Should corporation law inform aspirations for good corporate governance practices - or vice versa?

• Jurisdiction: United States
• Author: Veasey, E. Norman
• Date: 01 June 2001

Yesterday I had the honor to give the keynote address in Stockholm, Sweden, to the Organization for Economic Cooperation and Development ("OECD"). Some of what was discussed there is relevant here.

At the OECD Conference, all European countries and many other countries around the world were represented in a kind of United Nations setting. The conferees were exchanging ideas on issues of company law reform. One theme emerged as dominant: Many conferees were yearning for a judicial system like the well-developed system of judge-made fiduciary duty law we have in Delaware. They all seemed to believe our system works well, even with all its warts. They were amazed by, and envious of, our expertise, fact-specificity, and the speed of our decisions. But they seemed to be resigned to the reality that their judicial systems were not set up to replicate Delaware's.

1. THE ENABLING MODEL

   An overarching global debate is whether corporate law rules should be mandatory or enabling. I agree with those scholars whose thesis is that the enabling model is the better economic model for the stockholders. The enabling model, patterned after the Delaware approach, is based on a few fundamental statutory guideposts and latitude for private ordering, with primary reliance on self-governance centered around judicial decisionmaking in applying fiduciary duties to fact-intensive settings.

   A word of caution is that the judge-made law must not be of a free-wheeling or ad hoc quality. It must involve a disciplined and stable stare decisis analysis based on precedent and a coherent economic rationale. The private ordering aspect of it must provide ex ante the contractual stockholder protections deemed important, as distinct from ex post judicial rewriting of the contractual framework.

   At the end of the day the enabling model--at least in Delaware--rests on a two-fold trust in the judiciary and in the board of directors. That trust, in turn, is predicated on two fundamental principles: The first is character--by that I mean expertise, diligence, good faith, independence, and professionalism. The second is a sound economic rationale dedicated to the best interests of stockholders.

   First, the courts. Investors, as the owners of corporations, have certain expectations of the role of courts in the enforcement of fiduciary duties. The judicial process is a key ingredient in the overall corporate construct among the four parties involved--the stockholders, directors, management, and state government (legislative, executive, and judicial). Courts should be prompt, clear, predictable, stable, and economically coherent.

   Second, the directors. All the attributes of character are important. But perhaps the most effective stockholder protection device is the independence of directors. Stockholders vote for directors and expect proper governance from them. The expectation is a strong bond of trust vested in the directors. Courts enforce that trust. At the same time, courts should be reluctant to interfere with business decisions and should not create surprises or wild doctrinal swings in their expectations of directorial behavior.

   The duties of directors are defined in broad outline by the enabling act. The fiduciary aspects of the directors' duties are fleshed out by the case law. That is the corporate law dimension. The remainder of the corporate governance regime consists of private ordering, norms, and aspirations of well-motivated directors to achieve best practices with the precatory encouragement of courts.

   Modern and enlightened corporation law driven primarily by judicial decisions is a remarkable vehicle in our jurisprudence. There is a significant self-governing aspect to the corporation law in that daily functions of the enterprise are based largely on norms--i.e., nonlegally enforceable governance mechanisms. Self-governance works for the most part because of the sensitivity of directors to do what is right, what is professional, what is honorable, and what is profitable. There are also negative motivators such as peer pressure, "shaming," and fear of lawsuits.

2. THE ROLES OF THE BOARD

   Let us focus on the various roles of the board. Under statutory law, the business and affairs of the corporation are to be managed by or under the direction of the board of directors. The board hires management--personified by the CEO--and management makes most of the "enterprise decisions"--(e.g., should the plant be in Peoria or Pittsburgh?). Enterprise decisions are to be distinguished from "ownership decisions." The interests of stockholders are affected directly by ownership decisions, which can happen in corporate mid-life, but usually come as part of final period decisions (such as mergers).

   The question then becomes: How should corporate law--nestled in the enabling mode--approach the judicial oversight of the board? Complete lack of judicial review of all corporate conduct is clearly not an option. A generalized, regulatory review of internal affairs or corporations is not an option either, in my view. Judicial review is triggered by a case that is usually brought by a stockholder in some individual or representative capacity. The scope of judicial review varies with the subject matter. Generally speaking, enterprise decisions receive deferential judicial review, as do some ownership decisions. Interested director transactions, hostile takeovers, change of control transactions, and some ownership decisions may receive more intense judicial scrutiny.

   Courts do not reach out to monitor boards or to resolve disputes. Courts, therefore, are like the clams sitting in the water waiting for some activity to come their way. That said, I think judges can and should perform a service by speaking out to encourage best corporate practices that could have a prophylactic benefit in minimizing the exposure of directors to liability.

   When a controversy comes their way, the courts must approach the resolution realistically, fairly, efficiently, and based on a coherent economic and jurisprudential rationale. In this connection, I would like to mention just four issues: (1) independence of directors; (2) best interests of stockholders; (3) duty of care; and (4) best corporate practices.

   1. Independence of Directors

      Under Delaware fiduciary duty law, the...