《法律与金融》课程教学资源（参考资料）A Political Theory of Corporate Finance

1991] A POLITICAL THEORY OF THE CORPORATION 25 pany's pension managers limits the ability of private pension funds to control companies. Thus,the one instifution that is substantially unree ability to invest in large blocks of is This com intha some restrictions that stopped banks.insurance ce might no companies,and mutual funds from influencing operating companies arose and persisted because of a populist,anti-Wall Street sensibility that allied with the interests of small banks and industrial managers Pension funds s are not likely to be the ta et of eithe er po olitical int tere they are not direct connected with Wall Street but are for the benefi of employees.And since managers control their company-sponsored pensions,private pensions do not pose a direct threat to operating company managers E.Joint Ventures and General Restrictions on Contro Despite these legal roadblocks,I suspect some financial institutions determined to control or influence an industrial company could acquire a large block.True,banks could not.True,diversified mutual funds can devote only a portion of their assets to a single company,but 25% of a large mutual fund is a lot,even%of a hu e New york-r nilated ins ur mpany s sset might be enough,an d ERISA alloy sdevia tion from diversification when clearly prudent. And financial institu- tions could form joint ventures to manage the ownership.The SEC once concluded that for many large companies,a groub of institutions owned enough stock to put together an influential block if they acted jointly.65 However,four problems would afflict such joint ventures. First, not all organizational forms succeed.Second,legal restrictions on joint activity and control make many actions futile or costly.Third,institu- tions fear that their control would be publicized and criticized,and in- duce reaction of in d on. Fourth me finar institutions expec e profits by trading;the securities laws inh trading by large blockholders who manage. 1.Organizational Fragility.-Despite much study of organizationa forms,we do not fully understand why some work,and others fail.6e Joint action has costs.Coordination among institutionally separate ners would be e necessary;mistrust among s and agency problems might not be controllal 1 cost When the costs of joint action are too high,joint monitoring fails. 65.SEC,Institutional vN6,92d Cong.,Ist Sess 1 56.Cf.R.Coase,The Firm,the Market,and the Law 30-31(1988)(choice of eco- nomic institutions matters because transactions costs vary among different forms of or- ganization).When the costs of control are raised,even if not by much,a substitute institutional form takes over.See infra Part IV.B

1991] A POLITICAL THEORY OF THE CORPORATION 25 pany's pension managers limits the ability of private pension funds to control companies. Thus, the one institution that is substantially unregulated in its ability to invest in large blocks of equity securities is controlled by oper￾ating company managers. This confluence might not be accidental. I suggest in Part III that some restrictions that stopped banks, insurance companies, and mutual funds from influencing operating companies arose and persisted because of a populist, anti-Wall Street sensibility that allied with the interests of small banks and industrial managers. Pension funds are not likely to be the target of either political interest: they are not directly connected with Wall Street, but are for the benefit of employees. And since managers control their company-sponsored pensions, private pensions do not pose a direct threat to operating company managers. E. Joint Ventures and General Restrictions on Control Despite these legal roadblocks, I suspect some financial institutions determined to control or influence an industrial company could acquire a large block. True, banks could not. True, diversified mutual funds can devote only a portion of their assets to a single company, but 25% of a large mutual fund is a lot, even 2% of a huge New York-regulated insurance company's assets might be enough, and ERISA allows devia￾tion from diversification when clearly prudent. And financial institu￾tions could form joint ventures to manage the ownership. The SEC once concluded that for many large companies, a group of institutions owned enough stock to put together an influential block if they acted jointly.65 However, four problems would afflict such joint ventures. First, not all organizational forms succeed. Second, legal restrictions onjoint activity and control make many actions futile or costly. Third, institu￾tions fear that their control would be publicized and criticized, and in￾duce a reaction of increased regulation. Fourth, some financial institutions expect to make profits by trading; the securities laws inhibit trading by large blockholders who manage. 1. Organizational Fragility. - Despite much study of organizational forms, we do not fully understand why some work, and others fail. 66 Joint action has costs. Coordination among institutionally separate owners would be necessary; mistrust among several players might arise; and agency problems might not be controllable at low enough cost. When the costs ofjoint action are too high, joint monitoring fails. 65. SEC, Institutional Investor Study Report, H. Doc. No. 64, 92d Cong., 1st Sess., pt. 5, at 2561 (1971). 66. Cf. R. Coase, The Firm, the Market, and the Law 30-31 (1988) (choice of eco￾nomic institutions matters because transactions costs vary among different forms of or￾ganization). When the costs of control are raised, even if not by much, a substitute institutional form takes over. See infra Part IV.B

26 COLUMBIA LAW REVIEW [Vol.91:10 2.Regulatory Costs a.Secti s 13 and change Act of 1934 requires that the group make a public filing,outlin- m the requ at would be a lin ted dete rrent. ng information that the in nstitution wishes to keep confidential, require a statement of intention when the plans are vague (the institu- tion wants to talk with other institutions to form a plan of action),and have been the basis for nasty litigation in the takeover wars as target firm managers seek to wear down the morale of those who would assert ntrol.Insti nal ir esto avoid that kir nd of lit nd public- ity.68 They seek to avoid conflict and routinize administration Group formation requires communication.But if an institution contacted enough other institutions,the communications would be deemed a p solicitation and would have to proceed under section 14 of the 1934 Act.69 Filings would h e to de.tho contacted must be given the information specified in schedule 14A.7 The securi- ties acts also trigger liability of controlling persons.71 Groups that con- trol could be liable for the misdeeds of the controlled portfolio company b.Short-Swing Profit Liability. also be liable for profits mad six month less,regardless of whether the profits were made on material inside information.72 A control group filing a schedule 13D would be subject to section 16(b).73 67.Rules 18d-1-5(b)(1).17 C.ER.s 240.13d-1.-5(b)(1)(1990).Institutional in vestors are ordinarily allo d to file fewer less fre but not if they intend to inffuence control of the issuer. Rule 13d-1(6)(1),56)(2), 17C.FR.S24 0.13d 1(b1,-5〔6 (2(1990).Conard and Bla critique these control rules 220 Mich.LL.Re 162 988):Black sh ssivity Re-Ex 89 Mich L Rev 521 (1990)(forthcom )cf.1940 Act Hearings note 81 at 510-11 (direc tors of one mutual fund could not,in proposed mutual fund bill,be directors of another mutu fund because in combination the oupmightcoodui) 69. Rule 40142.1m1990 This rule d tes hack to SEC's early structuring of the prox (1942). 1934 ,520,15U. 78t(198 9 xch of1934,s16,15U.s.C.s78p(1988):cf.Feder Martin Marietta Corp.,406 F.2d 260(2d Cir.1969)(deputized director triggers princi- pal's 16(b)liability),cert.denied,396 U.S.1036(1970). 633335a24682s52aa5685798h

COLUMBIA LAW REVIEW 2. Regulatory Costs. a. Sections 13 and 14 of the Securities Exchange Act of 1934: Controlling Persons. - When a 5% shareholder group is formed, the Securities Ex￾change Act of 1934 requires that the group make a public filing, outlin￾ing the group's plans and revealing its ownership and sources of financing.6 7 Were it only a single piece of paper that had to be filed, the requirement would be a limited deterrent. But filings often require information that the institution wishes to keep confidential, sometimes require a statement of intention when the plans are vague (the institu￾tion wants to talk with other institutions to form a plan of action), and have been the basis for nasty litigation in the takeover wars as target firm managers seek to wear down the morale of those who would assert control. Institutional investors avoid that kind of litigation and public￾ity.6 8 They seek to avoid conflict and routinize administration. Group formation requires communication. But if an institution contacted enough other institutions, the communications would be deemed a proxy solicitation and would have to proceed under section 14 of the 1934 Act.69 Filings would have to be made; those contacted must be given the information specified in schedule 14A. 70 The securi￾ties acts also trigger liability of controlling persons. 71 Groups that con￾trol could be liable for the misdeeds of the controlled portfolio company. b. Short-Swing Profit Liability. - The control group probably would also be liable for profits made on trades of stock held six months or less, regardless of whether the profits were made on material inside information. 72 A control group filing a schedule 13D would be subject to section 16(b). 73 67. Rules 13d-1, -5(b)(1), 17 C.F.R. § 240.13d-1, -5(b)(1) (1990). Institutional in￾vestors are ordinarily allowed to file fewer papers, less frequently, but not if they intend to influence control of the issuer. Rules 13d-l(b)(1), -5(b)(2), 17 C.F.R. § 240.13d￾l(b)(1), -5(b)(2) (1990). Conard and Black critique these control rules as applied to institutional investors. Conard, Beyond Managerialism: Investor Capitalism?, 22 U. Mich.J.L. Ref. 117, 162 (1988); Black, Shareholder Passivity Re-Examined, 89 Mich. L. Rev. 521 (1990) (forthcoming); cf. 1940 Act Hearings, supra note 31, at 510-11 (direc￾tors of one mutual fund could not, in proposed mutual fund bill, be directors of another mutual fund because in combination the group might control an industrial company). 68. See Conard, supra note 67, at 162. 69. Rule 14a-1(1), 17 C.F.R. § 240.14a-1(1) (1990). This rule dates back to the SEC's early structuring of the proxy rules under the 1934 Act. SEC Release No. 3347 (1942). 70. Rules 14a-2(b)(1), (a), 17 C.F.R. § 240.14a-2(b)(1), -3(a) (1990). 71. Securities Act of 1933, § 15, 15 U.S.C. § 77o (1988); Securities Exchange Act of 1934, § 20, 15 U.S.C. § 78t (1988). 72. Securities Exchange Act of 1934, § 16, 15 U.S.C. § 78p (1988); cf. Feder v. Martin Marietta Corp., 406 F.2d 260 (2d Cir. 1969) (deputized director triggers princi￾pal's 16(b) liability), cert. denied, 396 U.S. 1036 (1970). 73. The SEC wants this requirement explicit. Exchange Act Release Nos. 34- 26333, 35-24768, IC-16669, 26,333, 42 SEC Dock. 464, 471 (1988); see Exchange Act Release No. 18,113, 23 SEC Dock. 856, 857 (1981). [Vol. 91:10

1991] A POLITICAL THEORY OF THE CORPORATION 27 If an investor is certain that it will be a long-run player with the portfolio company,then section 16(b)might seem unimportant.But as a member of the group,16(b)pres sents a problem.Nasty questions would arise if another em sells within six m nths of one group trigger 16(b)liability?Of Or of the seller only?Even if the seer had less than 10%but the group had more than 10%? Also,institutions must consider their relative advantage tions often believe company before individuals do.group or single ins ey about a portfolic institution with 16(b)and 10b-5 insider trading responsibilities would have to forego that advantage.Institutional investors in general,and mutual funds in particular,do not want to be"locked in'to any investment:if they took a big block,16(b)would lock them in When an investor or group controls a portfolio company,its re- sales of the security require registration or an exemption under the 1933 Act.The expense and inconvenience of registration is one more reason to avoid control.The combination of trading restrictions and registration requir decisive for many fina ncial in titu tions.An open-end mutual fund in particular must be ready to redeem shares immediately;the cost of legally-inspired illiquidity may be too great for the mutual fund to bear.74 3.Fear.-Of equal consequence is the institutional investors'his- toricalfear of gre ater political controls and their s ocial vie that institu tional control of management was improper. Although difficult to document.institutional investors have considered joint action to affect management and,I understand,an important consideration militating against joint action was fear that political regulation would follow. Some nal inve stors believe not only that regulation may fol low,but that joint action is aready The SEC concluded in its institutional investor study that: Institutions appear to believe that particpation or u con rn may [rea cal;th en d Bu impos I Dower wou their ex isting relative 74.See Symposium Pa.L.Re tual Funds as Investors of Large Pools of Money,115 U .66 677-78(1967)(statement by Fred 58 r of the Division of Investment for the state of New Jersey and co- chair of the Council of Institutional Investors said: Observors.speculate on whether a handful of large investors might act in collusion I order to control corporations.I ve t at,und ing state thei ca 39 p or individual. Machold,The American Corporation and the Institutional Investor:Are There Lessons From Abroad?,3 Colum.Bus.L Rev.751,757(1988)

1991] A POLITICAL THEORY OF THE CORPORATION 27 If an investor is certain that it will be a long-run player with the portfolio company, then section 16(b) might seem unimportant. But as a member of the group, 16(b) presents a problem. Nasty questions would arise if another member sells within six months of one group member's purchase. Does that trigger 16(b) liability? Of the group? Or of the seller only? Even if the seller had less than 10%o, but the group had more than 10%? Also, institutions must consider their relative advantage. Institu￾tions often believe they can get word of bad news about a portfolio company before individuals do. A group or single institution with 16(b) and lOb-5 insider trading responsibilities would have to forego that advantage. Institutional investors in general, and mutual funds in particular, do not want to be "locked in" to any investment; if they took a big block, 16(b) would lock them in. When an investor or group controls a portfolio company, its re￾sales of the security require registration or an exemption under the 1933 Act. The expense and inconvenience of registration is one more reason to avoid control. The combination of trading restrictions and registration requirements may be decisive for many financial institu￾tions. An open-end mutual fund in particular must be ready to redeem shares immediately; the cost of legally-inspired illiquidity may be too great for the mutual fund to bear.74 3. Fear. - Of equal consequence is the institutional investors' his￾toricalfear of greater political controls and their social view that institu￾tional control of management was improper. Although difficult to document, institutional investors have considered joint action to affect management and, I understand, an important consideration militating against joint action was fear that political regulation would follow. Some institutional investors believe not only that regulation may fol￾low, but that joint action is already illegal. 75 The SEC concluded in its institutional investor study that: [I]nstitutions appear to believe that participation may be ille￾gal or unethical. The concern may [really] be political; that laws may be enacted or regulation imposed out of fear of fi￾nancial power that would inhibit their existing relative invest- 74. See Symposium, Mutual Funds as Investors of Large Pools of Money, 115 U. Pa. L. Rev. 669, 677-78 (1967) (statement by Fred E. Brown, President of Broad Street Investing Corp.). 75. The director of the Division of Investment for the state of New Jersey and co￾chair of the Council of Institutional Investors said: Observors. speculate on whether a handful of large investors might act in collusion in order to control corporations. I believe that, under existing state and federal law, such collusion is illegal. [A]s fiduciaries for the funds under their supervision, institutional investors cannot delegate that responsibility to any other group or individual. Machold, The American Corporation and the Institutional Investor: Are There Lessons From Abroad?, 3 Colum. Bus. L. Rev. 751, 757 (1988)

28 COLUMBIA LAW REVIEW [Vol.91:10 Institutions are particularly sensitive to. ation by a up of institutions with common esting as aws and the 1968 tender offen ons in the Exchange Act ap mpeding frank discussion of concerted action by institutions, eding frank discussion An official of CREF(the College Retirement Equities Fund,a huge investor in the stock market)said he felt perfectly will be sitting in the wit- ngress o itt the as to npan relation att ere toc f power by the e use of exce Mutual funds held the decisive votes in the 1967 proxy fight to control MGM.Senator Sparkman,chairman of the Senate Banking Committee,asked the undecided funds what their policy was in proxy contests,to side with management or not. One fu ind annou ced that would vote for management.Sparkman pointedly omitted that fund from his inquiry.The mutual fund industry viewed Sparkman as threat- ening restrictive legislation if they voted against management.One of the undecided funds,unable to sell at an attractive price soon enough, tilted the balance by voting with management.78 Institutions typically use the "Wall Street Rule":either vote with management or,if unhappy,sell.The SEC attributed the Wall Street Rule to the ins titutions's nse that they ought to make only investment decisior an effo ce en]would subject them to criticism. The SEC le t unc ar from whom tha m wo d come.It could come from the institution's employer,from the portfo lio company,or from political and regulatory actors.It could also come from pee ers.critical of the "socially improper control activities Fear of regulation should be e an rmal economic predic tion would be that atomized institutions would take the plunge,ifit wer immediately profitable,and let the regulation come later.The costs would be borne by all,the benefits appropriated by the first mover.But,the ected costs of"over"-regulation might be high enough action And would have large start-up costs be cause the monitor would have to build a new organizational: Mutual Fu Comp n0e65,at2760 The Role of 78.The Bautle.Not the War.Fo Mar 25.25-27:The Senators the Funds,and the Law,Fortune,May 1967,at 152,152-53;Sen.Sparkman Polls Mu- tual Funds Holding MGM Stock to Learn Proxy-Fight Policies,Wall St.J.,Jan.19,1967. at 3,cols

COLUMBIA LAW REVIEW ment freedom. Institutions are particularly sensitive to. joint participation by a group of institutions with common objectives. Existing antitrust laws and the 1968 tender offer provisions in the Exchange Act appear to have the effect of impeding frank discussion of concerted action by institutions, if not of precluding such action.76 An official of CREF (the College Retirement Equities Fund, a huge investor in the stock market) said he felt perfectly confident that some day I will be sitting in the wit￾ness chair before a Congressional committee defending the record of our fund, as to portfolio company relations. [If we were too active, it might be] Wright Patman . attacking us for abusing our position of power by the use of excessive influence. 77 Mutual funds held the decisive votes in the 1967 proxy fight to control MGM. Senator Sparkman, chairman of the Senate Banking Committee, asked the undecided funds what their policy was in proxy contests, to side with management or not. One fund announced that it would vote for management. Sparkman pointedly omitted that fund from his inquiry. The mutual fund industry viewed Sparkman as threat￾ening restrictive legislation if they voted against management. One of the undecided funds, unable to sell at an attractive price soon enough, tilted the balance by voting with management. 78 Institutions typically use the "Wall Street Rule": either vote with management or, if unhappy, sell. The SEC attributed the Wall Street Rule to the institutions' sense that they ought to make only investment decisions and "an effort to [influence management] would subject them to criticism."' 79 The SEC left unclear from whom that criticism would come. It could come from the institution's employer, from the portfo￾lio company, or from political and regulatory actors. It could also come from peers, critical of the "socially improper" control activities. Fear of regulation should be analyzed. A normal economic predic￾tion would be that atomized institutions would take the plunge, if it were immediately profitable, and let the regulation come later. The costs would be borne by all, the benefits appropriated by the first mover. But, the actor's own expected costs of "over"-regulation might be high enough to deter action. And monitoring would have large start-up costs be￾cause the monitor would have to build a new organizational structure. 76. SEC, Institutional Investor Study Report, supra note 65, at 2760. 77. Note, Mutual Funds, Portfolio Companies and the Small Investor: The Role of Institutional Influence, Colum.J.L. & Soc. Probs., Aug. 1969, at 69, 80-81. 78. The Battle, Not the War, Forbes, Mar. 15, 1967, at 25, 25-27; The Senators, the Funds, and the Law, Fortune, May 1967, at 152, 152-53; Sen. Sparkman Polls Mu￾tual Funds Holding MGM Stock to Learn Proxy-Fight Policies, Wall St.J.,Jan. 19, 1967, at 3, cols. 2-3. 79. SEC, Institutional Investor Study Report, supra note 65, at 125 (summary volume). [Vol. 91:10

1991] A POLITICAL THEORY OF THE CORPORATION 29 The short-run profit might not exceed the start-up costs,and the insti- tution might well believe that in the long-run regulation would kill the financial monitoring process anyway 4.Trading and M -Diversification req nts dampen influence. Peter Lynch successfully managed the$1 billion Magellan Fund,a diversified mutual fund.Imagine his organizational problem if he had wanted to take a few controlling positions.Three-quarters of the portfolio could not have been used for control under the 1940 Act's restrictions one-half of the por folio de r the ta code).Exceller stock pick the noncontrol par of the portfolio would not enough.The fund's managers would have had to acquire another skill, in monitoring,to manage the quarter of the portfolio devoted to con- trol.Lynch would have needed to split expertise,but the two skills and cultures may not match The diversification requirements would also have denied him other means of influence.When Carl Icahn takes a 13%position in USX Corporation,he obtains p ower and induence from two sources:his ac tual stock positi on itself r plus the th eat that he will incre ase it and oust management.That threat entitles him at least to have dinner on a reg- ular basis with the USX chairman.Peter Lynch could not have made that threat.Indeed,when Lynch recently joined a public firm's board (before resigning from Magellan),the mutual fund he managed divested itself of the company's stock.s F.Creditors in Control A creditor in control will be subject in bankruptcy to subordination of its loans:it will be paid last whicl h often means not paid at all.The rinal standard fo ubo di ation in bank uptc control ccompa nied by action solely for the benefit of the creditor,not the enter prise. -seems innocuous,but,fearing the doctrine's application to murky fact settings,creditors shy away from control.81 And bankruptcy is not a sine qua non of such control liability.bankers fear liability to a controlled sol nt G 82 Accordingly,ever n if ba ks c diversification ould overcom les for t he r dis onary trust fun nds ar d make contr investments,83 they would fear the effect of control on their commercial loans to the same company.Control might also create RICO liability or veil-piercing liability for the general debts of the controlled entity. 80.Cowan,A Savvy Outsider Ventures Inside,N.Y.Times,Aug.3,1989,at D8,col 3. Creditor liabilities resulti gement of a Financially Troubled Debtor 31 Bus Law.843.865 (1975);Taylor v.Standard Gas Elec.Co.,306 U.S.307 (1939). 82.See State Nat'l Bank of El Paso v.Farah Mfg.Co.,678 S.W.2d 661 (Tex.Ct. App.1984). 83.See supra text accompanying notes 24-26

1991] A POLITICAL THEORY OF THE CORPORATION 29 The short-run profit might not exceed the start-up costs, and the insti￾tution might well believe that in the long-run regulation would kill the financial monitoring process anyway. 4. Trading and Monitoring. - Diversification requirements dampen influence. Peter Lynch successfully managed the $11 billion Magellan Fund, a diversified mutual fund. Imagine his organizational problem if he had wanted to take a few controlling positions. Three-quarters of the portfolio could not have been used for control under the 1940 Act's restrictions (one-half of the portfolio under the tax code). Excellent stock pickers for the noncontrol part of the portfolio would not be enough. The fund's managers would have had to acquire another skill, in monitoring, to manage the quarter of the portfolio devoted to con￾trol. Lynch would have needed to split expertise, but the two skills and cultures may not match. The diversification requirements would also have denied him other means of influence. When Carl Icahn takes a 13%o position in USX Corporation, he obtains power and influence from two sources: his ac￾tual stock position itself plus the threat that he will increase it and oust management. That threat entitles him at least to have dinner on a reg￾ular basis with the USX chairman. Peter Lynch could not have made that threat. Indeed, when Lynch recently joined a public firm's board (before resigning from Magellan), the mutual fund he managed divested itself of the company's stock.80 F. Creditors in Control A creditor in control will be subject in bankruptcy to subordination of its loans: it will be paid last, which often means not paid at all. The doctrinal standard for subordination in bankruptcy-control accompa￾nied by action solely for the benefit of the creditor, not the enter￾prise-seems innocuous, but, fearing the doctrine's application to murky fact settings, creditors shy away from control. 81 And bankruptcy is not a sine qua non of such control liability. Bankers fear liability to a controlled solvent firm.8 2 Accordingly, even if banks could overcome diversification rules for their discretionary trust funds and make control investments, 83 they would fear the effect of control on their commercial loans to the same company. Control might also create RICO liability or veil-piercing liability for the general debts of the controlled entity. 80. Cowan, A Savvy Outsider Ventures Inside, N.Y. Times, Aug. 3, 1989, at D8, col. 3. 81. See Douglas-Hamilton, Creditor Liabilities Resulting from Improper Interfer￾ence with the Management of a Financially Troubled Debtor, 31 Bus. Law. 343, 365 (1975); Taylor v. Standard Gas & Elec. Co., 306 U.S. 307 (1939). 82. See State Nat'l Bank of El Paso v. Farah Mfg. Co., 678 S.W.2d 661 (Tex. Ct. App. 1984). 83. See supra text accompanying notes 24-26