This post summarizes “The Dodd-Frank Act’s Maginot Line:  Clearinghouse Construction,” which will appear in the California Law Review later this year.

Regulatory reaction to the 2008–2009 financial crisis, following the failures of AIG, Bear Stearns, Lehman Brothers, and the Reserve Primary Fund, focused on complex financial instruments that deepened the crisis. A consensus emerged that these risky financial instruments should move through safe, strong clearinghouses, which would be bulwarks against systemic risk.

The consensus turned into law, via the Dodd-Frank Wall Street Reform Act, in which Congress instructed regulators to construct clearinghouses through which these risky financial instruments would trade and settle. Clearinghouses could repel financial risk, reduce contagion, and halt a local financial problem before it became an economy-wide crisis.

But clearinghouses are weaker bulwarks against financial contagion, financial panic, and systemic risk than is commonly thought. They may well be unable to defend the economy against financial stress such as that of the 2008–2009 crisis. Although they can be efficient financial platforms in ordinary times, they do little to reduce systemic risk in crisis times.

…continue reading: The Dodd-Frank Act’s Maginot Line: Clearinghouse Construction

Frederick Tung and I recently posted “Breaking Bankruptcy Priority: How Rent-Seeking Upends the Creditors’ Bargain,” to SSRN. It is scheduled to appear in Virginia Law Review later this year. In “Breaking Bankruptcy Priority,” we examine the stability of bankruptcy’s priority structure.

Overall, bankruptcy reallocates value in a faltering firm. The bankruptcy apparatus eliminates some claims and alters others, leaving a reduced set of claims to match the firm’s diminished capacity to pay. This restructuring is done according to statutory and agreed-to contractual priorities, so that lower-ranking claims are eliminated first and higher ranking ones are preserved to the extent possible. Bankruptcy scholarship has long conceptualized this reallocation as a hypothetical bargain among creditors: creditors agree in advance that if the firm falters, value will be reallocated according to a fixed set of predetermined rules and contracts.

…continue reading: Breaking Bankruptcy Priority: How Rent-Seeking Upends the Creditors’ Bargain

Last month I posted to SRRN Corporate Short-Termism – In the Boardroom and in the Courtroom, which the Business Lawyer will publish this August.

In this paper, I examine a long-held view in corporate circles has been that furious rapid trading in stock markets has been increasing in recent decades, justifying more judicial measures that shield managers and boards from shareholder influence, so that boards and managers are freer to pursue sensible long-term strategies in their investment and management policies.

However, when I evaluate the evidence in favor of that view, the evidence turns out to be insufficient to justify insulating boards from markets further. While there is evidence of short-term distortions, the view is countered by several under-analyzed aspects of the American economy, each of which alone could trump the board isolation prescription. Together they make the case for further judicial isolation of boards from markets untenable.

…continue reading: Corporate Short-Termism – In the Boardroom and in the Courtroom

I recently examined the problem of corporate short-termism from two nonstandard angles. One was that some short-termism is sensible. Large firms face an increasingly fluid economic, technological, and political environment – owing to more global and competitive markets, to the greater potential of technological change to alter firms’ business environment, and to governments’ growing influence over what makes business sense. In this kind of a fluid environment, large companies must be cautious before making large, long-term commitments.

…continue reading: Apple’s Cash-Flow Problem

The report by the US Senate staff on JPMorgan Chase’s “London Whale” trades, delivered last Friday, excoriates the bank for failing to make the full extent of the problem known to regulators and the public. But a focus on who knew what when can result in missing the big point: the cost of our too-big-to-fail banks is even heftier than is widely appreciated.

The conventional wisdom in many circles is that the losses caused by the trades are regrettable but we can all move on. After all, JPMorgan’s equity cushion can readily absorb it. Private shareholders and managers have paid the price – shareholders lost $6bn and several senior managers have black marks against their names. The episode is embarrassing but the bank can earn more than $20bn a year. “A tempest in a teapot,” said Jamie Dimon, its chief executive, last year.

But before the London Whale sinks from view, consider what would befall a conventional industrial company that suffered such a horrendous, expensive managerial lapse. If JPMorgan were in the business of making things, it would have already attracted significant corporate governance activity. The loss might be the trigger for a takeover and break-up effort.

…continue reading: London Whale is the Cost of Too Big to Fail

Economic trends are sometimes more closely related to one another than news reports make them seem. For example, one regularly encounters reports of governments’ financial troubles, like the “fiscal cliff” in the United States and the debt crisis in Europe. And much attention has been devoted, often in nearby opinion pieces, to the view that hyperactive equities markets, particularly in the US and the United Kingdom, push large corporations to focus disproportionately on short-term financial results at the expense of long-term investments in their countries’ economies.

The two are not unconnected. And examining that connection provides a good opportunity to assess the weaknesses and ambiguities of the longstanding argument that a furiously high-volume stock-market trading shortens corporate time horizons.

…continue reading: Corporate Short-Termism in the Fiscal Cliff’s Shadow

Earlier in October, Federico Cenzi Venezze and I posted “A Capital Market, Corporate Law Approach to Creditor Conduct” up on SSRN. Michigan Law Review is scheduled to publish the article in their next volume.

In this article, we focus on the problem of creditor conduct in distressed firms — for which policymakers ought to have the economically-sensible repositioning of the distressed firm as a central goal. This problem has vexed courts for decades, without coming to a stable doctrinal resolution. It’s easy to see why developing an appropriate rule here has been difficult to achieve: A rule that facilitates creditor operational intervention going beyond ordinary collection on a defaulted loan can induce creditors to intervene perniciously, to shift value to themselves. But a rule that confines creditors to no more than collecting their debt can allow failed managers to continue mismanaging the distressed firm, with the only real alternative to the failed incumbent management — the creditor — being paralyzed by unclear and inconsistent judicial doctrine.

The article proceeds in four steps. For the first step, we show that existing doctrines do not address themselves to facilitating efficacious management of the failing firms. Yet with corporate and economic volatility as important as ever, courts should seek to make doctrine here more functionally-oriented than it now is.

…continue reading: A Capital Market, Corporate Law Approach to Creditor Conduct

Last month, the Columbia Business Law Review published “A Spatial Representation of Delaware-Washington Interaction in Corporate Lawmaking.” In this brief paper, I examine interaction between Delaware and Washington in corporate lawmaking, focusing on the shareholder access initiatives in each jurisdiction. The paper uses a straight-forward spatial model of the state-federal interaction, paralleling spatial models that political scientists have used to illustrate other instances of jurisdictional interaction.

In prior work I showed how Delaware corporate law can be, and often is, confined by, or influenced by, federal action. Sometimes Washington acts and preempts the field, constitutionally or functionally, leaving no space for state corporate law action. Sometimes Delaware tilts toward or follows Washington opinion, even if Washington opinion does not square perfectly with the state lawmakers’ own consensus view of the best way to proceed. I examined these channels in Delaware’s Competition, 117 Harvard Law Review 588 (2003), and Delaware’s Politics, 118 Harvard Law Review 2491 (2005).

…continue reading: A Spatial Representation of Delaware-Washington Interaction in Corporate Lawmaking

Five articles on corporate law subjects by Harvard Law School faculty appear in the list of the most-cited law review articles (in all legal fields) just published in a study on the subject by Fred R. Shapiro and Michelle Pearse in the Michigan Law Review. The study is available here.

This study updates two classic earlier studies from 1985 and 1996 by Fred Shapiro, and uses new research tools and databases to create accurate lists. The study includes two lists: A list of the 100 most-cited articles of all time, and a list of the 100 most-cited articles from the last twenty years, consisting of a list of the five most-cited articles for each year.

An examination of these two lists indicates that there are five articles on corporate law topics authored or coauthored by Harvard Law School faculty:

• The Case for Increasing Shareholder Power, authored by Lucian Bebchuk;
• The Myth of the Shareholder Franchise, authored by Lucian Bebchuk;
• The Mechanisms of Market Efficiency, coauthored by Reinier Kraakman (with Ronald Gilson);
• The End of History for Corporate Law, coauthored by Reinier Kraakman (with Henry Hansmann); and
• Delaware’s Competition, authored by Mark Roe.

At the Columbia Law School conference on the Delaware Chancery Court this November, I summarized my recent working paper The Corporate Shareholder’s Vote and Its Political Economy, in Delaware and in Washington. I discuss this paper below. Related work includes Delaware’s Competition, Delaware’s Politics, and Delaware and Washington as Corporate Lawmakers.

Shareholder power to effectively nominate, contest, and elect the company’s board of directors became core to the corporate governance reform agenda in the past decade, as corporate scandal and financial stress put business failures and scandals into headlines and onto policymakers’ agendas. As is well known to corporate analysts, the incentive structure in corporate elections typically keeps shareholders passive, and incumbent boards largely control the electoral process, usually nominating and electing themselves or their chosen successors. Contested corporate elections are exceedingly rare. But shareholder power to directly place their nomination for a majority of the board in the company-paid-for voting documents, as the SEC has pushed toward, could revolutionize American corporate governance by sharply shifting authority away from insiders, boards, and corporate managements. During the past decade, the SEC proposed, withdrew, and then promulgated rules that would shift the control of some corporate election machinery, to elect a minority of the board, away from insiders and into shareholders’ hands. Then, in July 2011, the D.C. Circuit Court of Appeals struck down the most aggressive of the SEC’s rules.

…continue reading: The Corporate Shareholder’s Vote and Its Political Economy