Archives For lynn stout

UCLA’s Milken gift

Larry Ribstein —  23 August 2011

The NYT discusses a controversy at UCLA (mainly, it seems, involving objections by Lynn Stout) to the $10 million gift it just announced from Lowell Milken, Michael’s brother.  Lowell was accused many years ago in connection with his brother’s securities violations and escaped prosecution because of his brother’s plea deal. Steve Bainbridge comments in response to the NYT story, discussing this ancient history:

Some of us who were active in the field at the time–as I was–remember the story a bit differently. In our view, the government used threats to go after Lowell as one of the ways on which they coerced Michael into taking a plea deal.

I have more perspective in my paper, Imagining Wall Street.  There I note that Oliver Stone’s film Wall Street

may have helped create an environment that became increasingly unfriendly to takeovers.  In the year following the film’s release, Drexel and Milken were prosecuted, eventually culminating in the fining and jailing of Milken along with many others in the takeover game, and the demise of Drexel Burnham. Milken pleaded guilty and was sentenced to ten years in jail.68 [United States v. Milken, No. (S) 89Cr.41(KMW), 1990 WL 264699 (S.D.N.Y. Nov. 21, 1990)]  * * * It is hard to say how much of that attitude was based on actual events reported in the media, and how much on the fiction Wall Street helped create. Milken was prosecuted not for insider trading, but rather for technical violations of the Williams Act—that is, using Boesky to accumulate non-disclosed positions in target shares.69 [Id. at 4]

In short, there is a big question whether Lowell’s history is such as to taint UCLA by his gift.

But I am not unsympathetic with the idea that law schools are supposed to be teaching their students that ethics trumps money, and so should be careful about whom they take money from, and more generally the company they keep. Indeed, for that reason I wrote critically last year about Bill Lerach’s foray into law teaching.

The real question here is where you draw the line and who decides.  Is the decision to turn down a gift based on ethics or politics?  More to the point, would the same people who oppose the Milken gift also object to an association with Lerach?

And how do you balance those considerations against the institution’s needs?  Interestingly, Professor Stout has written extensively about the need to take the interests of all constituencies into account in corporate decision-making.  Where would UCLA’s students stand in the decision Professor Stout favors to reject the Milken gift?

Lynn Stout, writing in the Harvard Business Review’s blog, claims that hedge funds are uniquely “criminogenic” environments.  (Not surprisingly, Frank Pasquale seems reflexively to approve):

My research, shows that people’s circumstances affect whether they are likely to act prosocially. And some hedge funds provided the circumstances for encouraging an antisocial behavior like not obeying the laws against insider trading, according to these investigations.

* * *

Recognizing that some hedge funds present social environments that encourage unethical behavior allows us to identify new and better ways to address the perennial problem of insider trading. For example, because traders listen to instructions from their managers and investors, insider trading would be less of a problem if those managers and investors could be given greater incentive to urge their own traders to comply with the law, perhaps by holding the managers and investors — not just the individual traders — accountable for insider trading. Similarly, because traders mimic the behavior of other traders, devoting the enforcement resources necessary to discover and remove any “bad apples” before they spoil the rest of the barrel is essential; if the current round of investigations leads to convictions, it is likely to have a substantial impact on trader behavior, at least for a while. Finally, insider trading will be easier to deter if we combat the common but mistaken perception that it is a “victimless” crime.

Rather than re-post the whole article, I’ll direct you there to see why she thinks hedge funds are so uniquely anti-social.  Then I urge you to ask yourself whether she has actually demonstrated anything of the sort.  Really what she demonstrates, if anything, is that agency costs exist.  Oh, and people learn from their peers.  Remarkable!  And this is different than . . . the rest of the world, how?  There are Jewish people in the world, a lot of them work on Wall Street, and many of them attend synagogue.  No doubt Jews mimic the behavior of other Jews.  Bernie Madoff was Jewish.  The SEC should be raiding temples all across New York, New Jersey and Connecticut!

The point is that she has no point, and directing her pointless observations toward hedge funds in particular is just silly (and/or politically expedient).  There are bad apples everywhere.  There are agency costs everywhere.  A police state could probably reduce the consequences of these problems (but don’t forget corruption (i.e., bad apples) in the government!).  The question is whether it’s worth it, and that requires a far more subtle analysis than Stout provides here.

And all of this is because insider trading really needs to be eradicated, according to Stout:

Of course, insider trading isn’t really victimless: for every trader who reaps a gain using insider information, some investor on the other side of the trade must lose. But because the losing investor is distant and anonymous, it’s easy to mistakenly feel that insider trading isn’t really doing harm.

Actually, the reason most people feel that insider trading isn’t really doing harm is because it isn’t.

I’ll leave the synopsis of the argument to Steve Bainbridge.  On the adverse selection argument, see Stanislav Dolgopolov.  Sure, there is debate.  Empirics are hard to come by.  But the weight of the evidence and theory, especially accounting for enforcement costs (one study even seems to suggest that making insider trading illegal actually induces more insider trading to occur (and impedes M&A activity)), is decidedly against Stout’s naked assertion.  The follow on claim that, in essence, agency costs justify stepped up dawn raids at hedge funds is even more baseless.

I am privileged to have the opportunity to travel to Palo Alto next week alongside my senior colleague Prof. Todd Zywicki to participate in a conference on The Constitution in the Financial Crisis organized by the Stanford Constitutional Law Center.  I will in large part be discussing my work in this area, including Treasury Inc.: How the Bailout Reshapes Corporate Theory and Practice as well as The Bailout Through A Public Choice Lens: Government-Controlled Corporations As A Mechanism for Rent Transfer.  More details on how to confirm registration are available here, and also below:

About the Event: Leading scholars in law, economic history, and monetary policy will discuss the constitutional questions that have been raised by the financial crisis and the government response. Panels will consider the government’s role as shareholder and its implications for corporate governance and for bankruptcy, the ability of the executive branch to respond to a crisis, the place of the Federal Reserve in our constitutional system; and, cutting across many of these subject areas, the question of discretion.

The conference will feature the following speakers:

Thursday, November 11

Welcome and Introductory Remarks by Michael W. McConnell, Stanford

The Executive in Crisis:  Constitutional Capabilities
· Moderator : Hon. Carlos Bea, U.S. Court of Appeals for the Ninth Circuit
· David Barron, Harvard
· Mariano-Florentino Cuèllar, Stanford
· Gillian Metzger, Columbia
· Saikrishna Prakash, Virginia

Bankruptcy and the Rule of Law
· Moderator: Hon. William Fletcher, U.S. Court of Appeals for the Ninth Circuit
· Marcus Cole, Stanford
· Stephen Lubben, Seton Hall
· David Skeel, Penn
· Todd Zywicki, George Mason

Friday, November 12

The Federal Reserve in Our Constitutional System
· Moderator: Larry Kramer, Stanford
· Allan Meltzer, Carnegie Mellon
· John Taylor, Stanford
· Michael W. McConnell, Stanford
· John Steele Gordon, Author

The Government as Shareholder: The Implications for Corporate Governance
· Moderator: Joseph Grundfest, Stanford
· Jonathan Macey, Yale
· Edward Rock, Penn
· Lynn Stout, UCLA
· J.W. Verret, George Mason

Rules and Standards Revisited: Discretion in the Financial Crisis
· Moderator: Jane Schacter, Stanford
· Kenneth Anderson, American
· Louis Kaplow, Harvard
· Eric Posner, Chicago
· Kenneth Scott, Stanford

Concluding Remarks by Michael W. McConnell, Stanford

Congratulations to Professor Joe Grundfest of Stanford Law School for being selected to present this year’s 26th Annual F.G. Pileggi Distinguished Lecture in Law.  It is a great event and I highly recommend attending.  If by chance you can’t make it, be sure to read the resulting article in the Delaware Journal of Corporate Law, which is a part of the award and has contributed to the high reputation of the Del. J. Corp. L. over the years.

The Pileggi Lecture is sort of the the Corporate Law Academy’s version of the Screen Actor’s Guild Lifetime Achievement Award.  The award was named in honor of Francis G. Pileggi, father of Francis G.X. Pileggi.  The award began in 1985, a watershed year for the Delaware courts, when our blog neighbor Francis G.X. Pileggi was Managing Editor of the Delaware Journal of Corporate Law and wanted to develop a way for top scholars across the country to engage in a regular dialogue with the Delaware bench and bar.  Some of the most notable scholars in the field have given the lecture over the last 26 years, including Stephen Bainbridge, Larry Ribstein, Ed Rock, Mark Roe, Hillary Sale, Robert Thompson, Melvin Eisenberg, Lynn Stout, Charles Elson, Ron Gilson, Joel Seligman, Don Langevoort, Jack Coffee, Harvey Pitt, Louis Loss, and Ralph Winter among others.

Congrats Professor Grundfest and to Francis and the students and staff at the Delaware Journal of Corporate Law for this fantastic event.

Incidentally, here’s an interesting question…people seem to like handicapping the Oscars and the elections, so I’ll ask our readers to take a look at the list of prior recipients.  Who do you think the smart money is on for next year?  As an untenured guy it is probably smart if I don’t make guesses, but you should feel free to in the comments, by email or on your blogs and I will report what our readers say.

Lynn Stout from UCLA School of Law just posted a paper on SSRN entitled “The Mythical Benefits of Shareholder Control.” The article is forthcoming in the Virginia Law Review. Here’s the abstract:

In ‘The Myth of the Shareholder Franchise‘ [also forthcoming in the Virginia Law Review], Professor Lucian Bebchuk argues that the notion that shareholders in public corporations can remove directors is a myth. The same argument was made by Berle and Means in 1932. Not only is shareholder power to remove directors largely a myth in U.S. public companies, it has been widely recognized as a myth for three-quarters of a century.What should we conclude from this? Professor Bebchuk concludes the time has come make shareholder power a reality. But there are many myths – vampires, alligators in the sewers – we would not want to make real. Part I of this Response to Professor Bebchuk’s article argues that we should not want to make shareholder power to oust directors more real because, while board control worsens agency costs, it offers important economic benefits to shareholders as well. In particular, board control promotes efficient and informed decisionmaking; discourages intershareholder opportunism; and encourages valuable specific investment in corporate team production.

Because board control has costs and benefits, theory cannot tell us whether we should make it easier for shareholders to oust directors. We must look to the evidence. Part II concludes the evidence does not support Bebchuk’s proposal. To the contrary, it suggests shareholders in public firms reap net benefits from board control.

Why then do so many observers believe shareholders need more power over boards? Part III argues that calls for “shareholder democracy” appeal to the media and many observers not because they are based on evidence, but because of emotion. The emotional appeal of shareholder power can be traced to three sources; the common but misleading metaphor that shareholders “own” corporations; the opportunistic calls of activists seeking leverage over boards for self-interested reasons; and a strong but unfocused sense that something (anything!) should be done in the wake of recent corporate scandals. The result has been widespread propagation of a second myth – the myth that shareholder control of public companies benefits shareholders. The Response concludes by reminding readers of the dangers of policymaking based on myth rather than evidence, using the cautionary case of stock options.

I read the article with interest for a number of reasons, including that it is timely in light of the featured discussion of “Who’s the Boss?” between Profs. Smith and Bainbridge over at Point of Law, and I heavily cited Bebchuk’s piece in my latest article “The Case Against Mandatory Annual Director Elections and Shareholders’ Meetings.” I was particularly interested in Part II of the article, “Empirical Evidence Favoring Board Power” (Note that a mere two days ago Mike Guttentag in a comment on the Glom re: the “Who’s the Boss?” discussion posited “[s]ince we appear to be moving into the golden age of empirical legal scholarship, the next question to address would seem to be: what is the evidence (other than past precedent) that the extent of authority granted the board is about right, too little or too much? ” See here.). However, I found the article disappointing on this front. It points out that investors can choose which firm’s shares they buy and firms can choose through there governing documents how much power to allocate to shareholders. It then cites some unnamed studies indicating “that equity investors generally don’t prefer companies that give them stronger rights.” The article points out that during the 1990s between 34% and 82% of IPO companies had staggered boards, a feature that weakens shareholder rights. Further, the article notes that Google went public with a dual-class capitalization, a feature “that left outside investors largely powerless.” Yet, investors nonetheless gobbled up the shares. This, the article asserts, indicates “investors ‘revealed’ a preference for a firm in which they themselves had almost no power,” and serves as “compelling empirical evidence that investors themselves often prefer weak shareholder rights.”

The article fails to address, however, an alternative explanation–the IPO price for Google reflected a lack-of-control discount. Yes, this would mean that the Google guys “could have raise[d] more money by offering shareholders more control.” But perhaps the Google guys concluded that the benefit of the retained control outweighed the price, i.e., the lack-of-control discount. I don’t know whether this alternative explanation is correct, but it seems entirely plausible. And it would not support a claim that investors preferred a firm where “they themselves had almost no power,” but instead a requirement that they be compensated for giving up power. Hence, I think the question Mike raises remains open.