Posts filed under ‘Corporate Governance’
New Essays on Insider Trading
| Peter Klein |
Steve Bainbridge reviews the history of insider-trading litigation and characterizes Henry Manne’s classic contribution.
Here are Manne’s own reflections (in 2005) on the influence of his work from the 1960s. The new paper, “Insider Trading: Hayek, Virtual Markets, and the Dog that Did Not Bark,” suggests that the activities of insider traders, in so far as they help move stock prices toward their “true” (full-information) values, provides valuable information to corporate decision-makers facing the Hayekian knowledge problem.
Shared Governance: Benefits and Costs
| Peter Klein |
Back in grad school I was regularly hectored by a fellow student about joining the Association of Graduate Student Employees (AGSE), our local collective-bargaining association. Despite his attempt to stigmatize me as a free rider, I never joined. I didn’t think I agreed with the organizations goals, and I was sure I didn’t want to be associated with AGSE’s parent organization, the United Auto Workers (go figure). One year there was even a strike, which I found silly (I scabbed).
This semester I’m getting repeated invitations to join the American Association of University Professors (AAUP). Again, I hesitate. Of course, as an American university professor, I’m happy to see more power, prestige, and perquisites go to American university professors (OK, specifically, to me). But the AAUP has a strange agenda. Its mission includes not only protecting academic freedom and defending the role of the university in public life, but also preserving shared governance. Having spent many years in university settings, I’m convinced that shared governance is grossly inefficient, at least most of the time. There can be benefits, of course, to offset these costs, as is the case with worker-owned cooperatives and other non-standard forms of organization. But one searches the AAUP’s website in vain for any analysis or evidence on shared governance. What are the benefits and costs, relative to other feasible organizational forms? Why should professors defend this peculiar institution? (more…)
Does Performance Cause Organizational Form?
| Peter Klein |
There is a large literature on the performance effects of organizational form. Obviously, for the strategist, getting organizational form right is important only if it leads to superior performance. Of course, the empirical literature recognizes that organizational form, governance, strategy, and other key decision variables are at least partly endogenous. Still, the causal arrows are usually thought to run from strategy to performance.
Ben Hermalin was at Missouri this week to present his paper, “Firm Value and Corporate Governance: Does the Former Determine the Latter?”, which argues that good governance can be the result, not the cause, of good performance. He constructs a model in which the benefits of getting governance right are, on the margin, increasing in the value of the firm’s investment opportunities. Better-performing firms have better opportunities and hence more to gain from designing governance structures that align managers’ incentives with owners. The model is based on an agency framework and applies specifically to managerial governance, but the general problem would seem to apply to a variety of organizational problems and contexts. (more…)
Private Equity and Innovation
| Peter Klein |
LBOs do not reduce patent activity, and the quality of patents may actually increase following a “going-private” transaction, according to a new paper by Morten Sorensen, Per Strömberg, and Josh Lerner.
A long-standing controversy is whether LBOs relieve managers from short-term pressures of dispersed shareholders, or whether LBO funds themselves are driven by short-term profit motives and sacrifice long-term growth to boost short-term performance. We investigate 495 transactions with a focus on one form of long-term activities, namely investments in innovation as measured by patenting activity. We find no evidence that LBOs decrease these activities. Relying on standard measures of patent quality, we find that patents applied for by firms in private equity transactions are more cited (a proxy for economic importance), show no significant shifts in the fundamental nature of the research, and are more concentrated in the most important and prominent areas of companies’ innovative portfolios.
I very much like this kind of work even though I’m a patent skeptic (1, 2, 3, 4).
Still More on Legal Origins
| Peter Klein |
John Armour, Simon Deakin, Prabirjit Sarkar, Mathias Siems, and Ajit Singh add to the debate with a new dataset and a new interpretation: common-law countries offer better shareholder protection not because of the characteristics of common law per se, but because the emergence of a global common-law standard gave common-law countries a head start, a sort of network effect. Here is the paper. Abstract:
We test the ‘law matters’ and ‘legal origin’ claims using a newly created panel dataset measuring legal change over time in a sample of developed and developing countries. Our dataset improves on previous ones by avoiding country-specific variables in favour of functional and generic descriptors, by taking into account a wider range of legal data, and by considering the effects of weighting variables in different ways, thereby ensuring greater consistency of coding. Our analysis shows that legal origin explains part of the pattern of change in the adoption of shareholder protection measures over the period from the mid-1990s to the present day: in both developed and developing countries, common law systems were more protective of shareholder interests than civil law ones. We explain this result on the basis of the head start common law systems had in adjusting to an emerging ‘global’ standard based mainly on Anglo-American practice. Our analysis also shows, however, that civil law origin was not much of an obstacle to convergence around this model, since civilian systems were catching up with their counterparts in the common law. We then investigate whether there was a link in this period between increased shareholder protection and stock market development, using a number of measures such as stock market capitalisation, the value of stock-trading and the number of listed firms, after controlling for legal origin, the state of economic development of particular countries, and their position on the World Bank rule of law index. We find no evidence of a long-run impact of legal change on stock market development. This finding is incompatible with the claim that legal origin affects the efficiency of legal rules and ultimately economic development. Possible explanations for our result are that laws have been overly protective of shareholders; transplanted laws have not worked as expected; and, more generally, the exogenous legal origin effect is not as strong as widely supposed.
Henry Manne, Academic Entrepreneur
| Peter Klein |
Henry Manne did as much as anyone to create the modern discipline of law and economics. I refer here not only to his scholarly contributions, particularly his work on the market for corporate control and on insider trading, but also his creation of institutions (such as the original Law and Economics Center at the University of Miami) to support the emerging field. So it’s nice to see this essay by Larry Ribstein, “Henry Manne: Intellectual Entrepreneur,” coming out in Pioneers of Law and Economics edited by LLoyd Cohen and Josh Wright. (Via Josh.)
Writing when there was a theory vacuum in legal academia, Manne breathed life into corporate law by using economic principles to formulate a sweeping new theory of the corporation. Then he took his show on the road with seminars, programs and ultimately a law school to create a market for his ideas. The Chapter shows that Manne was an entrepreneur not only in bringing people and ideas together, but also in the Schumpeterian sense Manne discussed in his work on insider trading — an active participant in the creative destruction of the existing paradigm rather than merely a manager of existing ideas. Manne’s career demonstrates that, under the right conditions, a single scholar can leave noticeable ripples in the stream of intellectual history. By demonstrating that corporations, and by inference other important institutions, are best analyzed in market terms, and by creating an intellectual market for these and other economic ideas, Manne changed the way scholars, judges, regulators and others think about the role of law in society.
See also this Manne essay on the emergence of the field. And these papers by my former student Alex Padilla on insider trading. (And these cool gowns worn by the examiners at Alex’s dissertation defense at l’Université d’Aix en Provence.)
The Original Corporate Raider
| Peter Klein |
Did you catch Henry Manne’s tribute to Louis E. Wolfson, whom Manne calls “the original corporate raider,” in the 18 Jan WSJ?
[T]he obituaries dutifully acknowledged that he was a serious and valued benefactor of children’s health care, and that he devoted himself in later life to the cause of penal reform. . . . They missed the big story. Wolfson’s contribution to human welfare far exceeded the total value of all private philanthropy in history. He invented the modern hostile tender offer. This invention, which activated and energized the market for corporate control, was the primary cause of the revolutionary restructuring of American industry in the 1970s and ’80s, and the ensuing economic boom.
Before Wolfson’s innovation, executing a “hostile” (i.e., against the wishes of incumbent management) takeover required winning a long and potentially costly proxy contest. Now, potential bidders could appeal directly to shareholders, asking them to “tender” their shares at the offered price, bypassing the incumbent management team altogether. Naturally, this outraged the business establishment — the “powerful corporate elite of the 1960s,” as Manne calls them — and pressure mounted for legislation to restrict hostile takeover offers, leading to the 1968 Williams Act, designed to protect incumbent managers by giving them time to prepare counter-offers and otherwise restricting “raiders.” (more…)
Ken Lay: Not Such a Bad CEO After All?
| Peter Klein |
Jim Brickley combs through the mess of Enron trial materials to examine the behavior and performance of Missouri’s own Ken Lay. His findings may surprise you:
Internal documents released through the Enron litigation allow for a more detailed examination of the activities of top executives than is typically possible. This clinical study of Enron’s Ken Lay highlights the difference between popular opinion on the role and knowledge of CEOs with that suggested by economic theory and evidence. In contrast to popular opinion, the evidence is consistent with the following three hypotheses: 1) Lay performed a role at Enron that is consistent with existing economic theory and evidence, 2) he performed this role with reasonable diligence, and 3) while he was relatively well informed about Enron at a high level, it is unlikely that he would have had detailed information on many of Enron’s transactions — including deals with Fastow’s partnerships. News analysts assert that a positive feature of Lay’s legacy is that CEOs are now spending more time monitoring the details of financial reports and internal controls. This study suggests that the opportunity costs of this change in CEO behavior are higher than these analysts suggest.
On a related note, here is an interview with Gene Fama (via Don Boudreaux) covering principal-agent issues and CEO compensation, as well as efficient-markets theory.
Reflections on LLSV
| Peter Klein |
I meant to blog on the newest LLSV paper (actually LLS, in this case) but never got around to it. LLSV, you’ll recall, inaugurated a stream of empirical research on the financial and economic effects of legal systems (focusing on the differences between common- and civil-law countries). The newest paper clarifies the argument and reflects on ten years of research, discussion, and debate on the role of legal origins.
Fortunately, Daniel Sokol has written some comments on the Conglomerate blog (one of my regular reads, by the way — keep up the good work, guys!). Daniel notes, wisely:
I believe that LLSV makes certain assumptions about history and political economy in legal origins that are not exactly supported by the underlying historical record. A number of scholars have attacked LLSV on these grounds. Nevertheless, I still find myself strangely attracted to LLSV. In many ways, the results are what you would intuitively expect if you were on your own to attempt to rank countries based on investor protection or other similar features. More importantly, a number of the variables that LLSV uses are a bit squishy but we have yet to come up with better cross country measurements. Indeed, as a result of the critiques, LLSV have gotten better as to how they measure shareholder protection. From a policy perspective, the key to change to various bottlenecks requires not merely a top down approach in the change of the legal system but a bottom up approach by the users of these legal systems to overcome various bottlenecks that are regulatory. This makes me believe that over time the common law/civil law distinction will be seen as a rather false one where instead you will find countries lumped into categories based on their ability to respond to local and changing conditions (even the United States, which in recent years may have created increased regulatory bottlenecks such as SOX). This evolutionary approach is what I believe holds the key to understanding how to think about law and institutions.
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