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«Theodore N. Mirvis, Paul K. Rowe, & William Savitt ∗ Responding to Lucian Bebchuk, The Case for Increasing Shareholder Power, 118 HARV. L. REV. 833 ...»

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BEBCHUK'S "CASE FOR INCREASING SHAREHOLDER

POWER": AN OPPOSITION

Theodore N. Mirvis, Paul K. Rowe, & William Savitt ∗

Responding to Lucian Bebchuk, The Case for Increasing Shareholder

Power, 118 HARV. L. REV. 833 (2005).

Lucian Bebchuk's characteristically provocative article, The Case for

Increasing Shareholder Power, 1 has stimulated lively and fruitful debate in

the pages of the Review and beyond. We are honored to comment on Pro- fessor Bebchuk's Article in this Forum.

The central argument of the Article is that the traditional, director- centered corporate form should be replaced in favor of a novel governance system of Bebchuk's own invention — a regime that nominally retains di- rectorial primacy, but in fact eviscerates directorial discretion by vesting directly in shareholders the authority to change the company's charter and authorize mergers and other transformative corporate events. 2 As Vice Chancellor Strine's "corporate law traditionalist" recognizes, the Bebchuk approach would undermine "the core element of the Delaware way: the empowerment of centralized management to make and pursue risky busi- ness decisions through diverse means." 3 This is a proposal for radical and risky change, offered notwithstanding — with no recognition of — the enormous historical success of the Dela- ware approach. The adage "if it ain't broke don't fix it" does not begin to capture the risk of Bebchuk's agenda. One would rather have to say some- thing like "if it has performed superlatively over the course of generations, and the visible preferences of the market confirm its wisdom, and its con- tinued proper functioning is central to the nation's economy, don't gratui- tously disassemble it."

In our view, the "case for increasing shareholder power" is exceedingly weak, and in this space we summarize several of our core objections.

First, Bebchuk's proposal involves the abrupt overthrow of core Delaware corporate law principles and therefore risks extraordinarily costly disrup- tion without any assurance of corresponding benefit. Second, Bebchuk's proposal — which rests on the (virtually explicit) hypothesis that corporate ––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––– ∗ Theodore N. Mirvis, Paul K. Rowe and William Savitt are partners at Wachtell, Lipton, Rosen & Katz in New York who specialize in corporate and Mergers & Acquisitions-related litigation.

1 Lucian Bebchuk, The Case for Increasing Shareholder Power, 118 HARV. L. REV. 833 (2005).

2 See id. at 835.

3 Leo Strine, Jr., Toward a True Corporate Republic: A Traditionalist Response to Bebchuk's Solu- tion for Improving Corporate America, 119 HARV. L. REV. 1759, 1763 (2006).

43 44

–  –  –

boards cannot be trusted to respect their fiduciary duty — finds no resonance in the observed experience of boardroom practitioners. And third, Bebchuk's proposal exalts shareholder power in a manner that is not only inconsistent with statute and decades of Delaware case law, but also is particularly suspect in light of the palpable practical problems of any shareholder-centric approach.

I.

The "business and affairs" of every Delaware corporation "shall be managed by or under the direction of a board of directors." 4 This simple statement of board primacy, which appears as Section 141(a) of the Delaware General Corporation Law, announces a general principle that echoes in specific applications throughout the Delaware statute and case law. Accordingly, the Delaware model "invests corporate managers with a great deal of authority to pursue business strategies through diverse means, subject to a few important constraints." 5 Significant corporate action (including the "rules of the road" and "game ending" decisions at issue in Bebchuk's proposed reforms) may be undertaken under existing law only with the informed and deliberate assent of the board of directors — a legally accountable fiduciary obliged by law to advance the interests of the corporation and its shareholders. In the context of charter amendments and certain extraordinary corporate events, shareholders are asked to react to board recommendations, but have very limited power to initiate corporate action.

This basic framework has been in place for nearly a century and by any measure it has performed admirably. As the economists Bengt Holmstrom and Steven Kaplan have observed, notwithstanding "the alleged flaws in its [corporate] governance system, the U.S. economy has performed very well, both on an absolute basis and particularly relative to other countries.... If anything, [the broad evidence] suggests a [corporate governance] system that is well above average." 6 Moreover, as Bainbridge persuasively argues in his separate reply to Bebchuk, informed IPO investors have historically chosen and continue to choose the default, directorcentric governance terms provided under Delaware law. 7 Indeed, "in the real world, companies almost never 'go public' with enhanced shareholder ––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––– 4DEL. CODE. ANN. tit. 8, § 141(a) (2006).





5Strine, supra note 3, at 1762.

6Stephen M. Bainbridge, Director Primacy and Shareholder Disempowerment, 119 Harv. L. Rev.

1735, 1739–40 (2006) (quoting Bengt Holmstrom & Steven N. Kaplan, The State of U.S. Corporate Governance: What's Right and What's Wrong? 1 (European Corporate Governance Inst., Finance Working Paper No. 23/2003, 2003).

7 Id. at 1743–44.

45 2007] REPLY power." 8 The revealed preferences of informed investors thus powerfully confirm the wisdom of the Delaware approach.

Bebchuk waves off these broad lessons from experience, and, armed with little more than a theory and a smattering of concededly inconclusive data, urges a fundamental reapportionment of the balance of decisionmaking power between shareholders and directors. Make no mistake: Bebchuk is after a revolution. As Bainbridge puts it, Bebchuk wishes "to replace the existing, mostly permissive rules disempowering shareholders with a new set of mostly mandatory rules empowering them." 9 And Vice Chancellor Strine's "traditionalist" observes that Bebchuk aims at nothing less than the replacement of the traditional corporate republic with a form of direct shareholder democracy. 10 It is impossible to predict all the results of Bebchuk's approach (and the law of unintended consequences is a powerful independent reason to resist sweeping uncompelled change of the sort Bebchuk proposes). 11 At a minimum, however, we must be prepared for wasteful and expensive contested ballots on any number of purported "rules of the road" or "specific business" changes, and — as the specter of such elections hangs over management — a concomitant erosion of board collegiality and directors' ability to manage for long-term value. In addition, the pool of qualified directors would be certain to diminish, perhaps precipitously, as experienced businessmen and businesswomen would have far less incentive to serve in what would be a much reduced capacity. Why be a pin in a bowling alley, subject to being knocked down by the fancy of whatever unaccountable shareholder "body" steps up to the line for a shot? At the same time, there is reason to fear a decline in the quality of corporate decisionmaking on fundamental issues, as shareholder plebiscite by diverse shareholders, sometimes ill-informed, sometimes fractured by divergent interests, replaces the situation-specific business judgment of a fully-informed board. That is an awful lot to ask in the name of a slogan.

Thorny new practical and legal problems would also ensue. For example, would shareholders setting corporate policy owe fiduciary duties to ––––––––––––––––––––––––––––––––––––––––––––––––––––––––––––– 8 Lynn Stout & Iman Anabtawi, Sometimes Democracy Isn't Desirable, WALL ST. J., Aug. 10, 2004, at B2; see also Lynn A. Stout, Takeovers in the Ivory Tower: How Academics Are Learning Martin Lipton May Be Right, 60 BUS. LAW. 1435, 1453 (2005) ("[C]ompanies 'going public' follow [Delaware] default rules as a matter of course, even though the enabling nature of U.S. corporate law allows them substantial room to modify their charters to weaken director power or to increase shareholder clout.").

9 Bainbridge, supra note 6, at 1735.

10 See Strine, supra note 3, at 1782–83.

11 Recent scholarship confirms the risk that "shareholder empowerment" may yield deleterious unintended consequences. For example, Lynn Stout observes that so-called "shareholder democracy" appears to be encouraging private buy-outs of public companies, concluding that "[t]here is reason to suspect that the modern trend toward greater 'shareholder power' has gone too far and is beginning to harm the very shareholders it was designed to protect." Lynn Stout, Investors Who Are Too Bolshy For Their Own Good, FIN. TIMES, Apr. 23, 2007 at 9.

46 HARVARD LAW REVIEW [Vol. 121:43 one another? What legal recourse (if any) would be available when a majority shareholder (or group) changes "the rules of the road" to the detriment of the minority? Would shareholders (like directors under the current regime) owe fiduciary duties to non-shareholder corporate constituencies in non-Revlon circumstances? If so, how and by whom might be they enforced? And if not, what other redress, if any, would be available for these dispossessed constituencies? And what result when the shareholders vote for divergent "rules of the road" — which are to be binding and which ignored, and who decides? What if these rules are constantly changed?

The Bebchuk proposal likewise raises complex issues relating to the allocation of risk and reward between shareholders and corporations. As a general rule, those entrusted with corporate management — officers and directors — bear legal risk for the actions of their corporations. Shareholders do not: the law deems investments in corporate enterprises sufficiently socially desirable that it allows shareholders to reap the benefits of corporate performance through share ownership without risk of liability for harm that the corporation may cause to others. In exchange for the privilege of investing without exposure to personal liability, shareholders must cede control and responsibility over corporate conduct to others, namely directors and officers. But would this trade-off continue to make sense under the Bebchuk regime of shareholder empowerment?

Making matters worse, practitioners and businesspeople would be unable to look to the well-developed corpus of Delaware common law for guidance in navigating such issues. Contemporary Delaware corporations jurisprudence is built on the bedrock understanding that "a corporation is not a New England town meeting," 12 and that directors are "not a passive instrumentality" for effectuation of shareholder will. 13 But in Bebchuk's brave new world, these foundational propositions are, by hypothesis, no longer true — which means that the utility of Delaware's doctrinal inheritance would be substantially compromised.

Now, we are not quite ready to declare that blood will run red in the streets of Wilmington if Bebchuk has his way. But it is critical to appreciate just how radical a break with all history Bebchuk proposes. This would be an abrupt and fundamental reordering of power within the corporate form. In view of the enormous long-term success of the Delaware approach and the apparent satisfaction of the marketplace, and given the absence of any persuasive empirical basis for Bebchuk's proposal, we believe that such a break is plainly unwarranted.

Moreover, it is borderline facetious for Bebchuk to invoke "the lessons of history" to justify his agenda. 14 The relevant historical point — appar–––––––––––––––––––––––––––––––––––––––––––––––––––––––––––– 12 TW Servs., Inc. v. SWT Acquisition Corp., Nos. CIV.A. 10427, 10298, 1989 WL 20290, at *8 n.14 (Del. Ch. Mar. 2, 1989).

13 Unocal Corp. v. Mesa Petroleum Co., 493 A.2d 946, 954 (Del. 1985).

14 Lucian A. Bebchuk, Letting Shareholders Set the Rules, 119 HARV. L. REV. 1784, 1812 (2006).

47 2007] REPLY ently lost on Bebchuk — is that evolutionary development is a far more reliable path to improved corporate governance than upheaval. Indeed, part of the genius of the Delaware way has been the courts' ability to develop incremental legal changes to meet evolving corporate circumstances within the existing doctrinal framework. An important example: during the then-unprecedented wave of takeover activity in the 1980s, the Delaware courts rejected calls from the academy to disqualify directors from the takeover arena and instead announced — in Unocal, Moran, and other decisions — a nuanced approach, crafted to protect shareholder interest and consistent with precedent and long history, that has facilitated the world's most robust and sustained market for corporate control. The historical record powerfully suggests that Delaware got it right. With Holmes, we say that the logic of the law is — and should be — experience.

II.



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