Opting Only In: The Bottom Line (Part 7)

The nexus of contracts approach is a worthy theoretical framework for the examination of issues relating to corporate governance. This is particularly true in emphasizing the importance of private ordering in the regulatory process. The usefulness, however, breaks down when the approach is used to explain the relationship between diffused shareholders and management. There is little evidence in practice that the relationship between shareholders and managers can be accurately characterized as a process of private ordering. Instead, as this essay shows, when the law defers to private ordering, the result is that it allows management to impose on shareholders a categorical rule that embodies its self-interest. In the context of waiver of liability provisions, the approach has resulted in one categorical rule being replaced by another, precisely the opposite of what contractarians desire.

Thus, it would seem that the contractarian approach does not offer an adequate explanation for the situation with regard to waiver of liability provisions. Based on our evidence, the managerial model might offer better predictive power. Management would always want the reduced liability. Given learning and network effects, over time, such provisions would become universal. Management would also want protection to the fullest extent permitted. This would yield provisions consistent with the evidence that we have presented.

The evidence is consistent with a race to the bottom. The waiver of liability provisions were not designed to solve a corporate governance problem but were intended to provide a benefit sought by management. With management controlling the reincorporation process, they could and would move the company to Delaware to take advantage of the reduced liability. Other states, aware of this dynamic, quickly mimicked the approach, not because it promoted good governance or efficient behavior but because it prevented a flight to Delaware.