Volume 13, Issue 2

Governments in Europe and the United States have recently acquired significant stakes in a number of financial institutions, raising fears that they will use their investments to pursue interventionist goals. The comparative analysis of sixteen major bailouts in Belgium, Germany, France, Ireland, Switzerland, the United Kingdom and the United States provides evidence to the contrary. Fiscal and political considerations have prompted governments to generally avoid common stock investments, limit direct managerial involvement and favor early exits. While this investment strategy may prove detrimental to other stakeholders, it resembles the approach distressed asset investors would adopt under the circumstances.

This Article draws lessons from Italian history as to how the state may possibly intervene in economic crises without jeopardizing the economy or affecting competition. It first describes how and why Italy got to the point in the 1930s where the government had to save the financial system. That was accomplished by setting up a public financial holding company (IRI), which became the majority shareholder of banks and companies in the telecommunications, steel, shipping, engineering, and energy industries, among others. The so-called IRI formula has long been considered a model both in the European Union and outside it, with many countries setting up similar companies. Initially, the IRI performed well in Italy and acted as a market player. In the 1960s, however, its performance deteriorated under pressure from political parties. This degeneration combined with pressure from the European Union prompted Italy to gradually (or partially) privatize the state-owned companies, a process that ended only recently. Ironically, the pendulum is now swinging back. In preparation for the next crisis, Italy is currently planning to go “back to the state.” The Article presents different ways of public intervention in the economy and offers suggestions for future reforms.

Payment for performance is widely embraced as a key component of any well-designed executive compensation package. There is a price to be paid, however, for the heavy reliance on incentives as a way of controlling agent behavior. In particular, evidence exists demonstrating that incentives can crowd out an agent’s social preferences towards her principal. Social preferences are pro-social tendencies of people to do things for others for reasons such as fairness, reciprocity, altruism, and ethical or moral beliefs. The use of incentives in compensation can result in self-interested agents. When crowding out occurs, in order to elicit the desired level of performance, principals may need to increase the level of incentive employed. Crowding out therefore provides an additional account for rising levels of executive compensation. In addition, crowding theory can provide a helpful explanation for the tension around the U.S. government’s reaction to preexisting banker incentive contracts during the 2008 financial crisis.

On March 11, 2011, a magnitude 9.0 earthquake and thirty-eightmeter high tsunami destroyed Tokyo Electric’s Fukushima nuclear power complex. The disaster was not a high-damage, low-probability event. It was a high-damage, high-probability event. Massive earthquakes and tsunamis assault the coast every century. Tokyo Electric built its reactors as it did because it would not pay the full cost of a meltdown anyway. Given the limited liability at the heart of corporate law, it could externalize the cost of running reactors. In most industries, firms rarely risk tort damages so enormous they cannot pay them. In nuclear power, “unpayable” potential liability is routine. Privately owned companies bear the costs of an accident only up to the fire-sale value of their net assets. Beyond that, they pay nothing — and the damages from a nuclear disaster easily soar past that point. Government ownership could eliminate this moral hazard — but it would replace it with problems of its own. Unfortunately, the electoral dynamics in wealthy modern democracies combine to replicate nearly perfectly the moral hazard inherent in private ownership. Private firms will build reactors on fault lines — but so will governments.

Corporations controlled by the Chinese government originated as state-owned enterprises (SOEs) and still constitute the foundation of the Chinese economy. In addition to their profit-maximization goal, they are expected to contribute to the national welfare, maintain a harmonious society, and ensure sustainable economic development. They thus pursue both firm goals and national goals. This dual goal has shaped corporate governance under state control. While Chinese SOE performance has improved in recent years, certain problems remain. This Article suggests how the governance of these firms can be reformed in line with their dual goal.

Despite waves of privatization around the world, state ownership of enterprise remains significant. The focus of scholars and policymakers has accordingly shifted from the defense and promotion of privatization to the design and improvement of corporate governance practices in state-owned enterprises (SOEs). A broad consensus has emerged suggesting that state-owned firms should be corporatized, publicly traded and subject to the greatest extent possible to the same legal regime applicable to private firms. However, by focusing exclusively on what corporate and securities laws can do to increase the efficiency of state enterprise, this view ignores the other side of the problem: How does the presence of SOEs affect the efficiency of corporate and securities laws as they apply to private firms? Brazil’s long historical experience with SOEs suggests that state ownership of listed firms can have unintended consequences that go beyond the potential firm mismanagement if the state pursues political goals inconsistent with shareholder wealth maximization. The state’s financial interest as the controlling shareholder of listed firms can lead it to disfavor legal reforms that improve minority shareholder rights, thus impairing the ability of private firms to raise outside financing. In ignoring the conflicts of interest inherent in the state’s dual role as shareholder and regulator, the conventional wisdom has likely overestimated the aggregate benefits of a unitary corporate law regime for both state-owned and private firms.

Conventional economic theory portrays privatization as a transformative event for a company, even when it is partial and the state maintains control. According to this view, private investors have stronger incentives than voters to monitor management performance and constrain side-payments to political allies of the government. But how exactly can private investors discipline managers they cannot fire? Proponents of privatization place their hopes on disclosure obligations under securities laws, triggered by privatized companies’ stock exchange listings. They argue that, because company disclosures can reveal side-payments to government allies and cause private investors to abandon the stock, management should avoid political favoritism after a stock exchange listing. The Article explores whether investors responded to indications of political favoritism as the above theory would predict. Case study evidence comes from major privatizations in Greece during the last two decades in telecommunications, energy, and gaming. The Article examines the public disclosures of partially privatized companies in two key areas where the risk of political side-deals and corruption remains high: contracts with suppliers and relationships with labor. Greek companies’ disclosure documents included clear indications that payouts to suppliers and labor continued to increase during the period of partial privatization. However, these companies’ stocks remained attractive to investors.

In this Article we examine Israel’s ongoing process of bank privatization to explore the link between privatization programs and the ownership structure of public companies. Our thesis is that concentrated ownership provides regulators with a platform for exerting informal influence over corporate decision-making. This platform serves regulators as a safety valve when all else fails, especially when they would like firms to terminate senior executives or board members. Communicating with controlling shareholders increases the likelihood that both the regulatory intervention and the reasons underlying it will remain confidential. Moreover, controlling shareholders can make swift decisions and implement them quickly, with no need for formal group deliberation. When informal influence is important — as in the case of banks — the government may prefer firms with controlling shareholders to widely held firms. It may therefore prefer to sell a control block in the firm undergoing privatization rather than distribute its shares through the stock market.

This Article analyzes the composition of the board of directors as a vehicle for state intervention in corporate governance. Such intervention is ubiquitous and often motivated by goals that stray from shareholder wealth maximization, or corporate governance more generally, to promote other national interests such as diversity. Regulating board composition thus is merely the continuation of politics by other means. After briefly discussing direct state ownership in business firms as a way to advance policy goals, the Article explicates the tensions between boards’ dual responsibilities of monitoring and strategy-setting. These oftentimes conflicting missions curb the law’s ability to guide board members’ conduct through the conventional legal duties of loyalty and care or other injunctions. Although the two roles also may entail conflicting implications for board composition, regulation of board composition nonetheless may prove a superior means for promoting policy goals, especially with regard to the objective of the corporation. Composition regulation harnesses board members’ personal attributes — specifically, their values — to facilitate the attainment of these goals. Instead of telling board members what to do, the state may fare better by regulating who they are.

After the 2008 financial panic, long-term compensation measures have gained favor as a way to limit managerial opportunism and excessive risk-taking. These measures, which may become mandatory for systemically important institutions, include restriction (i.e., deferral) of stock grants for a period of years, and, in the event of performance reversals, divestment of deferred stock and clawbacks of bonus compensation. These measures are considered uncontroversial enough that some have suggested that all public companies, not just systemically important firms, should adopt them. In this Article, I argue that the benefits of long-term compensation have been overstated while the potential downsides have been largely ignored. Restricted periods for equity grants must be large compared to the executive’s tenure in order to have a significant effect upon behavior overall, and mandatory clawback provisions end up transferring what would have been bonus pay into salary. Furthermore, to the extent that long-term compensation does affect behavior, these consequences are not necessarily good. I show that given fairly reasonable assumptions of executive risk aversion, the information content of long-term and short-term price signals, and managerial control over the timing of project execution and disclosure, a long-term focus can have significant negative effects.

Sovereign Wealth Funds (SWFs) have attracted significant attention over the past few years, as a result of their increasing role in the global economy and their controversial minority investments in distressed financial and infrastructure companies in Western economies. Although SWFs provide important benefits to home, host and global markets, they have been perceived by the Western mind as a growing threat to economic supremacy and national security. While the current legal scholarship provides an incomplete policy response, by either selectively referring to specific legal instruments within the international law framework or proposing an entirely new legal regime, this Article attempts to address this crucial lacuna by providing an original and comprehensive legal analysis of the SWF phenomenon and its interaction with the preexisting framework of international law. The various abovementioned concerns have prompted various Western attempts to block SWF cross-border investments through legislative reforms or ad hoc protectionism of the executive branch. These governmental policies frequently violate international commitments in the international economic law arena and call for a closer look at the nature of such commitments and their respective implementation in the SWF environment. The Article looks at recent practices in Western countries aimed at blocking SWF investments, especially in the context of iconic brands and national champions. It then reviews various relevant provisions in international legal instruments, which are applicable to these potential investments, and examines the question of their violation by capital-importing countries. A proposed innovative adaptation to this new reality is provided. I argue that the existing framework of international investment law can provide adequate solutions to investment protectionism against SWFs. Regarding regulation of SWFs’ investments, since recent experience has underlined that SWFs function largely like any other commercial entities, there is a need to shift the discussion and terminology towards regulation of sovereign activity rather than sovereign funds. Finally, the Article explores the broad consequences of investment law and corporate governance reforms following the debate around SWF investments on maintaining healthy and productive cross-border economic relations in a globalized world.