Working Papers 201-210
201. The Rise and Fall of Article 2 (Scott, Robert E.) Forthcoming Louisiana Law Review, Vol. 63, 2002
On August 13, 2001 the National Conference of Commissioners on Uniform State Laws voted 89 to 53 to reject the 2001 Amendments to Article 2 of the Uniform Commercial Code that had just been approved in May by the American Law Institute. While negotiations continue, this public split between the two bodies that have together shepherded the UCC project for over fifty years represents the likely end of the fourteen year effort to revise the law of sales as embodied in Article 2.
In this Essay, I examine the political economy of the Article 2 project from its origins to the present. I begin by analyzing the drafting and enactment process of the original Article 2 and evaluate the success of the new sales law it introduced, a success attributable in no small measure to the replacement of archaic vestiges of property law with efficient contract default rules. I then I consider the effects of the compromises Karl Llewellyn made to secure the enactment of the Code. Of particular significance is how the vague terms that invoke the commercial context (originally intended by Llewellyn as a means of incorporating ex ante default rules) have been used to challenge the objective meaning of disputed contracts. For many commercial contractors, exit may have been a cheaper option than lobbying for clearer and more predictable default rules. But the parties to mass-market sales transactions remain subject to Article 2, and their representatives have sought to influence the revision process. Thus, the focus has shifted from Llewellyn's original goal of prescribing optimal default rules for commercial contracts to the current debate over proscribing freedom of contract in mass-market transactions. The resulting divergence between the interests of producers and those of consumer buyers, computer information licensees and their representatives has produced deadlock.
I conclude that the flaws in the Article 2 project were present from its inception. Given the limits of legal regulation, it is unlikely that any set of "uniform" rules that are promulgated for adoption in every state can both efficiently complete the gaps in commercial contracts as well as optimally police consumer transactions. In sum, the uniform laws process works when there is distributional symmetry (when today's buyer might be tomorrow's seller). On the other hand, the process deadlocks when it seeks to produce uniform rules for transaction-types in which the distributional effects are asymmetric and prices do not adjust efficiently to compensate for the victory of one group in the legislative process. wp201.pdf
202. Deals: Bringing Corporate Transactions into the Law School Classroom (Fleischer, Victor) Columbia Business Law Review, Spring, 2002
In this Essay, Victor Fleischer describes the "gap" between what is taught in law schools and what is needed in corporate transactional practice. The Essay identifies three related reasons why schools have struggled to teach transactions effectively: (1) the lack of a conceptual framework, (2) the lack of qualified teachers, and (3) the lack of quality teaching materials. The Essay then describes how the Deals program at Columbia Law School addresses these problems and provides students with a pedagogically sound and effective introduction to corporate transactional practice wp202.pdf
203. What Enron Means for the Management and Control of the Modern Business Corporation: Some Initial Reflections (Gordon, Jeffrey N.) University of Chicago Law Review, Summer, 2002
The Enron case challenges some of the core beliefs and practices that have underpinned various positions in the debates about corporate law and governance, including mergers and acquisitions, since the 1980s. In particular, Enron raises at least the following problems for the received model of corporate governance:
First, it provides another set of reasons to question the strength of the efficient market hypothesis, here, the company's dizzyingly high stock price despite transparently irrational reliance on its auditors' compromised certification.
Second, it undermines faith in the corporate governance mechanism - the monitoring board - that has been offered as a substitute for unfettered shareholder access to the market for corporate control. In particular, the board's capacity to protect the integrity of financial disclosure has not kept pace with the increasing reliance on stock price performance in measuring and rewarding managerial performance.
Third, it suggests the existence of tradeoffs in the use of stock options in executive compensation because of the potential pathologies of the risk-preferring management team.
Fourth, it shows the poor fit between stock-based employee compensation and employee retirement planning. More generally, it raises questions about the shift in retirement planning towards defined contribution plans, which make employees risk bearers and financial planners, and away from defined benefit plans, which impose some of the risk and fiduciary planning obligations on firms.
Although the disclosure, monitoring and other failures may lead to useful reforms, Enron also reminds us that there is a problem that cannot be solved but can only be contained in the tension between imperfectly fashioned incentives and self-restraint.
Keywords: Enron, corporate governance, efficient market, accountants, directors, stock options, pensions WP203.PDF
204. Incomplete Law - A Conceptual and Analytical Framework And its Application to the Evolution of Financial Market Regulation (Pistor, Katharina & Chenggang Xu) April 2002
This paper develops a conceptual framework for the analysis of legal institutions. It argues that law is inherently incomplete and that the incompleteness of law has a profound impact on the design of lawmaking and law enforcement institutions. When law is incomplete, residual lawmaking powers must be allocated; and enforcement agents have to be vested with law enforcement powers. The optimal allocation of lawmaking and law enforcement powers under incomplete law is analyzed with a focus on the legislature, regulators and courts as possible lawmakers, and courts as well as regulators as possible law enforcers. The timing and process of lawmaking and law enforcement differs across these agents. Legislatures are ex ante, courts are ex post lawmakers, regulators have combine ex ante and ex post lawmaking functions. Courts are reactive law enforcers, while regulators are proactive law enforcers in that - unlike courts - they can initiate enforcement procedures. We argue that the optimal allocation of residual lawmaking and law enforcement powers is determined by the degree and nature of incompleteness of law, the ability to standardize actions that may result in harm, and the magnitude of harm and externalities expected from such actions. Under highly incomplete law, regulators are superior to courts when actions can be standardized and, if allowed to proceed, may create substantial externalities. Otherwise courts are optimal holders of lawmaking and law enforcement powers. We apply this analytical framework to the development of financial market regulation in England since the mid 19th century, with comparative reference to developments in the United States and Germany. The comparative evidence suggests that financial market regulators with both residual lawmaking and proactive law enforcement powers emerged in all three jurisdictions in response to ineffective judicial law enforcement of highly incomplete law. wp204.pdf
205. RACING TOWARDS THE TOP?: The Impact of Cross-Listings and Stock Market Competition on International Corporate Governance (Coffee, John C. Jr) May 30, 2002
During the 1990's, the phenomenon of cross-listing by issuers on international exchanges accelerated, with the consequence in the case of some emerging markets that trading followed, draining the original market of its liquidity. Traditionally, cross-listing has been viewed as an attempt to break down market segmentation and reach trapped pools of liquidity in distant markets. The globalization of financial markets, however, renders this explanation increasingly dated. A superior explanation is "bonding:" issuers migrate to U.S. exchanges in particular because by voluntarily subjecting themselves to the U.S.'s higher disclosure standards and greater threat of enforcement (both by public and private means), they partially compensate for weak protection of minority investors under their own jurisdiction's law and also credibly signal their intention to make fuller disclosure, thereby achieving a higher market valuation and a lower cost of capital.
Still, many issuers who are eligible to cross-list do not do so. Increasing evidence suggests that cross-listing firms are significantly different from firms in the same jurisdiction that do not cross-list, most notably in that the former have higher growth prospects and are willing to sacrifice some of the private benefits of control to obtain equity finance. Conversely, firms that do not cross-list typically have controlling shareholders who have less interest in stock market valuation because they anticipating selling only in a control transaction at a control premium that they will disproportionately capture. As a result, specialized markets seem likely to persist in order to accommodate both firms that wish to offer superior protections to minority investors and those that prefer to cater to controlling shareholders who want to continue to realize the private benefits of control. Path dependency then may persist.
The latest developments in this new form of regulatory competition have been both (i) the creation of new "high disclosure" exchanges in emerging markets, and (ii) the enactment of reform legislation intended to protect minority shareholders by jurisdictions that have seen their securities markets lose liquidity to international exchanges. Both efforts seek to share control premia with minority shareholders in order to encourage equity investment. However, such efforts appear to be impeded by the continuing willingness of U.S. exchanges to waive governance listing requirements that are mandatory for their domestic firms in the case of foreign firms. Finding this new form of regulatory competition to be desirable, this article argues that its distinguishing characteristic is that it is "exit-less"(and thus differs from the "issuer choice" model of regulatory competition), and it recommends that the current broad exemption under which U.S. exchanges waive all governance listing requirements for foreign issuers should be reconsidered.
206. Law's Dominion and the Market for Legal Elites in Japan (Milhaupt, Curtis J. & Mark D. West) June 14, 2002 I n this Article, we present data on legal elites in Japan - legally trained university graduates poised to pursue successful careers either as fast-track bureaucrats or lawyers handling sophisticated business transactions. The data show a marked shift in employment patterns over the past decade: increasingly, Japan's most elite university graduates are forsaking the bureaucracy for law. We find that changes in Japan's underlying economic, political, and legal institutions are a primary cause of this shift. We argue that this trend is not a temporary phenomenon, but reflects a more fundamental transfer of authority in Japan from the bureaucracy to the legal system. The evidence sheds new light on two longstanding debates: the impact of law and lawyers on economic success, and the bureaucracy's role in the governance of the Japanese economy.
The data we examine are hard to square with the widespread view of Japan as "Exhibit A" for the proposition that societies encourage economic growth by steering their most talented youth away from "redistributive legal careers." Rather, the data indicate that in Japan (as elsewhere), talented college graduates pursue positions of power, prestige, and profit. While those positions were once located in the elite economic bureaucracy, they are now migrating to the legal system. Contrary to the evidence of stagnation in the economic and policy environments flowing out of Japan in recent years, close examination of the career choices of Japan's most highly regarded youth reveals a society in transition. wp206.pdf
207. Understanding Enron: It's About the Gatekeepers, Stupid (Coffee, John C. Jr.) July 30, 2002
Debacles of historic dimensions tend to produce an excess of explanations. So has it been with Enron, as virtually every commentator has a different diagnosis and a different prescription. Yet, in most respects, Enron is a maddeningly idiosyncratic example of pathological corporate governance, which by itself cannot provide evidence of systematic governance failure. Properly understood, however, the Enron debacle furnishes a paradigm of a gatekeeper failure - - that is, of why and when reliance may not be justified on a reputational intermediaries, such as auditors, securities analysts, attorneys, and other professionals who pledge their reputational capital to vouch for information that investors cannot easily verify. This comment shows that, during the 1990's, the expected liability costs associated with gatekeeper acquiescence in managerial misbehavior went down, while the expected benefits went up - - with the unsurprising result that earnings restatements and earnings management increased. Diagnosing the circumstances under which Agatekeeper failure is likely leads in turn to prescriptions focused on re-aligning the incentives of gatekeepers with those of investors. WP207.pdf
208. Reducing the Tax Costs of Indexed Options (Schizer, David M.) July 31, 2002
To encourage pay for performance, Congress offers certain tax advantages when stock options are used as compensation. Yet these advantages arguably are not available to so-called "indexed" options, which reward executives for good relative performance (i.e., instead of absolute increases in stock price). The tax costs of indexed options are as ironic as they are unintended. The relevant tax rules are supposed to favor performance-based pay and, if anything, indexed options are more performance-based than conventional options. As a result, these tax rules should be reformed.
While portions of this Article originally appeared in David M. Schizer, Tax Constraints on Indexed Options, 149 U. PA. L. REV.(2001), this Article is substantially different. Most importantly, this Article explains why some practitioners believe indexed options cannot qualify as performance-based pay under Section 162(m), and thus cannot be deducted in excess of $1 million. This Article offers a legal interpretation that allows a deduction, and suggests that the tax authorities are likely to offer a favorable ruling on this issue. WP208.pdf
209. An American Perspective on Anti-Takeover Laws in the EU: The German Example (Gordon, Jeffrey N.) 12 Die Aktiengesellschaft, December 2002 Guido Ferrarini et al, Reforming Company and Takeover Law in Europe (Oxford 2004)
The new German Takeover Act contains antitakeover provisions that reject the "board neutrality/shareholder choice" of the rejected draft of the 13th Directive. These antitakeover provisions may have a particular (albeit temporary) justification as part of negotiating strategy to obtain a Directive with a "level playing field" approach to a wide variety of control barriers in the EU. This is because assent to cross-border mergers and the transnational economic integration associated with such mergers ultimately depends upon the control of economic nationalism. General vulnerability to takeover bids, in which acquirers who engage in value-reducing home country bias would face a control threat, can play a valuable role in controlling economic nationalism.
Nevertheless, the German antitakeover provisions would have much more adverse impact than the US counterparts to which they are frequently compared. First, the favored US defensive measure, the poison pill, is not available under prevailing German principles of preemptive rights and non-discrimination against any shareholder. German firms are likely to substitute irreversible, value-decreasing measures that were replaced in the US by the pill, such as capital structure changes or asset dispositions. Second, the typical US practice of annual shareholder elections of board members combined with heavy institutional investor ownership in large public firms means that managements are highly sensitive to public shareholder interests in considering a takeover bid. By contrast, German supervisory boards turn over much more slowly, and are co-determined. German management feels less legal and cultural pressure to adhere to public shareholder interests. Third, stock option-laden compensation packages make US managers highly receptive to premium bids, especially because a takeover typically triggers the accelerated vesting of such options. German compensation arrangements do not now and, as a matter of culturally constraint, are unlikely to imitate the US version. So if Germany insists too hard on a 13th Directive to its exact taste, it risks sacrificing internal and cross-border mergers that would produce efficiency gains and aid the EU transnational project. WP209.pdf
210. Should the Behavior of Top Management Matter? (Khanna, Vikramaditya S.) Forthcoming, Georgetown Law Journal, Vol. 91, 2003
Recent events, such as the Enron, Worldcom, and Global Crossing debacles, have brought to the forefront the issue of corporate and organizational wrongdoing and the involvement of top management in it. To date, the law's response to the knowing or reckless involvement of top management in corporate wrongdoing has been primarily two-fold. First, it increases the sanction imposed on top management. Second, it increases the sanction imposed on the corporation (i.e., the shareholders). This paper examines the second response.
The second response can be examined in multiple ways depending on the analytical perspective being utilized. In this paper I consider the question from three perspectives. First, whether our current law can be justified under a deterrence-based approach to corporate criminal liability. This is the bulk of the paper as that has been where much of the literature in the corporate crime area has developed. Second, whether our current law can be justified under an expressive approach to corporate criminal liability. Third, whether our current law might reflect an attempt to place most of the risk of liability on the corporation, which is generally a better risk bearer than top management. My conclusions are that our current law is difficult to justify under any of these approaches and that it is likely imposing costs on society. This suggests that our current law is in need of reform. WP210.pdf