INTRODUCTION I. BRAZIL'S NOVO MERCADO A. Brazil Before the Novo Mercado B. The Novo Mercado Standards C. Enforcing the Novo Mercado Standards D. Experience with the Novo Mercado II. OTHER EXAMPLES OF REGULATORY DUALISM IN CORPORATE LAW A. The Frankfurt Neuer Markt B. The EU Choice of Corporate Law Regime: Centros and the Societas Europaea 1. Centros and choice of state of incorporation 2. The Societas Europaea C. Corporate Chartering in the United States 1. General corporation chartering 2. Bank chartering III. RELATED REGULATORY STRATEGIES A. Grandfathering B. Menus C. Default Rules D. Grand Bargains IV. WHO PROVIDES THE REFORMIST REGIME? A. The Problem of a Unitary Lawmaker B. Dualism via Private Regulatory Organizations 1. Enforcement 2. Network efficiencies 3. Revision of regulations 4. Political independence C. Regulatory Dualism Across Federated States D. Regulatory Dualism Across Independent States CONCLUSION: THE PROMISE OF REGULATORY DUALISM INTRODUCTION
Countries pursuing economic development confront a fundamental obstacle. Reforms that, by stimulating growth, will increase the size of the overall pie are blocked by groups that, having achieved economic success and therefore political influence under the existing regime, believe that their positions will be threatened by the growth-inducing reforms.
This problem is conspicuous in developing countries' efforts to establish effective capital markets. Both logic and an increasing body of empirical evidence suggest that economic development receives strong stimulus from an effective capital market, (1) which in turn requires a substantial and effective legal infrastructure to protect the interests of minority shareholders in publicly traded business corporations. (2)
Yet the development of effective shareholder protection to support capital market development commonly threatens already-established firms and their controlling owners. First, it shifts both wealth and corporate power (and ultimately political power as well) away from the controlling owners and toward public shareholders. In particular, by reducing self-dealing, effective minority protection lowers the value of controlling shares. And by constraining control, it also opens governance of the corporation to outside influence. Second, effective shareholder protection facilitates the financing of potential competitors, since new firms generally need outside equity financing more than do well-established firms. These threats give the controlling owners and managers of established firms a powerful incentive to resist expansion of the legal protection afforded shareholders. And, because those owners and managers generally have strong influence over the political process, they are frequently in a position to make their resistance to reform effective.
We will call this resistance of the established economic and political elite to growth-promoting reforms the Olson problem, after the economist who has described it most eloquently and insightfully. (3) The question, then, is what can be done to overcome the Olson problem--that is, to defuse the tension between future growth and the current distribution of wealth and power.
Olson himself pessimistically suggested the intractability of the tension; in his view, solving the Olson problem may require massive social upheaval--such as revolution or war--that destroys the existing establishment. (4) More optimistic approaches stop short of destroying the elite and instead mitigate their opposition by protecting their interests from the growth-inducing reforms. (5) In this Article, we examine one approach of the latter type, which we label regulatory dualism.
Regulatory dualism seeks to avoid, or at least mitigate, the Olson problem by permitting the existing business elite to be governed by the prereform regime, while pursuing development by allowing other businesses to be governed by a reformed regime. Put in terms of capital market and shareholder protection, regulatory dualism establishes a new and more rigorous shareholder protection regime, operating parallel to the existing one, that is open to any new or existing firm that wishes to make use of it. The maintenance of the relationship between controlling and minority shareholders in existing firms insulates the interests of established elites, while more effective shareholder protection makes public financing available to the entrepreneurial sector, thereby expanding the capital market's capacity to support economic development. (6)
To be sure, regulatory dualism is not without costs to the elites. However, the two more extreme alternatives--comprehensive reform and no reform--also impose costs on the elites. Comprehensive reform brings a direct transfer of corporate wealth and power to public shareholders, the improvement of financing options available to competitors, and--as an ultimate consequence--reduction in the political clout of the currently controlling owners vis-a-vis outside investors and new businesses. On the other hand, seeking to block all reform can be expensive, not just directly but by upsetting the elites' relationship with previous allies, such as government officials and stock exchange owners. Worse, extreme intransigence toward reform could lead to general economic decline harmful to all classes, and might ultimately produce a popular backlash that seriously damages the overall economic and political position of the current elites.
Given the alternatives, regulatory dualism can provide an attractive compromise from the elites' standpoint, since it avoids the costs of blocking all reform, dilutes the costs of sweeping legal changes, and reduces the political pressure for more comprehensive reform. A dual regulatory regime preserves the legal entitlements of incumbents, at least initially, thus avoiding the immediate economic and political costs associated with stronger minority investor rights at the firm level. The immediate economic and political costs associated with a dual regulatory regime are principally those stemming from increased competition. But if the new firms are expected to concentrate in different industries than the established ones--the "new" as opposed to the "traditional" economy--the slope of the incumbents' decline may be gentle enough to allow them to move their wealth out of the old businesses in time. The result is that, even if the elites ultimately lose their economic and political dominance, they can still protect most of their wealth, perhaps permanently. (7)
Our particular focus here is on dual regulatory regimes as a solution to the Olson problem. Multiple regulatory regimes can play other roles as well. In particular, it is helpful to distinguish what we term regulatory dualism from regulatory diversification, regulatory experimentation, and regulatory competition. For clarity, we offer characterizations here--in sharply delineated, ideal type terms---of each of these four rationales for maintaining multiple regulatory regimes.
Regulatory Diversification. The actors being regulated are not homogeneous in their needs for regulation. Consequently, it is efficient to maintain two or more parallel regimes of regulation, with each regime designed to deal with the particular characteristics of a distinct set of actors. Regulatory Experimentation. The actors being regulated may or may not be homogeneous. It is unclear what form of regulation is most efficient, or perhaps even whether efficiency calls for one regime or multiple regimes. For this reason, alternative experimental regulatory regimes are created, either in different jurisdictions or in a single jurisdiction, and then compared to see which function best, with an eye to replicating, ultimately, the best regime(s). The Brandeisian notion of federated states as laboratories of democracy reflects this approach to regulation. Regulatory Competition. The actors being regulated are relatively homogeneous, with the consequence that a single regulatory regime would, in principle, be most efficient. But--perhaps owing to laxity, self-interest, ignorance, or ideology--a single agency with a monopoly on regulatory authority cannot be trusted to adopt the efficient form of regulation. The regulated actors have an incentive to be governed by an efficient regulatory regime--for example, so that they can attract patrons, such as investors, workers, or customers. Creating multiple regulators with overlapping jurisdictions, so that the regulated actors can choose the regulatory regime to which they will be subject, puts the various regulators in competition with each other as they seek to attract, or not to lose, actors subject to their system of regulation. Regulatory Dualism. As with regulatory competition, a single homogeneous regulatory regime for all actors would in principle be most efficient. Here, however, the preexisting system of regulation--the established regime--has been captured by a subset of the actors that it regulates and inefficiently permits those actors to pursue their private interests. A second, more efficient system of regulation--the reformist regime--is created, and is made available to all actors. Meanwhile, the established regime is maintained and is also made available to all actors, whether they have previously been governed by that regime or not. Maintaining the established regime reduces the incentive for those who benefit from that regime to oppose creation of the reformist regime. An important difference between regulatory competition and regulatory dualism--in the ideal types we have defined here--is that regulatory competition causes the various regulatory regimes to converge toward the efficient regime, while under regulatory dualism the alternative regulatory regimes remain divergent. Indeed, under regulatory dualism, the introduction of the reformist regime may actually cause the established regime to become even less efficient than it would be if it were...