Harvard Business Law Review (HBLR)

Protecting Financial Stability: Lessons from the COVID-19 Pandemic

Howell E. Jackson & Steven L. Schwarcz

The COVID-19 pandemic has produced a public health debacle of the first order. But the virus has also propagated the kind of exogenous shock that can precipitate—and to a certain degree did precipitate—a systemic event for our financial system. This still not fully resolved systemic shock comes a little more than a decade after the last financial crisis. In the intervening years, much has been written about the global financial crisis of 2008 and its systemic dimensions. Considerable scholarly attention has focused on first devising and then critiquing the macroprudential reforms that ensued, both in the Dodd-Frank Act and the many regulations and policy guidelines that implemented its provisions. In this essay, we consider the coronavirus pandemic and its implications for the financial system through the lens of the frameworks we had developed for the analysis of systemic financial risks in the aftermath of the last financial crisis. While the COVID-19 pandemic differs in many critical respects from the events of 2008, systemic events in the financial sector have a common structure relevant to both crises. Reflecting back on responses to the last financial crisis also affords us an opportunity both to understand how financial regulators responded to the COVID-19 pandemic and also to speculate how the pandemic might lead to further reforms of financial regulation and other areas of public policy in the years ahead.

The Power of the Narrative in Corporate Lawmaking

Mark J. Roe & Roy Shapira

The notion of stock-market-driven short-termism relentlessly whittling away at the American economy’s foundations is widely accepted and highly salient. Presidential candidates state as much. Senators introduce bills assuming as much. Corporate interests argue as much to the Securities and Exchange Commission and the corporate law courts. Yet the academic evidence as to the problem’s severity is no more than mixed. What explains this gap between widespread belief and weak evidence?

In this Article, we explore the role of narrative power. Some ideas are better at being popular than others. The concept of pernicious stock market short-termism has three strong qualities that make its narrative power formidable: (1) connotation—the words themselves tell us what is good (reliable long-term commitment) and what is not (unreliable short-termism); (2) category confusion—disparate corporate misbehavior, such as environmental degradation and employee mistreatment, are mislabeled as short-term, when they in fact primarily emanate from other misalignments, thereby making us view short-termism as more rampant and pernicious than it is; and (3) confirmation—the idea is regularly repeated, because it is easy to communicate, and often boosted by powerful agenda-setters and interests that benefit from its repetition.

The Article then highlights the real-world implications of narrative power—powerful narratives can make decisionmakers be more certain than the underlying evidence is, thereby leading policymakers astray. For example, a favorite remedy for stock-market-driven short-termism is to insulate executives from stock market pressure. If lawmakers believe that short-termism is a primary cause of environmental degradation, anemic investment that holds back the economy, employee mistreatment, and financial crises—as many state—then they are likely to support insulating corporate executives further from stock market accountability. Doing so, however, may do little to alleviate the underlying problems, which would be better handled by, say, stronger environmental regulation and more astute financial regulation. Powerful narratives can drive out good policymaking.

Alibaba: A Case Study of Synthetic Control

Jesse M. Fried & Ehud Kamar

Alibaba, the NYSE-traded Chinese e-commerce giant, is currently valued at over $700 billion. But Alibaba’s governance is opaque, obscuring who controls the firm. We show that Jack Ma, who now owns only about 5%, can effectively control Alibaba by controlling an entirely different firm: Ant Group. We demonstrate how control of Ant Group enables Ma to dominate Alibaba’s board. We also explain how this control gives Ma the indirect ability to disable (and perhaps seize) VIE-held licenses critical to Alibaba, providing him with substantial additional leverage. Alibaba is a case study of how corporate control can be created synthetically with little or no equity ownership via a web of employment and contractual arrangements.

RETHINKING TAX FOR THE DIGITAL ECONOMY AFTER COVID-19
Tarcísio Diniz Magalhães and Allison Christians† 

Before COVID-19 arrived, policymakers from around the world were busy working on the makings of a new global tax consensus to reflect structural changes in the world economy as a result of the rise of digitalization. The pandemic disrupted this process by delivering a shock that resulted in major contractions for most firms even as it created enormous windfalls for others, prompting some to call for excess profits taxes, usually associated with wartime economies, as a corrective. But an excess profit or windfall tax designed during the world war period is not effective in today’s globalized and digitalized economy. To address effectively the fiscal crisis and tackle the challenges of the digital economy in a sustainable way, the world needs a “global excess profits tax”—a GEP tax. This article demonstrates that the vocabulary, the technical tools, and the political determination that were being built for the digital economy can and should be adapted to formulate a GEP tax. We establish the core elements of such a tax and demonstrate its compatibility with currently evolving thinking about how to tax highly digitalized firms.

† Dr. Tarcísio Diniz Magalhães, Professor of Tax Law, University of Antwerp Faculty of Law; Allison Christians, H. Heward Stikeman Chair in the Law of Taxation, McGill University Faculty of Law. Thanks to Jodie Côté-Marshall for research assistance, to the participants in the “Indiana/Leeds Summer Tax Workshop Series” (July 2, 2020) at Indiana University Bloomington Maurer School of Law/University of Leeds School of Law, the Brazilian Study Group on International Tax (GETI) (July 16, 2020), the “Purdy Crawford Business Law Workshop: Business Regulation and the Digital Economy” (Sep. 25–26, 2020) at Dalhousie University Schulich School of Law, the Brazilian Institute of Tax Law (IBDT) (Apr. 15, 2021), as well as to Stephen Shay and Christine Kim for reviewing a prior draft and this journal’s editors. This research is supported by grants from the Ford Foundation and the Social Sciences and Humanities Research Council (SSHRC) of Canada.

PATENT ENFORCEMENT, SHAREHOLDER VALUE, AND FIRM INNOVATIONS: EVIDENCE FROM THE SUPREME COURT RULING IN TC HEARTLAND (2017) 
Andy Law, Buhui Qiu, and Teng Wang† 

This paper studies the impact of patent enforcement on shareholder value and firms’ innovation patterns. Using the landmark U.S. Supreme Court case TC Heartland LLC v. Kraft Foods Group Brands LLC (2017), which significantly constrained forum shopping practices in patent litigation, we find that the weakening of patent holders’ ability to enforce intellectual property protection leads to more negative stock return reactions for firms that are more innovation-intensive before the ruling. We further find that weakened enforcement of patent protection shifted firms’ innovation patterns. While innovation-intensive firms do not reduce their overall R&D investment, they choose to keep their innovation outputs as trade secrets and apply for patents significantly less frequently. Our findings shed new light on the current debate on intellectual property protection.

† Andy Law is affiliated with the Board of Governors of the Federal Reserve System, Constitution Ave, N.W., Washington, DC 20551, USA; Email: andy.law@frb.gov. Buhui Qiu is affiliated with the University of Sydney, NSW 2006, Australia; Email: buhui.qiu@sydney.edu.au. Teng Wang is affiliated with the Board of Governors of the Federal Reserve System, Constitution Ave, N.W., Washington, DC 20551, USA; Email: teng.wang@frb.gov. We are greatly indebted to Annie Zhou for her great help with the patent data collection. The views expressed in this article are the authors’ alone and do not necessarily reflect the views of the Federal Reserve Board or the United States government.

CAN BLACKROCK SAVE THE PLANET? THE INSTITUTIONAL INVESTORS’ ROLE IN STAKEHOLDER CAPITALISM
Giovanni Strampelli†

Within a context of increasing concentration of ownership, where the Big Three –BlackRock, State Street and Vanguard– now hold over 20% of the shares in S&P500 companies, the spotlight now falls more than ever on institutional investors, which are being increasingly called upon to play a major role in favoring the shift towards stakeholder capitalism by pursuing environmental and societal objectives. These expectations are reinforced by leading institutional investors’ commitments –such as those included in Larry Fink’s last annual letter– to do well by doing good. In spite of this however, while the incorporation of ESG issues into investment policies is surely intended –perhaps above all– to attract an increasing share of clients that place central attention on those aspects, institutional investors’ commitment to pursue sustainability objectives face several limitations. First, promoting more virtuous conduct by investee companies entails significant costs, thereby impairing institutional investors’ returns. Secondly, even though portfolio value maximization objectives may, to some extent, favor the incorporation of ESG factors into investment and stewardship policies, the dissemination of passive funds (i.e. portfolios that track a particular benchmark equity index) is a factor that can impinge upon the effective capacity of institutional investors to encourage the adoption by investee companies of policies that pursue sustainability objectives. Against this backdrop, this article shows that it is illusory to assume that institutional investors can be charged with the task of pursuing objectives of general interest, such as fighting climate change (thus essentially acting in place of the state), where such a task is not aligned with their clients’ and their own interest in improving risk-adjusted returns.

† Full Professor of Business Law; Director of the PhD in Legal Studies, Bocconi University, Milan.

ESTIMATING THE NEED FOR ADDITIONAL BANKRUPTCY JUDGES IN LIGHT OF THE COVID-19 PANDEMIC
Benjamin Iverson, Jared A. Ellias, and Mark Roe†

In this Article, we present the first effort to use an empirical approach to bolster the capacity of the bankruptcy system during a national crisis—here, the COVID-19 crisis. We provide two analyses, one using data from May 2020, very early on in the crisis, and another using data from September 2020, closer to the publication of this Article. Our analysis is based on an empirical observation: Historically, an increase in the unemployment rate has been a leading indicator of a rise in bankruptcy filings. If this historical trend continues to hold, the May 2020 unemployment rate of 13.3% would have predicted a substantial increase in bankruptcy filings and the lower September 2020 level would still predict noticeably increased filings. Clearly, governmental assistance, the unique features of the COVID-19 pandemic, the possibility of a quick economic recovery, and judicial triage are likely to reduce the volume of bankruptcies and increase the courts’ capacity to handle those that occur. It is also plausible that the recent unemployment spike will be short-lived—indeed, by September 2020, the rate had declined to 7.9%. Further, medical solutions to the underlying pandemic—such as the recent initial distribution of an effective vaccine—would further reduce the pressure on the bankruptcy system. Yet, even assuming that the worst-case scenarios are averted, our analysis suggests that a substantial investment in the bankruptcy system resources should be considered, even if only on a standby basis.

Our model assumes that Congress would like to have enough bankruptcy judges so that the average judge would not work more than the last bankruptcy peak in 2010, when the bankruptcy system was pressured and judges worked 50 hour weeks on cases on average. Because the bankruptcy system before the pandemic was not stretched as severely as it was prior to the 2010 financial crisis, it has some extra capacity to handle extra cases.

To keep judicial workload at 2010 levels, the bankruptcy system would need at least 50 additional temporary judges based on the number of unemployed in May 2020 who did not see themselves as temporarily unemployed. In the worst-case scenario, in which none of the May 2020 unemployed returned to work quickly, the bankruptcy system would have needed as many as 243 temporary judges—which would have represented a considerable expansion, even if only temporary, of the bankruptcy judiciary. The lower September 2020 unemployment rate points to a need for 20 temporary judges. Because of this model’s sensitivity to unemployment data, it reports a wide range of estimations for additional bankruptcy judgeships.

We discovered a considerable administrative lag of about a year or more for appointing additional bankruptcy judges. Therefore, given that economic crises can unfurl much faster, embedding extra capacity in the bankruptcy judicial system in normal economic times is a prudent precaution to prepare for unexpected stress of additional bankruptcy petitions.

† BYU Marriott School of Business; University of California, Hastings College of the Law; and Harvard Law School. The authors thank Jacob Barrera, Denise Han, Jessica Ljustina, Spencer Kau, Victor Mungary, Julia Staudinger, and Sara Zokaei for research assistance. We earlier, at the very beginning of the COVID-19 crisis, wrote a report on the potential pressure on bankruptcy judicial capacity due to the Covid-19 crisis, on which this document is based. That report was endorsed by a group of bankruptcy academics and then forwarded to Congress. For recent Congressional action related to our report, see infra note 8.

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GE ENERGY V. OUTOKUMPU: NON-SIGNATORIES CAN NOW ENFORCE INTERNATIONAL COMMERCIAL ARBITRATION AGREEMENTS ON EQUITABLE ESTOPPEL GROUNDS
Tamar Meshel†

The recent unanimous decision of the United States Supreme Court (“Supreme Court” or “Court”) in GE Energy Power Conversion France SAS, Corp. v. Outokumpu Stainless USA, LLC (“Outokumpu”) resolves a relatively straightforward question: whether a non-signatory to an international commercial arbitration agreement can enforce it on the basis of the equitable estoppel doctrine. The United States Courts of Appeals for the Eleventh and Ninth Circuits had categorically ruled out the availability of equitable estoppel in this context. In contrast, the First and Fourth Circuits had applied the doctrine to enforce international commercial arbitration agreements by or against non-signatories. Answering the question in the affirmative and reversing the Eleventh Circuit, the Supreme Court has now resolved this split among the circuit courts. Its decision also brings much-needed clarity and predictability to the enforcement of international commercial arbitration agreements in the United States. However, in its narrow judgment the Supreme Court left unresolved two related and equally contentious questions: first, whether international commercial arbitration agreements must be signed to be valid and enforceable in the United States,  and second, how the equitable estoppel doctrine is to be formulated in this context and whether state or federal law governs its application.

A brief introduction to international commercial arbitration in the United States will set the stage for further discussion of Outokumpu and these lingering questions. Congress enacted the Federal Arbitration Act (“FAA” or “Act”) to govern the enforcement of arbitration agreements falling within its jurisdiction. Chapter 1 of the Act governs domestic arbitration agreements, while Chapter 2 incorporates the Convention on the Recognition and Enforcement of Foreign Arbitral Awards (“New York Convention” or “Convention”), which governs the enforcement of international commercial arbitration agreements and awards. Chapter 1 of the FAA also applies to actions and proceedings brought under Chapter 2 to the extent that Chapter 1 is not “in conflict” with Chapter 2 or the New York Convention.

The Supreme Court has consistently interpreted the FAA as embodying a “liberal federal policy favoring arbitration agreements,” and as creating “a body of federal substantive law”  that requires arbitration agreements to be placed “upon the same footing as other contracts.” Moreover, “[t]he goal of the [New York] Convention, and the principal purpose underlying American adoption and implementation of it, was to encourage the recognition and enforcement of commercial arbitration agreements in international contracts and to unify the standards by which agreements to arbitrate are observed and . . . enforced in the signatory countries.” In line with this pro-arbitration approach, the Supreme Court in Outokumpu held that non-signatories can rely on the equitable estoppel doctrine to enforce international commercial arbitration agreements under the Convention. However, two related questions that have long been the subject of contradictory circuit court decisions remain unresolved in the Court’s opinion.

The first question is antecedent to the equitable estoppel issue and relates to the “in writing” requirement of Article II(1) of the New York Convention. Article II(1) provides that the “[c]ontracting State shall recognize an [arbitration] agreement in writing.” The term “in writing” is in turn defined in Article II(2) as including “an arbitral clause in a contract or an arbitration agreement, signed by the parties or contained in an exchange of letters or telegrams.” Circuit courts have not consistently interpreted the Convention’s “in writing” requirement. The Second,  Third, Ninth,  and Eleventh Circuits have found that the Convention requires an actual signature for an international commercial arbitration agreement to be valid. The First, Fourth,  and Fifth Circuits, in contrast, have not insisted on a strict signature requirement and have enforced international commercial arbitration agreements on the basis of various contract and agency principles. The Supreme Court’s decision in Outokumpu may be interpreted as effectively siding with the latter circuit courts on this question. After all, how can courts continue to impose a strict signature requirement when the Supreme Court has allowed non-signatories to rely on equitable estoppel under the Convention? Nonetheless, the Court explicitly declined to decide “whether Article II(2) requires a signed agreement.”

The second question, which the Supreme Court left to the Eleventh Circuit to determine on remand, arises from the Court’s holding that non-signatories can enforce international commercial arbitration agreements on the basis of equitable estoppel. This question relates to the specific formulation of the equitable estoppel doctrine in this context and to “which body of law”  governs its application––federal or state law. In her concurring opinion, Justice Sotomayor noted the varied formulations of the doctrine across jurisdictions, but she would leave lower courts to determine the matter “on a case-by-case basis.”  The general understanding has been that courts are to apply “ordinary state law principles that govern the formation of contracts”  to the enforcement of domestic arbitration agreements under Chapter 1 of the FAA. However, circuit courts have divided as to whether federal common law or state law governs the application of equitable estoppel in the international context. The First, Second, and Fourth Circuits have applied federal law to address this question, while the Fifth and Eight Circuits have held that state law governs the enforcement of international arbitration agreements on the basis of doctrines such as equitable estoppel. The Supreme Court’s opinion in Outokumpu is ambiguous on this question

This Note will next summarize the facts of the Outokumpu case and the lower courts’ judgments. It will then turn to the opinion of the Supreme Court and discuss both the questions the Court decided and the questions that it left unanswered or ambiguous.

† Assistant Professor, University of Alberta Faculty of Law