Fact and Fiction in Corporate Law and Governance
Klausner, Michael, Stanford Law Review
INTRODUCTION I. CONTRACTING AT THE IPO STAGE A. IPO Charters and Takeover Defenses B. Innovation, Diversity, and the "Plain Vanilla" Charter II. STATE COMPETITION TO PROVIDE CORPORATE LAW III. GOVERNANCE ADJUSTMENTS ONCE A COMPANY GOES PUBLIC: THE "MIDSTREAM" STAGE A. Corporate Governance from the Mid-1980s to the Mid-2000s 1. Takeover defenses a. Poison pills b. Staggered (or "classified") boards c. Other takeover defenses 2. Board independence B. Corporate Governance Since the Mid-2000s IV. A BRIEF DETOUR: ONGOING MISUNDERSTANDINGS REGARDING TAKEOVER DEFENSES AND GOVERNANCE INDICES A. Elements with No Impact on Management Entrenchment B. Elements with No Impact on Firms with an Effective Staggered Board C. Elements with an Impact Only Under Limited Circumstances D. Elements That Are Unrelated to Entrenchment and Affirmatively Good for Corporate Governance E. Use of Governance Indices in Other Research INTERPRETATION, IMPLICATIONS, AND CONCLUSION
This issue of the Stanford Law Review, marking the Seventh Annual Conference on Empirical Legal Studies (CELS), provides each of its six authors an opportunity to address the impact of empirical work on important questions in our respective fields. In corporate law and governance, the impact of empirical work has been pervasive, as reflected by the fact that over one quarter of the papers submitted to CELS related to these topics. Beginning in the 1970s, theorists in economics and law laid the foundations of the field. With respect to key questions, however, theory could not provide an answer. For example, are staggered boards value enhancing? Are independent directors? Is separating the positions of CEO and board chair? For each of these questions, there is theoretical support on both sides. Empirical analysis is therefore necessary to answer them.
The same is true of the most fundamental question regarding corporate law--whether market forces promote optimal corporate governance arrangements, independent of law--a theoretical proposition that has framed the study of corporate law since the 1980s. There has been no systematic analysis of where this proposition stands in light of empirical evidence. In this Essay, I provide such an analysis. I conclude that, for the most part, the evidence is not supportive.
The theoretical framework within which we understand corporate law and corporate governance dates back to the finance literature of the late 1970s and the legal literature of the 1980s. In 1984, Roberta Romano commented that "[u]ntil recently, corporate law has been an uninspiring field for research." (1) She quoted Bayless Manning's famous statement in 1962 that "[c]orporation law, as a field of intellectual effort, is dead in the United States.... We have nothing left but our great empty corporation statutes--towering skyscrapers of rusted girders, internally welded together and containing nothing but wind." (2) From both an intellectual perspective and a legal perspective, a "revolution in corporate law" (3) began in 1976 with the publication of Theory of the Firm." Managerial Behavior, Agency Costs and Ownership Structure, by Michael Jensen and William Meckling. (4) That article developed a theory of agency costs in the public corporation, which remains the dominant framework of analysis for corporate law and corporate governance today. A year later, Ralph Winter published State Law, Shareholder Protection, and the Theory of the Corporation, an article that implicitly applied the Jensen and Meckling agency cost model to analyze the question of whether state competition to attract incorporations was a race to the bottom or a race to the top. (5) Then, in a series of articles published in the 1980s that culminated in a highly influential book, Frank Easterbrook and Daniel Fischel extended the Jensen and Meckling framework to develop what they called a positive and normative theory of corporate law. …