Litigiousness and Gatekeeper Scholarship

Law and scholarship on capital market gatekeepers rely mainly on liability threats to promote gatekeeper effectiveness.  The literature struggles with individual versus enterprise liability, strict or negligence-based, compensatory versus deterrence, joint versus several, fines versus jail terms and so on.  Come Fall, the Supreme Court, in Stoneridge Investment v. Scientific-Atlanta, will reexamine aiding and abetting liability for secondary actors under its Central Bank decision. 

The preoccupation with sticks for gatekeepers could reflect US litigiousness or an occupational hazard of legal scholars.  Whatever the reason, a new approach emerging in the literature looks to carrots instead.  Examples are Tamar Frankel’s recent Business Lawyer piece, David McGowan’s California piece and my own forthcoming Minnesota piece.

The intuition behind rewarding gatekeepers using carrots rather than merely threatening with sticks follows the intuition behind incentive compensation used in other contexts.  Examples are stocks options for executives and contingent fees for bankers in takeovers.  Both can actually create perverse incentives, with managers using aggressive accounting and bankers blessing deals not in the client’s best interest. 

To correct for such perversions, as Warren Buffett quipped, “If I’m going to pay $5 million to somebody if they give me the advice and the deal goes through, then I think I probably ought to pay $5 million to somebody else whose advice I listen to who gets paid the $5 million only if the deal doesn’t go through.”  Similarly, if shareholders pay executives incentive compensation to achieve performance measures, they should be willing to pay gatekeepers incentive compensation to assure that such performance goals are achieved using fair reporting. 

Max Weber and “Principles-Based” Accounting

I have expored how the prevailing romance over “principles-based” corporate regulation, especially in accounting, cannot be explained by a correspondence between the labels “principles-based” or “rules-based” and any actual accounting or regulatory system.  The interim report of the Committee on Capital Markets Regulation (a.k.a. the Paulson Committee) unwittingly shows the difficulty  of connecting the labels to reality when it advocates “principles-based” systems yet prescribes reforms that would yield more rules than principles.   

The lack of connection between rhetoric and reality concerning principles-based accounting might be explained as an unconscious move to a new stage of accounting necessary to facilitate globalization of capitalism and democracy.   This new stage evokes the theories that Max Weber explored about capital accounting as a pre-condition to capitalism within the broader social and political dimensions of market exchanges (see, e.g., Weber, The Protestant Ethic and the Spirit of Capitalism).

Accounting was a representation of the calculative mentality focused on maximizing rates of return on invested capital.  Other social institutions were necessary too, including requisite technologies, religious sensibilities, state bureaucracies and an entrepreneurial spirit.  Those remain mostly in place.  What is needed is a system of international capital accounting as a pre-condition to the globalization of capitalism and democracy. 

The current challenge is to forge a single system commanding worldwide recognition.  For decades, US GAAP has been the front-runner but other powers, especially Europe and its member states, champion International Financial Reporting Standards (IFRS).  Lately, IFRS is attracting more support, including from the Securities and Exchange Commission  (SEC).  The SEC has long indirectly controlled US GAAP and increasingly exerts indirect control over IFRS. The result is that IFRS may emerge as the system of capital accounting necessary for globalization.  The US and other countries all can claim some ownership of IFRS: it appears to emanate from outside the hegemonic power but really is its product.  Packaging and celebrating IFRS as “principles-based” increases the chances that it will command requisite global recognition.  

The Dawning Eclipse of FASB?

The Securities and Exchange Commission (SEC) plans to issue a release  this summer proposing rules that would allow non-US enterprises to report financial statements using International Financial Reporting Standards (IFRS), eliminating the longstanding requirement that such statements be reconciled to US GAAP.  Companies would elect to use either IFRS or US GAAP.   The proposal also entertains the possibility of allowing US enterprises to make the same election. 

If approved, these changes would intensify competition between the promulgators of IFRS, the International Accounting Standards Board (IASB), and the promulgators of US GAAP, the Financial Accounting Standards Board (FASB).  What will define the terms of the heightened competition?  Race to the bottom or race to the top?  Will accounting standards—and financial statements—be friendlier to investors and other users or to managers and auditors? 

The changes likely would hasten the move to a single international capital accounting system, with one of the two winning the race.   The loser could go out of business.  Picking the winner is difficult.  But the packaging of the relatively young IFRS to fit the prevailing romance with so-called “principles-based” accounting is a clue: the smart money bets that adopting the proposal would put FASB out of business within a decade. 

More Thanks

Many thanks to Professor Bainbridge and Barbara Black of Securities Law Prof blog for welcoming the Corporate Law and Democracy blog. 

Like Larry, I also noticed a slight disconnect between Professor Bainbridge’s mention of my blog and his ensuing critique of “left communitarianism.”  I took Professor Bainbridge’s comment as a response to the blog’s stated themes, rather than the blog itself. Perhaps he will clarify in a comment.

What’s in a Label?

Thanks, Renee, for inviting me to guest on this valuable new academic blog!  My stint starts with queries about temptations to label it.  I love the site description: a repository for multidisciplinary thought on “corporate law and democracy” and the influence of “corporations and corporate law on political and social structure.”  The posts so far are wonderfully varied, highlighting work by Professors Ahdeih, Bilder and Macey among others.

Yet, over at PropertyProf , Al Brophy welcomes Corporate Law and Democracy by noting how, along with BC’s Kent Greenfield, BC Law “has emerged as one of the leading schools for progressive corporate scholarship.”  At Professor Bainbridge , the eponymous blogger says that “the role of corporations in a democratic society is a vital question . . .  so I will be watching [Renee’s] blog with interest” and follows with a summary of his “critique of the strain of left communitarianism . . .  in corporate law scholarship.” 

Why these labels? Is this site “progressive” or “communitarian” (or “left communitarian”)?  Is federalism progressive?  Is democracy communitarian?  Is an “ownership society” left wing?  Is your humble guest blogger?  I don’t think so!  Labeling is a curious thing, and political labeling perhaps a sign of our “polarized times.”  What I see is an academic blog collecting ideas without political boundaries (and my guest posts will follow that spirit!).

Introducing Guest Blogger Lawrence A. Cunningham

I am pleased to introduce our first guest blogger, Lawrence A. Cunningham of Boston College Law School.  Larry is a good friend and a wonderful colleague.  He is a prolific scholar with a wide range of interests.  He is perhaps best known for his work on corporate law and accounting, auditing and internal controls.  Larry has teed up a number of interesting posts exploring international competition in accounting standards, the potential eclipse of FASB, and accounting as “the language of capitalism.”  He will start posting here next week. 

Robert Hockett, What Kinds of Stock Ownership Plans Should There Be?

Robert C. Hockett of Cornell Law School has posted an interesting article, What Kinds of Stock Ownership Plans Should There Be? Of ESOPs, Other SOPs and “Ownership Societies” which is forthcoming in 92 Cornell Law Review (2007).  The article is the third in a trilogy that examines the ideal of, and the paths to, an “ownership society” in America.  This third piece looks at corporate equity ownership as the missing piece of a three-legged stool that could support an ownership society. Here is the abstract:

Present-day advocates of an ownership society (OS) do not seem to have noticed the means we have already employed to become an OS where homes and human capital (higher education) are concerned. Nor do they appear to have considered whether these same means – which amount to publicly enhanced private credit markets – might be employed to spread shares in business firms, with a view to completing our OS. This article, the third in a series, seeks tentatively to fill that gap. It does so first by demonstrating how the Employee Stock Ownership Plan, or ESOP, in effect replicates our home and education spreading programs in piecemeal fashion. But piecemeal replication, the article shows, is not sufficient; a completed OS requires complete replication. So the article, second, generalizes from the ESOP along two salient dimensions – what it labels the patronage and credit dimensions – in order both to complete SOP-financing’s replication of our federal home- and higher-education finance programs, and with that our OS itself. Our OS is, in effect, a three-legged stool that awaits its third leg.

The Sarbanes-Oxley Cure?

For an antidote to all the Sarbanes-Oxley doom and gloom that surrounds us see Jay Brown’s recent post  at his Race to the Bottom blog discussing a recent Joel Seligman and Harvey Goldschmid opinion piece System is Working in the National Law Journal.

Thanks

I would like to express my thanks to fellow bloggers Al Brophy at  PropertyProf , Jay Brown at Race to the Bottom , Dan Filler at Concurring Opinions , and Gordon Smith at Conglomerate , for their warm welcome to Corporate Law and Democracy.  I greatly appreciate their encouragement and kind words.

Yair Listokin on why “Management Always Wins the Close Votes”

Yair Listokin of Yale Law School is guest blogging at PrawfsBlawg.  He has an interesting post on his work in progress investigating the phenomenon of corporate management winning “close” votes on proxy statement proposals more often then would be expected in the random course of events. Here is the link: Management Always Wins the Close Votes.