Optimal Defaults for Corporate Law Evolution

Abstract

Public corporations live in a dynamic and ever-changing business environment. This paper examines how courts and legislators should choose default arrangements in the corporate area to address new circumstances. We show that the interests of the shareholders of existing companies would not be served by adopting those defaults arrangements that public officials view as most likely to be valueenhancing. Because any charter amendment requires the board's initiative, opting out of an inefficient default arrangement is much more likely to occur when management disfavors the arrangement than management supports it. We develop a "reversible defaults" approach that takes into account this asymmetry. When public officials must choose between two or more default arrangements and face significant uncertainty as to which one would best serve shareholders, they should err in favor of the arrangement that is less favorable to managers. Such an approach, we show, would make it most likely that companies would be ultimately governed by the arrangement that would maximize shareholder value.Evaluating some of the main choices that state corporate law has made in the past two decades in light of our proposed approach, we endorse some but question others. The arrangements we examine include those developed with respect to director liability, state antitakeover statutes, and the range of permitted defensive tactics.

A regulation and transaction cost perspective on the design of corporate law

“…In contract theory, Ayres and Gertner (1999) are using this argument to argue for so-called minoritarian or penalty defaults (later questioned by Posner 2005). In corporate law, Bebchuk and Hamdani (2002) uses a similar argumentation to promote so-called reversible defaults, i.e. whenever lawmakers face a choice between two default arrangements when neither is clearly superior, preference should generally be given to the alternative that is more restrictive of managers (see also Bebchuk 1989Bebchuk , p. 1412.…”

“…If the parties fail to fulfill these requirements, the derogation from the default rule will not be legally binding. Scholars has specifically paid attention to the requirement in some American state corporate acts, stating that charter amendments must be precede by a proposal put forward by the board of directors (see e.g., Bebchuk and Hamdani 2002;Hannes 2004;McDonnel 2007), essentially giving management veto power over all charter amendments. We should also consider the costs of different majority requirements.…”

“…In literature, we also find a specific discussion on enabling default arrangements in the regulation of takeovers. Two articles dealing with this issue are Bebchuk and Hamdani (2002) and Hannes (2004). Bebchuk and Hamdani consider the case where, without an initiative from the boards of directors, shareholders are unable to change the corporate charter in order to opt-out of the default antitakeover devices.…”

Social Enterprise, Corporate Objectives, and the Corporate Governance Narrative

“…In order to determine what alternative default objective should replace the current majoritarian default objective, it is important to consider why the corporate contract is incomplete with respect to the corporate objective, such that a default term is even needed . Corporate contracts virtually always will be incomplete in some aspect because unanticipated contingencies always exist for which the parties did not specifically contract . However, the failure to state a corporate objective in the corporate contract is not due to an unforeseen contingency or a foreseeable contingency that was too costly to include in the contract .…”

Institutional Investors as Blockholders

“…39 In firms with dominant shareholders, for example, Bebchuk and Hamdani note that the dominant shareholders can use selfdealing transactions with other entities affiliated with them to extract value. 40 Anabtawi and Stout observe that this situation can also arise with IIs in countries such as the US (i.e., where ownership is assumed to be diffused), as in the case where IIs represent and promote their own interests. 41 This relates to the risks associated with interplay between interest group politics and diffused ownership.…”