Jon Macey on Corporate Governance (Part 9)

Jon Macey, Deputy Dean and Sam Harris Professor of Corporate Law, Corporate Finance, and Securities Law at Yale, has recenlty published a book titled Corporate Governance, Promises Kept, Promises Broken.  This is the last post.

Macey rightfully views the central problem of corporate governance as capture of the board by management.  He views a robust market for corporate control as the solution. The problem with the approach (among others) is that this would require considerable change by the Delaware courts by, for example, invalidating the use of poison pills, the defensive tactic that has all but ended the hostile acquisition market.

Are there other fixes, either that are better than a robust market for corporate control or have a more realistic chance of implementation than sudden and dramatic change by the Delaware courts with respect to poison pills?  We noted that facilitating the election of dissident directors is one possible solution and a solution that receives only modest attention in Macey's book.

The other is to refocus the attention of management on the interests of shareholders by increasing their obligations and, perforce, their liability for failing to follow these obligations.  SOX to some degree does this by expanding the duties of the audit committee and by requiring the implementation of internal controls.  Expanded obligations imposed directly on the board of directors (say to review risk profiles of a company) or independent access to information (perhaps through regular meetings with officers other than the CEO), reduce the CEO's control over the information flow.  Moreover, if directors have specific duties such as reviewing a company's risk profile, it will be more inclined to insist that it receive specific types of information rather than simply accepting what the CEO provides.

But all of this depends upon the consequences on directors for failing to fulfill these duties.  That in turn requires an examination of liability, particularly derivative suites.  Macey doesn't like them.  As he noted, "litigation is part of the corporate governance problem, not part of the solution."  He does propose some possible reforms and notes that reform of the system is "theoretically possible."  But his main concern is with attorneys and monitoring. 

The derivative suit area is a mess, but the main problem once again rests with the Delaware courts.  As he notes, the data shows that plaintiffs almost always allege demand excusal.  The reason is that if they make demand, the board will accept the suit and dismiss it.  In other words, the truth is that once the suit is in the hands of management (and the captured board), the interests of shareholders are not protected.  This again comes back to the standard of review used by the Delaware courts.  They are willing to allow boards to use relatively meaningless procedural safeguards to dismiss meritorious suits against management. 

If derivative suits turned on the underlying merits rather than demand excusal (which is primarily a process of rotely counting the number of independent directors on the board), the suits would do a better job in policing fiduciary responsibilities of boards and force them to more often act in the best interests of shareholders.  Under the current structure, however, most derivative suits are dismissed on procedural grounds and those that go forward are settled.  Directors, therefore, have no meaningful expectation of liability for failing to act in the best interests of shareholders.  It stands to reason if the risk increased (through a system that focused on the merits rather than the number of "independent" directors), the board would keep its promise to shareholders more often.

Anyway, we found Jon Macey's book thoughtful and provocative and strongly recommend that you not use this Blog's short analysis as a substitute for reading the entire tome.