Corporate governance reform for the 21st century: a critical reassessment of the shareholder primacy model.

• Author: Liao, Carol

This article questions the efficiency of the shareholder primacy model of corporate governance in light of the financial calamities that have plagued the first decade of the 21st century. Reform efforts following the global financial crisis have focused on failures in securities regulation, but that is only part of the story. Effective reform measures must also address the legal and normative prescriptions found within existing governance structures, and the collateral effect those prescriptions have on political and regulatory inaction.

There was strong ideological support for the shareholder primacy model at the start of the century. Following the corporate and accounting scandals of 2001 and 2002, three scholarly perspectives emerged addressing the effectiveness of the model. This article continues the dialogue on those perspectives and examines two factors that contributed to the collapse of the US subprime mortgage market: the repeal of the Glass-Steagall Act and the originate-to-distribute model of lending. The examination reveals how the shareholder primacy model played a key role in the onslaught of the global financial crisis by incentivizing the obstruction of efficient regulation. Alongside this analysis is an interwoven account of the evolution of law and economics scholarship. The article provides a timely outlook on how the shareholder primacy model encourages corporate behaviour that perpetuates the likelihood of future crises. It concludes by offering potential solutions for reform.

Dans cet article, on s'interroge sur l'efficacite du modele de la primaute des actionnaires dans le cadre de la gouvernance d'entreprise a la lumiere des desastres financiers qui ont marque la premiere decennie du 21e siecle. Les projets de reforme qui ont suivi la crise financiere mondiale se sont concentres sur les lacunes de la reglementation des valeurs mobilieres, mais ce n'est la qu'une partie du probleme. Si l'on veut que les mesures de reforme aient une reelle efficacite, il faut egalement s'attaquer aux prescriptions juridiques et normatives que l'on retrouve dans les structures de gouvernance existantes et l'incidence collaterale que ces prescriptions ont sur l'inaction en matiere politique et reglementaire.

Le modele de la primaute des actionnaires a beneficie d'un fort appui ideologique au debut du siecle. Dans la foulee des scandales financiers et comptables de 2001 et 2002, trois perspectives savantes se sont penchees sur la question de l'efficacite de ce modele. L'auteur de cet article poursuit le dialogue amorce par ces differentes perspectives et analyse deux des facteurs ayant contribue a l'effondrement du matche des prets hypothecaires americains a risque: l'abrogation de la Glass-Steagall Act et le modele d'octroi puis de cession du credit. Cette analyse permet de degager la maniere dont le modele de la primaute des actionnaires a joue un role determinant dans le declenchement de la crise financiere mondiale en incitant a l'obstruction d'une reglementation efficace. Elle s'accompagne d'un compte rendu entrelace de l'evolution de l'erudition en matiere de droit et d'economie. Cet article presente une perspective tout a fait d'actualite sur la maniere dont le modele de la primaute des actionnaires encourage chez les entreprises un comportement qui perpetue la probabilite de futures crises. Il conclut en offrant d'eventuelles solutions de reforme.

Table of Contents I. INTRODUCTION II. LAW, ECONOMICS AND THE SHAREHOLDER PRIMACY MODEL A. Shareholder Primacy at its Peak B. Three Perspectives Following the Corporate and Accounting Scandals of 2001 and 2002 C. Ascendancy of Behavioural Approaches III. NARRATIVES FROM THE GLOBAL FINANCIAL CRISIS A. Repeal of the Glass Steagall Act B. Originate-to Distribute Model of Lending and Repeal of Anti-Predatory Lending Legislation C. Developments Arising from the Crisis IV. COMPARING PERSPECTIVES IN THE AFTERMATH OF THE CRISIS V. RETHINKING CORPORATE GOVERNANCE REFORM A. Borrowing Old and New Institutional Approaches B. "Other Constituency" Statutes and the B Corporation C. State Benefit Corporations D. Way Forward VI. CONCLUSION I. INTRODUCTION

The financial calamities that have marked the first decade of the 21st century indicate it is time to pose new challenges to the assumed efficiencies of the shareholder primacy model of corporate governance. As the facts behind the global financial crisis continue to unfold, reform efforts have focused on failures within securities regulation--but that is only part of the story. While the shareholder primacy model may be ideologically entrenched in the United States of America (US), the severity of the crisis calls for a reassessment on the merits of dais mainstream corporate governance model.

It is important to recognize that the account in this article is based on US sources, and addresses US-specific issues. The global financial crisis clearly affected many other nations, among which the causes and timelines may differ. Part II of this article looks back in time to the corporate and accounting scandals that immobilized the US financial markets between 2001 and 2002. It first identifies the prevalent support of the shareholder primacy model prior to the scandals, and then traces three scholarly perspectives that emerged shortly thereafter. The first group of scholars supported laissez-faire market principles and felt the demise of companies embroiled in the scandals only evidenced that the market was working effectively. The second group called for stricter market regulations to support the existing governance model. The third group believed nothing less than a fundamental rethinking of corporate governance practices was required, and pushed for deep normative and structural reform. Within law and economics scholarship, the scandals marked a period when behavioural approaches began to gain greater momentum and influence in the field.

Part III then delves into an analysis of some of the factors that contributed to the collapse of the subprime mortgage market (recognized as the first in a series of events that have come to define the global financial crisis): the repeal of the Glass-Steagall Act (1) and subsequent development of large financial conglomerates and "shadow banks;" (2) and the development of the originate-to-distribute model of lending in an unregulated over-the-counter derivatives market. The narrative behind the repeal of the Glass-Steagall Act exposes how regulators can be intimately involved with the corporate entities that they govern, and cannot be relied upon as sole protectors of broader stakeholder interests. In the narrative behind the originate-to-distribute model of lending, the competitive need to generate profit induced several mortgage lending institutions to use questionable and even predatory lending tactics on potential borrowers. The examination shows how intensive lobbying efforts by interested corporate institutions essentially forced legislators to roll back anti-predatory lending laws.

In Part IV, key scholarly perspectives that emerged in the aftermath of the crisis are identified and incorporated into the three perspectives examined in Part II to reveal how positions have changed since the scandals of 2001 and 2002. The article highlights how the legal and ideological support of the shareholder primacy model of governance has laid the groundwork for corporate behaviour that heavily influences regulatory inaction and perpetuates the likelihood of future crises. Part V concludes by offering elements from both old and new institutional law and economics approaches as a starting point to recalibrate efficiencies within the existing governance model, and then provides examples from emerging hybrid corporate structures as potential solutions for reform.

Power and control issues among corporate actors, and the placement of incentives that support existing power arrangements, are only amplified when viewed from within an industry capable of impacting the economic health and well-being of so many. Several types of corporate and financial institutions played key roles in the crisis. It was a large-scale event that involved a significant cast of characters: banks, shadow banks, mortgage lending institutions, credit rating agencies and trade and lobby groups, among others. The governance of financial institutions may statutorily differ in many ways from that of large, public corporations, but there are intricate and delicate commonalities found in the balancing of relationships between the actors familiar to both types of institutions: directors, officers, shareholders and other stakeholders. The events of the crisis highlight how similar norms pervade the structural makeup of both corporate and financial institutions. The prescriptive model that drives the ongoing development and application of corporate and regulatory law is what matters. Reforming that model is the key to bringing about lasting change to the way corporate and financial institutions conduct themselves going forward.

2. LAW, ECONOMICS AND THE SHAREHOLDER PRIMACY MODEL

   1. Shareholder Primacy at its Peak

      In their well-known 2001 article "The End of History for Corporate Law," Henry Hansmann and Reinier Kraakman argued that the basic law of corporate governance had already achieved a high degree of uniformity to the shareholder primacy model and that "continuing convergence toward [this] single, standard model is likely." (3) According to Hansmann and Kraakman, some key normative principles in this consensus include:

      1) ultimate control over the corporation should rest with the shareholder class;

      2) the managers of the corporation should be charged with the obligation to manage the corporation in the interests of its shareholders;

      3) other corporate constituencies, such as creditors, employees, suppliers, and customers [which, together with shareholders, are included as "stakeholders"], should have their interests...