State Law and the Myth of Private Ordering: Mandating Staggered Boards (Part 1)

There is a sort of myth that in the shareholder governance area, companies are better off with a system that relies on private ordering.  The idea is that governance requirements ought to eschew the one size fits all, categorical approach.  Instead, companies can pick and choose the most efficient set of governance requirements that fit their specific needs.

As a theoretical idea, private ordering has much to offer.  The theory, however, often fails when translated into practice.  Private ordering is often a synonym for a categorical rule that favors management. 

Thus, waiver of liability provisions are supposed to be an example of private ordering.  Companies can, in their articles, decide to waive liability by directors for breach of the duty of care.  Private ordering would suggest that some companies will opt for full waiver of liability, some for partial waiver and some for no waiver at all.  The choice will depend upon efficiency. 

In fact, nothing of the sort has happened.  Empirical evidence indicates that all large companies (Pepsi the inexplicable exception) waive liability to the fullest extent possible.  In other words, private ordering with respect to waiver of liability for breach of the duty of care is not private ordering at all.  It has resulted in a categorical rule in favor of waiver.  This is all discussed at length in Opting Only in: Contractarians, Waiver of Liability Provisions, and the Race to the Bottom. 

The other side of the issue is that sometimes shareholders succeed in pressuring management to change its governance structure.  Under a private ordering system, this is how things ought to work.  But where private ordering seems to work, states at least sometimes step in and eliminate the possibility by imposing a categorical rule that favors management.  This is taking place in some states with respect to staggered boards.  Shareholders have pressured management of some companies into removing staggered boards.  The result is that three states have, by statute, mandated their use.  Iowa has become the third entrant into the market for categorical rules concerning staggered boards.  We will discuss this new statute in the next few posts. 

Comments

[Former Law Student]

Two comments. First, I wonder if Pepsi as the exception was a result of simple oversight? Second, there is a distinct difference between the waiver of liability provision and the staggered board provision. I can understand why states would step in to protect the staggered board provision as a anti-takeover measure. I'm not so sure I see a similar need for states to step in regarding the waiver of liability. It'll be interesting to see what happens.