This Article examines how the two blind spots of economics—markets and the interior of firms—combined over the past 40 years to create the modern corporate governance regime. The focus of corporate law reformers over the past four decades on achieving ex-post welfare outcomes ignored the traditional centrality of supporting ex-ante market behaviors in corporate law. Corporate law was originally designed from the bottom up to promote the activities of bargaining, experimentation, and competition. None of these activities are currently much in evidence around the governance of public companies. The current corporate governance regime has not succeeded, even on its own terms, and it has seriously damaged the relevant markets. This Article joins a trend in recent legal scholarship of pointing out the intrinsic social value of market activities and their importance in making sense of legal doctrine. Economic efficiency arises from market activities like bargaining and experimentation that are, themselves, inefficient. The modern corporate governance regime has forgotten this fact.

Many of the central discussions in corporate governance, including those regarding proxy contests, shareholder proposals, and other activism or stewardship, can be understood as a single question: Is there under-initiation of corporate changes that investors would collectively prefer? This Article sheds light on this question in three ways. First, the Article proposes a theory of investor initiation, which explains the hypothesis that there is under-initiation of collectively-preferred corporate change by investors. Even though investors collectively prefer that certain corporate changes take place, the costs to any individual investor from initiating such changes through high-cost proxy contests, or even low-cost shareholder proposals, would outweigh the benefits to that investor. Second, the Article puts forward a concrete, tractable, and readily implementable proposal that would eliminate any under-initiation by investors. If the problem is indeed that costs to an initiator exceed the benefits, the solution follows clearly: “Initiation payments” to investors that initiate corporate changes, contingent on the approval of the change by investors or managers, sufficient to increase the benefits to investors that initiate successful changes above their costs. Third, the Article explains how the only requirement necessary for initiation payments to be implemented is that institutional investors support them. This means that whether initiation payments are actually implemented is effectively a test of whether institutional investors believe there is under-initiation and whether they have incentives to rectify it. Observing whether institutional investors support initiation payments will thus shed light not only on whether there is under-initiation, but also on the ongoing debate regarding the incentives of investment managers.

Studies show that the usefulness of public companies’ annual reports has been consistently declining. In the past, financial metrics disclosed in regulated financial statements, such as a company’s book value or operating income (GAAP metrics), provided a meaningful explanation of stock prices and thus allowed for an efficient marketbased allocation of capital among publicly traded firms as well as the economy at large. Disturbingly, GAAP metrics no longer provide a strong correlation with stock prices or with the economy at large. While enjoying a booming economy, nearly half of all U.S. public companies reported losses in their pre-Covid financial statements. Meanwhile, publicly traded companies have been increasing disclosures of alternative metrics—i.e., newly-created adjustments to GAAP metrics (non-GAAPs) appearing in press releases and in formats other than audited statements—thereby exacerbating the potential for opportunistic and misleading reporting by managers. The reporting and content of non-GAAPs are carried out at the discretion of management alone, do not follow any consensually binding practices, and are not the result of negotiations with stakeholders. Not surprisingly, findings show managers opportunistically disclose non-GAAP earnings to conceal reported losses and meet or beat analysts’ expectations. When faced with deficiencies in regulated financial disclosure, private parties can negotiate alternative novel metrics that substitute the use of GAAP metrics in contractual arrangements. Executives of publicly traded firms act alike and use tailor-made financial indicators in compensation schemes. Investors in publicly traded companies, however, do not enjoy similar privileges, cannot negotiate the financial metrics disclosed, and remain bound to a flawed generic financial disclosure regime. Juxtaposing private parties’ negotiation over the financial metrics used in voluntary contracts with the limitations investors in public companies face, this Article proposes a novel approach for financial disclosure regulation—a Voting on Reporting regime under which companies, after gaining the consent of their shareholders, are allowed to report alternative but audited financial metrics that replace GAAP metrics and better fit their shareholders’ information needs. Currently, financial metrics disclosed by publicly traded companies are either dictated by the regulator (GAAP) or opportunistically used and governed by managers alone (non-GAAPs). By allowing shareholders to participate in devising and regulating a company’s financial reporting, the new regime could kill two birds with one stone: (i) it would allow financial statements to better cater to investors’ interests and information needs; and (ii) it would curtail managers’ opportunistic reporting of non-GAAPs.

Many have started to look to the corporate sector to control carbon emissions, mitigate climate change, and redress other problems. But any serious effort to control carbon emissions (or other problems) will have winners and losers: companies that will benefit from reduction; and companies that will bear the brunt of mitigation efforts. In particular, concentrated carbon emitters, such as oil exploration and production companies, are likely to suffer. If so, who will force the carbon emitters to cut their carbon output? Who will be the agents of change in the corporate sector? In recent years, the proponents of a corporate-focused strategy have started to look to “universal owners”—the asset managers and owners that hold a significant swath of many public companies. Some commentators have argued that universal owners should use their influence in portfolio companies to maximize the value of the overall portfolio rather than the value of any particular company. For some, this means that universal owners should adopt “systemic stewardship” that would push for market-wide initiatives to reduce environmental externalities and control systemic risk (e.g., standardized climate risk disclosure). According to others, universal owners should pursue a more ambitious agenda and take affirmative steps to mitigate the risks of climate change to the long-term value of the portfolio by, for example, pushing carbon emitters to cut output, whether or not that promotes individual firm value. But shareholders, even universal owners, do not manage companies. Rather, the business and affairs of a corporation are managed by full-time senior management teams under the general oversight of a board of directors within a framework created by corporate law. In this Article, we analyze the extent to which universal owners can and should be expected to sacrifice single firm value even when doing so increases the value of the overall portfolio. We are quite pessimistic about the potential of systemic stewardship that entails substantial tradeoffs among portfolio companies. This pessimism stems from three principal reasons. First, universal owners would have to consider the possibility that inducing some firms to reduce environmental externalities and mitigate risk will generate a competitive response that will eliminate the benefits from these actions for their other portfolio companies. If that were to happen, universal owners would be stuck with the losses without receiving any corresponding gains. Second, corporate law, as it currently stands, has a strong “single firm focus” (SFF) that stands in sharp contrast to the potential “multi-firm focus” (MFF) of large portfolio investors. If universal owners were to work individually or together to protect their overall portfolios from systemic risk, it would clash with corporate law in a fundamental way that could create significant risks of liability. Third, universal owners typically manage a wide variety of portfolios for clients, each of whom is owed fiduciary duties. A “tradeoff” strategy that would benefit some portfolios at the expense of other portfolios would conflict with these fiduciary duties as well as with the core multi-client, multi-portfolio business model. As a result, we expect that universal owners will not act in concert and will not openly pursue an MFF strategy. Rather, they will act unilaterally and under the cloak of promoting single firm value. But because any serious effort to mitigate climate change will involve tradeoffs, we do not expect universal owners to be effective in controlling carbon emissions.