《法学资料大全》（英文版）逐渐联邦化的公司法

University of California, Los Angeles School of law Research Paper Series The Creeping Federalization of Corporate Law STEPHEN M. BAINBRIDGE Regulation, Spring 2003 Research Paper No. 03-7 his paper may be downloaded without charge at The Social Science Research Network Electronic Paper Collection http://ssrn.com/abstract=389403 UCLA School of law UCLA OOL OF LI UCLA School of law Los Angeles Ca 90095-1476

University of California, Los Angeles School of Law Research Paper Series UCLA School of Law Research Paper No. 03-7 This paper may be downloaded without charge at: The Social Science Research Network Electronic Paper Collection: http://ssrn.com/abstract=389403 UCLA School of Law Los Angeles CA 90095-1476 STEPHEN M. BAINBRIDGE The Creeping Federalization of Corporate Law Regulation, Spring 2003

secUrities eXCHaNGes The Sarbanes-Oxley Act extends Washingtons oversight of corporate governance practices but offers questionable benefits to investors The le creeping Federalization of Corporate Law BY STEPHEN M. BAINBRIDGE UCLA School of law HE NEW MILLENNIUM HAS NOT BEEN For over 200 years, corporate governance has been a mat kind to Wall Street. In 2000-01, the stock ter for state law. Even the vast expansion of the federal role market recorded back-to-back years ofloss- begun by the New Deal securities regulation laws left the inter- es for the first time since 1973-74. With a nal affairs and governance of corporations to the states. To be furtherloss in 2002, the market fell for three sure, over the years, there have been countless proposals to fed- consecutive years for the first time since the eralize corporate law.To date, however, none have succeeded Great Depression The collapse of Enron and World Com, along with the varying On top of the continuing retrenchment of the economy fol- degrees of fraud uncovered at too many other companies, rein- lowing thelate'90s bubble, concerns over terrorismand the Mid- vigorated the debate over state regulation of corporate gover- dle East, and uncertainty over oil, investor confidence remains nance. Many politicians and pundits called for federal regulation shaky in the wake of last year's corporate governance revelations. not just of securities but also of internal corporate governance, We all know the litany: repeated accounting scandals, of which claiming it would restore investor confidence in the securities Enron and World Com are merely the most notorious; a high pro- markets. As Congress and market regulators began implement file investigationby New Yorks attorney general calling into ques- ing some of those ideas, there has been a creeping-but steady tion the integrity of stock market analysts; and so or federalization of corporate governance law. The NYSE's new In such an environment, it was inevitable that Congress and listing standards regulating directorindependence are oneexam- the Securities and Exchange Commission would step in toease ple of that phenomenon. Otherexamples appeared to little pub- investors'fears. But how quickly we forget Ronald Reagan's licdebatein thesweeping Sarbanes-Oxley legislation. Takenindi adage: "The nine most terrifying words in the English language vidually, each of Sarbanes-Oxley's provisions constitutes a are:'T'm from the government and Im here to help significant preemption of state corporate law. Taken together, they In responding to the Enron and World Com scandals, Con- constitute the most dramatic expansion of federal regulatory gress and the regulators have implemented a set of reforms that power over corporate governance since the New Deal are deeply flawed. They have adopted policies that have no empirical support or economic justification. Worse yet, in WHO REGULATES CORPORATIONS? doing so, they have eviscerated basic federalism rules that have No one seriously doubts that Congress has the power under the long served us well Commerce Clause, especially as it is interpreted these days create a federal law of corporations if it chooses. The question stephen M,Bainbridge is a professor at the ucLA School of Law where he specializes in of who gets to regulate public corporations thus is not oneof aw and Economics(Foundation Press, 2002). He can be contacted by e-mail at constitutional law but rather of prudence and federalism Until the New Deal, corporate law was exclusively a matter 26 REGULATION SPRING 2003

26 REGULATION SPRING 2003 For over 200 years, corporate governance has been a mat￾ter for state law. Even the vast expansion of the federal role begun by the New Deal securities regulation laws left the inter￾nal affairs and governance of corporations to the states. To be sure, over the years, there have been countless proposals to fed￾eralize corporate law. To date, however, none have succeeded. The collapse of Enron and WorldCom, along with the varying degrees of fraud uncovered at too many other companies, rein￾vigorated the debate over state regulation of corporate gover￾nance.Many politicians and pundits called for federal regulation not just of securities but also of internal corporate governance, claiming it would restore investor confidence in the securities markets. As Congress and market regulators began implement￾ing some of those ideas, there has been a creeping — but steady — federalization of corporate governance law. The nyse’s new listing standards regulating director independence are one exam￾ple of that phenomenon. Other examples appeared to little pub￾lic debate in the sweeping Sarbanes-Oxley legislation. Taken indi￾vidually, each of Sarbanes-Oxley’s provisions constitutes a significant preemption of state corporate law. Taken together, they constitute the most dramatic expansion of federal regulatory power over corporate governance since the New Deal. WHO REGULATES CORPORATIONS? No one seriously doubts that Congress has the power under the Commerce Clause, especially as it is interpreted these days, to create a federal law of corporations if it chooses. The question of who gets to regulate public corporations thus is not one of constitutional law but rather of prudence and federalism. Until the New Deal, corporate law was exclusively a matter SECURITIES & EXCHANGE he new millennium has not been kind to Wall Street. In 2000-’01, the stock market recorded back-to-back years of loss￾es for the first time since 1973-’74. With a further loss in 2002, the market fell for three consecutive years for the first time since the Great Depression. On top of the continuing retrenchment of the economy fol￾lowing the late ’90s bubble, concerns over terrorism and the Mid￾dle East, and uncertainty over oil, investor confidence remains shaky in the wake of last year’s corporate governance revelations. We all know the litany: repeated accounting scandals, of which Enron and WorldCom are merely the most notorious; a high pro￾file investigation by New York’s attorney general calling into ques￾tion the integrity of stock market analysts; and so on. In such an environment, it was inevitable that Congress and the Securities and Exchange Commission would step in to ease investors’ fears. But how quickly we forget Ronald Reagan’s adage: “The nine most terrifying words in the English language are: ‘I’m from the government and I’m here to help.’” In responding to the Enron and WorldCom scandals, Con￾gress and the regulators have implemented a set of reforms that are deeply flawed. They have adopted policies that have no empirical support or economic justification. Worse yet, in doing so, they have eviscerated basic federalism rules that have long served us well. T Stephen M. Bainbridge is a professor at the UCLA School of Law where he specializes in business and corporate law. A prolific writer, Bainbridge recently released Corporation Law and Economics (Foundation Press, 2002). He can be contacted by e-mail at bainbridge@law.ucla.edu. The Sarbanes-Oxley Act extends Washington’s oversight of corporate governance practices but offers questionable benefits to investors. The Creeping Federalization of Corporate Law BY STEPHEN M. BAINBRIDGE UCLA School of Law Bainbridge.Final 3/13/03 2:34 PM Page 26

ers refused to surrender their hopes for a more federal ro ighout the 1930s, there were repeated corporate law. All failed Preserving federalism Legislative inaction is inherently ambiguous l that can be said with ainty is that Con- nevertheless has rou- tinely rejected regula state law and create a de As the Court noted in its 1987 deci sion in cts co A Dynamics Corp,“ State ation of corpo tion of entities whose attributes are a produc of state law” The Court further noted that it " is business landscape in this country forstates to and to define the rights ng th for the states. Around the beginning of the last century, howev-I shares "Concluded the Court, "No principle of corporation law er,economic progressives began arguing for federal preemption and practice is more firmly established than a State's authority frequently in response to various corporate scandals of the to regulate domestic corporations day. After the Great Crash of 1929, serious consideration was It is state law, for example, that determines therights of share- given to creating a federal law of corporations holders. State law tht us determines such questions as which mat The New Dealers'initial response to the Crash, of course, ters the board of directors, acting alone, may authorize and consisted of the now familiar federal securities laws. The key which must be authorized by the shareholders. State law typi statute here is the Securities Exchange Act of 1934, which crit- cally requires, for example, that certain control transactions ics claimed was a federal attempt to usurp corporate gover- such as mergers or sales of substantially all corporate assets be nance powers. On its face, however, the Exchange Act says approved in advance by the shareholders, and establishes the nothing about regulation of corporate governance. Instead, the vote required (often a supermajority) for shareholder approval Acts basic focus is trading of securities and securities pricing. of such matters. State law likewise regulates the conduct of Virtually all of its provisions are addressed to such matters as shareholder meetings, specifies who may call such meetings, the production and distribution of information about issuers and prescribes whether (and the procedures by which)action and their securities, the flow of funds in the market, and the may be taken without a shareholder meeting basic structure of the market The Supreme Court also has consistently recognized that While the federal securities laws thus left the internal affairs state law governs the rights and duties of corporate directors and governance of corporations to the states, many New Deal-I For instance, in its 1979 decision in Burks v. Lasker, the Court REGULATION SPRING 2003 27

REGULATION SPRING 2003 27 for the states. Around the beginning of the last century, howev￾er, economic progressives began arguing for federal preemption — frequently in response to various corporate scandals of the day. After the Great Crash of 1929, serious consideration was given to creating a federal law of corporations. The New Dealers’ initial response to the Crash, of course, consisted of the now familiar federal securities laws. The key statute here is the Securities Exchange Act of 1934, which crit￾ics claimed was a federal attempt to usurp corporate gover￾nance powers. On its face, however, the Exchange Act says nothing about regulation of corporate governance. Instead, the Act’s basic focus is trading of securities and securities pricing. Virtually all of its provisions are addressed to such matters as the production and distribution of information about issuers and their securities, the flow of funds in the market, and the basic structure of the market. While the federal securities laws thus left the internal affairs and governance of corporations to the states, many New Deal￾ers refused to surrender their hopes for a more expansive federal role. Throughout the 1930s, there were repeated proposals to federalize corporate law. All failed. Preserving federalism Legislative inaction is inherently ambiguous. All that can be said with certainty is that Con￾gress chose not to act. Yet, the Supreme Court nevertheless has rou￾tinely rejected regulato￾ry efforts to preempt state law and create a de facto federal law of cor￾porations. As the Court noted in its 1987 deci￾sion in CTS Corp. v. Dynamics Corp., “State regulation of corporate governance is regula￾tion of entities whose very existence and attributes are a product of state law.” The Court further noted that it “is an accepted part of the business landscape in this country for states to create corporations, to prescribe their powers, and to define the rights that are acquired by purchasing their shares.” Concluded the Court, “No principle of corporation law and practice is more firmly established than a State’s authority to regulate domestic corporations.” It is state law, for example, that determines the rights of share￾holders. State law thusdetermines such questions as which mat￾ters the board of directors, acting alone, may authorize and which must be authorized by the shareholders. State law typi￾cally requires, for example, that certain control transactions such as mergers or sales of substantially all corporate assets be approved in advance by the shareholders, and establishes the vote required (often a supermajority) for shareholder approval of such matters. State law likewise regulates the conduct of shareholder meetings, specifies who may call such meetings, and prescribes whether (and the procedures by which) actions may be taken without a shareholder meeting. The Supreme Court also has consistently recognized that state law governs the rights and duties of corporate directors. For instance, in its 1979 decision in Burks v. Lasker, the Court MORGAN BALLARD Bainbridge.Final 3/13/03 2:34 PM Page 27

sECURITIes eXchange noted, "As we have said in the past, the first place one must look the provision will mark a substantial restriction on the power to determine the powers of corporate directors is in the relevant of the board. Finally, the audit committee is granted federal state's corporation law. Corporations are creatures of state law authority to retain independent legal and financial advisers and it is state law which is the font of corporate directors'pow- whose fees are paid by the board. Each of those provisions pre- ers "State law defines the directors' powers over the corpora- empts state law governing the board of directors tion, forexample. State law establishes the vote required to elect directors.State law determines whether shareholders have the Directors and officers The Act also partially preempts state ight to cumulative voting in the election of directors, whether law governing the appointment, removal, and compensation he corporation'sdirectors may have staggered terms of office, of directors and officers. As to the former, the SEC is now and whether shareholders have the right to remove directors empowered to remove officers and directors from their posi- prior to the expiration of their term of office tions, as well as bar them from serving at other public corpo- Or, at least, it did so until recently. rations, on mere grounds of"unfitness As to the latter, executive compensation long has been a The anti-federalists strike back For proponents of a bigger fed- controversial issue. Many critics of state corporate law com- eral government, corporate scandals are always a bullish sig- plain that it does not do enough to limit allegedly excessive nal. There is nothing a politician wants more than to persuade compensation. While Sarbanes-Oxley does not directly regu- upset investors that he or she is"doing something"and being late executive compensation, it does contain anumber of pro- aggressive"in rooting out corporate fraud. Hence, it was visions that do so indirectly. First, in theevent a corporation is entirely predictable that the shenanigans at Enron, World Com, obliged to restate its financial statements because of miscon et al, coming after a period of steady decline in the stock mar- duct, the chief executive officer and chief financial officer must ket, would lead to regulation return to the corporation any bonus, incentive, orequity-based President Bush praised the Public Company Accounting compensation they received during the 12 months following Reform and Investor Protection Act of 2002- popularly the original issuance of the restated financials, along with any known as the Sarbanes-Oxley Act-formaking"the most far- profits they realized from the sale of corporate stock during reaching reforms of American business practices since the time that period of Franklin Delano Roosevelt. "Odd praise, indeed, coming There are many objections to that provision from a conservative president. Such praise was especially odd oming from a former state governor with a track record of a It preempts the board's power over executive com- stated respect for basic federalism principles SARBANES-OXLEY AND CORPORATIONS a It fails to define the kinds of misconduct that trigger the reimbursement obligation Because auditing failures by accounting firms, especially Arthur Andersen, received a substantial share of the blame forthe Enron It requires reimbursement even if others committed and World debacles, much of the Sarbanes-Oxley Act focus- the misconduct, and extends to the officers no good es on auditors and their relationship to public corporations. In faith defense regulating that relationship, however, Congress for the first time regulated such matters as the composition,role, and function of All of those problems will tend to encourage CEOs and CFOS he board of directors of public corporations. Forexample, Sar- to resist restating flawed financial statements and/or to game banes-Oxley requires national securities exchanges(such as the the timing of their compensation and stock transactions rela- New York Stock Exchange and NASDAQ)to adopt listing stan- tive to any such restatements dards mandating that listed companies have an audit commit- Second, the Act prohibits a corporation from directlyorindi tee and thatthat committee be comprised solely of independent rectly making or even arranging for loans to its directors and directors. At least one member of the committee must qualify executive officers, subject to some minorexceptions.That pro- as a"financial expert"as defined by the statute. Given the NYSE vision directly preempts the interested-party transaction provi- and NASDAQ's recent expansion of their director independence sions of state corporate law, which currently permit the making standards, it is not clear that those provisions will result in any of loans to directors and officers provided they are authorized substantial newregulation At the veryleast, however, they con- by a majority of the disinterested directors or the shareholders firm andendorse the troubling expansion of stock exchange list- Worse yet, the Sarbanes-Oxley Act fails to define many key ing standards that displace state corporate law terms. Under state corporate law indemnification statutes, for The audit committee must establish a system for employ- example, corporations frequently do(and in some cases must) ees to blow the whistle anonymously on questionable account- advance legal expenses to covered officers and directors.Given ing or auditing matters. Also, the audit committee is charged thesweeping language of the Act s prohibition on insider loans, with being"directly responsible for the appointment, com- some observers believeit preempts state law in that respect and pensation, and oversight"of the corporation's independent therefore prohibits any such advancement of funds auditor. If that provision is interpreted topreclude not only cor- Finally, the Act prohibits executives from trading during so porate officers but also the board of directors as a whole from called blackout periods in which employees participating in being involved in the hiring and firing of independent auditors, I 401(k) and other stock-based pension plans are forbidden from 28 REGULATION SPRING 2003

28 REGULATION SPRING 2003 noted, “As we have said in the past, the first place one must look to determine the powers of corporate directors is in the relevant state’s corporation law. ‘Corporations are creatures of state law’ and it is state law which is the font of corporate directors’ pow￾ers.” State law defines the directors’ powers over the corpora￾tion, for example. State law establishes the vote required to elect directors. State law determines whether shareholders have the right to cumulative voting in the election of directors, whether the corporation’s directors may have staggered terms of office, and whether shareholders have the right to remove directors prior to the expiration of their term of office. Or, at least, it did so until recently. The anti-federalists strike back For proponents of a bigger fed￾eral government, corporate scandals are always a bullish sig￾nal. There is nothing a politician wants more than to persuade upset investors that he or she is “doing something” and being “aggressive” in rooting out corporate fraud. Hence, it was entirely predictable that the shenanigans at Enron, WorldCom, et al., coming after a period of steady decline in the stock mar￾ket, would lead to regulation. President Bush praised the Public Company Accounting Reform and Investor Protection Act of 2002 — popularly known as the Sarbanes-Oxley Act — for making “the most far￾reaching reforms of American business practices since the time of Franklin Delano Roosevelt.” Odd praise, indeed, coming from a conservative president. Such praise was especially odd coming from a former state governor with a track record of stated respect for basic federalism principles. SARBANES-OXLEY AND CORPORATIONS Because auditing failures by accounting firms, especially Arthur Andersen, received a substantial share of the blame for the Enron and WorldCom debacles, much of the Sarbanes-Oxley Act focus￾es on auditors and their relationship to public corporations. In regulating that relationship, however, Congress for the first time regulated such matters as the composition, role, and function of the board of directors of public corporations. For example, Sar￾banes-Oxley requires national securities exchanges (such as the New York Stock Exchange and nasdaq) to adopt listing stan￾dards mandating that listed companies have an audit commit￾tee and that that committee be comprised solely of independent directors. At least one member of the committee must qualify as a “financial expert” as defined by the statute. Given the nyse and nasdaq’s recent expansion of their director independence standards, it is not clear that those provisions will result in any substantial new regulation. At the very least, however, they con￾firm and endorse the troubling expansion of stock exchange list￾ing standards that displace state corporate law. The audit committee must establish a system for employ￾ees to blow the whistle anonymously on questionable account￾ing or auditing matters. Also, the audit committee is charged with being “directly responsible for the appointment, com￾pensation, and oversight” of the corporation’s independent auditor. If that provision is interpreted to preclude not only cor￾porate officers but also the board of directors as a whole from being involved in the hiring and firing of independent auditors, the provision will mark a substantial restriction on the power of the board. Finally, the audit committee is granted federal authority to retain independent legal and financial advisers whose fees are paid by the board. Each of those provisions pre￾empts state law governing the board of directors. Directors and officers The Act also partially preempts state law governing the appointment, removal, and compensation of directors and officers. As to the former, the sec is now empowered to remove officers and directors from their posi￾tions, as well as bar them from serving at other public corpo￾rations, on mere grounds of “unfitness.” As to the latter, executive compensation long has been a controversial issue. Many critics of state corporate law com￾plain that it does not do enough to limit allegedly excessive compensation. While Sarbanes-Oxley does not directly regu￾late executive compensation, it does contain a number of pro￾visions that do so indirectly. First, in the event a corporation is obliged to restate its financial statements because of miscon￾duct, the chief executive officer and chief financial officer must return to the corporation any bonus, incentive, or equity-based compensation they received during the 12 months following the original issuance of the restated financials, along with any profits they realized from the sale of corporate stock during that period. There are many objections to that provision: ■ It preempts the board’s power over executive com￾pensation. ■ It fails to define the kinds of misconduct that trigger the reimbursement obligation. ■ It requires reimbursement even if others committed the misconduct, and extends to the officers no good￾faith defense. All of those problems will tend to encourage ceos and cfos to resist restating flawed financial statements and/or to game the timing of their compensation and stock transactions rela￾tive to any such restatements. Second, the Act prohibits a corporation from directly or indi￾rectly making or even arranging for loans to its directors and executive officers, subject to some minor exceptions. That pro￾vision directly preempts the interested-party transaction provi￾sions of state corporate law, which currently permit the making of loans to directors and officers provided they are authorized by a majority of the disinterested directors or the shareholders. Worse yet, the Sarbanes-Oxley Act fails to define many key terms. Under state corporate law indemnification statutes, for example, corporations frequently do (and in some cases must) advance legal expenses to covered officers and directors. Given the sweeping language of the Act’s prohibition on insider loans, some observers believe it preempts state law in that respect and therefore prohibits any such advancement of funds. Finally, the Act prohibits executives from trading during so￾called blackout periods in which employees participating in 401(k) and other stock-based pension plans are forbidden from SECURITIES & EXCHANGE Bainbridge.Final 3/13/03 2:34 PM Page 28

trading. If the executive does so, the corporation may sue to pendence is hardly a panacea for all that ails corporate gover receive any profits. If the corporation fails to do so, a share- nance: The head of Enron's audit committee, Robert Jaedicke holder maybring a derivative action a la the short-swing prof- was a professor of accounting at Stanford University and could it provision under $16(b) hardly have been more qualified for the job. And we all know Even when we turn from the provisions of the Act that direct- what happened at Enron. ly mandate substantive corporate behavior to those that purport merely to regulate disclosure, we find that many provisions Managerial accountability The new standards imposed by the effectively displace applicable state corporate law. The relevant NYSE and Sarbanes-Oxley are premised on the conventionalwis- concept here is so-called"therapeutic disclosure. " In other dom that board independence is an unalloyed goodAs wehave words, the Act uses disclosure requirements to effect changes seen, the empirical evidence on the merits of board independ in substantive behavior. Forexample, the corporation must dis- ence is mixed, at best. Indeed, the clearest take-home lesson to close whetherit has adopted a code of ethics for its financial offi- be gleaned from that evidence is that one size does not fit all cers.The Act identifies a host of issues the code must address, That result should not be surprising. On one side of the such as the handling of conflicts of interest and the like. If a equation, firms do not have uniform needs fo r manage company has not adopted such a code, it must disclose its rea- accountability mechanisms. The need for accountability is sons for not doing so. In addition, the corporation's manage- determined by the likelihood of shirking, which in turn is ment must annually issue an"internal control report"in which determined by management's tastes, which in turn is deter- management acknowledges its responsibility for establishing mined by each firms unique culture, traditions, and compet and maintaining adequate internal financial reporting controls itive environment. We all know managers whose preferences and assesses the effectiveness of those controls include a penchant for hard, faithful work. Firms where that Eventhe widely touted requirement that the CEO and CFo cer- sort of manager dominates the corporate culture haveless need tify the corporations financial statements effects stealth pre- for outside accountability mechanisms emptions ofstate law. Under that provision, the CEO and CFO are On the other side of the equation, firms have a wide range maderesponsible for the establishment, design, and maintenance of accountability mechanisms from which to choose. Inde- of the corporation'sinternal financial controls. Hence, corporate pendent directors are not the sole mechanism by which man- boards have lost their freedom under state law to assign those agement,s performance is monitored. Rather, a variety of forces duties to other corporate officers (let aloneto omit such controls). work together to constrain management's incentive to shirk:the State law governing the boards oversight responsibilities is fur- capital and product markets within which the firm functions her preempted by provisions requiring that the CEo and cFo the internal and external markets for managerial services,the report directly to the audit committee on an array of issues deal- market for corporate control, incentive compensation systems, ing with internal controls and financial reporting auditing by outside accountants, and many others. The impor tance of the independent directors' monitoring role in a given OTHER OVERSEERS firm depends in large measure on the extent to which those Congress is not the only regulator getting into the act. Under other forces are allowed to function. Forexample, managers of he NYSE aegis, a blue ribbon panel of usual-suspect Brahmins a firm with strong takeover defenses are less subject to the con- has"anointed boards of directors, especially independent straining influence of the market for corporate control than are directors'as the capitalist cavalry. "Acting on the panels rec- those of a firm with no takeover defenses. The former needs a ommendations, the NYSE adopted new stock exchange listing strong independent board more than the latter does standards requiring that independent directors comprise a The critical mass of independent directors needed to provide majority of any listed corporations board of directors. The new optimallevels of accountability also will varydepending upon the standards also effect a number of changes to the NYSE's long- types of outsiders chosen.Strong, active, independent directors standing audit committee standards, which anticipate(and with little tolerance for negligence or culpable conduct do exist. even exceed)those mandated by Sarbanes-Oxley a board having a few such directors is more likely to act as a faith- ful monitor than is a board having many nominallyindependent Director independence The utility of director independence directors who shirk their monitoring obligations is now so deeply established in the conventional wisdom that it seems almost pointless to ask if corporations really need a Federal preemption The NYSE's new standards strap all list majority of independent directors. But when one answers that ed companies into a single model of corporate governance.By question, it turns out to be pretty complicated establishing a highly restrictive definition of director inde e. The theoretical arguments are complex and highly con- pendence and mandating that such directors dominate both tested. But we can cut to the bottom line: If independent direc- the board and its required committees, the NYSE fails to take tors have utility, there should be an identifiable correlation into account the diversity and variance amongfirms.The NYSE between the presence of outsiders on the board and firm per- and Congress therefore should have allowed each firm todevel- formance. Yet, the empirical data on the issue is decidedly op the particular mix of monitoring and management that best mixed.In fact, the bulk of the evidence suggests that board suits its individual needs composition has no effect on profitability. The NYSE should be especially cautious about promulgat- Anecdotal evidence confirms the view that board inde- I ing corporate governance listing standards because such stan- REGULATION SPRING 200

REGULATION SPRING 2003 29 trading. If the executive does so, the corporation may sue to receive any profits. If the corporation fails to do so, a share￾holder may bring a derivative action à la the short-swing prof￾it provision under §16(b). Even when we turn from the provisions of the Act that direct￾ly mandate substantive corporate behavior to those that purport merely to regulate disclosure, we find that many provisions effectively displace applicable state corporate law. The relevant concept here is so-called “therapeutic disclosure.” In other words, the Act uses disclosure requirements to effect changes in substantive behavior. For example, the corporation must dis￾close whether it has adopted a code of ethics for its financial offi￾cers. The Act identifies a host of issues the code must address, such as the handling of conflicts of interest and the like. If a company has not adopted such a code, it must disclose its rea￾sons for not doing so. In addition, the corporation’s manage￾ment must annually issue an “internal control report” in which management acknowledges its responsibility for establishing and maintaining adequate internal financial reporting controls and assesses the effectiveness of those controls. Even the widely touted requirement that the ceoand cfocer￾tify the corporation’s financial statements effects stealth pre￾emptions of state law. Under that provision, the ceoand cfoare made responsible for the establishment, design, and maintenance of the corporation’s internal financial controls. Hence, corporate boards have lost their freedom under state law to assign those duties to other corporate officers (let alone to omit such controls). State law governing the board’s oversight responsibilities is fur￾ther preempted by provisions requiring that the ceo and cfo report directly to the audit committee on an array of issues deal￾ing with internal controls and financial reporting. OTHER OVERSEERS Congress is not the only regulator getting into the act. Under the nyse aegis, a blue ribbon panel of usual-suspect Brahmins has “anointed boards of directors, especially ‘independent directors’ as the capitalist cavalry.” Acting on the panel’s rec￾ommendations, the nyse adopted new stock exchange listing standards requiring that independent directors comprise a majority of any listed corporation’s board of directors. The new standards also effect a number of changes to the nyse’s long￾standing audit committee standards, which anticipate (and even exceed) those mandated by Sarbanes-Oxley. Director independence The utility of director independence is now so deeply established in the conventional wisdom that it seems almost pointless to ask if corporations really need a majority of independent directors. But when one answers that question, it turns out to be pretty complicated. The theoretical arguments are complex and highly con￾tested. But we can cut to the bottom line: If independent direc￾tors have utility, there should be an identifiable correlation between the presence of outsiders on the board and firm per￾formance. Yet, the empirical data on the issue is decidedly mixed. In fact, the bulk of the evidence suggests that board composition has no effect on profitability. Anecdotal evidence confirms the view that board inde￾pendence is hardly a panacea for all that ails corporate gover￾nance: The head of Enron’s audit committee, Robert Jaedicke, was a professor of accounting at Stanford University and could hardly have been more qualified for the job. And we all know what happened at Enron. Managerial accountability The new standards imposed by the nyseand Sarbanes-Oxley are premised on the conventional wis￾dom that board independence is an unalloyed good. As we have seen, the empirical evidence on the merits of board independ￾ence is mixed, at best. Indeed, the clearest take-home lesson to be gleaned from that evidence is that one size does not fit all. That result should not be surprising. On one side of the equation, firms do not have uniform needs for managerial accountability mechanisms. The need for accountability is determined by the likelihood of shirking, which in turn is determined by management’s tastes, which in turn is deter￾mined by each firm’s unique culture, traditions, and compet￾itive environment. We all know managers whose preferences include a penchant for hard, faithful work. Firms where that sort of manager dominates the corporate culture have less need for outside accountability mechanisms. On the other side of the equation, firms have a wide range of accountability mechanisms from which to choose. Inde￾pendent directors are not the sole mechanism by which man￾agement’s performance is monitored. Rather, a variety of forces worktogether to constrain management’s incentive to shirk: the capital and product markets within which the firm functions, the internal and external markets for managerial services, the market for corporate control, incentive compensation systems, auditing by outside accountants, and many others. The impor￾tance of the independent directors’ monitoring role in a given firm depends in large measure on the extent to which those other forces are allowed to function. For example, managers of a firm with strong takeover defenses are less subject to the con￾straining influence of the market for corporate control than are those of a firm with no takeover defenses. The former needs a strong independent board more than the latter does. The critical mass of independent directors needed to provide optimal levels of accountability also will vary depending upon the types of outsiders chosen. Strong, active, independent directors with little tolerance for negligence or culpable conduct do exist. A board having a few such directors is more likely to act as a faith￾ful monitor than is a board having many nominally independent directors who shirk their monitoring obligations. Federal preemption The nyse’s new standards strap all list￾ed companies into a single model of corporate governance. By establishing a highly restrictive definition of director inde￾pendence and mandating that such directors dominate both the board and its required committees, the nyse fails to take into account the diversity and variance among firms. The nyse and Congress therefore should have allowed each firm to devel￾op the particular mix of monitoring and management that best suits its individual needs. The nyse should be especially cautious about promulgat￾ing corporate governance listing standards because such stan￾Bainbridge.Final 3/13/03 2:34 PM Page 29