Major index fund operators have been criticized as ineffective stewards of the firms in which they are now the largest shareholders. While scholars debate whether this passivity is a serious problem, index funds’ generally docile approach to ownership is broadly acknowledged. However, this Article argues that the notion that index funds are passive owners overlooks an important dimension in which index funds have demonstrated outspoken, confrontational, and effective stewardship. Specifically, we document that index funds have taken a leading role in challenging management and voting against directors in order to advance board diversity and corporate sustainability. We show that index funds have engaged in a pattern of competitive escalation in their policies on environmental, social, and governance (“ESG”) issues. Index funds’ confrontational and competitive activism on ESG issues is hard to square with their passive approach to more conventional corporate governance questions. To explain this dichotomy in approaches, we argue that index funds are locked in a fierce contest to win the soon-to-accumulate assets of the millennial generation, who place a significant premium on social issues in their economic lives. With fee competition exhausted and returns irrelevant for index investors, signaling a commitment to social issues is one of the few dimensions on which index funds can differentiate themselves and avoid commoditization. For index funds, the threat of millennial migration to another fund is more significant than the threat of management retaliation. Furthermore, managers themselves, we argue, face intense pressure from their millennial employees and customers to respond to their social preferences. This three-dimensional millennial effect—as investors, customers, and employees—we argue, is an important development with the potential to provide a counterweight to the wealth-maximization paradigm of corporate governance. We marshal evidence for this new dynamic, situate it within the existing literature, and consider the implications for the debate over index funds as shareholders and corporate law generally.
This Article shows that a variety of fundamental rules of corporate law are based on myth. The Article explains that the myths on which corporate law is based play an important role in attracting public acceptance and support for what otherwise would likely be unpopular and controversial regulations. Thus, one can view the role played by myth in corporate law in a particular context as having either positive or negative characteristics depending on one’s opinion of the social value of the underlying legal rule that is being buttressed and affirmed by the myth.
Four political and sociological myths that continue to play important roles in law are examined. These are: (1) the myth that corporations are owned by their shareholders and represent ownership interests in businesses rather than mere financial claims on the cash flows of those businesses, coupled with certain political (voting) rights that protect those claims; (2) the “shareholder value myth,” that corporate officers and directors are legally required to maximize firm value; (3) that subsidiary companies are entirely independent from and not subject to the control of their parent companies and must remain so in order for the parent company to avoid liability for the contract and tort debts of the subsidiary under various alter ego and piercing the corporate veil theories of corporate law; and (4) the legal regulation of insider trading is justified because of the necessity of creating a “level playing field” among participants in financial markets. Reasonable people can disagree about whether the role played by these myths is normatively positive or negative in each of these contexts.
Article | Corporate LawThe Law of Corporate Investigations and the Global Expansion of Corporate Criminal Enforcement by Jennifer Arlen* […]
Big investment managers, such as Vanguard and Fidelity, have accumulated an astonishing amount of common stock in America’s public companies—so much that they now have enough corporate votes to control entire industries. What, then, will these big managers do with their potential power?
This Article argues that they will do less than we might think. And the reason is paradoxical: the biggest managers are too big to be activists. Their great size creates intense internal conflicts of interest that make aggressive activism extremely difficult or even impossible.
The largest managers operate hundreds of different investment funds, including mutual funds, hedge funds, and other vehicles that all invest in the same companies at the same times. This structure inhibits activism, because it turns activism into a source of internal conflict. Activism by one of a manager’s funds can damage the interests of the manager’s other funds. If a BlackRock hedge fund invests in a company’s equity, for instance, at the same time a BlackRock mutual fund invests in the company’s debt, then any attempt by either fund to turn the company in its favor will harm the interests of the other fund. The hedge fund and mutual fund might similarly come into conflict over the political and branding risks of activism and the allocation of costs and profits. Federal securities regulation and poison pills can create even more conflicts, often turning activism by a hedge fund into serious legal problems for its manager’s entirely passive mutual funds. A big manager, in other words, is like a lawyer with many clients: its advocacy for one client can harm the interests of another.
The debate about horizontal shareholding and index fund activism has ignored this truth. Research on horizontal ownership tends to treat a manager and its funds as though they were a single unit with no differences among them. Traditional analyses of institutional shareholder activism tend to go the opposite direction, treating mutual funds as though they were totally independent with no connection to other funds under the same management.
By introducing a subtler understanding of big managers’ structures, I can make sense of shareholder activism more clearly. Among other things, I show why aggressive activism tends to come entirely from small managers—that is, from the managers whose potential for activism is actually the weakest.
In a 2017 Virginia Law Review article, The Untenable Case for Perpetual Dual-Class Stock, Professors Lucian Bebchuk and Kobi Kastiel argued that time-based sunset provisions (the forced unification of shares into one share structure with equal voting rights after a certain period of time) should be a mandatory feature of dual class share structures (classes of common stock with unequal voting rights). This article has recently been used as authority by the Council of Institutional Investors (“CII”) to petition to the NASDAQ Stock Market (“NASDAQ”) and the New York Stock Exchange (“NYSE”) to amend their listing standards. The requested amendments would require companies seeking to go public with dual class shares to include in their certificates of incorporation a time-based sunset provision that would go into effect no more than seven years after the initial public offering (“IPO”) unless minority shareholders vote to extend it up to an additional seven years. This delayed unification based on a shareholder vote is incorporated in Bebchuk and Kastiel’s argument.
This Article, which is based on comment letters I sent in response to the CII’s petitions, argues that such a mandatory provision would be extremely unwise and harmful to our most important public companies and their shareholders, current as well as future. As a creation of private ordering, the absence of time-based sunset provisions in dual class share structures serves a significant value enhancing purpose. It prevents the risk that a premature and therefore sub-optimal unification of shares may occur. This risk has so far been ignored by those advocating for the implementation of a mandatory time-based sunset provision. As subsequently discussed, this risk has been ignored because their analysis lacks an appreciation for how the positive skewness in stock market returns negatively impacts the value of mandatory time-based sunset provisions.
In 2005, the perception that wealthy executives were being rewarded for failure led Congress to ban Chapter 11 firms from paying retention bonuses to senior managers. Under the new law, debtors could still pay bonuses to executives—but only “incentive” bonuses triggered by accomplishing challenging performance goals that go beyond merely remaining employed. This Article uses newly collected data to examine how this reform changed bankruptcy practice. While relatively fewer firms use court-approved bonus plans after the reform, the overall level of executive compensation appears to be similar, perhaps because the new regime left large gaps that make it easy for firms to bypass the 2005 law and pay managers without the judge’s permission. This Article argues that the new law was undermined by institutional weaknesses in Chapter 11, as bankruptcy judges are poorly situated to analyze bonus plans and creditors have limited incentives to police executive compensation themselves.
What are business entities for? What are security interests for? The prevailing answer in legal scholarship is that both bodies of law exist to partition assets for the benefit of designated creditors. But if both bodies of law partition assets, then what distinguishes them? In fact, these bodies of law appear to be converging as increasing flexibility irons out any differences. Indeed, many legal products, such as securitization vehicles, insurance products known as captive insurance, and mutual funds, employ entities to create distinct asset pools. Moreover, recent legal innovations, including “protected cells” (which were created to facilitate such products), further blur the boundaries between security interests and entities, suggesting that convergence has already arrived.
This Article identifies and defends a central distinction between business entities and security interests. We argue that while both bodies of law support asset partitioning, they do so with different priority schemes. Security interests construct asset pools subject to fixed priority, meaning that the debtor is unable to pledge the same collateral to new creditors in a way that changes the existing priority scheme. Conversely, entities are associated with floating priority, whereby the debtor retains the freedom to pledge the same assets to other creditors with the same or even higher priority than existing ones.
One of the most enduring debates in corporate law centers on why Delaware has become the dominant state in the market for corporate charters. Traditionally, two perspectives dominated the debate, the “race-to-the-top” perspective that sees competition among states as driving legal rules toward efficiency and the “race-to-the-bottom” perspective that sees competition among states as driving legal rules toward the interests of corporate managers. The two dominant perspectives have struggled to explain why approximately half of large companies incorporate in Delaware, while the other half incorporate in their home states. Whether the choices are attributable to the quality of state law, the characteristics of the companies themselves, or both has given rise to a large, but inconclusive empirical literature.
The integrity of shareholder voting is critical to the legitimacy of corporate law. One threat to this process is proxy “bundling,” or the joinder of more than one separate item into a single proxy proposal. Bundling deprives shareholders of the right to convey their views on each separate matter being put to a vote and forces them to either reject the entire proposal or approve items they might not otherwise want implemented.
In this Paper, we provide the first comprehensive evaluation of the anti-bundling rules adopted by the Securities and Exchange Commission (“SEC”) in 1992. While we find that the courts have carefully developed a framework for the proper scope and application of the rules, the SEC and proxy advisory firms have been less vigilant in defending this instrumental shareholder right. In particular, we note that the most recent SEC interpretive guidance has undercut the effectiveness of the existing rules, and that, surprisingly, proxy advisory firms do not have well-defined heuristics to discourage bundling.
This Article addresses the proposition advanced by academic and press commentators that European corporation law promotes stockholder welfare better than its U.S. counterpart. Those who express that view often point to the stronger rights afforded to stockholders under the laws of the European member states, including the non-frustration rule, the ability of stockholders to take direct action by calling a special meeting and replacing directors, and rules that aim to provide equal treatment for all target stockholders. But claiming that stockholders are economically better off as a result of the literal law on the books is akin to judging the Soviet Union’s protection of human freedom by reading its constitution. That is, if one looks only at the Soviet Constitution on paper, one might conclude that it was a model of liberalism because it provided for separation between church and state, freedom of speech, freedom of the press, and freedom of assembly. But in reality, the Soviet citizens were unable to exercise any of those rights. In an admittedly far less extreme way, the claim that European corporate law better advances stockholder welfare than the U.S. approach relies upon a similar misplaced emphasis on paper rights. This Article proposes that scholars who tout Europe as a stockholder paradise slight the social and regulatory context in which laws operate, and elide the fact that American corporate law creates a system where directors have an intense focus on generating stockholder profits.