors to mitigate the problems of borrower adverse selection and moral hazard in the companies that they manage, thereby reducing creditors’ costs of lending to these companies. Private equity-owned companies are thus able to borrow money on more favorable terms than standalone companies, all else being equal. By acting as gatekeepers, private equity firms render the debt markets more efficient and provide their portfolio companies with an increasingly valuable borrowing advantage. Ironically, then, debt may well be private equity’s greatest asset