The Economist's Schumpeter column this week takes on a recurring fad:
Lord Percy of Newcastle, Britain’s minister of education in 1924-29, was no fan of the fad for happy-clappy “progressive” education that spread among the country’s schools on his watch. He declared that it was all nonsense: “a child ought to be brought up to expect unhappiness.” This columnist feels the same suspicion of the fashion for happy-clappy progressive management theory that is rushing through the world’s companies and even some governments. ...
A weird assortment of gurus and consultancies is pushing the cult of happiness. Shawn Achor, who has taught at Harvard University, now makes a living teaching big companies around the world how to turn contentment into a source of competitive advantage. One of his rules is to create “happiness hygiene”. Just as we brush our teeth every day, goes his theory, we should think positive thoughts and write positive e-mails. ...
Disneyland is still “the happiest place on Earth”. American firms regularly bid their customers to “have a nice day”. One of the sharpest books published on the phenomenon is “The Managed Heart” from 1983, in which Arlie Hochschild, a sociologist at the University of California, Berkeley, noted that many employers demanded “emotional labour” from workers in the form of smiles and other expressions of “positive emotion”. Firms are keen to extract still more happiness from their employees as the service sector plays an ever greater role in the economy. ...
Various academic studies suggest that “emotional labour” can bring significant costs. ... But the biggest problem with the cult of happiness is that it is an unacceptable invasion of individual liberty.
I concur. As I detailed in my article, Privately Ordered Participatory Management, the evidence does not support the happiness cult:
Over two decades ago, Nobel economist Kenneth Arrow opined that “the empirical evidence, such as it is, points to very little relation between the morale of workers and their performance.” Kenneth J. Arrow, The Limits of Organization 76 (1974). The intervening years have done little to change that conclusion. A more recent literature review likewise concluded that there is “simply no direct connection between job satisfaction and subsequent productivity.” Edwin A. Locke et al., Participation in Decisionmaking: When Should it be Used?, 14 Org. Dynamics 67, 71 (1986). Accord Thomas A. Kochan et al., The Transformation of American Industrial Relations (rev. ed. 1994) (same); Oliver E. Williamson, The Economic Institutions of Capitalism 270 (1985) (same); Tom Juravich, Empirical Research on Employee Involvement: A Critical Review for Labor, 21 Lab. Stud. J. 51, 56 (1996) (based on research to date no proof that “happy workers are necessarily more productive”); Charles D. Watts, Jr., In Critique of a Reductivist Conception and Examination of “The Just Organization,” 50 Wash. & Lee L. Rev. 1515, 1518 (1993) (“I do not see the propagation of just or participative organizations that one would expect if these benefits [i.e., increased job satisfaction etc...]” were as significant as the proponents of participatory management suggest); cf. Alan Hyde, In Defense of Employee Ownership, 67 Chi-Kent L. Rev. 159, 201 (1991).
Because that article was written circa 1997, of course, there may be more recent research. And so there is. But the more recent research is consistent with my rather pessimistic view:
Job satisfaction has traditionally been thought of by most business managers to be key in determining job performance. The prevailing thought is if you are satisfied and happy in your work, you will perform better than someone who isn’t happy at work.
Not so, according to a research project by Nathan Bowling, Ph.D., an assistant professor of psychology at Wright State. His findings, which will be published soon in the Journal of Vocational Behavior, show that although satisfaction and performance are related to each other, satisfaction does not cause performance.
“My study shows that a cause and effect relationship does not exist between job satisfaction and performance. Instead, the two are related because both satisfaction and performance are the result of employee personality characteristics, such as self-esteem, emotional stability, extroversion and conscientiousness,” he explained.
Bowling, who specializes in industrial and organizational psychology, said his findings are based on reviewing data from several thousand employees compiled over several decades. His subjects, mostly in the United States, involved several hundred different organizations.
Bowling said the public, and even researchers, can get confused over the relationship between job satisfaction and job performance. “Just because two things are related doesn’t mean that one causes the other. For example, there is a relationship between the amount of ice cream sold on a given day and the crime rate for that day. On days when ice cream sales are high, the number of crimes committed will also tend to be high. But this doesn’t mean that ice cream sales cause crime. Rather, ice cream sales and crime are related because each is the result of the outdoor temperature. Similarly, satisfaction and performance are related because each is the result of employee personality.”
Very interesting special report in last week's Economist on the growth of superstar companies--especially in tech--that dominate their sectors. In the lead article, Adrian Wooldridge observes that:
A small number of giant companies are once again on the march, tightening their grip on global markets, merging with each other to get even bigger, and enjoying vast profits. As a proportion of GDP, American corporate profits are higher than they have been at any time since 1929. Apple, Google, Amazon and their peers dominate today’s economy just as surely as US Steel, Standard Oil and Sears, Roebuck and Company dominated the economy of Roosevelt’s day. Some of these modern giants are long-established stars that have reinvented themselves many times over. Some are brash newcomers from the emerging world. Some are high-tech wizards that are conjuring business empires out of noughts and ones. But all of them have learned how to combine the advantages of size with the virtues of entrepreneurialism. They are pulling ahead of their rivals in one area after another and building up powerful defences against competition, including enormous cash piles equivalent to 10% of GDP in America and as much as 47% in Japan. ...
The McKinsey Global Institute, the consultancy’s research arm, calculates that 10% of the world’s public companies generate 80% of all profits. Firms with more than $1 billion in annual revenue account for nearly 60% of total global revenues and 65% of market capitalisation.
What's driving this development? Wooldridge suggests several forces are at work, which are complementary rather than competing. But the one I want to focus on is the role of regulation:
The most powerful force behind the rise of the new giants is technology. But two other forces are pushing in the same direction: globalisation and regulation. ...
The growth in regulation has also played into the hands of powerful incumbents. The collapse of Enron in 2001 arguably marked the end of the age of deregulation, which began in the late 1970s, and the beginning of re-regulation. The financial crisis of 2008 served to reinforce that trend. The 2002 Sarbanes-Oxley legislation that followed Enron’s demise the previous year reshaped general corporate governance; the 2010 Affordable Care act re-engineered the health-care industry, which accounts for nearly a fifth of the American economy; and in the same year the Dodd-Frank act rejigged the financial-services industry.
Regulatory bodies have got bigger. Between 1995 and 2016 the budget of America’s Securities and Exchange Commission increased from $300m to $1.6 billion. They have also become much more active. America’s Department of Justice has used the Foreign Corrupt Practices act of 1977 to challenge companies that have engaged in questionable behaviour abroad. The average cost of a resolution under this act rose from $7.2m in 2005 to $157m in 2014.
Regulation inevitably imposes a disproportionate burden on smaller companies because compliance has a high fixed cost. Nicole and Mark Crain, of Lafayette College, calculate that the cost per employee of federal regulatory compliance is $10,585 for businesses with 19 or fewer employees but only $7,755 for companies with 500 or more. Younger companies also suffer more from regulation because they have less experience of dealing with it. Sarbanes-Oxley imposed a particularly heavy burden on smaller public companies. The share of non-executive directors’ pay at smaller firms increased from $5.91 out of every $1,000 in sales before the legislation to $9.76 afterwards. The JOBS act of 2012 exempted small businesses from some of the more onerous requirements of the legislation, but the number of startups and IPOs in America remains at disappointingly low levels.
The complexity of the American system also serves to penalise small firms. The country’s tax code runs to more than 3.4m words. The Dodd-Frank bill was 2,319 pages long. Big organisations can afford to employ experts who can work their way through these mountains of legislation; indeed, Dodd-Frank was quickly dubbed the “Lawyers’ and Consultants’ Full-Employment act”. General Electric has 900 people working in its tax division. In 2010 it paid hardly any tax. Smaller companies have to spend money on outside lawyers and constantly worry about falling foul of one of the Inland Revenue Service’s often contradictory rules.
I think that analysis is spot on. I wrote about the role SOX and Dodd-Frank have played in retarding economic growth in my article, Corporate Governance and U.S. Capital Market Competitiveness (October 22, 2010), available at SSRN: http://ssrn.com/abstract=1696303, and which was published in The American Illness: Essays on the Rule of Law. In that essay I argued that:
During the first half of the last decade, evidence accumulated that the U.S. capital markets were becoming less competitive relative to their major competitors. The evidence reviewed herein confirms that it was not corporate governance as such that was the problem, but rather corporate governance regulation. In particular, attention focused on such issues as the massive growth in corporate and securities litigation risk and the increasing complexity and cost of the U.S. regulatory scheme.
Tentative efforts towards deregulation largely fell by the wayside in the wake of the financial crisis of 2007-2008. Instead, massive new regulations came into being, especially in the Dodd Frank Act. The competitive position of U.S. capital markets, however, continues to decline.
This essay argues that litigation and regulatory reform remain essential if U.S. capital markets are to retain their leadership position. Unfortunately, the article concludes that federal corporate governance regulation follows a ratchet effect, in which the regulatory scheme becomes more complex with each financial crisis. If so, significant reform may be difficult to achieve.
I'd also refer you to Chester Spatt's essay Complexity of Regulation, which cogently argues that:
Complexity in regulation leads to complexity in financial structures and systems, particularly in light of the efforts of market participants to mitigate the costs and complications induced by regulation, including attempts to engage in regulatory arbitrage. Consequently, much of the costs of regulation in my view are associated with its intricacies. It also is useful to recognize that complexity in regulation leads to huge entry barriers associated with the cost of regulatory compliance. Instead of addressing “too big to fail,” this can lead to maintaining “too big to fail” institutions. This is a connection that appears to be underappreciated by our financial regulators.
So concludes Tyler Cowen.
Keith Paul Bishop notes:
In Jones v. H. F. Ahmanson & Co., 1 Cal. 3d 93 (1969), the California Supreme Court famously held:
Majority shareholders may not use their power to control corporate activities to benefit themselves alone or in a manner detrimental to the minority. Any use to which they put the corporation or their power to control the corporation must benefit all shareholders proportionately and must not conflict with the proper conduct of the corporation’s business.
Id. at 108. The Nevada Supreme Court has not explicitly adopted Jones, but has recognized the possibility that minority stockholders may be able to pursue a breach of fiduciary duty claim against the majority stockholders. Cohen v. Mirage Resorts, Inc., 119 Nev. 1, 11 (2003).
In Jones v. H.F. Ahmanson & Co., 460 P.2d 464 (Cal. 1969), the California supreme court, per Chief Justice Traynor, limited the ability of controlling shareholders to create a market for their shares without providing comparable liquidity for the minority.
The United Savings and Loan Association of California was a closely held financial institution. The defendants owned about 85 percent of United’s shares. Defendants wished to create a public market for their shares, a task that could have been accomplished using any of several methods, most of which would have created a market for all shareholders’ stock. Instead of adopting any of those options, however, the defendants set up a holding company, to which they transferred their shares. The holding company then conducted a public offering of its stock, which created a secondary trading market for that stock. The 15 percent of United’s stock that was not owned by the holding company was thus left without a viable secondary market.
The California supreme court held that when no active trading market for the corporation’s shares exists, the controlling shareholders may not use their power over the corporation to promote a marketing scheme that benefits themselves alone to the exclusion and detriment of the minority.
It once seemed likely that Ahmanson would become an important precedent, perhaps precluding a wide range of transactions including sales of control blocks at a premium. At least outside California, that has not happened. See Nixon v. Blackwell, 626 A.2d 1366 (Del.1993); Toner v. Baltimore Envelope Co., 498 A.2d 642 (Md. 1985); Delahoussaye v. Newhard, 785 S.W.2d 609 (Mo. App. 1990).
Even in California, there seems to be something of a trend towards limiting Ahmanson to its unique facts and procedural posture. See, e.g., Miles, Inc. v. Scripps Clinic and Research Foundation, 810 F. Supp. 1091 (S.D. Cal. 1993) (“The Jones case did give the narrow circumstance in which a fiduciary duty may be imposed: when a majority shareholder usurps a corporate opportunity from or otherwise harms the minority shareholder.”); Kirschner Bros. Oil Co., Inc. v. The Natomas Co., 229 Cal. Rptr. 899 (Cal. App. 1986) (noting that Ahmanson’s sweeping dicta must be “carefully related” to the facts before a violation can be found; hence, plaintiffs must explain with “specificity what they . . . might have been entitled to that they did not receive”). But see Stephenson v. Drever, 16 Cal. 4th 1167, 1178, 947 P.2d 1301, 1307 (1997) (calling Jones a "leading case").
If Ahmanson is to remain on the books, a debatable proposition, it should be so limited. The case was decided on appeal from the trial court’s grant of a motion to dismiss. Interpreting the facts most favorably for the plaintiffs, the defendants went out of their way to deprive the minority shareholders of a market for their shares, reduced the dividend in order to deprive the minority shareholders of any economic return, at least in the short run, and displayed their true objective by offering a low price for the minority shares. In short, this is just a run of the mill squeezeout case. Unfortunately, there is much broader dicta in the opinion—and it is that dicta for which the case is frequently cited.
John O. McGinnis contends that the Harvard Law Review's history with preferences illustrates three laws most such systems follow:
First, once instituted they expand over time in numbers, degree, and scope of categories preferred. ...
Second, preferences also move from assuring that people have a seat at the table to assuring that they have one of the most honored seats. ...
Third, the conceit that racial, ethnic, and gender preferences will result in the representation of more diverse views, which indeed could be important in putting out a publication, is often false, as it is in this case.
It's an interesting introduction to the course, especially focused on persuading social justice warriors to take the course.
Marcia Narine reports that:
Earlier this week the House Financial Services Committee voted to repeal the Dodd-Frank Conflict Minerals Rule, which I last wrote about here and in a law review article criticizing this kind of disclosure regime in general.
Under the proposed Financial Choice Act (with the catchy tagline of "Growth for All, Bailouts for None"), a number of Dodd-Frank provisions would go by the wayside, including conflict minerals because:
Title XV of the Dodd-Frank Act imposes a number of overly burdensome disclosure requirements related to conflict minerals, extractive industries, and mine safety that bear no rational relationship to the SEC’s statutory mission to protect investors, maintain fair, orderly, and efficient markets, and promote capital formation. The Financial CHOICE Act repeals those requirements. There is overwhelming evidence that Dodd-Frank’s conflict minerals disclosure requirement has done far more harm than good to its intended beneficiaries – the citizens of the Democratic Republic of Congo and neighboring Central African countries. SEC Chair Mary Jo White, an Obama appointee, has conceded the Commission is not the appropriate agency to carry out humanitarian policy. The provisions of Title XV of the Dodd-Frank Act are a prime example of the increasing use of the federal securities laws as a cudgel to force public companies to disclose extraneous political, social, and environmental matters in their periodic filings.
The House Financial Services committee has created a very flashy (by government standards) website to promote the bill. The summary of the proposed legislation, by the way, makes clear that they want to make sweeping changes in Dodd-Frank, not just get rid of conflict mineral disclosure.
As readers of my book on Dodd-Frank (Corporate Governance after the Financial Crisis) know, of course, I think there is much in Dodd-Frank that deserves repeal. But conflict minerals has been high on my list for quite a while:
Buried in the gargantuan mess that was the Dodd-Frank act was a requirement which, as the SEC explains: ... directs the Commission to issue rules requiring certain companies to disclose their use of conflict minerals if those mineral...
The WSJ reports that: A federal appeals court, citing free-speech concerns, partly overturned a controversial rule requiring publicly traded U.S. companies to disclose whether their goods contain certain minerals whose sales result in...
The SEC is scheduled to hold a roundtable on conflict minerals disclosures tomorrow. When the roundtable was announced, BNA reported that: The matters to be debated include appropriate reporting approaches for the final rule, the cha...
I am delighted to announce that you can now pre-order Limited Liability: A Legal and Economic Analysis, which I had the honor of co-writing with my dear friend Professor Todd Henderson of the University of Chicago Law School. Here's the blurb:
The modern corporation has become central to our society. The key feature of the corporation that makes it such an attractive form of human collaboration is its limited liability. This book explores how allowing those who form the corporation to limit their downside risk and personal liability to only the amount they invest allows for more risks to be taken at a lower cost.
This comprehensive economic analysis of the policy debate surrounding the laws governing limited liability examines limited it not only in an American context, but internationally, as the authors consider issues of limited liability in Britain, Europe and Asia. Stephen Bainbridge and M. Todd Henderson begin with an exploration of the history and theory of limited liability, delve into an extended analysis of corporate veil piercing and related doctrines, and conclude with thoughts on possible future reforms. Limited liability in unincorporated entities, reverse veil piercing and enterprise liability are also addressed.
This comprehensive book will be of great interest to students and scholars of corporate law. The book will also be an invaluable resource for judges and practitioners.
And here are some reviews:
This book does a wonderful job of bringing sharp and clear analysis to a breathtakingly complex and poorly understood area of law. In particular, the book is distinctive for its careful treatment of the inefficiencies generated by current confusion and apparent subjectivity of the law in many states. Also of interest is the book's thoughtful economic analysis of the various ways that parent companies and other controlling investors react to the confused state of the law.' --Jonathan Macey, Yale University
'Professors Bainbridge and Henderson have made an outstanding contribution to the literature on limited liability. There is something valuable for everyone in this book, which provides not only a clear and comprehensive exposition of the doctrine and theory of limited liability, but also with a cogent and clever solution to limited liability's deeply troubled exception, veil-piercing. This is an important book in one of the most important areas of business law, and is a tremendous, versatile resource for attorneys, entrepreneurs, students and scholars alike.' --Peter Oh, University of Pittsburgh
'Bainbridge and Henderson have given us one of the most important books on one of the most important contemporary legal issues, the liability of individual and corporate shareholders for corporate debts. There is no issue in corporate law more subject to uncertainty and no issue more likely to be litigated. No single book has ever attempted, much less carried off, the complete historical, international, economic and legal theoretical exegesis of limited liability, which these two authors do with range, depth, confidence and even a bit of panache. This monograph, of crucial interest both to scholars and practitioners, will become an instant classic and an immediate authority.' --Stephen B. Presser, Northwestern University and the author ofPiercing the Corporate Veil
Back in 1982 Roberta Karmel published a classic article book, Regulation by Prosecution, the way the federal SEC was using prosecutions to regulate American business. As Mark Sargent summarized her argument:
Karmel concludes that this exaggerated emphasis on investor protection and corporate governance (each to be achieved primarily through prosecution of individual offenders) diverted the SEC from its other major task, the encouragement of capital formation.
Karmel expounds this general critique through case studies of the SEC's role in the corporate governance movement, its approach to the evolving national market system, its jurisdictional expansionism, and its tendency to erode materiality as a prerequisite to mandatory disclosure. Although a full summary of each of these case studies is be- yond the scope of this review, some of her specific criticisms deserve attention.
For example, Karmel's analysis of how the SEC used its control over the proxy rules to promote reforms in corporate governance, in overseas selling practices, and, generally, in the corporate sense of so- cial responsibility, points clearly to one unresolved contradiction in the agency's conduct. Specifically, the SEC would bring or threaten to bring enforcement actions against corporations which had paid foreign officials to secure contracts from their governments on the ground that such payments had not been adequately disclosed to the stockholders in a proxy statement or annual report. The corporation would ordinarily agree to a consent injunction through which the SEC would cause a restructuring of the board of directors or would apply other, ever more novel, forms of ancillary relief. The SEC would bring all of this about in the name of investor protection. The contradiction, however, is that most shareholders of those companies were not concerned with the illegality or immorality of foreign payments. Rather, those shareholders, like most shareholders, were primarily investors interested in tapping the corporation's income stream, thereby receiving a return on their investment. Thus, the relatively small amounts paid by management to receive lucrative foreign contracts were not matters of information material to the shareholders and, Karmel concludes, should not have been a basis for SEC action.
In addition, as Sargent recounts, Karmel objected to the SEC's creeping federalization of state corporate governance law:
The SEC's attempt to force preemption of state tender offer statutes would perhaps be more defensible if it had been the result of a careful, thorough, and open analysis of the regulatory alternatives, and not, as Karmel emphasizes, ad hoc litigation. The SEC's behavior in this episode appears even more reprehensible once it is realized that the tender offer statute ad- ministered by the SEC (the Williams Act) was not the product of careful study and policy formulation by the agency, but was an expedient political compromise. The SEC's preemptive strike on state takeover regulation thus seems more and more like institutional self-aggrandizement coupled with utter disregard for the effects of its actions on the traditions of federalism.
The more things change ....
Jennifer Arlen and Marcel Kahan have posted an interesting article on the latest twist in this story, which is the use of fevered prosecution agreements:
Over the last decade, federal corporate criminal enforcement policy has undergone a significant transformation. Firms that commit crimes are no longer simply required to pay fines. Instead, prosecutors and firms enter into pretrial diversion agreements (PDAs). Prosecutors regularly use PDAs to impose mandates on firms creating new duties that alter firms’ internal operations or governance structures. DOJ policy favors the use of such mandates for any firm with a deficient compliance program at the time of the crime. This Article evaluates PDA mandates to determine when and how prosecutors should use them to deter corporate crime. We find that the current DOJ policy on mandates is misguided and that mandates should be imposed more selectively. Specifically, mandates are only appropriate if a firm is plagued by “policing agency costs” — in that the firm’s managers did not act to deter or report wrongdoing because they benefitted personally from tolerating wrongdoing or from deficient corporate policing. Moreover, only mandates that are properly designed to reduce policing agency costs are appropriate. The policing agency cost justification for mandates that we develop thus calls into question both the extent to which mandates are used and the type of mandates that are imposed by prosecutors.
In Unocal at 20: Director Primacy in Corporate Takeovers, Delaware Journal of Corporate Law, Vol. 31, No. 3, pp. 769-862, 2006, available at SSRN: http://ssrn.com/abstract=946016, I argued that:
In Unocal Corp. v. Mesa Petroleum Co., the Delaware Supreme Court made clear that the board of directors of a target corporation is not a passive instrumentality in the face of an unsolicited tender offer or other takeover bid. To the contrary, so long as the target board's actions are neither coercive nor preclusive, the target's board remains the defender of the metaphorical medieval corporate bastion and the protector of the corporation's shareholders.
Unocal is almost universally condemned in the academic corporate law literature. Building on his director primacy model of corporate governance and law, however, Bainbridge offers a defense of Unocal in this article. Bainbridge argues that Unocal strikes an appropriate balance between two competing but equally legitimate goals of corporate law: on the one hand, because the power to review differs only in degree and not in kind from the power to decide, the discretionary authority of the board of directors must be insulated from shareholder and judicial oversight in order to promote efficient corporate decision making; on the other hand, because directors are obligated to maximize shareholder wealth, there must be mechanisms to ensure director accountability. The Unocal framework provides courts with a mechanism for filtering out cases in which directors have abused their authority from those in which directors have not.
A key part of that article is devoted to rebutting the arguments by those who would deny target boards of directors their usual discretionary powers in the takeover context. And now we have a case in point:
Airgas is a leading distributor of industrial, medical and specialty gases in the United States, selling canisters of oxygen and other gases to more than a million customers across the country. The deal to sell the company was an eye-opener for corporate America. ...
Wall Street law firms now hold up Airgas as one of the best arguments for management’s right to defend its company. Business schools around the country are seeking to turn the tale into a case study. ...
Despite the long odds, Mr. McCausland prevailed, by winning on appeal at the Delaware Supreme Court. The case preserved the ability of companies to defend themselves against hostile takeovers, without input from shareholders.
Despite the mewling and howling from the takeover industry, activist hedge and pension funds, and their academic allies along the Acela corridor, courts have given boards the power to determine what is in the best interests of the company ... if only the board has the stomach for it.
An interesting new paper, which I commend to your attention:
The doctrine of USACafes holds that whenever a business entity (a “fiduciary entity”) exercises control over and, therefore, stands in a fiduciary position to another business entity (the “beneficiary entity”), those persons exercising control, whether directly or indirectly, over the fiduciary entity (the “controller(s)”) owe a fiduciary duty to the beneficiary entity and its owners. Focusing on control as the defining element, courts have applied this far-reaching doctrine across all statutory business forms — including corporations, limited partnerships, and LLCs — and through successive tiers of parent-subsidiary entity structure to assign liability to the individuals that ultimately exercise control over an entity. In this respect, USACafes enables what two prominent business law jurists have aptly described as “a particularly odd pattern of routine veil piercing.”
This Article argues that USACafes is a needless doctrine that stands in conflict with other, more fundamental precepts of law and equity. Accordingly, when presented with the opportunity, the courts of Delaware and other jurisdictions should reject its holding. Instead, the law ought to respect the fiduciary entity for what it is: a legal person separate and apart from its owners and controllers. If the limited liability veil of a fiduciary entity is to be pierced, then it should be under the more rigorous legal standard that courts have traditionally applied in veil piercing cases.