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to grow, the labor force has continued to grow, yet unemployment rates have remained among the most stable in all of western civilization and, by the way, among the lowest. What that means, of course, is that the system has created continuously rising income levels for more people while creating more jobs for larger and larger numbers of people. But this is not a new discovery.

Much of the material from John Maynard Keynes' The General Theory of Employment; Interest and Money was based on Thomas Malthus' works of the late eighteenth century. The fact is that even then some scholars realized that there is a distinct relationship between income and employment. This is no less certain today. No economy has yet discovered how to increase employment while decreasing general demand. It's pretty clear what the philosophical commitment of the United States government is—we will do everything possible to ensure that every person who wants a job can get one. This goal was rather clearly stated in the Employment Act of 1946 and the commitment hasn't diminished.

Has the system responded to this caveat? Most assuredly! In 1970 there were 78,627,000 members of the civilian labor force employed. Today there are 86,692,000. That means that in less than six years there have been eight million new jobs created. What other complex society based on freedom of choice can make a claim like that? What about inflation? For decades there has been a very real concern that price increases were wrong and excessive and yet, since 1900, the average annual rate of inflation has been roughly 242 to 3 percent. No other major society in western civilization can make the claim that its record comes anywhere near that low a figure. In many economies the levels of inflation over long periods of time have wreaked havoc with real growth in income and rising population levels have actually decreased per capita income and wealth.

Now comes Mr. Nader with his simplistic solutions to complex problems. Break up all large corporations, overhaul their systems of government in accordance with the Nader model, diminish stockholder prerogatives in line with Mr. Nader's perceptions of who should and who should not be allowed to exercise his corporate suffrage rights, create a new bureaucracy within the corporation to duplicate management functions and deal with social concerns while ignoring such fundamental functions as manufacturing, open the corporate records to public scrutiny except for "trade secrets" (whatever that means), create massive new bureaucratic reporting requirements, and so forth ad nauseam.

Apart from the defects in his personal views as the great social architect of our time, part of the defects from which this study suffers is caused by Mr. Nader's misconception of what a corporate director is and does. He has selected isolated abuses among a limited number of companies and draws the faulty conclusion that all corporations must be that way. I would like to suggest that there is a much more accurate and better balanced viewpoint of directors in the May 15, 1976 issue of Forbes magazine. Copies are provided for your consideration.

Perhaps the best explanation of what a board of directors is was voiced by T. William Miller in his article "Invitation to a Board Meeting" in the May 15 issue of Forbes. He describes the Board of Trustees as a "council of peers" for chief executives strong enough to seek that advice. Other directors indicate that they see their roles as that of policy makers but not as managers. Mr. Nader's model would have the board of directors second guessing all of management's decisions and effectively acting as some kind of watchdog. Attitudes in a corporate boardroom have changed very significantly since the revelations of Watergate and nowadays corporate directors are demanding and receiving a great deal more information than ever before and the policy decisions which are made by boards of trustees are made after a great deal more soul searching and definitive explanation than has ever been the case before. To now substitute a federal bureaucracy for this council of peers would fundamentally change the nature of the American corporation in a direction which is not desirable.

Specifically this committee announced that its purpose was to address the broad issues of corporate rights and responsibilities. If Mr. Nader's model on the nine areas of corporate social responsibilities is used as a starting point and I strongly suggest that they are most inappropriate, one might wonder what possible goals expansion of government involvement could accomplish. There are already such a plethora of laws and regulations to conform to that corporations are becoming overburdened with staffs whose interests are external to the central issues of providing quality products at the lowest possible prices.

For istance under Mr. Nader's very first title of employee welfare, one might list the Fair Labor Standards Act; the Wagner, Taft-Hartley, and LandrumGriffin Acts; the Occupational Safety and Health Act; the Employees Retirement Insurance Act; the Hobbs (Anti-Racketeering) Act; the Lea (Anti-Petrillo) Act; the Railway Labor Act; the Walsh-Healey Act; the Davis-Bacon (Prevailing Wage) Act; the Miller (Heard) Act; the Copeland (Anti-kickback) Act; Executive Order 10925 (Committee on Equal Employment Opportunities); Title VII of the Civil Rights Act; and literally thousands of cases interpreting these laws. Pick any other area of major corporate concern, and governmental regulation is equally pervasive and comprehensive.

Now all this time we have addressed ourselves to concerns which are primarily public or social concerns. What about the concern for providing the best possible product or service at the lowest possible price? What about concerns over the survival of the firm? What about profits? What about growth?

It's unfortunate that in 1976 we address the questions about profits or return on investments almost apologetically. It's almost as though we though there is something wrong with earning a profit. On one hand there is a great hue and cry about high unemployment levels at the same time Mr. Nader is attacking profits. The very fundamental fact that the very real risks of low profits, or perhaps even losses, keep investors from new venture capital moves and thus don't allow the creation of new plants which create new jobs seems to escape the loudest critics of the system. Profits as a source of or stimulus of new capital is not well understood except by freshmen in princples of economics courses.

Perhaps the most important defect in the study, however, is that it attempts to substitute the judgment of the Corporate Accountability Research Group for the judgment of the American consumer. It removes the freedom of choice of the American consumer to determine for himself what products he wishes to purchase, what advertising he wishes to respect, which stocks he wishes to buy, which corporate directors he chooses to elect, and a myriad of other decisions which basically are vested in the consumer at this point. The study takes a condescending approach which implies that the American consumer is ignorant and incapable of thinking for himself, without the guidance of the federal government and the restructuring of American corporate enterprise.

In my considered judgment, Mr. Chairman, the Congress of the United States cannot, should not, and must not allow this research study to find legitimacy through the legislative process. To do so would be a travesty against the American public and the American economic system. I encourage you as forcefully as I know how to discard the proposals currently being offered. Thank you for your very kind attention.

Note: All of the figures for employment and national income were taken from the March 1976 issue of The Federal Reserve Bulletin.

Senator HARTKE. We have Prof. Donald Schwartz from Georgetown University Law Center.


UNIVERSITY LAW CENTER, WASHINGTON, D.C. Mr. SCHWARTZ. Thank you, Mr. Chairman. It's a pleasure to appear before you in this ambitious undertaking by the Senate to ask some very basic questions about our economy and the performance of corporations.

I have a long statement that I will not read. I even have a shortened version of that that I won't read, but I have still a shorter version that I will read and ask that the full copy be inserted in the record.

Senator HARTKE. Let me say that the fact that you don't read it certainly does not mean that it goes unattended.

Mr. SCHWARTZ. I understand that and that's why I will just try to summarize my remarks in about 10 minutes.

Proposals for corporate reform in this country have a unique character to them because of the uniqueness of our Federal system. What troubles the critics of corporations and what impels reform is a catalog of serious substantive issues: Conflicts of interest that benefit managers at the expense of stockholders, stock market manipulations and unfair securities transactions, corporate improprieties that go unchecked and often undiscerned by an ineffective board of directors, anticompetitive trade practices, an unhealthy concentration of power, and socially irresponsible behavior.

Mr. Chairman, I do think that most people are honest. Most business people are honest, but I'm reminded of a story about the late Paul Porter when he was Chairman of the OPA. He was visited by a group of business people who said, "Mr. Porter, you do great injustice to businessmen; 90 percent of business people are honest men.” And Porter said, “No; I disagree with you. I'll do you one better-100 percent of American business people are honest men—90 percent of the time.”

Despite the fact that there are serious substantive problems that trouble us, we devote considerable energy talking about jurisdictional issues—whether a particular problem is one for the States or for the Federal Government. The jurisdictional argument is often an euphemism masking the underlying inquiry into the substance of the problem.

Proposals for corporate reform, at least the kind that is accomplished by law, concern the role the Federal Government should play in corporate law, and more specifically, whether corporations should be chartered by the Federal Government. What is really at stake is not whether application for a charter should be sent to Washington, D.C., or Dover, Del., but what kind of law will govern the creation and continued existence of the corporation. The drive for Federal chartering expresses a goal for corporate law reform that its advocates firmly believe cannot be achieved unless there is a break from the existing State jurisdiction over corporation law.

The main function of corporation law is to define the internal relationship between the corporate entity and its stockholders and the managers, as well as establishing the relationship of the corporations to other interests in the society that are affected by the corporation. Advocating reform of this law amounts to an assertion that corporate structure, and not just particular corporate conduct, and that organic law, not just regulatory law, are related to the issues of corporate reform. Moreover, there is implicit in this approach a downgrading of reliance on specific regulation as a means of dealing with at least some of the problems.

There are more than 50 State corporation laws. The content of each State law differs somewhat, and Delaware has emerged as the most popular choice among major companies. However, the differences are relatively slight. The State legislatures claim to share in a policy of enablingism.

Undoubtedly, the fact that there is a marketplace for corporation law has much to do with the content of those laws. Each State has a law for sale. The purchase is made theoretically by the corporation, but one must remind himself that this shopper is a legal fiction, and the real choice has been made by the promoters or the managers of the corporation whose interests do not always coincide with the stockholders, creditors, employees, or customers of the corporation. Moreover, the package has been designed by the shoppers to suit their particular needs.

Taking account of these phenomena, Pro. Ernest Folk, who served as the reporter for the Delaware and South Carolina statutory revisions, has described State statutes not as enabling laws, a neutral term, but as promanagement and antishareholder. This is manifested in numerous provisions affecting stockholder rights: reduced voting rights; partial elimination of appraisal rights; exalting form over substance in dealing with acquisitions and self-dealing transactions; and generous indemnification allowance.

But, accepting the fact that corporations are managed by persons who are not accountable to serious legal restraints, does that prove that we should now try to assert them? If so, how? Are there dangers?

I would ask first, what are the goals of corporation law and whether State chartering as we now know it, together with the existing Federal statutes, some of which Dr. Smith referred to, can meet those goals.

First. The internal governance arrangements should be oriented toward achievement of the long-term economic goals of the corporation. This embraces a respect for the corporations social obligations. Busi. ness people should make business decisions which, by and large, should be evaluated in a business context, not a legal one. But merely because one claims a business judgment has been exercised does not prove it.

Second. The law should seek to create a climate of confidence among investors so they will continue to furnish the capital necessary.

Third. Conflicts of interest between managers and the corporation or with stockholders should be minimized. The goal here is fairness to investors who must necessarily rely on the efforts, honesty, and good faith of others for the attainment of their own economic goals.

Fourth. The law should provide an effective means of enforcement of stockholders' rights, and a means whereby the other interests affected by the corporation may also obtain redress for wrongs that injure them.

Fifth. A political process to achieve accountability of managers is one of the main structural goals. This may mean that we have to provide an effective board of directors which may not be a reality today.

Sixth. The law should preserve what Prof. Henry G. Manne has called "the market for control.” The ability to change management is critically important if a system of accountability is to function. This means that transactions that have the effect of hardening management's grip on control, or structural arrangements that impede an outsider's chance to succeed in the market for control, should be viewed suspiciously.

Seventh. The law should provide wide access to information. Disclosure is one of the most effective means of controlling the whole wide range of those with interests in the corporation.

Finally, the law should operate to prevent impediments to the functioning of an efficient marketplace.

State corporation statutes do not strive for the attainment of these goals. In one notable respect, State legislatures have taken a decidedly regressive step away from the goals. A growing number of States have adopted tender offer legislation that discourages the making of tender offers hostile to management. This is clearly the intent of these laws, and it is probably their effect. These statutes all require an offer to be filed in advance of its being made, an approach specifically rejected by Congress when it adopted the Williams Act as too favorable to management.

I realize I may be treading on some toes, Senator Hartke, since Indiana has adopted one of the laws which I think most easily fits into this description. I think that what the thrust of these laws has been is to discourage the making of tender offers; that is, an outside attempt to take over control of the corporation. Indiana, I might add, didn't start this trend. Ohio did, and it may well be that when one State adopts a law that works in the interest of management other States really have little choice but to follow that lead or else they will see corporations abandon their existing home and run for cover of another jurisdiction.

So what started as a modest development has now grown to 15 States that have adopted this kind of legislation and it's pending in several others, including some of the largest. I think no legislation more clearly reveals a continuing promanagement bias by the State legislatures. The reforms Dr. Smith referred to opening up the boards in terms of more outside directors, more audit committees is a goal that I think is simply unattainable under State laws. Corporate managements are not flocking to adopt many of these changes and the State legislatures won't do it. The only possibility of achieving any kind of legislative change, I submit, is through the Congress.

The judge-made law of corporations is perhaps more important than State statutes. Professor Cary has proved, I believe, that State courts, exemplified by Delaware, have faithfully administered the State legislature policy.

The issue, of course, is not Delaware, but State law. Defenses of Delaware that its courts are more protective of stockholders, or at least no worse, prove very little about State law in general. Professor Cary has been faulted for not having paid enough attention to important Delaware decisions that imposed high fiduciary standards on management, which in part is true. The main issue is whether Professor Cary misrepresented the state of State law in general. That, I think, he did not do. My own paper develops this a bit more fully in dealing with some of these cases.

Despite some progress, and some occasional good language in the cases. State courts do not seem capable of achieving a balanced corporation law. Affirmative obligations to be fair are rare; diligence is permitted to be minimal; control may still be protected. Only grossness will be condemned, and this is not good enough.

Professor Winter is correct when he says that the definition of fiduciary duties by courts is difficult. It is precisely for that reason that I do not want that task to be performed under the aegis of a statute whose bias is clear and by judges who seek to fulfill that lopsided policy.

If State law is mired in a promanagement position, can Federal law fulfill the goals of corporation law? Federal law mainly refers to Federal securities law and the judicial interpretations that have done much to expand the Federal presence.

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