By Paredes, Troy A.
Regulation , Vol. 28, No. 1
POLICYMAKERS CAN CHOOSE FROM TWO competing models of corporate governance. The first is a market-oriented model that relies on relatively little mandatory law to protect shareholders. Instead, it depends on a host of other formal and informal mechanisms, such as incentive-based compensation and hostile takeovers, to hold managers and directors accountable. The United States (or, more correctly, Delaware) embodies this approach, with its so-called "enabling" corporate law that parties can opt out of in crafting their governance structures. The second approach depends on a mandatory model of corporate law in which the state, as opposed to the marketplace, plays a central role in shoring up shareholder protections by fashioning mandatory rules that define shareholder property rights.
Which corporate governance model should developing countries follow? The stakes are high in answering this question correctly, as studies show a link between strong protections that shield shareholders from exploitation at the hands of insiders and the promotion of equity markets and economic growth. The basic intuition is that shareholders are more willing to invest when they are sufficiently confident that the system is not rigged against them.
If the goal is to protect shareholder interests from the abuses and mismanagement of directors and officers, and similarly to protect minority shareholders from the opportunism of controlling shareholders, developing countries generally should turn to a mandatory model of corporate law instead of a market-oriented corporate governance system.
U.S. CORPORATE GOVERNANCE
Corporate law in Delaware allows directors, officers, and shareholders to order their affairs as they see fit. To be sure, the Delaware corporation code contains a number of important provisions, although most are default rules and few protect shareholders from insider abuses. It is not much of an overstatement to say that the Delaware corporation code is largely beside the point when it comes to protecting shareholders. In fact, the most important provision of the Delaware corporation code cuts against shareholder protection. Section 141 (a) of the code provides that the "business and affairs of every corporation ... shall be managed by or under the direction of a board of directors." Section 141 (a) grants expansive authority to the board and, in effect, to the officers to whom the board delegates managerial control. Thus, the section deprives shareholders of any legal control over day-to-day business affairs and overall corporate policy, although shareholders, particularly institutional investors, can and do involve themselves informally on those matters. The Sarbanes-Oxley reforms ushered in by Congress after the scandals at Enron and WorldCom have not upset this basic allocation of corporate authority.
FIDUCIARY DUTY To the extent that substantive corporate law matters in the United States, it is not the law on the books but the common law of fiduciary duties that judges craft. Fiduciary duties do not give shareholders any "positive" control over the firm but they do constrain management's and the board's exercise of their authority and thus are a sort of "negative" control right that shareholders hold.
In brief, the fiduciary duty of care requires directors and officers to run the company with reasonable care and spend the time and effort needed to make prudent business decisions. The duty of loyalty charges directors and officers with acting honestly and prohibits them from looting the company, engaging in self-dealing that is unfair to the corporation, or otherwise acting in their own self-interest. The concept of good faith is marbled into both the duty of care and the duty of loyalty, although a separate fiduciary duty of good faith is starting to take shape in Delaware.
An important benefit of policing management through fiduciary obligations is that it allows the Delaware judiciary to craft corporate law on a case-by-case basis. …