Conceptions of Corporate Purpose in Post-crisis Financial Firms

• Publication year: 2012

Washington Law ReviewVolume 36, No. 2, WINTER 2013

Conceptions of Corporate Purpose in Post-Crisis Financial Firms

Christopher M. Bruner(fn*)

I. INTRODUCTION

American "populism" has had a major impact on the development of U.S. corporate governance throughout its history. Specifically, appeals to the perceived interests of average working people have exerted enormous social and political influence over prevailing conceptions of corporate purpose-that is, the aims toward which society expects corporate decision-making to be directed. In this Article, I assess the impact of American populism upon prevailing conceptions of corporate purpose, contrasting its unique expression in the context of financial firms with that arising in other contexts. I then examine its impact upon corporate governance reforms enacted in the wake of the financial and economic crisis that emerged in 2007.

In Part II, I explore how populism has historically shaped conceptions of corporate purpose in the United States. I begin with non-financial firms, arguing that corporate law has long remained ambivalent regarding the consistency of shareholders' interests and incentives with those of the broader public. The unique vulnerabilities of U.S. employees relative to their counterparts in otherwise similar common law countries have historically heightened this ambivalence. The consequence has been substantial social and political pressure to constrain the power of U.S. shareholders and to diminish their formal centrality to the corporate enterprise, toward the aim of enhancing firm sustainability.

I contrast these dynamics with those observed in the context of financial firms, where U.S. misgivings regarding shareholders have historically been even greater, reflecting not only the economic significance of financial firms, but also recognition of their shareholders' greater inclination toward risk-taking. While the "employee" conceptual category best encapsulates the perceived interests of average working people in the non-financial context, the "depositor" conceptual category best encapsulates their perceived interests in the financial context. Accordingly, American populism has long fostered strong emphasis on the interests of bank depositors, resulting in remarkable corporate architectural strategies aimed at ensuring firm sustainability in order to insulate depositors from destabilizing social and economic shock. While foreclosing hostile takeovers has provided the clearest legal expression of populist pressure to prioritize firm sustainability over shareholder interests in the non-financial context, foreclosing excessive risk-taking has provided its clearest expression in the financial context-a goal historically pursued not only through prudential regulation, but also by imposing heightened fiduciary duties on directors and personal liability on shareholders.

In Part III, I turn to the crisis, arguing that growing shareholder cen-trism over recent decades goes a long way toward explaining excessive risk-taking in financial firms-a conclusion rendering post-crisis reforms aimed at further strengthening shareholders a surprising and alarming development. While many have observed that the inherent challenges of financial-firm management have grown substantially as financial firms and their products alike have grown larger, more complex, and increasingly opaque, far fewer have acknowledged that corporate architectural strategies that historically constrained risk-taking in U.S. banks were effectively marginalized, or discarded entirely, in parallel with those developments. The trend over recent decades toward full-service financial firms with publicly traded stock has placed greater emphasis on generating returns for financial firm shareholders while simultaneously blurring corporate law's historical distinction between financial and non-financial firms. The results have been stronger incentives to engage in financial risk-taking and a weaker capacity to limit it through corporate law.

Our increasingly shareholder-centric conception of the purpose of financial firms has greatly constrained our sense of the possible in the wake of the crisis. While traditional American populism has remained a powerful political force, it has expressed itself differently in this new environment, fueling a post-crisis narrative that has actually facilitated shareholder empowerment not only in today's highly diversified financial mega-firms, but in all public companies. Widespread outrage over managerial recklessness dovetailed with populist sympathy for hard-hit "middle class" working families, effectively merging traditional "shareholder" and "employee" concerns regarding the stability of retirement funds and job-linked social welfare benefits into a powerful anti-manager political coalition.

That post-crisis populism would express itself in shareholder-centric corporate governance reforms demonstrates just how narrow and ossified our sense of corporate purpose has become and the degree to which we have lost sight of the relationship between limited liability and risk-taking in corporate governance. Armed with a diminished vocabulary for describing the relationship between corporate governance and financial risk-and correlatively, a much smaller conceptual toolbox for constraining excessive risk-taking through corporate law-we have found ourselves unable to tackle a set of problems requiring the ability to think creatively about how the corporate architecture ought to be structured. The result has been a crisis narrative and corresponding corporate governance reforms that not only fail to acknowledge the role of equity market pressures toward excessive risk-taking in financial firms, but also reinforce such pressures moving forward.

I conclude in Part IV that the potential corporate governance reforms most worthy of consideration include those aimed at accomplishing precisely the opposite: insulating financial-firm management from equity-market pressures and associated risk incentives. This may well require resurrecting corporate architectural strategies embraced in the past. Notably, such strategies include imposing more robust fiduciary duties upon financial firm directors, while at the same time imposing some measure of personal liability for financial firm losses upon the shareholders themselves-including directors, officers, and employees receiving equity-based pay. As a threshold matter, however, we must first grapple effectively with a more fundamental and pressing social and political problem. Until we firmly combat the growing popular misconception that financial firms exist merely to maximize stock prices for the short-term benefit of their shareholders, we will at best fail to address the core problem, and at worst endure similar crises in the future.

II. AMERICAN POPULISM AND CORPORATE PURPOSE

Populism has long exerted substantial influence over U.S. corporate law-including prevailing conceptions of corporate purpose-but has manifested itself in different ways in financial and non-financial contexts, respectively. In this part of the Article, I contrast these differing manifestations of populism in U.S. corporate law, focusing particularly on remarkable corporate architectural strategies aimed at foreclosing excessive risk-taking in financial firms as a means of ensuring their sus-tainability.

A. Corporate Law's Ambivalence Regarding Shareholders

Ambivalence regarding corporate purpose-most notably with respect to the governance role of shareholders and the centrality of their interests in corporate decision-making-has long been a defining feature of U.S. corporate law.(fn1) Undoubtedly, the core governance structure of the corporation favors shareholders over other corporate stakeholders in real and meaningful ways. For example, in Delaware (the jurisdiction of incorporation for most U.S. public companies),(fn2) it is the shareholders who are empowered to elect the board of directors,(fn3) to ratify charter amendments and fundamental transactions,(fn4) and to advance corporate claims in certain circumstances through so-called "derivative" suits.(fn5) Shareholders even possess some (unspecified) degree of unilateral power to alter governance rules through the corporation's bylaws.(fn6)

Notwithstanding their special status, however, a number of aspects of U.S. corporate law cast doubt on the claim that the corporation's singular purpose is to maximize shareholder wealth. Under the business judgment rule, courts generally will not second-guess unconflicted business decisions. As the Delaware Supreme Court has emphasized, "[c]ourts do not measure, weigh or quantify directors' judgments . . . . Due care in the decisionmaking context is process due care only. Irrationality is the outer limit of the business judgment rule."(fn7) This hands-off posture effectively gives the board of directors substantial discretion to deviate from strict shareholder centrism in day-to-day business affairs, as a growing body of scholarship has recognized.(fn8) That discretion, then, is strongly reinforced by corporate statutes rendering it relatively difficult to remove U.S. directors. Unlike in the United Kingdom, where public company shareholders with five percent voting power can call meetings and directors can be removed by ordinary resolution of a simple majori-ty,(fn9) Delaware shareholders possess no default power to call meetings and, if the...