The Legal Infrastructure of Business

Boards, Shareholders, Executive Compensation and HR1257

http://www.govtrack.us/congress/bill.xpd?bill=h110-1257

In 2007, H.R. 1257: Shareholder Vote on Executive Compensation Act passed in the House, and has gone nowhere since. This legislation would require that shareholders have a non-binding vote on executive compensation. A similar provision is already in place in the U.K.

 This legislation in interesting in light of the scrutiny placed on executive compensation in the wake of the recent corporate failures. It is plausible that we will see a push for greater corporate governance going forward, and the principles contained in this legislation raise some questions in my mind.

First, proponents of a free market would argue that government intervention is not required in this case, and that if the market supported it (i.e. shareholders demanded it), we would see companies voluntarily implementing such a vote. Perhaps this is why Aflac has already willingly instituted a shareholder vote on executive pay. Will shareholders start to demand this transparency and advisory role?

Critics of this bill suggested that it would erode board responsibilities, and/or may drive the most talented executives to private equity firms where their compensation would not face as much scrutiny as it would at a public firm. In week 2, we discussed the responsibility of the board to its shareholders. This legislation may provide an additional avenue for shareholders to express their desires to the board. However, as the board is likely has access to greater information than shareholders do, do shareholders universally have enough information to cast this vote in the best interest of the company? Does the fact that the vote is non-binding counter this problem?

For further discussion and analysis of H.R. 1257:

http://corplawcenter.bna.com/pic2/clb.nsf/id/BNAP-6Z4VAP?OpenDocument

Our Policy Makers’ Fatal Conceit

Based on the recent news and the last week’s stock market fiasco ( it was the worst week ever for the Dow Jones Industrial Average!) and the extremely tight credit markets Bush administration is now considering whether to use the authority that was provided in the $700 billion rescue plan to take ownership stakes in many financial institutions.

While I understand the good intentions of this particular strategy coupled with the great bailout plan which is hoping to stabilize and restore confidence, provide more liquidity, loosen the credit markets and calm the stock market, I am becoming increasingly concerned and skeptical of our government’s ability to truly correct this situation.

To admit, all these good intention of our government’s recent decisions and future plans are increasingly resonating with the “socialistic planning” I was so accustomed to when growing up in my native (now former) Czechoslovakia. Why are we so afraid to let the free market do what it is supposed to be doing? Everyone is so concerned that all hell will break loose if we don’t interfere but how sure are we that the taxpayer’s money will save us when all that we are dealing with are unsupported assumptions?

Instead of being afraid of the forces of the free market we should be more concerned about our policy maker’s admitted ignorance whether or not the 700 billion will actually be enough to loosen certain credit markets and their false confidence to find a better solution to the whole problem than what the free market would accomplish on its own. Also, how can they just assume that by using taxpayer money to buy assets that can not be actually traded or which no one will purchase at current market prices they can correct the situation?

Friedrich A. Hayek – who was one of the preeminent social philosophers and a pioneer in monetary theory of our times would not be happy to see that the warnings he issued in his book “The Fatal Conceit - the Errors of Socialism” have been ignored.

He calls the fatal conceit the idea that “man is able to shape the world around him according to his wishes” and he warns about “government planning in markets and in the belief in the inevitability of the ultimate victory of planning”…

I have to add that what I also think is the “fatal conceit” is the assumption that our government will be able to stop its interventions when situation improves. What it is unknowingly contributing to is increasing moral hazard in financial markets in the long run where future “mistakes” will only foster new desires for government bailouts.

Sources:

U.S. planning to buy bank stocks

http://money.cnn.com/2008/10/10/news/economy/paulson_capital_injection/index.htm?postversion=2008101021

Republican anger at ‘financial socialism’

http://www.ft.com/cms/s/0/cdfbdcb6-89a3-11dd-8371-0000779fd18c.html

The Fatal Conceit

http://www.press.uchicago.edu/presssite/metadata.epl?mode=synopsis&bookkey=58673

Joe Bankruptcy?

http://online.wsj.com/article/SB121978535306574101.html?mod=googlenews_wsj

Although the article is mildly dated (August 2008), I found it pertinent to both our discussion of the aftermath that ensued in Delaware’s legislature after Van Gorkom as well as the current political climate. In 2005, there was a proposal to amend legislation so that the state of incorporation would not determine the state in which a company filed bankruptcy. Senator Biden promised a long fight over this proposed change to legislation, and many attribute his position to his generous attorney support he receives in Delaware (as Delaware state rules require companies to retain local bankruptcy counsel).

 

 Some of the arguments for why companies bring bankruptcy filings to Delaware are related to our discussion of Delaware’s monopoly of the corporate governance procedures. Biden credits Delaware’s popularity with the courts’ expertise in complex business bankruptcies. A more wary explanation is that Delaware judges award lawyers and management teams generously in their respective fees and pay packages. 

 

The former is less powerful an argument for two principal reasons:  1) Courts could easily replicate Delaware’s legislature (as discussed in last week’s class) and 2) It is unlikely that any efficiency advantage rooted in the courts’ expertise could compensate for the filing company’s (and counsel’s) loss in efficiency due to traveling to Delaware (i.e. legal fees, hotel rooms and other costs).  The Delaware judges’ treatment of management teams and attorneys is a much more compelling argument for Delaware’s share of public-company-bankruptcy filings. However, I think that this proves to be an example of Biden fulfilling his role as a Senator in looking out for his state and constituents rather than an example of corporate pandering.