Ideoblog

Law profs as free agents

Clay Gillette (NYU) has written an article that I am sure just about all law faculty will be reading soon, Law School Faculty as Free Agents. Here’s the abstract:

The phenomenon of law professors changing jobs from one law school faculty to another - faculty free agency - has increased in recent years and appears to be part of a general phenomenon of increased mobility across academia. In this paper, I consider the consequences of free agency in law school markets. It is likely that law professors have benefited financially from free agency. Whether it has benefited law schools generally, or advanced the quality of legal education is another matter. The paper raises some issues that at least give reason for pause about free agency. The consequences of free agency have been similarly questioned in other industries, most notably professional sports. But studies suggest that the adverse effects that some predicted when free agency was officially instituted there have not materialized. Thus, in the absence of similar studies about academic free agents, one might claim that my concerns are overstated. But those studies are often most interesting because they focus on characteristics of professional sports that have little or no analogue in faculty markets. The market for professional sports differs from the academic market in ways that I suggest have significant effects on free agency. Academic free agency may have different, and more negative, impact in academia. To the extent that is true, law schools face a classic prisoners' dilemma in adjusting. Even if it would benefit legal education generally to constrain free agency, it is contrary to the interests of any law school to constrain itself unless competitors do the same. I conclude, therefore, with some practical ideas about how to address the negative effects of free agency.

Gillette suggests that free agency may reward scholarship more than teaching or institutional contributions, and therefore may skew output to the rewarded behavior. He also suspects that any benefits in improving scholarship are outweighed by losses in the other areas.

Of course what Gillette is really talking about is the effect of an enhanced buy-side market for law professors. Academic agency has never been “unfree” on the sell side in the way that sports free agency has been.

To the extent that this is about markets, there have been similar complaints about the effect of market pressures in many other areas, such as professional practice. And Gillette explicitly recognizes that faculty free agency cannot practicably be made less free, if only because faculty would unite against any such move.

The solution to any problems here would seem to be better metrics for scholarship (i.e., beyond cites and downloads), teaching (better mechanisms for evaluating) and institutional service. Since all of these talents should have value in the market for academic services, markets are not themselves the problem. Rather, what we need are stronger and more efficient markets.

Kirkendall on the Pai settlement

Tom Kirkendall provides an unusually insightful and balanced view of former Enron executive Lou Pai’s recent settlement with the SEC – on why the case against him was not a slam dunk, why we should not punish him for getting out of Enron before many other investors, and generally why the negative reaction to the settlement is all part of the misguided “greed narrative” about Enron.

The AALS boycott

I read of a boycott by some groups of the AALS’s annual meeting of law professors: (HT Garnett, who links to a Mirror of Justice debate):

The groups object to holding the annual meeting at the San Diego Manchester Grand Hyatt, a hotel whose owner, Douglas Manchester, has donated $125,000 to an initiative to outlaw same-sex marriage in California. The groups say that to attend the five-day event hosted primarily at the Manchester Grand Hyatt would conflict with their policies of nondiscrimination based on sexual orientation. The groups are the Society of American Law Teachers; the Legal Writing Institute; the AALS Section on Legal Writing Research and Reasoning; and the AALS Section on Teaching Methods. The groups represent as many as 2,500 members.

Now, let’s be clear: this isn’t about boycotting a hotel that discriminates. Also, I have no question about these groups' right to boycott (indeed, I can't say I'd be bitterly upset if they do). But I do have a few questions:

• What if Mr. Manchester didn’t contribute money to oppose same sex marriage cause, but supported it vocally? Of course contributions are a form of expression. Would or should these groups make a distinction between contributions and other expression of belief?
• What if Mr. Manchester were only a majority shareholder? A minority shareholder? Vice president?  CFO?  Since the protest here isn’t over the hotel’s policies, control would seem to be irrelevant. What if he had only invested a lot of his money in the holding company of the hotel? The franchisor?
• Why just the hotel? Why not the restaurant owner? The food supplier to the hotel? Or any of their shareholders?
• Who exactly would the boycott be hurting? I assume that Mr. Manchester has some kind of contract with the AALS. But what about his workers, many of whom depend on tips? Come to think of it, what if hotel workers or one of its unions had expressed homophobic or anti-same-sex marriage views?
• How would the boycotters feel about teaching students who opposed same sex marriage? (I note that the chair of one of the boycotting groups heads the legal writing program at a Catholic law school).
• If you were a student, would you feel comfortable expressing an anti-same-sex marriage view if you knew that the teacher couldn't stand to stay at a hotel owned by somebody who opposed same sex marriage?

Now I wouldn’t presume to express my own opinion about these proceedings. But I did a mini public opinion poll by asking my wife, who is about as non-political as you can get, her reaction to the boycott. Her response: “These people don’t have enough to do.”

Update: Prof B has some views, with a lot of links, plus an open letter to AALS executive director Carl Monk. Among other things I learn that a union is co-organizing the boycott.  And Tom Smith has some of the same questions I do.

Wood v. Baum discussed on the Harvard Corporate Governance Blog

My post on Wood v. Baum, in which the Delaware Supreme Court enforced a fiduciary opt out in a publicly held LLC, is up on the Harvard blog. This case is particularly important given the recent Ryan case.  With the Delaware courts retreating from 102(b)(7), unincorporated firms are looking like the only reliable refuge from Van Gorkom.

Fairness in civil vs. criminal trials

Are corporations in civil cases as entitled to an impartial jury as criminal defendants? The judge in the Mattel-MGA case apparently thinks not, and WSJ Law Blog’s Dan Slater finds his reasoning “compelling.” I don't know whether the judge should have ordered a mistrial for juror bias, but I certainly don't find the distinction compelling. I should think that the WSJ of all news sources would realize how socially important it is that businesses and property rights find a fair forum. 

Sorkin and rumor-mongers

Andrew Ross Sorkin writes in today's NYT about Credit Suisse’s Steven Rattner having to quit his job as head of DLJ Merchant Banking because of a relentless Internet campaign against him by a jilted husband. The story is about how the Internet run amok can destroy even basically good family men. Or, as Sorkin says,

this isn’t about a man who made a mistake and had an affair. It is a story about a man who said he was helpless against the destruction that can be wrought by aggressive campaigns on the Internet.

But in the press, and especially in the NYT, there’s usually something else going on just behind the newsprint. In this case, it’s hard not to think that it’s really all about dispute a few weeks ago between Sorkin and Dealbreaker’s John Carney.

Sorkin wanted the SEC to go after rumor-mongers. Carney called this “a frightening curtailment of freedom of speech. . . Your right to express your doubts about the financial health of a company would suddenly turn on ex post-facto decisions of prosecutors, judges and juries.” This sparked responses by Sorkin and Portfolio’s Felix Salmon, discussed here.

So now it seems Sorkin is switching gears, pulling a technique out of his colleague Gretchen Morgenson’s toolbox – that is, find a practice you don’t like, and then find an anecdote that has little to do with the general issue (Wall Street rumor-mongering getting an adulterer fired) that you can use to tar the practitioners you’re fighting against.

I’m with Carney on the basic issue. More information is good for markets. Yes, false rumors are bad. But sending the SEC out on a fishing expedition against rumors could have a very costly effect in chilling true speech.

Moreover, it’s hard to miss Sorkin’s motive here. Sorkin needs to be the one to break stories – that’s what he gets paid the big bucks for. So he’s in direct competition with other sources of information, particularly including Dealbreaker. This relates to the public choice argument about insider trading regulation – that it’s all about interest groups competing for information. See David D. Haddock and Jonathan R. Macey, A Coasian Model of Insider Trading, 80 Nw U L Rev 1449 (1986).

Just keep all this in mind the next time Sorkin or other MSM type goes on the warpath against rumor-mongering.

Faculty as furniture

Jeffrey Harrison goes beyond the dead wood concept to discuss dry rot, balsa, composite and pulp (HT Leiter). What about veneer?  You know -- a thin strip of mahogany glued onto paperboard.

Artists as capitalists

Today’s NYT discusses the U of C economic historian David Galenson’s work on ranking artists through “citation counts” in art texts. See also MR. But I’m actually more interested Galenson’s recent book introduction, The Back Story of Twentieth-Century Art. Here’s a piece of the abstract:

The single most important change [in the 20th century art market] involved the structure of the market for advanced art. Innovation had always been the hallmark of important art, but since the Renaissance nearly all artists were constrained in the degree to which they could innovate by the need to satisfy powerful individual patrons or institutions. The overthrow of the Salon monopoly of the art market in Paris and the rise of a competitive market for art in the late nineteenth century removed this constraint, and gave advanced artists an unprecedented freedom to innovate. Conspicuous innovation subsequently became necessary for important modern art. All artists recognized the increased demand for innovation, but it would be conceptual artists who could take advantage of it more quickly than their experimental counterparts. Early in the twentieth century Pablo Picasso became the prototype of the conceptual innovator who maximized the economic value of his inventiveness in the new market setting, and during the remainder of the century, a series of young conceptual artists followed him in producing more radical innovations, and engaging in more extreme new forms of behavior, than had ever existed before, making this an era of revolutionary artistic change.

Galenson says that scholars who think of the art market as dealers and collectors are missing artists' central role. It was Monet and other artists who overthrew the Salon in 1874 and organized an independent exhibition. Today we think of the promotional activities of artists like Picasso, Pollock, Warhol and Hirst. (I can't resist referring to my personal favorite in the annals of artist self-promotion, Clouzot’s Le Mystere Picasso). These efforts feed a broad market for art, led by museums with their blockbuster shows and wealthy collectors (including hundreds of galleries in Chelsea alone), that has broken the stranglehold by official gatekeepers like the Salon.

The existence of this market, in turn, has an important effect on the art. The market craves innovators who get cited the most and therefore have the highest market value. This, in turn, provides an incentive to innovate, as in any product market.

What’s missing in this paper (though maybe it’s in the book) is a convincing account of why this market developed. After all, it’s not like artists had no commercial interests before Monet broke free of the Salon. A visit to Rembrandt’s factory in Amsterdam should cure anyone of the idea that great artists only wanted art for art’s sake. But where did all those buyers come from?

In Galenson’s account, Monet and friends in fact did not actually single-handedly create this market in 1874. Rather, he says, the key event was a 1914 Paris auction. Ten years earlier a businessman named Andre Level had formed a private investment fund that bought works mainly of younger artists such as Matisse and Picasso. In the 1914 auction, the works were sold for more than four times the group’s investment. Galenson says

this sale was the first time an important group of works by the leading artists of the day had come to auction, and its public success helped to convince many people that contemporary innovative art could be a good investment. This laid the foundation for a new era of artistic freedom, that allowed artists to follow their own interests rather than those of patrons.

I suggest that this growth of the art investment market occurred in tandem with the growth of other investment markets, including stock markets. This created a broad group both inclined and rich enough to invest in art. In other words, the art market is part of the capital market in which the artists themselves are now an important moving force.

I’ve focused for awhile on a different type of artist – filmmakers. I’ve argued (in Wall Street & Vine) that the anti-capitalist flavor of many films owes to the resentment of the artists, including directors, screenwriters and actors, of the capitalists whose control of the budget decides what films get made and what they say. So I find it ironic to read in Galenson that the visual artists are themselves the capitalists.

As I've said (discussing another Galenson article) I haven’t systematically studied anti-capitalism in modern visual arts. Anecdotally, it’s perhaps worth nothing that the highest price artist of our time, Damien Hirst, does not seem to have a problem with capitalism, or the worldly in general. For example, his diamond skull is generally seen (e.g., here) as a subversion of the memento mori theme in older paintings: since we’re going to die, let’s focus on worldly things now.

If we do see any of this resentment in modern art, I suspect it’s directed at capitalist-artists, not non-artist capitalists. It’s all about the entrenched businesses looking over their shoulders at the competition. For example, Galenson has a great little vignette about Picasso, the great promoter, disparaging the art of his formidable new competitor, Jackson Pollock.

Into the Breach!

There's a new blog by a couple of entering college freshmen.  It's already making more sense than some law professor blogs I could (but won't) name.  The early going brings us posts about the pointlessness of happiness research and why postal services (among other government functions) should be privatized.  I'm hooked.

Obama and Wall Street

Charlie Gasparino wonders why, if Obama is threatening to expand government, raise taxes and make trade less free, “Obamamania still seems to be sweeping the executive suites of some of the biggest Wall Street firms.” I've wondered about that too.

His answer: "At bottom, Obama is about taxing wealth creation - not the piles of cash these guys have already accumulated."

There’s a nice irony to the fat cats rolling in their dough while the economy goes down the tubes because of measures supposedly designed to redistribute wealth from the rich to the poor and middle class.

John Carney at Dealbreaker adds:

There's a generational aspect to this. While the senior executives on Wall Street might not have much to lose from higher taxes, junior Wall Streeters may well feel the sting of higher taxes. In short, supporting Obama is another way for the bosses to screw the worker bees on compensation.

But this doesn’t clarify why Wall Street is actively supporting Obama instead of just not actively opposing him. Also, I'm not sure that there really is a generation gap in Wall Street support for Obama.

Gasparino concludes with a warning about an Obama market:

Many traders I speak to think the markets have yet to fully digest the impact of Obama's economic plan on stock prices. The guess is that it will hit after Labor Day, when the campaigning picks up and traders stop taking Fridays off to hit the Hamptons. In other words, the markets could fall further from their already beaten-down levels once the street begins to focus on an Obama presidency.

And he adds that Wall Street’s problems will carry over to Main Street:

Never before have Wall Street and Main Street been so intertwined: Nearly every American has a 401-k plan to save for retirement. Here in New York, city and state budgets rely on Wall Street bonuses for tax revenues like never before - just ask Gov. Patterson, who last week warned of budget disaster, largely thanks to the Wall Street slowdown. One trader recently reminded me of another president who raised taxes and clamped down on free trade, as Obama seems set to do - just after the stock-market crash of 1929: His name was Herbert Hoover. And you know what happened next.

I have wondered if Obama isn't already affecting stock prices.

Of course, I doubt if any of this actually will touch Obama. The summer-fall Obama market will get blamed on the current president. So I suspect that people will be voting for Obama in the polling booth and against the economy when they call their brokers, without making any connection between the two. After the election, keep in mind that politicians are adept at taking credit for the good times and passing the blame for the bad ones, and there are few politicians as adept as Obama.

The latest moves in the market for marriage law

When Hawaii, 15 years ago, looked like it was going to recognize same sex marriage, it also looked like the idea would sweep the country. Then the federal government and most states passed laws or constitutional amendments against it. At that point it looked like only the Supreme Court could give same sex couples the legal right to marry -- that the market for same sex marriage law was dead.

But same sex marriage is proving the dynamic nature of our federal system. All it takes to recognize a right is one state. Mobile parties can go to that state or contract for its law.  Then they can try to take their rights on the road, and challenge other states to either send them away or recognize the right. States can’t afford to send away either big firms or entire groups of people.

It worked that way for corporate law, as Erin O’Hara and I discuss in our Corporations and the Market for Law. And it’s unfolding that way for same sex marriage.

To summarize the state of play (also discussed in my most recent posts in my marriage archive):

• Massachusetts became the first state to recognize full-fledged same sex marriage. But out of state couples couldn’t use the law because of a century-old Massachusetts law restricting local marriages by out of state couples.
• Then California recognized same sex marriage. So NY couples had an incentive to settle in California.
• Then NY recognized out of state same sex marriage, thus giving same sex couples an incentive to come back to NY after they get married in California.
• Meanwhile, Massachusetts had an eye on those New Yorkers flying all the way to California. According to a story about all this in today’s NYT: "A June memo from the Massachusetts Office of Housing and Economic Development estimated that 21,000 gay couples from New York might go there to marry if the state allowed. That is about 43 percent of the estimated 49,000 same-sex couples in New York."
• Not surprisingly, Massachusetts, by a law signed Thursday, now lets out of state couples marry in Massachusetts instead of having to go to California.

Any bets on how long it will take for NY to allow same sex marriages to be performed in NY? When that happens, the marriages will be fully legal in NY, California and Massachusetts.

I've been writing on this subject for several years now, in this article (published in 2001 Illinois Law Review 561), and then in this 2005 article. Both articles anticipated the jurisdictional competition for couples that recently unfolded in California, NY and Massachusetts, and compared it to the corporate law competition that gave rise to liberalization of business association law. Now it's part of my forthcoming book (from Oxford) with Erin O’Hara on The Law Market.

I have always thought that the market for law was a better way of resolving contentious issues than trying to end the debate with a federal law. Those who thought that same sex marriage could not survive without federal constitutional protection were simply wrong, as we now know.

Of course many will argue that this right deserves to be recognized in every state. But these people have to confront those who think the right should be recognized nowhere (and who are just as wrong as those who want a federal law for same sex marriage). As I said in my 2005 article (footnotes omitted):

[T]he relevant question is whether the process is likely in the long run to disregard rights that deserve recognition. A decision invalidating laws against same sex marriage would leave many questions unanswered concerning potential differences between same sex and heterosexual relationships. Agnosticism is particularly important for family law, given the clash of normative views and the difficulty of getting reliable data. * * * Courts and legislators can observe the results, particularly as children grow up under different regimes. Evolution also permits the law to adapt incrementally to unpredictable future events and changing mores, provides feedback as to alternatives, and minimizes the cost of mistake compared to a Supreme Court decree.

In short, the 51-state (and worldwide, for that matter) market for law is the best way to work this out, and recent events are making this clearer than ever. 

Stout vs. hedge funds

Lynn Stout writes in today’s WSJ that activist hedge fund managers are "robbing average investors of better returns.” The funds “push for strategies that raise the stock price of the few companies they own but may lower the stocks of other companies, or that raise prices in the short term while harming companies' long-term prospects.”

A specific example of this supposedly inefficient behavior is that hedge funds force a sale of the target for a premium price, in which “the shareholders of the generally much-larger acquirer often lose when the acquirer's stock declines.”

Yes, takeover laws make acquisitions very expensive. It would be nice if we could get rid of, for example, the Williams Act, and reduce some of the friction in the market for corporate control. As a result, a lot of the gains from takeovers go to targets. But that doesn’t mean that society doesn’t gain from takeovers. Moreover, if acquirers really are making bad deals, there’s a solution: takeovers, to discipline the profligate managers of the acquirers.

Lynn worries that hedge funds cause the targets to drain cash or take on debt. Often, however, the market reacts positively to these moves because the incumbent managers aren’t using the cash efficiently. Lynn says “[t]he result is often an anemic, over-leveraged company that lacks the funds to invest in long-term projects and that cannot weather economic downturns” which is a “serious problem for long-term average investors trying to save for retirement.” But remember that this firm likely was a target because it wasn’t particularly successful, and therefore wasn't making good use of the cash. So those long-term investors who are saving for retirement likely did better by getting the cash than having it frittered away by the managers of a dying firm.

Lynn says shareholder activism often results in sale to private equity, which makes “entrepreneurs and managers more reluctant to operate as public companies,” and reduces the number of good public companies to invest in. So, says Stout, private equity funds can make hefty returns “snap[ping] up well-performing companies” “while average investors' returns have been nearly flat.”

Yes, hedge funds often do end up provoking a sale to private equity. There’s recent evidence that “is consistent with the hypothesis that hedge funds play an active role and increase the wealth of target shareholders in LBOs”  (specifically, a hedge fund buyout premium of 7-10%).  Moreover, other institutional investors such as public pension funds and mutual funds don't make similar gains. So hedge funds are causing the public shareholders to get more out of private equity deals. Is that a bad thing?

Stout's real problem is that private equity can bring gains to the same companies that haven’t done so well by their public shareholders. Why is that? The standard explanation is the regulatory (e.g., SOX) and securities litigation penalty for being public. But I discuss a lot of theory and evidence in my Uncorporating the Large Firm that the gains both from hedge fund activism and from private equity come from the superior partnership-type governance structure of both hedge and private equity firms.

Bottom line: there’s little support for Stout’s conclusion “that increasing shareholder activism may be a cure that is worse than the disease, at least for the average investor.”

The diminishing role of due care waivers in Delaware

The ever-alert Francis Pileggi writes about the recent opinion by VC Noble in Ryan v. Lyondell, in which, as Mr Pileggi says:

The court found that at the procedural stage of a summary judgment motion, it would allow to proceed to trial the issue of whether the independent directors should be exposed to personal liability for their role in the sale of the company--despite selling the company to the only known buyer for a substantial premium.

But, hey, what about 102(b)(7)? Money quote from the court:

With a record that does not clearly show the Board’s good faith discharge of its Revlon duties. . . whether the members of the Board are entitled to seek shelter under the Company’s exculpatory charter provision for procedural shortcomings amounting to a violation of their known fiduciary obligations in a sale scenario presents a question of fact that cannot now be resolved on summary judgment.

It’s increasingly looking like the best and maybe only chance for managers to comfortably avoid liability, or at least a messy trial, is in an unincorporated firm. This makes the Delaware Supreme Court’s recent opinion in Wood v. Baum especially important, as I've written.

Update: My casebook co-author Jeff Lipshaw adds a bit of reality to this decision and brings home some of why this case is troubling.  Here's a taste (but read the whole thing):

My question to all the corporate law professors out there is this: You understand the facts. You understand the risks. You are sitting there advising the board at H-Hour. Do you really tell Lyondell's board it is duty-bound not to take this deal under this agreement, and watch a $48 offer on a $30 stock evaporate? What would you do?

Friends as fiduciaries?

In my article, Are Partners Fiduciaries? I make a rather simple point: that a fiduciary duty of unselfishness does, and should, apply only in the narrow situation in which one party delegates full control over her property to another. In support, I drew partly on my earlier article, Law v. Trust, in which I argued that imposing stringent legal duties in order to encourage one party to trust another can, in some situations, actually interfere with the establishment of trust. A main goal of my fiduciary article was to use legal and economic analysis to rescue fiduciary law from the murk of centuries of colorful dicta.

Had I been more creative, I might have tried to make my argument more persuasive by showing the dangers of rejecting my approach. I might have shown what can happen when one wants to make her case for liability by diving back into the murk of dicta and pulling out a wet glob of fiduciary lingo. For example, I might have shown that, eschewing the clarity of my approach, one could even argue that a friend is a fiduciary.

Of course you can’t very well say that a person has a legal duty of unselfishness just because she is your friend. You’d find people opting for the safer territory of acquaintanceship. Or maybe it would be more accurate to say that with that legal duty you'd find yourself with a whole lot more friends than you thought you had.

Maybe you could say that one who poses as your friend has a duty to keep your information confidential, or not to use it for his own benefit. As I show in my article, that wouldn’t be a fiduciary relationship in my definition, though it would be under some dicta. However, once you’ve dredged up the fiduciary lingo, maybe you could paste it into an argument for imposing a duty of unselfishness. At least you might get past a motion to dismiss. And that would certainly be horrid.

Alas, I wasn’t creative enough to make that sort of argument. But Ethan Leib has, and it's the subject of a lively debate over at the Glom.

Leib's good enough to cite me a few times and even to refute the argument he imagines I would make against his position. It would be churlish of me to point out that he’s not really talking about my argument. I was talking about a legal duty of unselfishness. Leib refers to the duty of unselfishness, but never shows that the courts do, or even should, recognize this duty based on friendship.

Rather than being churlish, I will be gracious in acknowledging that I couldn’t have shown the mischief of not being precise about fiduciary duties as convincingly as Ethan Leib has.

KKR: YBPblic

So, KKR is going public, probably as a last resort to shore up the value of its European affiliate, which will get about a fifth of the shares, the rest going to KKR partners and employees.

There’s no big payday for the insiders. The future for the publicly held firm’s shares looks murky, judging from Blackstone. Even if the shares go up in the near term, the insiders better hope they stay up because they’re locked in for six to eight years. Here’s a discussion of the deal.

Assuming they do make money, the insiders will have to balance that pleasure with some pain.

Like providing a platform for noisy activists.

As the process moves forward, SEIU will look very closely at this transaction.”

The messiness of public markets (per today's WSJ):

In the gossipy world of fund management, some firms are finding their businesses picked apart by rivals looking to profit from declines in their share prices. London's RAB Capital PLC found itself the target of short sellers earlier this year. The shorts were betting against RAB because they saw its public investment in troubled U.K. lender Northern Rock PLC sour. RAB lost money when the U.K. government stepped in and nationalized Northern Rock.

The same article discusses the joys of Regulation FD:

Christopher Peel, head of BlackSquare Capital LLP, a London fund-of-fund group with $300 million in assets, said public firms' funds are less appealing because public companies can't talk privately to big investors about information, like a manager's view of the markets. "From an investor's point of view, I like to be able to pick up my phone and communicate with my manager," he says.

And then you’ve got those new public shareholders, who may not be on the same page as KKR’s other constituencies. Per another WSJ article:

KKR must still appease its institutional clients. With KKR now on the verge of going public, some are wondering just how their interests will be served. Ron Schmitz, chief investment officer of Oregon Public Employees' Retirement Fund, says: "In general, we are somewhat concerned about the possible loss of alignment of interests" between buyout funds and their investors when buyout firms have "shareholder pressures."

No doubt there will be shareholder suits down the line complaining that KKR sided with its clients (though the KKR public company has the same sort of fiduciary waivers that we’ve seen in, e.g., Blackstone).

I’ve written (in Uncorporating the Large Firm, among other places) that going public is not inherently inconsistent with the private equity governance model. So these firms get the usual advantages of going public. But one wonders in the current environment what those are.

Masochism?

Sinclair v. Levien and corporations' hidden contracts

Bob Thompson has an interesting discussion of the venerable Delaware decision of Sinclair v Levien, which happens to be one of my favorite cases in the corporation course. As Bob explains, the case apparently expanded the space for selfish action by controlling shareholders – that is, the intrinsic fairness review appropriate to self-interested decisions doesn't apply if the controlling shareholder isn't getting something at the expense of the minority. So in Sinclair a parent corporation avoided intrinsic fairness review of a decision to get dividends from a non-wholly-owned sub (Sinven) since the dividends went proportionately to controlling and minority holders.

Bob points out that the case neatly illustrates the fine distinctions courts make in judging corporate decision-making and how this translates into standards of review. So, in class, we can ask why intrinsic fairness applies here and not there, both regarding the various board decisions involved in Sinclair, and the cases that came after, which as Bob said ended up applying a more complex set of distinctions than Sinclair itself hinted at.

In addition to being enjoyable and insightful, Bob's article gives me a chance to let out a theory I've long had about this case: when you get outside the realm of fiduciary relationships (which as I've argued in Are Partners Fiduciaries? exist only where a party is exercising open-ended delegated discretion), the scope of permissible selfish conduct depends on the parties' contract.  Unfortunately, in corporate cases (unlike in partnership cases, as I've argued here), the contractual analysis is often obscured by fiduciary language.  The nifty thing about Sinclair is that the contract is the only way to explain the case.

Sinven was outside the fiduciary realm, and in the land of obligations among shareholders, each with the right to vote its interest selfishly.  The question is, what are the limits on this selfish behavior? 

The Sinven minority understood that Sinclair had subsidiaries in each of the many countries it was operating in, and that each would exploit the oil in its respective country. That was the implied contract that arose out of the deal. So as long as Sinclair wasn’t, in effect, giving an opportunity that arose within Sinven's territory to another sub, Sinclair met its contractual obligation. And that is exactly what the court held in Sinclair, after you boil away the fiduciary language.

But the really interesting aspect of the case is the claim that involves a contract for the purchase of oil by Sinclair's wholly owned subsidiary, International, from Sinven. Sinven claimed that International’s payments under this contract were late, and that International failed to buy all the crude it had contracted to buy.

The court applied the intrinsic fairness test to the subsidiary’s claim that this contract was breached. As the court held, “late payments were clearly breaches for which Sinven should have sought and received adequate damages.” This doesn't need much more analysis. The tricky part is that

[a]s to the quantities purchased, Sinclair argues that it purchased all the products produced by Sinven. This, however, does not satisfy the standard of intrinsic fairness. Sinclair has failed to prove that Sinven could not possibly have produced or some way have obtained the contract minimums. As such, Sinclair must account on this claim.

But why does intrinsic fairness apply to this claim? Bob says it’s because (footnotes omitted)

[t]his claim fit within the traditional self-dealing claim in which a conflicted director or shareholder was on both sides, but held a different proportion of the claims on each side so as to tilt its incentives. Thus in the International/Sinven contract in which Sinclair owned all of International and 97% of Sinven, Sinclair would receive 100 cents of every dollar directed toward International but only 97 cents of every dollar directed to Sinven. If it were negotiating on behalf of both, an outside observer would expect that Sinclair would prefer a contract favoring the side where it would receive 100% of the benefit.

Not so fast, as I note in questions following the case in my casebook (at p. 553). After all, in the claim to which the court applied the business judgment rule, Sinclair was accused of effectively allocating oil opportunities to other wholly-owned subs. So Sinven was left without any oil to sell International. Why not force the subsidiary to prove that it should have had oil to sell to International, just as it was forced to prove that Sinclair deprived it of an opportunity it was entitled to?

I don't I think the answer has anything to do with fiduciary duties.  Rather, the answer boils down to the contract.  As the court said, "[a]lthogh a parent need not bind itself by a contract with its dominated subsidiary, Sinclair chose to operate in this manner." There was an explicit contract to sell a certain amount of oil to International, and the court could simply point to that contract as an indication of the limits of Sinclair’s selfish behavior. But there was no such contract governing the other claim. In fact, as I noted above, the circumstances pointed in the opposite direction.

Once you’re outside of fiduciary land, as you are in Sinclair, parties in a commercial relationship can act selfishly to each other, governed by their contracts. Sometimes the contract is implied and not obvious. But the court should look hard for these contractual guideposts. The fog of fiduciary language often obscures the search. This is the basic lesson of Sinclair. 

Unfortunately, fiduciary analysis continued to cloud the post-Sinclair cases.  Instead of a single rule of "apply the contract," we have a zillion different fiduciary rules. Maybe the only way out of this is to chuck the corporation and all of its baggage.

Junior Scholars @ Conglomerate: Venture capital governance

The Glom’s junior scholar workshop kicks off with Brian Broughman’s The Role of Independent Directors in VC-Backed Firms and comments by Gordon Smith, Bill Carney, Tom Ulen and me, organized by my colleague Christine Hurt.

It’s a great opportunity for scholars to get feedback. For readers, it offers in-depth analyses and discussion of an important issue – in this case, governance of VC-backed firms. Check it out.

The FASB plants a litigation bomb

PoL discusses the big problems brewing from proposed FASB Statement 5 on accounting from loss contingencies.

As PoL says, linking The Recorder, this would force disclosures of details and predictions concerning lawsuits that are non-remote, as compared with “probable” under the prior standard. But it’s worse than that, since the rule would require disclosure even of remote contingencies that could have a "severe impact on the entity’s financial position, cash flows, or results of operations." "Severe impact" is helpfully defined as one that has "a significant financially disruptive effect on the normal functioning of an entity," and "less than catastrophic." Here the rule goes even beyond international accounting standards.

PoL details the problems this causes for firms. But they basically boil down to one big problem: “companies will have a new reason to fold and pay a high settlement in order to get an even higher contingent liability off the books.” In other words, the standard significantly increases the strike value of litigation. As if that were not already enough of a problem.

Of course this gives firms a new reason to go private or elsewhere.

Aside from mumbling about improving disclosure, the FASB gives no hint that it took these costs of increased disclosure into account.

Kindle and the sociology of reading

[This post initiates a proposed weekly series on what I call “Sunday thoughts” -- that is, thoughts that are suitable for brains that are on idle. Please give me some feedback on whether I’m totally or just partially wasting my time.  Keep to yourself the comment that you can't distinguish these from my other posts.]

I’ve already mentioned that I’m reading on Kindle this summer, still liking it. Now I’m thinking about what broader social effects Kindle-type products might have if they catch on.

One thought was triggered by a book I’m now reading on Kindle: Mark Haddon’s A Spot of Bother (a great book, despite its dismissal by some critics who either don’t appreciate fine characterization or have decided to compensate for their wild praise of Haddon’s first book, Curious Incident).

A character in Haddon's book generally reads trashy novels at home. But when he’s reading in coffee shops, he takes along Daniel Dennett’s Consciousness Explained, not because he likes the book (he doesn’t like or even comprehend it) but because it makes a better impression on passers-by.

Can’t do that with a Kindle, which looks the same whatever you're reading. Of course you can always put an anonymous cover on a book, but most people don't take that extra step.

So I wonder if e-books become more popular whether sales of challenging or other public-worthy books will decline, while trashy or other private-worthy books become more popular. Or maybe they'll figure out a way to clothe the appliance with the cover of the book the user is currently reading, which would itself be a telling development.

The future of journalism: aggregation or disaggregation?

Tyler Cowen quotes Matthew Yglesias:

The New York Times is known for its hard news coverage, but he observes that from a business perspective it's primarily a fashion and food publication that runs a small political news operation on the side. One issue of T Magazine, he says, pays for an entire NYT.

And Tyler responds:

[T]he broader logic of the internet is toward disaggregation of content -- the fact that newspapers cover such a wide array of content has to do with the economics of printing and distributing bundles of newsprint. In the future, fashion ads probably won't be able to cross-subsidize any bureaux anywhere.

I agree, but have wondered about the outcome of the competition between newspapers and blogs and other internet content:

Consumers may continue to prefer that their news be delivered in paper or other physical form even as web access becomes ubiquitous. Physical delivery requires capital investments that are beyond amateurs’ reach. Even if the web replaces physical delivery, consumers may prefer to forego search costs and, in effect, buy from the professional media the service of choosing, aggregating, and vouching for all of the types of information consumers want, including entertainment reviews, classified pages and other advertising information, sports scores, recipes, bridge advice, and comics. The professional media can shape the demand for this bundled product through advertising, promotion, and other mechanisms for creating goodwill. They can use their most popular features to promote other parts of the bundle. The professional media’s resources enable them to invest in popular writers and branded syndicated features.

This matters on whether competition from the wide spectrum of blogs ultimately can offset the media bias I discuss in my article. (Tyler points to real estate advertising as distorting coverage of the housing bubble. I discuss other, more endemic, sources of media bias). I suggest:

Consumers . . . may be willing to continue to buy biased reporting because they get offsetting benefits from the overall product. Even if consumers supplement their reading with blogs, they may continue to be influenced by professional reporting.

So whether aggregation beats disaggregation may help determine who wins the competition between big and new media.