Archives For corporate law

Professor Bainbridge offers a very detailed analysis of the complaint in the SEC’s case against Dallas Mavericks owner Mark Cuban.

David Zaring cuts to the chase.

Larry Ribstein is organizing the upcoming AALS session of agency, partnerships and LLCs and has posted the following call for papers:

The Section on Agency, Partnerships and Limited Liability Companies is calling for papers for the 2009 AALS Annual Meeting in San Diego. We are interested in presentations on the application of modern theories and empirical methods of business associations to agency and unincorporated firms. The program has two goals: First, to show how these theories can be enriched by taking them outside the “box” of corporate law; and second, to show the relevance of agency and unincorporated firms to the mainstream of corporate theory and empirics. A non-exhaustive list of possible topics includes the nature and function of fiduciary duties, agency theory, the role and enforcement of contracts, jurisdictional competition and choice of form, the relationship of federal and state law, jurisprudence, international and institutional comparisons, and legal and economic history. Please email either a draft paper if available, or if not an abstract and outline, to Larry E. Ribstein, University of Illinois College of Law, ribstein [at] by no later than September 1, 2008.

If you’ve got a paper that falls into this category, and want to head to San Diego for the 2009 AALS meeting, send the paper, abstract or outline to Larry at the email address in the post.

The Searle Center on Law, Regulation and Economic Growth at Northwestern University School of Law is continuing its excellent run of conferences with an event on June 18th-19th organized by Daniel Spulber centering around some new (and very interesting looking) papers on economic and legal issues involving entrepreneur and discuss high quality research relevant to the economics and law of the entrepreneurship.  Panels cover research on Venture Capital and the Entrepreneur; Entrepreneur Law; Economic Growth and Development; Innovation and the Entrepreneur; and The Social Context of Entrepreneurship.  The agenda (and links to the papers) is available here.

The Financial Times reported yesterday that an embarrassed GE CEO Jeffrey Immelt had to tell GE shareholders that the 10% growth in earnings for 2008 that he had promised analysts in March was not going to be possible.  GE missed its quarterly forecasts and halved its 2008 forecast to 5% growth in earnings (as opposed to the 10% growth promised).  The Financial Times article mentioned a “sense of shock among the investor community” and noted that one analyst, after Immelt’s downward revision, “compared GE’s promise of long-term improvements to the Chicago Cubs, the US baseball club that hasn’t won a championship in 100 years.”

Upon reading this FT article this morning, I thought “oh, dear God.  Do we remember none of the lessons learned just a few years ago about the perils of over-promising results to analysts?”  Why, exactly, does Immelt feel the need to promise a 5% increase in earnings for 2008 when (a) we are in a credit crunch, (b) GE is likely going to have to do more write-downs this year, (c) the cost of inputs is increasing, if not skyrocketing, (d) inflation is high, and (e) the economy is weak (among other things)?  Why is Immelt promising *growth* in earnings when the reality is that just achieving positive earnings for 2008 is likely to be good thing?  Why is Immelt putting pressure on himself and his officers to produce growth?

Memo to Immelt:  Earnings do not have to grow each year.  In some markets, in some economies, in some industries, in some “downturns,” simply having earnings – any positive earnings – is a good thing.  Matter of fact, sometimes earnings should NOT be growing each year.   Were I a GE investor, I would not want Immelt promising 5% growth for 2008 because I would figure that the only way he can promise to hit that number in such an uncertain market and gloomy economy is by commiting to fudge year-end 2008 numbers if needed.  And, as we learned several years ago, fudging year-end numbers tends to catch up with companies, and, when it does catch up, the valuation fall-out is worse than if the forthright disclosure (e.g. “2008 earnings might be flat”) had been made initially. Am I the only one who remembers back to the not-so-distant past, when unrealistic promises made to analysts by corporate officers led to companies cooking their books at year end to make the numbers?  As I recall, things did not always work out so well in those cases.  Enron, anyone?

Surely it is enough for a company in some years to produce returns that are merely equal to the prior year’s, as opposed to “besting” the prior year’s earnings. Didn’t we learn this lesson several years ago?  Investors are supposed to invest for the long term and diversify.According to the FT, one of the reasons why GE missed its quarterly numbers recently is because GE was unable to close “$900m-worth of real estate asset sales,” which the FT referred to as “a traditional way for GE to boost quarterly returns.”  If I were a GE investor, I would be peeved to read this.  I would rather GE just do the real estate deals when they make the most sense, when the market is most favorable for the deals at issue, regardless of when the gain/loss woulbe be booked.  If that means GE misses its numbers sometiemes due to the lack of a crystal ball regarding the best time to sell the assets, and I take a short-term valuation hit (on paper) as a GE investor, so be it.   It doesn’t create long-term value for shareholders if GE rushes through real-estate transactions just to make the numbers if the timing is not sensible for the transactions and waiting a little bit of time would garner value for shareholders.(The FT reports that “GE slashed its 2008 earnings forecast from $2.42 per share to $2.20-$2.30 – still an increase of as much as 5 per cent from last year.”  Slashed?  Slashed?  Are you KIDDING me?  “Slashed” implies something negative.  Earnings of $2.20-$2.30 per share for a year that is not likely to shape up particularly well  would be good.)

Tulane’s annual “Corporate Law Institute” is coming up!  The conference – widely viewed as the must-attend deal conference of the year is April 3 and 4 (only two weeks away).

The roster for this year’s conference reads like a who’s who of the deal world, with a range of Delaware jurists, investment bankers, top lawyers, and Wall Street media on the two days worth of panels.

The conference, which is organized by practitioners (not Tulane folks), was started twenty years ago by former Delaware jurist and Tulane Law alum former Justice Andrew Moore.  (As you corporate law wonks know, Justice Moore wrote several of the big takeover opinions from Delaware in the mid-1980s.  Many in the corporate law world were scandalized when Justice Moore was not reappointed when his term expired, but, based on the takeover opinions he penned, those of us who are cynical about just how political and pro-defendant Delaware tries to be were not surprised.)  Justice Moore will be making an appearance on the 20th year retrospective panel at the Tulane conference.

The conference should be stupendous, and I hope those of you who are reading this and will be attending the conference will make it your business to introduce yourselves to me.  I will be on the private equity panel on Friday, but I will be attending both days of the conference in full.

The specifics of the conference are here.

Microsoft has made a bid for Yahoo, and the Yahoo board of directors is anticipated to use the Nancy Reagan “Just Say No” defense.  I feel like I’m back in the 1980s merger boom.Â

Several thoughts:

1.  Rumor has it we are in a recession.  It is likely then that Yahoo stock is currently trading at a price that is not its highest.  Indeed, Microsoft’s bid for Yahoo is basically a big fat memo to Wall Street, in bolded all caps, indicating it (Microsoft) thinks Yahoo is a good buy.  How long before other bidders get the clue and come knocking on Yahoo’s door?

2.  Debt is cheap these days.  Super cheap.  Cheaper than it was in the 1980s when we saw a wave of debt-financed takeovers.  If Yahoo really is a bargain at its current price, other bidders will appear, using a good chunk of debt-financing, if necessary, to make their bids.

3.  If other bidders show up, can the Yahoo board members continue to “just say no” without violating their fiduciary duties?  At least for now, I am of the view that the Yahoo board can easily continue to keep the door to bidders closed.  Yahoo stock traded around $27-ish over the past year, and Microsoft is now offering $31 per share.  Given that, back in Jan. of ’06, when the S&P 500 and the DJIA were both weaker, Yahoo was trading in the vicinity of $40 per share, I have no problem thinking the Yahoo board can embrace their inner Nancy Reagan until a bidder steps forward with an offer well over $40 per share.

4.  Yahoo’s dance with Google is an interesting defensive move, making me think of the white knights, crown jewels, and lock-ups of the days of yore.

5.  Am I the only one who finds it *very* ironic that Microsoft is making a bid for Yahoo only days after AOL Time Warner has made clear it is going to try to undo its mega-merger from seven years ago between AOL and Time Warner?  Note to Microsoft:  It is important to have very specific business justifications – and related business plans – before indulging your urge to merge.

The M&A world seems to be flashing back to the 1980s.  Debt is cheap, private investors are bold, and some mega-mergers from the late 1990s might be perfectly situated for bust-ups.  It is just a matter of time before everyone is wearing parachute pants again.  You heard it here first.Â

Motivated by a slate of forthcoming articles, books, and various projects involving unincorporated firms, Professor Ribstein has announced his plans to begin blogging more extensively about partnership, LLCs and agency issues over at Ideoblog. This is good news to anybody interested in issues of business law and finance more generally. Two early installments in this endeavor are already up here and here. With all of Professor Ribstein’s upcoming projects, I was a bit concerned that the cost of these increased efforts might be less time dedicated to exposing the hand waving economic illiteracy of Ben Stein in the NY Times. I guess I don’t have to worry about that.

Much discussion of corporate governance in the last few years has centered on reforms advocated by ISS and CII and indices of good corporate governance practice created and maintained by such groups. A new study by Roberta Romano, Sanjai Baghat, and Brian J. Bolton, however, concludes that there is “no consistent relation between governance indices and measures of corporate performance.” The authors continue,

[T]here is no one “best” measure of corporate governance: the most effective governance institution appears to depend on context, and on firms’ specific circumstances. It would therefore be difficult for an index, or any one variable, to capture critical nuances for making informed decisions. As a consequence, we conclude that governance indices are highly imperfect instruments for determining how to vote corporate proxies, let alone for portfolio investment decisions, and that investors and policymakers should exercise caution in attempting to draw inferences regarding a firm’s quality or future stock market performance from its ranking on any particular corporate governance measure. Most important, the implication of our analysis is that corporate governance is an area where a regulatory regime of ample flexible variation across firms that eschews governance mandates is particularly desirable, because there is considerable variation in the relation between the indices and measures of corporate performance.

The paper is entitled The Promise and Peril of Corporate Governance Indices and the full text is available on SSRN.

U of Chicago Law Professors Douglas Baird and M. Todd Henderson (my very smart, very tall law school classmate) recently posted a provocative paper on SSRN. The paper, Other People’s Money, contends that “the oft-repeated maxim that directors of a corporation owe a fiduciary duty to the shareholders” is an “almost-right principle that has distorted much of the thinking about corporate law in recent decades.” Baird and Henderson argue that we should scrap this “almost-right” but mischief-causing principle in favor of a principle that would ground duties to all investors in contract.

Given innovations in corporate finance, the lines among shareholders, debtholders, and creditors have become quite blurred. Accordingly, Baird and Henderson argue, “[i]dentifying only shareholders as investors, as opposed to all providers of capital, is misleading.” Moreover, giving common stockholders the most privileged spot in the pecking order, as the notion of fiduciary duties owed to shareholders seems to do, may be inappropriate. How, for example, could the directors of a distressed corporation ever file for bankruptcy, thereby harming shareholders at the expense of creditors? Baird and Henderson argue that theorists committed to “the sacred cow that the duty of the directors is owed solely to the shareholders” have “paint[ed] themselves into embarrassing corners” trying to address the filing of a bankruptcy petition and other situations where shareholder interests seem appropriately subordinate to those of other capital providers.

If we are to jettison the notion that fiduciary duties are owed to shareholders, what principle should replace it? The most obvious candidate, Baird and Henderson observe, would be a rule that “directors must adopt the course that, in their judgment, maximizes the value of the firm as a whole.” (And a strong business judgment rule would apply to directors’ decisions.) Under this approach, which resembles the approach Judge Easterbrook took in In re Central Ice Cream Co., 836 F.2d 1068 (7th Cir. 1987), “claims by one class of investor against another alleging breach of fiduciary duty would fail so long as the directors acted reasonably to enhance firm value.”

But Baird and Henderson maintain that this “maximize the value of the enterprise” approach is also deficient. In particular, it fails to account for common situations in which senior investors, such as venture capitalists who own preferred stock with voting rights, bargain for the right to “pull the plug” on a venture — even though doing so would leave common stockholders with nothing and wouldn’t maximize the value of the firm ex post. Such arrangements, Baird and Henderson argue, may be value-maximizing ex ante because they give managers (generally junior claimants) an incentive to manage well. But, of course, the provisions can’t have this value-enhancing effect if they can’t be enforced due to a fiduciary duty running to common stockholders. Baird and Henderson thus argue that courts shouldn’t “stand in the way” of this “contracting regularity.” Instead, courts should honor contracts among directors and capital providers — even those that would disadvantage common stockholders.

In all, a terrific paper. It’s consistent with my view (explained in detail here) that the contracts between corporate constituents should be freely tailorable by the parties, and with my argument (set forth in the last part of this paper) that fiduciary duties should not preclude corporations from authorizing certain forms of insider trading.

My only quibble with the paper is that it seems to suggest in a couple of places that we should junk altogether the notion of fiduciary duties owed to shareholders. (See, e.g., page 8: “Hence, it may make sense to eliminate the concept of fiduciary duty from corporate law altogether.”) I wouldn’t go that far. Fiduciary duties running to shareholders exist because the cost of drafting contracts that would expressly state the constraints on managers’ conduct is simply too great. Because managers and shareholders can’t envision all the various contingencies that will arise, decide up front how those issues should be resolved, and memorialize those decisions in an express contract, the law polices manager conduct by positing amorphous duties of diligence and loyalty — duties whose precise content is fleshed out ex post. As Easterbrook and Fischel put it, “The only promise that makes sense in such an open-ended relation [as that between managers and shareholders] is to work hard and honestly.” The fact is, we need fiduciary duties running to shareholders to act as contractual gap fillers; we shouldn’t jettison them altogether.

That said, we should recognize that fiduciary duties owed to shareholders are nothing more than contractual gap-fillers. That is, they are contract terms that exist absent some provision to the contrary. Thus, to quote Easterbrook and Fischel again, “Because the fiduciary principle is a rule for completing incomplete bargains in a contractual structure, it makes little sense to say that ‘fiduciary duties’ trump actual contracts.”

If fiduciary duties are so construed, the concern that animates Baird and Hnderson becomes easy to remedy. Suppose a corporate charter were to include some provision stating that fiduciary duties to shareholders shall not be violated by executing or performing contracts with other capital providers as long as those contracts were in the best interests of the firm, measured from the perspective of the ex ante bargain among investors. The fiduciary duties owed shareholders — important contractual terms in the bargain between shareholders and managers — would still exist but wouldn’t be violated by actions authorized by contracts with other capital providers. This, I think, is a better outcome than scrapping altogether the notion of fiduciary duties running to shareholders.

Despite some language that might suggest otherwise, I believe this is the outcome Baird and Henderson are ultimately advocating. The penultimate paragraph of the paper suggests as much:

Board decisions should follow control rights, wherever and in whatever form they are manifest, and courts should largely get out of the way. This means courts should refuse to give creditors fiduciary duties (say in the zone of insolvency), refuse to allow shareholders to use fiduciary duties as a mechanism for upsetting director decisions that increase firm value or are conceivably part of the investors’ ex ante bargain, and refuse to perpetuate the inefficient link between disclosure and fidicuary duties. Directors should take from court decisions the simple maxim that they should do what is in the best interest of the firm, measured from the perspective of the ex ante bargain among investors. This will mean maximizing the firm value in nearly every case, but…sometimes acting in ways that seem selfish but are really just efficient and, when viewed ex ante, value-maximizing.


Keith Sharfman —  14 November 2007

Yet another major airline merger appears to be in the works: United and Delta. This calls for some antitrust analysis. A few months ago, Thom did a thorough job analyzing the antitrust aspects of AirTran’s proposed takeover of Midwest. The key point in Thom’s analysis was that assessment of an airline merger’s economic effects properly centers not on the merging parties’ overall market shares but rather on the extent to which the two firms compete head-to-head.

United and Delta are large carriers, the second and third largest in the industry. If one uses overall industry market shares to calculate HHI in the merger analysis, the transaction would seem presumptively unlawful. But if one looks at the actual routes on which the two airlines compete and the level of competition currently present on those routes from other carriers, the picture may look very different. If it is the case that the two firms now compete head-to-head only (or largely) on routes that are are served by a large number of carriers, then the firms’ high overall market shares may not matter very much.

That said, a note of caution. In a major airline asset acquisition some years ago, American/TWA, the firms argued that the transaction should be permitted on the ground that TWA (then in bankruptcy) was a “failing firm” and that therefore the transaction’s effect on HHI was not dispositive. The enforcement authorities (wrongly) bought into this argument and permitted the transaction, even though TWA’s airplanes would not have “left the industry” (the relevant standard under a failing firm theory) if they had been sold to the second highest bidder rather than to American. Commercial airplanes are a long term, durable capital good that can’t easily be converted into other uses. Sure TWA’s creditors wanted to maximize the value of TWA’s assets. But that’s not a reason to relax the requirements of antitrust law any more than it would be to permit a bankruptcy debtor to violate the Clean Water Act.

As with TWA, neither United’s nor Delta’s planes will disappear from the market if the deal is blocked, nothwithstanding the firms’ recent bankruptcies and the financial woes that chronically plague the industry. The United/Delta deal should be assessed solely on the basis of its competitive effects. The failing firm argument has no place here, and the parties should not assume that the enforcement authorities will treat them as generously as they treated American and TWA.

I’ve previously hypothesized that the persistence of legal rules that lead to less overall wealth but seemingly more equitable distributions (rules such as the insider trading ban and Regulation FD) may stem from the fact that individuals are “hard-wired” to favor fairness, even if they must sacrifice some wealth to achieve it. That seems to be one of the lessons of the Ultimatum Game, in which offerees routinely sacrifice wealth in order to protest proposed allocations they deem to be unfair. (I describe the Ultimatum Game in the post linked above.)

I also observed that there are reasons to believe there’s an evolutionary basis for this taste for fairness (and willingness to pay for it). Primatologists have observed that monkeys trained to exchange a pebble for a cucumber slice (a very good deal for the monkeys!) will quit making such beneficial exchanges if they observe other monkeys receiving more favorable treatment, such as a yummy grape for the pebble. The put-upon monkeys are apparently willing to suffer a wealth loss in order to protest what they perceive to be an inequitable outcome. Thus, I argued, there appears to be some evolutionary basis for the results of the Ultimatum Game.

So what am I to make of new research showing that chimpanzees playing the Ultimatum Game will not reject “unfair” offers? The chimps appear to take the seemingly rational view that it’s better to have some wealth, even if others get an unfairly large portion, than to have no wealth.

Wonder what a society of chimps would make of John Edwards’ candidacy?

(HT: Mizzou Law alumnus, Evan Fitts)