Docsity
Log inSign up
Docsity
Prepare for your exams
Prepare for your exams

Study with the several resources on Docsity

Earn points to download
Earn points to download

Earn points by helping other students or get them with a premium plan

Guidelines and tips
Guidelines and tips
Sell on Docsity
Sell on Docsity
Log inSign up

Prepare for your exams

Study with the several resources on Docsity

Find documents

Prepare for your exams with the study notes shared by other students like you on Docsity

Search Store documents

The best documents sold by students who completed their studies

Search through all study resources
Docsity AINEW

Summarize your documents, ask them questions, convert them into quizzes and concept maps

Explore questions

Clear up your doubts by reading the answers to questions asked by your fellow students

Earn points to download

Earn points by helping other students or get them with a premium plan

Share documents
download point icon20 Points

For each uploaded document

Answer questions
download point icon5 Points

For each given answer (max 1 per day)

All the ways to get free points
Get points immediately

Choose a premium plan with all the points you need

Study Opportunities

Choose your next study program

Get in touch with the best universities in the world. Search through thousands of universities and official partners

Community

Ask the community

Ask the community for help and clear up your study doubts

University Rankings

Discover the best universities in your country according to Docsity users

Free resources

Our save-the-student-ebooks!

Download our free guides on studying techniques, anxiety management strategies, and thesis advice from Docsity tutors

From our blog

Exams and Study
Go to the blog

A Taxonomy of Mechanisms for Regulating Corporate Conduct, Study notes of Corporate Finance

Cornell CollegeCorporate Finance

Corporate discourse often distinguishes between internal and external regulation of corporate behavior. The former refers to internal decisionmaking.

Typology: Study notes

2022/2023

Uploaded on 05/11/2023

sadayappan
sadayappan 🇺🇸

4.5

(15)

246 documents

1 / 37

Toggle sidebar

This page cannot be seen from the preview

Don't miss anything!

bg1
BEYOND INTERNAL AND EXTERNAL: A TAXONOMY
OF MECHANISMS FOR REGULATING CORPORATE
CONDUCT
ANN M. LIPTON∗
Corporate discourse often distinguishes between internal and external
regulation of corporate behavior. The former refers to internal decisionmaking
processes within corporations and the relationships between investors and
corporate managers, and the latter refers to the substantive mandates and
prohibitions that dictate how corporations must behave with respect to the rest
of society. At the same time, most commenters would likely agree that these
categories are too simplistic; relationships between investors and managers are
often regulated with a view toward benefitting other stakeholders.
As a result, this Article will seek to develop a taxonomy of tactics
available to, and used by, regulators to influence corporate conduct, without
regard to their nominal categorization of “external” or “internal” (or
“corporate” and “non-corporate”) in order to shed light on how those
categories both obscure and misdescribe the existing regulatory framework.
By reframing the shareholder/stakeholder debate, we can identify underutilized
avenues for encouraging prosocial, and discouraging antisocial, corporate
action, and recognize areas of contradiction and incoherence in current
regulatory policy. Finally, this exercise will demonstrate how corporations, far
from being “privately” ordered, are in fact the product of an overarching set of
choices made by state actors in the first instance.
Introduction ........................................................................................... 658
I. The First Method: Controlling Corporate Agents ...................... 661
II. The Second Method: Enlisting Private Actors to Control
Corporations ............................................................................... 662
III. The Third Method: Shaping the Corporate Form to Influence
Its Function ................................................................................ 664
A. Facilitating “Good” Decisionmaking .................................. 666
B. Incapacitation ...................................................................... 671
C. Promoting Public Participation ........................................... 678
D. Build a Better Shareholder .................................................. 681
1. Agenda Setting .............................................................. 681
2. Shareholder Architecture .............................................. 684
Conclusion ............................................................................................ 692
∗ Michael M. Fleishman Associate Professor in Business Law and
Entrepreneurship, Tulane Law School. I am grateful for the thoughtful comments of Adam
Feibelman, Elizabeth Pollman, the participants in The New Realism in Business Law and
Economics conference hosted by the University of Minnesota Law School, and the
participants in the Fourth Annual Tulane Corporate and Securities Roundtable.
pf3
pf4
pf5
pf8
pf9
pfa
pfd
pfe
pff
pf12
pf13
pf14
pf15
pf16
pf17
pf18
pf19
pf1a
pf1b
pf1c
pf1d
pf1e
pf1f
pf20
pf21
pf22
pf23
pf24
pf25

Partial preview of the text

Download A Taxonomy of Mechanisms for Regulating Corporate Conduct and more Study notes Corporate Finance in PDF only on Docsity!

BEYOND INTERNAL AND EXTERNAL: A TAXONOMY

OF MECHANISMS FOR REGULATING CORPORATE

CONDUCT

ANN M. L IPTON∗

Corporate discourse often distinguishes between internal and external regulation of corporate behavior. The former refers to internal decisionmaking processes within corporations and the relationships between investors and corporate managers, and the latter refers to the substantive mandates and prohibitions that dictate how corporations must behave with respect to the rest of society. At the same time, most commenters would likely agree that these categories are too simplistic; relationships between investors and managers are often regulated with a view toward benefitting other stakeholders. As a result, this Article will seek to develop a taxonomy of tactics available to, and used by, regulators to influence corporate conduct, without regard to their nominal categorization of “external” or “internal” (or “corporate” and “non-corporate”) in order to shed light on how those categories both obscure and misdescribe the existing regulatory framework. By reframing the shareholder/stakeholder debate, we can identify underutilized avenues for encouraging prosocial, and discouraging antisocial, corporate action, and recognize areas of contradiction and incoherence in current regulatory policy. Finally, this exercise will demonstrate how corporations, far from being “privately” ordered, are in fact the product of an overarching set of choices made by state actors in the first instance.

Introduction........................................................................................... 658

I. The First Method: Controlling Corporate Agents ...................... 661

II. The Second Method: Enlisting Private Actors to Control

Corporations ............................................................................... 662

III. The Third Method: Shaping the Corporate Form to Influence

Its Function ................................................................................ 664

A. Facilitating “Good” Decisionmaking.................................. 666

B. Incapacitation ...................................................................... 671

C. Promoting Public Participation ........................................... 678

D. Build a Better Shareholder.................................................. 681

1. Agenda Setting .............................................................. 681

2. Shareholder Architecture .............................................. 684

Conclusion ............................................................................................ 692

∗ Michael M. Fleishman Associate Professor in Business Law and Entrepreneurship, Tulane Law School. I am grateful for the thoughtful comments of Adam Feibelman, Elizabeth Pollman, the participants in The New Realism in Business Law and Economics conference hosted by the University of Minnesota Law School, and the participants in the Fourth Annual Tulane Corporate and Securities Roundtable.

658 WISCONSIN LAW REVIEW

I NTRODUCTION

One of the oldest debates in corporate law concerns whether

corporations should be run to benefit only their investors, or whether

instead corporations should be run with a view to benefitting society as a

whole.^1 In many ways, though, that frame is misleading. No one disputes

that corporations exist in order to contribute to society and to promote

human flourishing. We charter corporations, and develop rules regarding

their form, in the expectation that organizers will employ the form to

innovate, grow the economy, provide desirable goods and services, and

generate wealth for investors, employees, and contracting parties.

At the same time, few would dispute that corporations pose risks to

society. Their limited liability feature may create moral hazards that

ultimately result in uncompensated harm to third parties. Because

corporations may marshal staggering resources contributed by hundreds

or thousands of people, they are capable of inflicting injuries on a scale far

greater than most individuals acting alone can manage. For good or ill,

they may exercise significant influence over the political system, and via

sheer size, exert quasi-regulatory power over everyday life, dictating

everything from working conditions to consumers’ privacy rights.^2

As a result, we have developed myriad legal systems designed to

encourage corporate behavior that society believes to be prosocial, so as

to protect all corporate stakeholders. Labor law, environmental law,

consumer protection law, and the like, all exist to protect workers,

consumers, and communities in general from the harms that corporations

can inflict. Simultaneously, corporate and securities laws channel

investment toward profitable and productive business activity, while

protecting investors from exploitation.

In this respect, then, most commenters are stakeholder primacists, in

the sense that they agree that corporations should be run in a manner that

contributes to society as a whole, and that legal systems have a role to play

in ensuring that they do so.^3 Where disputes arise is not about whether

legal rules should encourage the prosocial use of corporate power and

discourage its antisocial use, but about whether the mechanisms by which

the law accomplishes these tasks should vary depending on the corporate

stakeholders whose interests are being protected.

  1. See William W. Bratton & Michael L. Wachter, Shareholder Primacy’s Corporatist Origins : Adolf Berle and The Modern Corporation, 34 J. CORP. L. 99, 143 (2008).
  2. E.g. , Stacy-Ann Elvy, Paying for Privacy and the Personal Data Economy , 117 C OLUM. L. REV. 1369 (2017).
  3. See Stephen M. Bainbridge, Corporate Social Responsibility in the Night- Watchman State , 115 C OLUM. L. REV. SIDEBAR 39, 45 (2015) [hereinafter Bainbridge, Corporate Social Responsibility ] (describing this point as “uncontroversial”).

660 WISCONSIN LAW REVIEW

and protect creditors. Eventually, however, these blanket limits on

business activities proved too stifling, and restrictions were loosened. In

their stead, specialized areas of law were developed to set substantive

limits on the types of business activities that would be required or

prohibited.^9

The rationale for the split was one of efficiency and competency.

Substantive limits on corporate behavior could guide business activities

more effectively than broad-strokes regulation of the corporate form and

could do so without inhibiting beneficial economic expansion. Private

parties could effectively contract with the corporation to protect their own

interests, subject to regulation in the event of market failure.^10 Government

came to be viewed as incompetent to dictate corporate process in a manner

that would both protect third parties and advance business goals.^11

Corporate law—namely, internal arrangements among investors and

managers—was viewed as a body of private arrangements among

contracting parties, providing little reason to regulate terms for the benefit

of nonparties.^12

That origin story, however, is overly simplistic. A plethora of

corporate architectural rules still exist primarily, if not exclusively, as

mechanisms of regulation for the benefit of non-investor constituencies.

Some are controversial—detractors contend they are less effective than

substantive regulation^13 —but not all of them are. More generally, even

“external” regulation depends on, and assumes the presence of, corporate

law rules to function effectively. And today, large corporations are so

complex—and their design so heavily structured by law—that it is simply

not possible to design rules addressing internal relationships without

impacting non-investor constituencies. Refusing to acknowledge this

reality only results in unintended consequences and, less benignly, allows

interested actors to manipulate corporate regulation to achieve their own

externally focused ends.

This Article seeks to develop a taxonomy of mechanisms that can be

used to exert social control over corporate conduct, without regard to

whether particular strategies are characterized as “external” or “internal.”

The hope is that, by focusing on how legal rules operate rather than their

nominal categorization as “corporate law” or “external law,” we can

9. JAMES WILLARD HURST, T HE L EGITIMACY OF THE BUSINESS CORPORATION IN

THE L AW OF THE UNITED STATES 1780-1970, at 161–62 (1970); Adam Winkler, Corporate Law or the Law of Business?: Stakeholders and Corporate Governance at the End of History , 67 L. & CONTEMP. PROBS. 109, 110–11 (2004); Pollman, supra note 4 , at 646–47.

  1. Hansmann & Kraakman, supra note 8.
  2. Griffith, supra note 6 ; Hansmann & Kraakman, supra note 8 , at 446–47.
  3. Jill E. Fisch, Governance by Contract: The Implications for Corporate Bylaws , 106 C ALIF. L. REV. 373, 375–78 (2018); Griffith, supra note 6 , at 2079.
  4. Griffith, supra note 6 ; Steven A. Bank & George S. Georgiev, Securities Disclosure as Soundbite: The Case of CEO Pay Ratios , 60 B.C. L. REV. 1123 (2019).

2020:657 Beyond Internal and External 661

improve our regulatory processes with more strategic interventions that

are more mindful of unintended consequences. As the Article will

demonstrate, corporate function is dictated by its form, and any attempt to

restrict certain tools of corporate regulation solely for use with respect to

investors relative to managers is both unwise and, in a real sense, futile.

I. T HE F IRST M ETHOD: CONTROLLING CORPORATE A GENTS

Companies do not act; individuals within them do.^14 Therefore, the

most obvious way to control corporate behavior is for the legal system to

directly impose obligations on managers to run the corporation in a manner

that accomplishes societal goals.

Perhaps the most fundamental legal obligation imposed on corporate

managers is the fiduciary obligation to advance shareholder interests,

which are assumed to be the attainment of profit.^15 That legal rule exists

to ensure that businesses activities are directed toward productive

endeavors and to protect investors against exploitation. Some have argued

that these duties may incentivize managers to harm third parties in pursuit

of profit; as a result, they have proposed expanding them to require

consideration of third party interests.^16 Yet the legal obligation of wealth

maximization has little practical force and, standing alone, is unlikely to

exert much pull on managerial behavior either way; managers are in fact

incentivized to pursue wealth maximization by other means, discussed in

the next Part.

Beyond fiduciary obligations to shareholders, managers also operate

under a host of other legal mandates. If they cause the company to

participate in fraud, or environmental contamination, or the production of

unsafe products, they will incur direct penalties from relevant authorities.

Some statutes may impose penalties on managers based on negligence, or

even strict liability, when prohibited acts occur within their scope of

authority.^17 The threat of legal sanction (not to mention the collateral

consequences that follow) directly incentivize managers to steer corporate

behavior in socially preferred directions.

  1. Jennifer Arlen & Reinier Kraakman, Controlling Corporate Misconduct: An Analysis of Corporate Liability Regimes , 72 N.Y.U. L. REV. 687 (1997).
  2. Ann M. Lipton, What We Talk About When We Talk About Shareholder Primacy , 69 C ASE W. RES. L. REV. 863, 867 (2019).
  3. See, e.g. , S. 3348, 115th Cong. § 2 (2018).
  4. Thaddeus J. North, Exchange Act Release No. 84500, 2018 WL 5433114 (Oct. 29, 2018); J.S. Nelson, The Corporate Conspiracy Vacuum , 37 C ARDOZO L. REV. 249, 283–90 (2015).

2020:657 Beyond Internal and External 663

profit-generation is only acceptable to the extent it is accomplished via

permissible means. Therefore, a variety of other regulatory mechanisms

are used to make profits easier or harder to achieve depending on corporate

compliance with social norms. The expectation is that shareholders, in

pursuit of profit, will then do public work of selecting managers who

conform with societal dictates and disciplining those who do not.

Most obviously, regulations can require the confiscation of corporate

assets when corporate agents violate the law. These mechanisms are

usually governed by principles of vicarious liability, and the resulting loss

of profit presumably angers shareholders, who then hold managers to

account.^23 Alternatively, the government may provide benefits to the

corporation—tax incentives, or regulatory privileges^24 —when the

corporation engages in prosocial conduct. Or, the state may use its own

purchasing power to favor some types of business conduct over others.^25

The profits occasioned by these programs presumably please shareholders,

who are then incentivized to select managers who will steer the

corporation in directions favored by the state.

More subtly, the government may enact regulations that enhance or

inhibit the ability of other private actors to influence corporate profits, by

increasing their power vis a vis corporations when bargaining for their own

interests. Disclosure regulations—such as those aimed at consumers,^26

employees,^27 and community members^28 —fall into this category, making

about the company’s long-term value, serves a critical role in ensuring that the company is actually meeting the public’s needs.”).

  1. Arlen & Kraakman, supra note 14 , at 699.
  2. Reuven S. Avi-Yonah, Corporations, Society and the State: A Defense of the Corporate Tax , 90 VA. L. REV. 1193, 1246–49 (2004).
  3. E.g. , Steve Janoski, NJ Won't Buy from Gun Manufacturers, Dealers Who Don't Comply with Safety Rules , N ORTH JERSEY RECORD (Sept. 10, 2019), https://www.northjersey.com/story/news/new-jersey/2019/09/10/nj-blocks-gun-sales- unless-manufacturers-meet-its-safety-rules/2275428001/ [https://perma.cc/HFV8-SAV3]; Aimee Pichi, Billionaire Ken Fisher's Sexist Comments Have Cost Him Almost $1 Billion , CBS NEWS (Oct. 18, 2019), https://www.cbsnews.com/news/billionaire-ken-fishers- sexist-comments-have-now-cost-him-almost-1-billion/ [https://perma.cc/HW7S-FUYM]; Ana Swanson, Chinese Investment Pits Wall Street Against Washington , N.Y. T IMES (Oct. 28, 2019), https://www.nytimes.com/2019/10/28/business/china-investment-federal- employees.html [https://perma.cc/7C3W-XKA9]; Nathan Heller, Is Venture Capital Worth the Risk? , T HE NEW YORKER (Jan. 20, 2020), https://www.newyorker.com/magazine/2020/01/27/is-venture-capital-worth-the-risk [https://perma.cc/9Y7S-6J8C].
  4. E.g. , Scot Burton et al., Attacking the Obesity Epidemic: The Potential Health Benefits of Providing Nutrition Information in Restaurants , 96 AM. J. PUB. HEALTH 1669, 1674 (2006).
  5. Cynthia Estlund, Just the Facts: The Case for Workplace Transparency , 63 STAN. L. REV. 351, 396–97 (2011).
  6. Charles M. Lamb et al., HMDA, Housing Segregation, and Racial Disparities in Mortgage Lending , 12 STAN. J. C.R. & C.L. 249, 254–60 (2016); Virginia

664 WISCONSIN LAW REVIEW

it easier for stakeholders to insist that their interests be accommodated

before profits can be achieved. Labor law, writ large, is also intended to

strengthen the bargaining power of employees relative to the corporation,

and thus ensure that profits cannot be achieved without labor’s buy-in.^29

Ultimately, then, the regulatory framework aligns the interests of

shareholders with the interests of the broader society, providing further

incentives for shareholders to select managers who will accommodate a

wide array of corporate stakeholders.^30

Critically, the government’s role here goes well beyond simply

facilitating a market in which private actors may act on their own

preferences; regulation may be designed to either inhibit or alter those

private preferences. For example, nutrition labeling may be designed to

focus consumer attention on calorie counts, which will ultimately

incentivize food manufacturers to offer healthier options.^31 Labels may

also be used to obscure facts about products in order to prevent consumer

choices from influencing corporate behavior.^32

III. T HE T HIRD M ETHOD: SHAPING THE CORPORATE F ORM TO

I NFLUENCE I TS F UNCTION

The final tool that can be used to control corporate behavior is the

corporate architecture itself, namely, the rules that govern the form, its

Harper Ho, Nonfinancial Risk Disclosure and the Costs of Private Ordering , 55 AM. BUS. L.J. 407, 452 (2018).

  1. Brian R. Cheffins, Corporate Governance and Countervailing Power , 74 BUS. L AW. 1 (2019).
  2. In particularly recursive fashion, the government may threaten penalties against private businesses unless they penalize business partners who fail to adhere to governmentally-mandate standards of conduct. See Rory Van Loo, The New Gatekeepers: Private Firms as Public Enforcers , 106 VA. L. REV. 467 (2020); see also Scott Killingsworth, The Privatization of Compliance , in T RANSFORMING COMPLIANCE: E MERGING PARADIGMS FOR BOARDS, MANAGEMENT, COMPLIANCE OFFICERS, AND GOVERNMENT 33, 33 (2014).
  3. See generally Cass R. Sunstein, Do People Like Nudges? , 68 ADMIN. L. REV. 177 (2016); Jane Black, Pizza Chains are Making a Desperate Push to Avoid Posting Calories on Menus , WASH. POST (Apr. 7, 2017, 7:30 AM), https://www.washingtonpost.com/lifestyle/food/pizza-chains-are-making-a-desperate- push-to-avoid-posting-calories-on-menus/2017/04/06/080a8d5e-18b0-11e7-bcc2- 7d1a0973e7b2_story.html (“[M]enu labeling affects corporate as well as consumer behavior.”).
  4. See, e.g. , Alina Selyukh, What Gets to be a 'Burger'? States Restrict Labels On Plant-Based Meat , NPR (July 23, 2019, 3:57 PM), https://www.npr.org/sections/thesalt/2019/07/23/744083270/what-gets-to-be-a-burger- states-restrict-labels-on-plant-based-meat [https://perma.cc/T248-RHQB]; Robert V. Percival, Who's in Charge? Does the President Have Directive Authority Over Agency Regulatory Decisions? Over Agency Regulatory Decisions? , 79 FORDHAM L. REV. 2487, 2509 (2011); Douglas A. Kysar, Preferences for Process: the Process/Product Distinction and the Regulation of Consumer Choice , 118 HARV. L. REV. 525, 584–87 (2004).

666 WISCONSIN LAW REVIEW

In truth, corporate architecture can be—and often is—employed as a

mechanism to control corporate conduct in several ways: to facilitate

substantively “good” corporate decisionmaking, to incapacitate

corporations from engaging in prohibited behavior, and to provide entry

points for public participation in the corporate decisionmaking process.

Going further, architecture can construct the actual shareholders who

invest in the first place, thus manipulating corporate preferences at a

fundamental level.

A. Facilitating “Good” Decisionmaking

The most obvious deployment of corporate architecture in service of

a particular goal is the well-recognized expectation that the rules

governing the corporate form—shareholder voting, managerial power and

qualifications, disclosure obligations, trading regulation, and so forth—

will be designed to ensure that corporate managers make “good” business

decisions, namely, those that maximize shareholder wealth. The corporate

form thus enables the use of a centralized, expert management team,

subject to shareholder discipline, while minimizing the opportunity for

rent-seeking and conflict among shareholders themselves.^38 Much ink has

been spilled about whether optimal designs for this function include

independent directors^39 who have particular qualifications,^40 the use of

subcommittees,^41 and different types of shareholder voting^42 and

information rights.^43 Properly calibrated, it is this design—which balances

power among investors, directors, and corporate officers—that

  1. See, e.g. , Michael C. Jensen & William H. Meckling, Theory of the Firm: Managerial Behavior, Agency Costs and Ownership Structure , 3 J. FIN. E CON. 305, 308 (1976); Stephen M. Bainbridge, Director Primacy: The Means and Ends of Corporate Governance , 97 NW. U. L. REV. 547, 572 (2003); Zohar Goshen & Richard Squire, Principal Costs: A New Theory for Corporate Law and Governance , 117 COLUM. L. REV. 767, 769 (2017).
  2. Jeffrey N. Gordon, The Rise of Independent Directors in the United States, 1950–2005: Of Shareholder Value and Stock Market Prices , 59 STAN. L. REV. 1465 (2007); Gregory H. Shill, Independent Board as Shield , 77 WASH. & L EE L. REV. (forthcoming
  1. (manuscript at 6), https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3454619.
  1. Lawrence J. Trautman, Who Qualifies as an Audit Committee Financial Expert under SEC Regulations and NYSE Rules? , 11 DEPAUL BUS. & COM. L.J. 205, 213– 18 (2013).
  2. Shill, supra note 39 , at 1, 5.
  3. Goshen & Squire, supra note 38 , at 805–10.
  4. Donald C. Langevoort & Robert B. Thompson, “Publicness” in Contemporary Securities Regulation After the JOBS Act , 101 GEO. L.J. 337, 376 (2013); George S. Geis, Information Litigation in Corporate Law , 71 ALA. L. REV. 407 (2019); Malone v. Brincat , 722 A.2d 5, 10 (Del. 1998) (“The duty of disclosure obligates directors to provide the stockholders with accurate and complete information material to a transaction or other corporate event that is being presented to them for action.”).

2020:657 Beyond Internal and External 667

incentivizes managers to pursue shareholders’ interests, far more so than

the formal fiduciary obligations to which managers are subject.^44

Though the design may be intended to ensure that corporate managers

make wealth maximizing decisions on shareholders’ behalf, it is also a

necessary component of any corporate regulatory system that operates by

manipulating the conditions under which shareholders can benefit. If the

law imposes penalties on the corporation itself for lawbreaking in the

expectation that shareholders will discipline errant managers to avoid

those penalties, shareholders must be granted sufficient control and

information rights to render the threat of discipline credible.^45 And within

that design, there are numerous subsidiary choices: we might ask, for

example, whether and under what circumstances shareholders should have

a right to recover damages against managers who engage in unlawful

activity. On the one hand, such damages may be a critical mechanism by

which shareholders control their managers, but on the other, it is precisely

the threat of loss that incentivizes shareholders to select law-abiding

managers in the first place.

The current design has a mixture of elements. Managers may be

deemed to have breached their state-imposed fiduciary obligations when

they cause the corporation to break the law,^46 and owe damages to the

corporation as a result. Meanwhile, under the federal securities laws, they

may owe damages to investors directly if they falsely describe the

corporation’s business activities as lawful.^47 Presumably, these forms of

liability promote managerial honesty—which makes it easier for

shareholders to monitor their behavior—and make managers accountable

to shareholders and the corporation, which deters them from lawbreaking

in the first place. If we assume these managerial payments are unlikely to

fully compensate shareholders for losses the regulatory system imposes on

the company for its misconduct, so much the better; investors remain

firmly incentivized to prevent misconduct at their portfolio companies.

Somewhat incongruously, however, the securities laws also make the

corporation itself liable for damages to individual investors who were

  1. Leo E. Strine, Jr., The Dangers of Denial: The Need for a Clear-Eyed Understanding of the Power and Accountability Structure Established by the Delaware General Corporation Law , 50 WAKE F OREST L. REV. 761, 765–74 (2015).
  2. Jill E. Fisch, Confronting the Circularity Problem in Private Securities Litigation , 2009 WIS. L. REV. 333, 340; Lawrence E. Mitchell, The “Innocent Shareholder”: An Essay on Compensation and Deterrence in Securities Class-Action Lawsuits , 2009 WIS. L. REV. 243, 258. This point is implicitly recognized in policy prescriptions that purport to make corporations more socially responsible by empowering shareholder constituencies. See Mariana Pargendler, The Corporate Governance Obsession , 42 J. CORP. L. 359, 378 (2016).
  3. Marchand v. Barnhill , 212 A.3d 805 (Del. 2019).
  4. James D. Cox, “We’re Cool” Statements After Omnicare : Securities Fraud Suits for Failures to Comply with the Law , 68 SMU L. REV. 715, 716–19 (2015).

2020:657 Beyond Internal and External 669

prosocial managerial (and thus corporate) behavior by loosening

shareholder control.^55

These impulses were on display recently in the context of Facebook’s

settlement with the Federal Trade Commission over corporate actions that

violated users’ privacy. Facebook is managed by Mark Zuckerberg, who

is both its controlling shareholder and its CEO. In the settlement, Facebook

agreed to create a committee of independent directors to handle privacy

policies, and their members would be chosen by independent directors on

Facebook’s nominating committee. In practical effect, then, the settlement

limited Zuckerberg’s control as a shareholder by constraining his ability

to select board members.^56 Or, to put it another way, shareholder power

within Facebook was restricted so as to enable corporate personnel to

comply with the law, free from shareholder pressure for wealth

maximization.

Whatever the optimal design, the larger point is that the “build” of

the corporate form is an inextricable feature of any legal attempts to

regulate corporate behavior. The rules governing the relationships among

shareholders and managers can provide greater—or lesser—incentives for

corporations to engage in antisocial or prosocial conduct.^57

But this regulatory design has a Rube Goldberg quality; it requires

precise calibrations of shareholders’ desire for profit, balanced against

their level of control of corporate operations, balanced against corporate

Incentives and Workplace Misconduct (2019), https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3511638; Gretchen Morgenson, Safety Suffers as Stock Options Propel Executive Pay Packages , N.Y. T IMES (Sept. 13, 2015), https://www.nytimes.com/2015/09/13/business/safety-suffers-as-stock-options- propel-executive-pay-packages.html [https://perma.cc/FM77-UKT6]; Jill E. Fisch, The Mess at Morgan: Risk, Incentives and Shareholder Empowerment , 83 U. CIN. L. REV. 651 (2015).

  1. This is what Martin Lipton of the Wachtell Lipton law firm has argued for most of his career, namely, that shareholder control rights should be limited in order to grant managers greater freedom to pursue prosocial policies. See, e.g. , Martin Lipton, Corporate Governance: The New Paradigm , HARV. L. SCH. F. CORP. ON GOVERNANCE (Jan. 11, 2017), https://corpgov.law.harvard.edu/2017/01/11/corporate-governance-the- new-paradigm/ [https://perma.cc/CZ8X-SVRW]; Unocal Corp. v. Mesa Petroleum , 493 A.2d 946, 955 (Del. 1985).
  2. Matt Levine, Facebook Gets a New Committee , BLOOMBERG (July 24, 2019, 11:00 AM), https://www.bloomberg.com/opinion/articles/2019-07-24/facebook-gets-a- new-committee [https://perma.cc/FU5A-J4NC].
  3. The point can be extended further, because fundamentally, the basic building blocks of the corporate form—rules of agency, vicarious liability, and veil-piercing—are intentionally designed to promote beneficial business activity while discouraging conduct that would harm third parties. For that reason, the most radical proposals to reform corporate incentives involve lifting the shield of limited liability. See, e.g. , Alessandro Romano et al., Extended Shareholder Liability for Systemically Important Financial Institutions 4–5 (European Corp. Governance Inst., Working Paper No. 477, 2019), https://ssrn.com/abstract=3475828; Stop Wall Street Looting Act, S. Res. 2155, 116th Cong. (2019).

670 WISCONSIN LAW REVIEW

penalties, taking into account the costs of administering an effective

enforcement apparatus, so as to obtain the optimal level of corporate

compliance with the law. When we fear that this calculus is too complex

for the regulatory system to comfortably bear, we may regulate the

corporate decisionmaking process more directly. Specifically, government

authorities may promise that corporations will enjoy reduced penalties for

the lawbreaking of their employees, so long as they employ practices for

detecting and deterring misconduct that the government deems to be

reasonably effective. In this manner, the government more directly aligns

shareholder interests in profit-making with corporate governance,

depending now not simply on law-abiding outcomes, but on the

decisionmaking procedures used to achieve these outcomes.^58 This is the

broad area known as “compliance,” and might involve such matters as

information flow within the corporation, monitoring of employee actions,

and collection of data regarding business practices.^59 As numerous

scholars have recognized, compliance itself is a direct regulation of

corporate governance.^60

To some extent, compliance may be viewed as any other architectural

regulation that facilitates wealth maximizing behavior: At least one theory

is that agency costs—either managerial incompetence or managerial

disloyalty—prevent corporations from designing compliance systems that,

taking into account expected corporate penalties from lawbreaking, will

maximize corporate wealth, and that this task is made easier if the

government provides an appropriate template.^61 Meanwhile, when the

government promises reduced penalties for lawbreaking for firms that, ex

ante, adopt preferred compliance arrangements, there is still room for

  1. Arlen & Kraakman, supra note 14 , at 693; Veronica Root, The Compliance Process , 94 I ND. L.J. 203, 210–15 (2019).
  2. Griffith, supra note 6 , at 2095–98. Compliance regulation should be distinguished from other kinds of regulation of corporate decisionmaking procedure, such as prohibitions on sex or race discrimination. Cf. Greenfield, supra note 7 , at 971– (categorizing regulation of procedure as a distinct mechanism of corporate regulation). Antidiscrimination law prohibits a type of decisionmaking that is itself inherently viewed as an affront to human dignity; it is, to put it in traditional terms, malum in se. By contrast, when the government encourages particular compliance procedures, it is not because there is any moral good attached to the procedure itself, but because the procedure is instrumental in achieving other aims.
  3. Mercer Bullard, Caremark’s Irrelevance , 10 BERKELEY BUS. L.J. 15, 33 (2013); Griffith, supra note 6.
  4. See, e.g. , Jennifer Arlen & Marcel Kahan, Corporate Governance Regulation Through Non-Prosecution , 84 U. CHI. L. REV. 323, 353 (2017); Roberta Romano, Metapolitics and Corporate Law Reform , 36 STAN. L. REV. 923, 973–74 (1984); Donald C. Langevoort, Cultures of Compliance , 54 AM. CRIM. L. REV. 933, 938–39 (2017); David Orozco, Compliance by Fire Alarm: Regulatory Oversight Through Information Feedback Loops , J. CORP. L. (forthcoming) (manuscript at 19), https://ssrn.com/abstract=3550124.

672 WISCONSIN LAW REVIEW

practical matter make mergers more difficult and thus less likely to occur,

are widely recognized as serving the interests of local employees and

community stakeholders by protecting them from corporate operational

changes that could result in layoffs or other cutbacks.^65 And the trend is

not limited to legislation: Delaware has used its common law to reify

directors’ ability to resist hostile offers, originally justifying its moves on

the ground that employees may need protection from rapacious takeover

artists.^66 Though subsequent caselaw rooted the justification more firmly

in shareholder primacy,^67 it has become increasingly difficult for Delaware

to square the near plenary power directors have to resist merger offers with

a shareholder wealth maximization norm.^68

Similarly, antitrust laws prohibit directors from simultaneously

serving on the boards of competing companies.^69 The underlying

substantive mandate of antitrust law is to prohibit corporations from

engaging in monopolizing or collusive behavior, but rather than solely rely

on prohibitions against such conduct, antitrust laws act on corporate

architecture directly to prevent collusion before it begins. Indeed, as the

prohibitions on conspiracies in restraint of trade are among the earliest

forms of substantive corporate regulation, first arising at a time when

corporate architecture was still the dominant mechanism for controlling

business activity, it is not surprising that the Clayton Act of 1914 operates,

in part, by manipulating the corporate form itself.

Compliance procedures also function as a form of incapacitation.^70

Though, as above, some compliance procedures are traded for reduced

penalties when misconduct occurs, in many instances, compliance

procedures are simply mandated by law,^71 or imposed by regulators in

  1. Winkler, supra note 9 , at 122–23.
  2. Unocal Corp. v. Mesa Petroleum , 493 A.2d 946, 955 (Del. 1985).
  3. Revlon, Inc. v. MacAndrews & Forbes Holdings, Inc. , 506 A.2d 173, 182 (Del. 1986).
  4. See, e.g. , Air Prods. & Chems., Inc. v. Airgas, Inc. , 16 A.3d 48, 57–58 (Del. Ch. 2011) (openly expressing disagreement with Delaware precedent on this issue); Myron T. Steele, Commentary, Continuity and Change in Delaware Corporate Law Jurisprudence , 20 FORDHAM J. CORP. & FIN. L. 352, 362 (2015) (same). Similarly, Delaware’s flat prohibition on intentional lawbreaking by corporate directors—even if accomplished to benefit the corporation—serves more of a regulatory purpose than a purpose to further shareholder interests. See Elizabeth Pollman, Corporate Oversight and Disobedience , 72 VAND. L. REV. 2013, 2026 (2019).
  5. 15 U.S.C. § 19 (2018).
  6. W. Robert Thomas, Incapacitating Criminal Corporations , 72 VAND. L. REV. 905, 911 (2019).
  7. See, e.g. , 15 U.S.C. §§ 78m(b)(2), 7241 (2018); 21 C.F.R. §§ 211.100, 211.115 (2020); Know Your Customer Notice, 75 Fed. Reg. 71479 (Nov. 23, 2010); Veronica Root, Coordinating Compliance Incentives , 102 C ORNELL L. REV. 1003, 1010– 12 (2017); Bullard, supra note 60 , at 46.

2020:657 Beyond Internal and External 673

exchange for foregoing more onerous forms of monitoring.^72 When this

occurs, there is no longer even the pretense that compliance is designed to

help the corporation make “correct” wealth maximizing decisions for

shareholders.^73 Instead, it operates by increasing both the efforts required

to evade the law and the likelihood of detection, thus (ideally) raising the

cost of lawbreaking prohibitively. Compliance procedures create a paper

trail for investigators, force specific corporate officers to take

responsibility for aspects of corporate performance^74 —thus limiting

plausible deniability—and perhaps even contribute to a corporate culture

that treats abidance with the law as routine and correct,^75 regardless of

whether shareholders would benefit from law breaking. In this respect,

corporate governance is directly harnessed to serve public—i.e.,

nonshareholder—interests.^76

Shareholder voting represents another incapacitating procedure, in

that it introduces friction into the corporate decisionmaking process by

dividing authority between decisionmaking bodies, akin to separation of

powers in government.^77 Historically, the shareholder vote was an

especially powerful mechanism of incapacitation because of unanimity

requirements (predicated on the need for each shareholder’s consent in

accord with traditional contractual principles).^78 Because unanimity was

so difficulty to achieve, the requirement of a shareholder vote prevented

corporations from acting at all. Later, due to a sense that unanimity

inhibited too much corporate activity, majority votes were permitted,

justified by a weaker concept of consent that holds that the mere act of

  1. Rory Van Loo, Regulatory Monitors: Policing Firms in the Compliance Era , 119 C OLUM. L. REV. 369, 398–402 (2019).
  2. E.g. , Robert B. Thompson & Hillary A. Sale, Securities Fraud as Corporate Governance: Reflections upon Federalism , 56 VAND. L. REV. 859, 910 (2003) (describing how federally mandated compliance standards—such as the internal control certifications required under the securities laws—function to enforce a duty of care).
  3. J.S. Nelson, Paper Dragon Thieves , 105 GEO. L.J. 871, 879–81 (2017); Bullard, supra note 60 , at 39; see also Roberta Romano, Metapolitics and Corporate Law Reform , 36 STAN. L. REV. 923, 974–75 (1984).
  4. Veronica Root Martinez, Complex Compliance Investigations , 120 C OLUM. L. REV. (forthcoming 2020) (manuscript at 16–17), https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3350463.
  5. Bullard, supra note 60 , at 22 (“The administrative state, through regulatory law, uses internal corporate structures to effectuate public policy.”).
  6. See, e.g. , Jonathan R. Macey, Transaction Costs and the Normative Elements of the Public Choice Model: An Application to Constitutional Theory , 74 VA. L. REV. 471, 494–95 (1988) (describing how transaction costs associated with the separation of powers impede all lawmaking).
  7. MORTON J. HORWITZ, T HE T RANSFORMATION OF AMERICAN L AW 1870-1960, at 90 (1992).

2020:657 Beyond Internal and External 675

directors—required under federal law—must be educated about the

company, introducing an additional layer of bureaucracy that may slow

corporate action. Numerous corporate actions must be filtered through

independent committees in order to ensure a favorable standard of review

should they become the subject of a shareholder lawsuit,^87 and those

procedures alone may be daunting enough that they deter corporate action

in the first instance.^88

To be sure, these procedures all have alternative functions. Most

obviously, corporate separation of powers may be viewed as a function of

“good” decisionmaking—providing oversight of agents to ensure their

faithfulness, or even just “slow[ing] down” decisionmaking to ensure

proper deliberation.^89 But the procedures themselves also inhibit the

exercise of power by the simple expedient of making it difficult for

corporations to act at all.

It is likely that at least some advocates recommend these types of

measures precisely because of the frictions they impose. Commenters will

not say so directly. Usually, demands for increased independence and

segmentation within the corporation are formally promoted on the grounds

that they contribute to wealth maximizing governance. It is also true that

empirically, we know very little about which measures (independent

directors, separation of chair and CEO roles) increase wealth at which

companies.^90 However, pension fund shareholders, for example, tend to

advocate for “friction-creating” policies at companies across the board,

whereas mutual funds treat these matters on a more case-by-case basis.^91

Law Working Paper No. 429/2018, 2019), https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3312596.

  1. Shill, supra note 39.
  2. Certainly, many a corporate transaction has faltered in litigation because of flaws in the committee process. See, e.g. , Deepa Seetharaman & Sarah E. Needleman, Facebook Abandons Plan to Change Share Structure, Avoiding Lawsuit , WALL STREET J. (Sept. 22, 2017), https://www.wsj.com/articles/facebook-abandons-plans-to-change- share-structure-avoiding-lawsuit-1506114877 [https://perma.cc/2PZS-9Y8C]; In re Oracle Corp. Derivative Litig. , 824 A.2d 917, 939–40 (Del. Ch. 2003).
  3. Robert B. Thompson, Anti-Primacy: Sharing Power in American Corporations , 71 BUS. L AW. 381, 408–09 (2016) (describing corporate directors as functioning to “slow down” hasty shareholder decisionmaking).
  4. Sean J. Griffith, Opt-In Stewardship: Toward an Optimal Delegation of Mutual Fund Voting Authority , 98 T EX. L. REV. (forthcoming 2020) (manuscript at 44–46), https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3404298; Paul Rose, The Corporate Governance Industry , 32 J. CORP. L. 887, 907–16 (2007).
  5. Independent Board Leadership , COUNCIL OF I NSTITUTIONAL I NV., https://www.cii.org/independent_board [https://perma.cc/8KPQ-FF3Y]; BlackRock Investment Stewardship , BLACKROCK (Jan. 2020), https://www.blackrock.com/corporate/literature/fact-sheet/blk-responsible-investment- guidelines-us.pdf [https://perma.cc/B4XT-R3L9]; Summary of the Proxy Voting Policy for U.S. Portfolio Companies , VANGUARD, https://about.vanguard.com/investment- stewardship/portfolio-company-resources/2020_proxy_voting_summary.pdf [https://perma.cc/366Y-TRVR]. Similarly, pension funds have sought to exclude

676 WISCONSIN LAW REVIEW

One explanation for the divergence of views is that pension funds, as labor

representatives, have dual concerns both about the value of their

investment and the power that corporations wield with respect to labor;

mutual funds, representing a more diverse set of beneficiaries, do not share

the latter concerns.^92

In sum, if, as described in Part II, corporations can be controlled by

manipulating the balance of power between corporations and non-

shareholder constituencies, we can empower those non-shareholder

constituencies not only by enhancing their ability to bargain, but also by

weakening corporations’ ability to act in the first instance.^93 In this vein,

the inhibiting effect of procedural friction is likely at least part of the

reason why some commenters have recommended that controversial

corporate activity—like political spending—receive independent director

approval.^94

There are legitimate questions about whether, and to what extent,

friction should be introduced into corporate decisionmaking for its own

sake, rather than as a means to improve outcomes. Certainly, it’s not an

unfamiliar regulatory technique: in addition to mirroring the separation of

powers in governments, it is the basis for antitrust law, and has historically

been applied in banking regulation.^95 Yet, as Cary Coglianese points out:

companies with dual-class shares from indices; mutual funds have not. Ning Choiu, BlackRock Wants Equal Voting Rights but Opposes Exclusion from Indexes , BRIEFING: GOVERNANCE (Oct. 23, 2017), https://www.briefinggovernance.com/2017/10/blackrock- wants-equal-voting-rights-but-opposes-exclusion-from-indexes/ [https://perma.cc/4A5N- 5BSL]; Major Stock Index Providers to Limit Inclusion of Multi-Class Companies , E UR. AM. CHAMBER OF COMMERCE N.Y., https://eaccny.com/news/member-news/major-stock- index-providers-to-limit-inclusion-of-multi-class-companies-what-it-means-and-why-it- matters/ [https://perma.cc/A7C2-EFF5].

  1. See DAVID H. WEBBER, T HE RISE OF THE WORKING CLASS SHAREHOLDER: L ABOR’ S L AST BEST WEAPON 214–20 (2018).
  2. Edward Rock and Marcel Kahan point out that the boardroom separation-of- power arrangements that are frequently the subject of debate may have little effect on shareholder value, while arrangements that might hand shareholders far more power—such as reimbursement for proxy contests—are rarely sought. They conclude that activists join battle over cosmetic measures because of their symbolic role in legitimating corporate power. See Edward Rock & Marcel Kahan, Symbolic Corporate Governance Politics , 94 B.U. L. REV. 1997 (2014). But an alternative explanation is that some activists’ goal is not to enhance shareholder power, but to inhibit corporate functioning. Rules that would make it too easy for shareholders to wrest control of corporate machinery (like proxy reimbursement) might facilitate corporate action rather than impede it. This is especially true when one considers that the type of shareholder likely to run a proxy contest (a hedge fund or potential acquirer) will likely seek to shed employees—precisely the opposite of what pension funds, who are among the most dedicated advocates for friction-creating policies, would want.
  3. See, e.g. , Bebchuk & Jackson, supra note 81 , at 101–02.
  4. Banking Act of 1933, Pub. L. No. 73-66, 48 Stat. 162 (1933).