Volume 2, Issue 1 (2012) – Sovereign Debt Crisis

Foreword

Hal S. Scott

Old Sins and Long Shadows

Lee C. Buchheit

Corporate Governance, Politics, and the SEC

Edward F. Greene

ARTICLES

The Corporate Shareholder’s Vote and Its Political Economy, In Delaware and in Washington

Mark J. Roe

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. 
During this decade-long process a core corporate law was up for grabs, but the action was in Washington, D.C. until the end of the decade, not the states, despite that a century of corporate law theory has focused on jurisdictional competition among states in making corporate law. In earlier work, I amended the state competition understanding with a view that many key features of American corporate lawmaking are Washington-oriented: Washington often makes corporate law directly, it did so for the central corporate controversy in most decades of the twentieth century, and it can influence state lawmaking, either directly or by establishing complements and substitutes to state corporate law. Shareholder access fits this federal-state paradigm and goes beyond it. It fits in that states were largely silent on these shareholder-power initiatives until 2009, when Delaware amended its corporate code to facilitate shareholder nominees. Indeed, it’s hard to understand Delaware passing its 2009 shareholder statute if the issue had not been on the national agenda for nearly a decade. But the interaction goes beyond the basic Washington-Delaware paradigm in that Delaware’s corporate lawmaking could have influenced the federal outcome and, quite plausibly, corporate players sought it, or used it, as a tool to dampen federal congressional, judicial, and regulatory actors’ enthusiasm for strong shareholder access. The federal-state interaction is two-way, with the strongest interest group inputs at each jurisdictional level sharply differing. Overall, the vertical interaction between states and Washington in reforming shareholder-insider voting power in the past decade is a far cry from the classical understanding of American corporate law being honed in horizontal state-to-state competition, and it implicates sharply differing political economy, interest-group dynamics.

 

The Law and Economics of Blockholder Disclosure

Lucian A. Bebchuk and Robert J. Jackson, Jr.

The Securities and Exchange Commission is currently considering a rulemaking petition that advocates tightening the rules under the Williams Act, which regulates the disclosure of large blocks of stock in public companies. In this Article, we explain why the Commission should not view the proposed tightening as a merely “technical” change needed to meet the objectives of the Williams Act, provide market transparency, or modernize its regulations. The drafters of the Williams Act made a conscious choice not to impose an inflexible 5% cap on pre-disclosure accumulations of shares to avoid deterring investors from accumulating large blocks of shares. We argue that the proposed changes to the SEC’s rules should similarly be examined in the larger context of the optimal balance of power between incumbent directors and these blockholders. We discuss the beneficial and documented role that outside blockholders play in corporate governance and the adverse effect that any tightening of the Williams Act’s disclosure thresholds can be expected to have on such blockholders. We explain that there is currently no evidence that trading patterns and technologies have changed in ways that would make it desirable to tighten these disclosure thresholds. Furthermore, since the passage of the Williams Act, the rules governing the balance of power between incumbents and outside blockholders have already moved significantly in favor of the former—both in absolute terms and in comparison to other jurisdictions—rather than the latter.Our analysis provides a framework for the comprehensive examination of the rules governing outside blockholders that the Commission should pursue. In the meantime, we argue, the Commission should not adopt new rules that would tighten the disclosure thresholds that apply to blockholders. Existing research and available empirical evidenceprovide no basis for concluding that such tightening would protect investors and promote efficiency. Indeed, there is a good basis for concern that such tightening would harm investors and undermine efficiency.

 

The Politicization of Corporate Governance: Bureaucratic Discretion, the SEC, and Shareholder Ratification of Auditors

J. Robert Brown, Jr.

One of the most significant changes in corporate governance of the last decade has been the shift in the role of the Securities and Exchange Commission. As Congress has become increasingly willing to preempt state corporate governance law, responsibility for setting substantive corporate governance standards has increasingly shifted from state legislatures and courts to the SEC. Although the SEC may bring an approach to decision-making in the corporate governance arena that is more balanced than that of the states, the SEC is also subject to significant political influences. These influences can be clearly seen in the positions taken by the SEC staff in interpreting the “ordinary business” exemption to Rule 14a-8, the shareholder proposal rule. The SEC’s decision in 2005 to abandon its longstanding interpretation of Rule 14a-8 concerning shareholder ratification of auditors is best explained not as a reasoned shift in legal analysis, but rather as having resulted, first and foremost, from a change in the political composition of the Commissioners of the SEC.Politicization of SEC decision-making and the resulting volatility in corporate governance standards impose significant costs on issuers, shareholders, and the SEC itself. One way to mitigate these costs is to reduce staff discretion, a goal which could be achieved by adopting objective decision-making standards and eliminating undefined standards such as the “ordinary business” exemption. Otherwise, as this Article illustrates, the potentially detrimental effects of political influence will only increase as the role of the SEC assumes a more central role in regulating corporate governance.

 

Sovereign Debt Restructuring Options: An Analytical Comparison

Steven L. Schwarcz

The recent financial woes of Greece, Ireland, Portugal, and other nations have reinvigorated the debate over whether to bail out defaulting countries or, instead, restructure their debt. Bailouts are expensive, both for residents of the nation being bailed out and for parties providing the bailout funds. Because the IMF, which is subsidized by most nations (including the United States), is almost always involved in country debt bailouts, we all share the burden. Yet bailouts are virtually inevitable under the existing international framework; defaults are likely to have systemic consequences, whereas an orderly debt restructuring is currently impractical. This Article analyzes and compares debt restructuring alternatives to bailouts. Under a free-market option, sovereign debtors and their creditors attempt to consensually negotiate a debt restructuring, aided by collective-action clauses and by exchange offers with exit consents. Under a statutory option, sovereign debtors and their creditors would be bound by an international convention that sets forth a process to facilitate debt restructuring. The absence of any systematic comparison of these options has made it difficult to facilitate country debt restructurings. This Article attempts to provide that comparison.

 

Lawyers, Ignorance, and the Dominance of Delaware Corporate Law

Why does Delaware continue to dominate the market for incorporations even though recent research has shown that the quality of Delaware corporate law has declined substantially? In this Article, we focus on one possible explanation: the rational ignorance of lawyers and investors. Using the results of our survey of lawyers involved in initial public offerings (IPOs) as well as our analysis of companies involved in IPOs, we conclude that lawyers recommend Delaware because they are ignorant about other states’ laws. Because Delaware is so dominant, law schools focus on Delaware corporate law, and a lawyer rationally learns the corporate law of only Delaware and his home state. Regardless of the quality of the laws of other states, lawyers will not recommend incorporating outside of Delaware because they are unfamiliar with those laws. Likewise, lawyers recommend only Delaware law because they believe that investors are ignorant of other states’ laws.

 

Sovereign Debt Restructuring: Problems and Prospects

This Article reviews the history of sovereign debt restructuring operations with private sector creditors with a view toward diagnosing the factors that lead to inferior outcomes. The Article also attempts to forecast potential problems that may arise in sovereign debt restructuring negotiations in the future and reviews possible modifications of existing institutions. The future potential problems range from the role of credit default swaps in discouraging creditor participation in voluntary exchange offers to the potential for manipulation of aggregation clauses. Other potential issues include the possibility of de facto sovereign default on state contingent debts through statistical manipulation, more widespread use of appeals to the notion of odious or illegitimate debts, and the extent to which recent regulatory changes aimed at restricting litigation against sovereigns in default might reduce the incentive for sovereigns to repay their debts in the future.

 

NOTE

Brazil and Russia During the Financial Crisis: A Tale of Two Commodity Exporters

Brazil and Russia were similarly placed on the eve of the recent financial crisis. Both countries were large middle-income commodity exporters with a shared history of vulnerability to financial contagion. Aided by the long commodities boom, both countries were thriving. They had accumulated large foreign exchange reserves, paid down their external public debt, and experienced rapid economic growth; it was the best of times. The collapse of Lehman Brothers and the ensuing global financial panic changed this rosy picture. The crisis quickly spread to Brazil and Russia. Financial markets in both countries dropped precipitously, their respective currencies came under speculative attack, and their strong public sector financial positions deteriorated quickly; it was soon the worst of times. Nevertheless, Brazil’s economic performance proved far more robust than Russia’s during the crisis because of the country’s relatively superior financial and macroeconomic regulation, as well as its deft crisis management. Compared to Russia, Brazil came out of the crisis with relatively stronger economic growth, more robust stock market performance, and greater policy flexibility.

This Note explores these and other reasons behind this divergence in performance, and makes two contributions to the literature. First, the Note analyzes the impact of the different policy responses adopted by Brazil and Russia in the lead-up to the crisis and the different policy interventions undertaken during the crisis. Second, the Note outlines three normative lessons for emerging market countries that are similarly placed, suggesting that countries should: manage total external debt (public and private), rather than target only public external debt; make deft and targeted interventions that conserve financial resources, rather than blunt and open-ended commitments; and, increase the quality and transparency of financial and macroeconomic regulation.