Volume 8, Issue 1 (2018)


Can Restitution Save Fragile Spiderless Networks?

Ariel Porat & Robert E. Scott

This Article examines the dramatic increase in business networks in recent decades and considers whether the law can play a useful role in supporting the efficient functioning of these inter-firm relationships for coordination and cooperation. Repeat play, reputational sanctions, and norms of trust and reciprocity are the common explanations for the flourishing of networks in many industries and places. But the evidence also shows that a certain class of networks often fails to survive or function effectively and beneficial cooperation among these network members is impaired. These fragile networks develop organically without a controlling party or hierarchy at the center of the network to facilitate network formation. Lacking a controlling entity, they are “webs without any spider.” Clusters of industrial districts are traditional examples of this class of networks. More recently, the information revolution has stimulated a dramatic increase in another type of “spiderless” network: networks of strategic alliances are now a common means of organizing collaborations among firms in high technology and R&D intensive settings. In both types of spiderless networks there are no legal mechanisms to control moral hazard and free riding risks during the period of network formation and operation. We show how in theory the law could support spiderless networks by allowing firms who externalize benefits to other firms in the network to recover for those benefits. Practical considerations may limit the implementation of a full-blown right of restitution. Nevertheless, by recognizing a limited right to recover for uncompensated costs and benefits in appropriate cases, the law can function as a background norm for sharing costs and benefits among network members, motivating them to overcome daunting coordination problems. We consider several implementation issues, show how they might be resolved, and apply our analysis to a set of well-known spiderless networks.

Concentrated Ownership and Long-Term Shareholder Value

Albert H. Choi

Corporate ownership structure with a controlling shareholder is wide- spread around the world. Conventional accounts of concentrated ownership warn against controlling shareholders’ abusive exercise of control and extrac- tion of “private benefits” at the expense of minority shareholders. These accounts, however, are in sharp contrast with the success achieved by many firms with concentrated ownership and the resurgent popularity of dual class struc- ture (which separates voting rights from rights to profits) with uncontested control, as evidenced by Google, Facebook, and many others. This Article attempts to reconcile the empirical evidence with the existing theory by demonstrating how a moderate amount of private benefits of control can actually enhance long- term value by inducing commitment and investment by the controlling shareholder. On the downside, because private benefits of control are less sensitive to firm performance, they can undermine the controlling shareholder’s incentive to maximize firm value. On the upside, because private benefits of control are non- transferrable (they are “private” and illiquid), they create a lock-in effect, making the controlling shareholder more likely to stay with the firm for the long-term and care about the firm’s long-term reputation and performance. The analysis renders a number of implications. For instance, this Article shows that achieving the optimal balance may require a formal separation of voting rights from rights to profits, as is done in a dual class structure. This can explain why certain founders are taking their companies public with a dual class structure even though such structure is considered to be inefficient and can lead to lower proceeds from equity sale. It also renders a normative argument that, instead of a categorical ban, a more nuanced approach towards such mechanisms, such as heightened judicial scrutiny, could be superior.

Is Say on Pay All about Pay? The Impact of Firm Performance

Jill Fisch, Darius Palia & Steven Davidoff Solomon

The Dodd-Frank Act of 2010 mandated a number of regulatory reforms including a requirement that large U.S. public issuers provide their shareholders with the opportunity to cast a non-binding vote on executive compensation. The “say on pay” vote was designed to rein in excessive levels of executive compensation and to encourage boards to adopt compensation structures that tie executive pay more closely to performance. Although the literature is mixed, many studies question whether the statute has had the desired effect. Shareholders at most issuers overwhelmingly approve the compensation packages, and pay levels continue to be high.
Although a lack of shareholder support for executive compensation is relatively rare, say on pay votes at a number of issuers have reflected low levels of shareholder support. A critical question is what factors drive a low say on pay vote. In other words, is say on pay only about pay?
In this Article, we examine that question by looking at the effect of three factors on voting outcomes—pay level, sensitivity of pay relative to economic performance, and economic performance. Our key finding is the importance of economic performance to say on pay outcomes. Although pay-related variables affect the shareholder vote, even after we control for those variables, an issuer’s economic performance has a substantial effect. Perhaps most significantly— shareholders do not appear to care about executive compensation unless an issuer is performing badly. In other words, the say on pay vote is, to a large extent, say on performance.
This finding has important implications. First, it raises questions about the federally-mandated shareholder voting right as a tool for concerns about executive compensation. Say on pay has limited effectiveness if it is only being used to discipline issuers that are underperforming, or if it is not being used as a vote on outsize or inordinate pay as it was intended to be. Second, to the extent that the shareholder vote influences board behavior, granting shareholders another forum for signaling their dissatisfaction with a firm’s economic performance may be counterproductive. If shareholders are communicating concerns over near-term stock performance through their say on pay votes, they may be increasing director incentives to focus on short-term stock performance rather than long-term firm value.

Inefficient Tailoring: The Private Ordering Paradox in Corporate Law

Michal Barzuza

The conventional wisdom in corporate law posits that private ordering has an important virtue: it allows firms to efficiently tailor governance terms to their particular needs. This virtue is routinely advanced to justify the largely “enabling” structure of U.S. corporate law, and to oppose “one-size-fits-all” mandatory regulation.
This Article argues that private ordering frequently produces inefficient tailoring of corporate governance terms—firms that need governance constraints are precisely the ones that do not volunteer to implement them. In theory, the conventional approach assumes that these firms will implement constraints voluntarily because otherwise they would be disciplined by market forces. Yet such reliance on market discipline has an inherent paradox: the firms that would benefit most from governance constraints are precisely the ones that are subject to weak market discipline.
Evidence from myriad studies and contexts suggests that firms’ needs for constraints are often not, or negatively, correlated with having them. For example, the inclination to cross-list on US exchanges is negatively correlated with controlling shareholders’ private benefits, and with the cross-listing premium; firms that benefitted from independent directors were precisely the ones that did not have them prior to SOX; managers of firms that investors believed would benefit most from proxy access were precisely those who were most likely to contest them; Nevada’s lax fiduciary duties attract firms that are prone to financial reporting failures. The Article concludes with implications for data interpretation and corporate law policy.