Corporate Stagnation: Discussion and Reform Proposal
Hannes, Sharon, Journal of Corporation Law
This Article concentrates on the tendency of the corporate structure to preserve the status quo. This phenomenon is most severe when the status quo is pro-managerial. The increasing gravity of institutional shareholders, vis-à-vis managements' central role in the corporate charter amendment process, is the crucial force that drives this corporate stagnation. Evidently, many frequently used corporate charter provisions that impede the ability to take over a corporation, such as provisions for staggered boards, are subject to the above-mentioned corporate stagnation. While seasoned firms only rarely adopt such charter provisions, firms that previously added the said provisions to their charters do not tend to repeal them.
Consequently, this Article advances a new legal standard, the Future Oriented Default, as a possible remedy. The Future Oriented Default pierces the status quo by eliminating current charter provisions that are suspected of being sub-optimal, but nevertheless allows the corporation to deviate, in the future, from the imposed standard. The Future Oriented Default is shown to be superior, in some circumstances, to any other proposal, whether mandatory or enabling. Finally, it is suggested that the Future Oriented Default might play a significant role in mitigating inefficiencies at the Initial Public Offering stage by helping the market to overcome an undesirable standard.
A recently published article suggests that certain types of inefficient corporate behavior may be solved by altering the content of the legal default standard instead of by applying the traditional remedy of mandatory intervention of the law.1 In this Article, I propose a different solution and call for regulators to consider another non-mandatory arrangement, which I term a Future Oriented Default standard. This standard offers the proper response to outdated corporate charter provisions that managers prefer not amend. Under the Future Oriented Default standard, when a charter provision is rendered detrimental following a change in the business environment, a new default standard will be enacted and all contradicting charter provisions will be eliminated. As a result, the corporate parties, i.e., shareholders and management, will be free to implement measures as they wish. By way of charter amendment, they can readopt the same charter provision that was eliminated or, alternatively, adhere to the new default standard by merely sitting idle. For example, a Future Oriented Default that governs staggered boards abolishes all existing staggered boards, but allows firms to readopt the old charter provisions should they wish to maintain their staggered boards.2
While at first glance, abolishing an existing charter provision seems a harsh intrusion into firm autonomy, it is actually a natural response on the part of the legal system. When an old default standard that was once efficient becomes outdated, the legal system often replaces it with a new standard. Now, suppose that this new default standard had, in fact, been the initial standard in place, though unsuited at that point to most firms. Due to this unsuitability, many firms would probably have adopted a charter provision to rectify the inefficient standard. In time, those charter amendments themselves would become outdated (similar to the outdated default standard scenario), but altering the existing default standard would not remedy the problem since firms would have charter provisions in place and explicit charter provisions prevail over default arrangements.3 Only a Future Oriented Default (or much harsher intervention in the form of a mandatory standard) could free such firms from their existing inefficient mode of operation. Put differently, the only reason that firms adopted the rectifying charter provisions in the first place was the initial choice of the default standard by the regulator. The use of the Future Oriented Default should, therefore, be considered as natural as a normal alteration of an existing default standard by the regulator. …