Monday, May 9, 2011

The Appearance of Reality: States as Laboratory

This is the sixth post in my effort to clarify corporate governance terms and concepts that now seem misleading to me. We all know what these words mean in a literal sense but in the context of governance, of business and of our post-crash world do they still mean the same thing?
I look forward to your comments.

States as Laboratory
Recently, when the possibility of a federal provision for shareholder access to the proxy ballot was proposed, the BRT wrote, “Recent SEC rules on proxy access, however, would impose a “one-size-fits-all” mandate and exacerbate focus on the short-term rather than long-term value creation… Congress should rescind the authority it gave the SEC on proxy access. This responsibility should remain in the purview of states and individual companies and their shareholders.” [1]
Throughout American history, whenever the federal government has threatened involvement in areas of regulation – or more particularly, areas governed by state law – the affected parties evoke the beguiling image of state innovation and creativity and claim state sovereignty to be under attack. This usually worthwhile experimentation stimulated by competition among the states is, or has become, seriously flawed in the area of corporate governance. Competition only works if the states must bear the costs of the benefits they provide to entice corporations.  Imagine, for example, that a state had the authority to exempt corporations from all federal environmental laws. Many states would enact this legislation to encourage corporations to incorporate there, while safe in the knowledge that most of the factories would be located elsewhere – along with the pollution, workers issues, health costs, etc. Economists call these costs externalities, and they is the problem with state corporation law. When a state can collect all of the benefit of corporate domicile but accrue none of the losses then they have no reason to address governance issues.
Are there any reasons that fundamental governance provisions should remain in the province of the states? At the risk of being simplistic, states want to attract corporations to charter (and locate) with their borders. This enhances tax revenue and employment with no correlative costs and is thus a reduction in the taxes for the present citizenry. Citigroup moving to North Dakota to take advantage of the absence of usury laws is an example of this. Corporate domicile is decided as a practical matter by the incumbent management. While statutes recite the need for shareholder approval, a careful reading by management usually provides the view that the capacity to pose the issue for a vote rests elsewhere.  
And the same goes for the removal of corporate directors. Outside of the United States, shareholders in all OECD countries have the right (5%) to call a special meeting at which any or all directors may be removed with or without cause. This simple right is denied shareholders in Delaware. Just to be clear, they have the right to remove, but they have no right to call a meeting at which to exercise that right. Delaware corporate law is as flagrantly pro management as possible; stopping just short of raising a level of outrage that would generate support for federalization of corporate law.
And yet, Delaware with an alert and intelligent judiciary and bar is by no means the worst.  There is much evidence of “race to the bottom” in the competition between states. Consider for example the legislative response to Justice Powell’s opinion, reversing prior precedent [CTS Corp v. Dynamics Corporation of America], that state anti-trust laws were within the scope of the Federal Constitution. The Commonwealth of Pennsylvania twice broke every known barrier to protect local companies, Armstrong World Industries and Sovereign Bank.
There is precious little evidence that states will enact provisions threatening to the existing corporate power arrangements. And so, the Business Roundtable’s exhortation can be understood as a defense of the status quo. The gap between the glib language of the BRT and the realities of the corporate governance world is large.
#1 – Is an effective system of corporate governance possible under the present American combination of federal and state laws and stock exchange regulation?
#2 – Is any system of corporate governance legitimate unless it includes the informed motivated and effective involvement of shareholders?
#2 – Is there a way to empower shareholders to act “economically rationally” in asserting their own interests?

[1] Business Roundtable – Roadmap for Growth, December 8, 2010
May 9, 2011 in corporate domicile , corporation law , proxy , corporate governance , Disinformation  |  2 comments  | 

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Posted by Lauren Kinsey on May 12, 2011 at 4:05 PM
#1 - No. I believe we need laws that are not biased toward the global courtship of capital and corporations. I believe we need laws that are for the benefit of the people.

#2 - No. Corporate governance is only legitimate when it includes the informed and effective involvement of shareholders and stakeholders.

#3- I'm not sure. If there could be some third party entity, that wasn't captured by the corporations, giving shareholders accurate information, perhaps.
Posted by Lauren Kinsey on May 12, 2011 at 3:52 PM
I believe there are many things we need to change to make the system work.
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