Returning Markets to the Center of Corporate Law

Bryce C. Tingle KC

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.

Continue Reading Article

Initiation Payments

Scott Hirst

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.

Continue Reading Article

Voting on Reporting

Israel Klein

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.

Continue Reading Article

Venture Predation

Matthew T. Wansley & Samuel N. Weinstein

Predatory pricing is a strategy firms use to suppress competition. The predator prices below its own costs to force its rivals out of the market. After they exit, the predator raises its prices to supracompetitive levels and recoups the cost of predation. The Supreme Court has described predatory pricing as “rarely tried” and “rarely successful” and has established a liability standard that is nearly impossible for plaintiffs to satisfy. We argue that one kind of company thinks predatory pricing is worth trying and at least potentially successful—venturebacked startups. A venture predator is a startup that uses venture finance to price below its costs, chase its rivals out of the market, and grab market share. Venture capitalists (VCs) are motivated to fund predation—and startup founders are motivated to execute it—because it can fuel rapid, exponential growth. Critically, for VCs and founders, a predator does not need to recoup its losses for the strategy to succeed. The VCs and founders just need to create the impression that recoupment is possible, so they can sell their shares at an attractive price to later investors who anticipate years of monopoly pricing. In this Article, we argue that venture predation can harm consumers, distort market incentives, and misallocate capital away from genuine innovations. We consider reforms to antitrust law and securities regulation to deter it.

Continue Reading Article