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.
Advisers by Another Name
Paul G. Mahoney & Adriana Z. Robertson
The rise of index funds has reshaped the modern American capital markets. Like mutual fund managers, indices now direct trillions of dollars of investor capital. Although it regulates mutual fund managers as investment advisers, the SEC has chosen not to treat the providers of market indices similarly.
In this Article, we argue that many index providers are not merely like investment advisers; under the relevant statutory and regulatory regimes, they are investment advisers. The SEC’s failure to recognize this fact reflects an inaccurate and antiquated view of the index fund market.
Having established that certain index providers are presently acting as unregulated investment advisers, we propose a regulatory solution. The SEC should create a nonexclusive, conditional safe harbor giving index providers guidance on what activities will and will not make them investment advisers. This would close the regulatory gap in a way that is consistent with the governing statutes and case law without unduly burdening market participants.