M. Todd Henderson · April 2009
77 GEO. WASH. L. REV. 708 (2009)
This Essay offers a different and more fundamental explanation for the persistence and political alignment of the classic debate in corporate law – whether the American way of making corporate law is one that will lead toward good rules or bad rules – using a recent contribution to the debate by Professor Robert Ahdieh as a foil. Ahdieh’s goal is to break the deadlock in this debate by trying to convince the opposing factions that the debate is based on a misunderstanding about the role played by state competition. Simply put, the race doesn’t matter for corporate governance, so everyone should stop talking about it. He argues that corporate governance is determined by markets, not state law. Specifically, the markets for managerial talent and corporate control, not state competition for corporate charters, are responsible for the ability of corporate law to restrain the inevitable agency costs arising when ownership and control are separated. If true, not only is the race debate pointless, but there is nothing special about state-based law. Federal law would do just as well in policing intrafirm governance, assuming the “right” answers as to optimal corporate law can be discovered by federal regulators.
This Essay shows why Ahdieh’s argument is unpersuasive, then offers an alternative explanation for the persistence of the debate. On the substance, Ahdieh’s argument that “markets” do the work of law avoids the fact that state law is ultimately determinative of the nature of the markets. While the market for corporate control disciplines managers, it is competition among states that disciplines states from distorting the market for corporate control. For instance, some important states, like California and Massachusetts, have tried to impose judicial review of merger contracts or tried to rewrite them to achieve substantive fairness. Delaware has offered an alternative for firms looking to avoid these doctrines by rejecting broad judicial rewriting of merger contracts and adhering to an enabling regime that gives parties maximum flexibility to structure their affairs. We see fewer mandatory rules, for good or bad, because of corporate federalism.
After showing why there really is a debate and why it matters, this Essay then offers an alternative explanation for its perseverance based on the insight of Thomas Sowell about individuals’ competing visions of what makes effective public policy. Sowell describes a conflict between a “constrained” and an “unconstrained” vision of the world. Those with a constrained vision are skeptical of top-down solutions imposed by experts of various kinds, relying instead on systemic processes, like markets, families, or tradition, to deal as best as they can with social problems. These people tend to be political conservatives and toppers. To them, getting the right corporate law rules, be they rules about takeovers or the optimal composition of the board of directors, is something that only can be achieved through a process designed to filter good rules from bad. In fact, good rules are defined as those that survive such a process.
Professor Ahdieh is to be commended for trying to resolve the race debate, but because the debate is premised on a conflict of fundamental points of view, it is unlikely that a single argument, no matter how interesting and persuasive, is likely to achieve this goal. The battle is bigger than corporate law, since these points of view clash on innumerable other policy issues. The battle over these competing visions was fought by Hayek and Keynes, by Reagan and Franklin Roosevelt, and countless politicians, economists, and philosophers. Without solving all of politics and social policy, there is little hope for solving the race debate.
The work-a-day world of law professors and policymakers, however, can still be valuable, since it is not their job to resolve our most basic differences, but to tweak the rules slightly here or there. Although beyond the scope of this Essay, it is possible to look for a locus of agreement. Common ground might be found on the question of how effective the market is in any particular environment. This may be the best hope for empirical scholarship in this field because it brings the debate down to the level of the real-world merits and applicability of the two conflicting visions of corporate law.
The rest of this Essay proceeds as follows. Part I describes the basic corporate law debate to set the stage for an analysis of Professor Ahdieh’s claim about markets doing the work of law in policing corporate governance. Part II takes on this claim, showing how law influences markets, and how competition for corporate charters or simply choice of law for firms has prevented excessive regulation that might have reduced the efficacy of the markets on which Ahdieh relies.
After showing why corporate federalism is important and efficient, Part III offers an alternative explanation for the perseverance of the debate. Drawing on Thomas Sowell’s classic work, A Conflict of Visions, this Part shows how the policy debate is really about different worldviews instead of just the merits of corporate law. Part IV then concludes by offering some preliminary thoughts on how to break the deadlock. Specifically, this Essay argues that the federalism debate should track antitrust law, in which claims about the efficacy of certain policies turn on an analysis of the vibrancy of the market as a whole instead of more narrow observations about things that seem not to work perfectly.
