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things, the board of directors would evaluate them, and that they would be publicly disclosed before the full body of shareholders when any major change in the business was made.

This also bears on one of the other complaints which have been made—that Federal corporation law will create a new bureaucracy which will increase inefficiency and add to the cost of doing business. I think a properly drafted statute could actually reduce bureaucratic costs by internalizing many of these processes within the corporation. If the management itself, in the course of working proposals through and explaining them to an independent board of directors and exposing them before the shareholders, refrains from doing the types of acts which the Federal Government now has to attack them for, you could well have a reduction in bureaucratic activity rather than an increase. Indeed, I think it would be possible to draft a law that didn't require the establishment of any new Federal agency, under which the new controls could be enforced either within the corporation itself, or through the courts or existing agencies such as the SEC. I don't think that there's any need for a new bureaucracy and Federal corporation law may in fact improve the present situation.

Mr. Chairman, I think that the type of statute I have outlined in my statement is a workable one, one that would make sense and one that I think would improve the whole tone and nature of corporate operations in the United States without any of the adverse effects which opponents of more drastic proposals have pointed to. Thank you for your attention.

Senator HARTKE. I have a policy committee meeting of the U.S. Senate where a board of directors are meeting and I have to go ahead and make sure I attend. I want to thank you, Mr. Ratner. I hope, too, that you will follow these hearings and feel free to make additional comments as we proceed through them. Thank you.

[The statement follows:] STATEMENT OF DAVID L. RATNER, PROFESSOR OF LAW, CORNELL LAW SCHOOL

Mr. Chairman and members of the Committee, my name is David L. Ratner. For the past 12 years, I have been a Professor of Law at Cornell Law School, specializing in corporation and securities law and business regulation. During that period, I have also had the honor of serving for two years as Executive Assistant to the Chairman of the Securities and Exchange Commission and for a year and a half as Chief Counsel to the Securities Subcommittee of the Senate Banking Committee in connection with its study of the securities industry. I am appearing before your committee today in response to your request for my views on federal chartering of large corporations.

The idea of a federal corporation law governing large corporations has been around for a long time. It has been raised-and subsequently dropped-at regular intervals for many decades. What is the reason for raising it again at this time? Obviously, renewed dissatisfaction with the way in which large corporations are being run, and with the results of their activities. I should therefore like to address myself today to the causes of that dissatisfaction, and to the appropriateness of a federal corporation law as a means of dealing with them.

What are the elements of dissatisfaction with our large corporations? I sug. gest there are basically three:

1. They are too large and powerful.
2. They are unresponsive to current needs of the society
3. They are corrupt.

Not all of these concerns are shared by everyone who is critical of our present corporate structure, but each of them is sufficiently widely held to serve as a focus for your inquiry.

SIZE AND POWER

The argument here is that some of our giant corporations are far larger than necessary for economic efficiency, that their size frees them from the economic constraints of the marketplace as well as the regulatory power of government, and that they constitute a threat to the flexibility of our society and the freedom of our people. I do not propose to debate whether that is in fact so, although I think a good case can be made that some corporations have extended themselves far beyond the point at which their continued growth serves any useful purpose for society.

My question is whether, assuming it is so, a federal corporation law is an effective way to deal with the problem. I am assuming that, when we talk about corporation law, we are talking about the laws which define the grant of power by the government to the corporate management, and prescribe the procedures by which that power may be exercised. The suggestions which I have seen for limiting corporate size and power through this type of law involve such things as limiting the life of any corporation to a specific number of years, limiting its activities to those specifically set forth in its charter, and requiring the approval of a federal corporation commission, after a full hearing, for any extension of life, entry into new businesses, issuance of additional securities, or other major changes.

I must confess to serious doubts about the efficacy or desirability of provisions of this nature. I believe that empowering a government agency to pass on all expansions or changes in the business of large corporations would expose the agency to intolerable political pressures. It would spread throughout the economy the problems we now face in regulated industries, such as electric power, transportation, and communication, where government agencies became an instrument for stifling competition, fostering inefficiency, and encouraging corruption. To the extent that some control on proposed expansions or diversification of business by large corporations is desired, it could better be done by expanding the power of the Antitrust Division and/or the Federal Trade Commission to block such actions where they could be shown to have undesirable effects.

This is not to say that a federal corporation law would be useless in dealing with problems of size and power. By requiring advance filing before large corporations could enter new businesses, expand existing business, or issue additional securities, a federal corporation law could help to assure that agencies responsible for preservation of competition or other national objectives were given adequate warning of important developments before they actually happened. Furthermore, as I will discuss later, federal corporation law could mitigate the consequences of undue concentrations of power by assuring that that power is more responsibily exercised.

SOCIAL RESPONSIBILITY The second thread of discontent is that the management of our large corporations lacks social responsibility. It produces gas-guzzling monsters when we need efficient means of mass transportation; it spews chemicals into our rivers and fumes into our atmosphere; it perpetuates race and sex discrimination at home and support apartheid in South Africa. All this and more may be true; but how will federal corporation law help? One suggestion is to require "public" directors, representing various constituencies or areas of expertise, who would assure that all important societal interests would be taken into account when corporate decisions were made. It is a nice concept, but the importance of the various interests differs greatly from industry to industry, and I despair of any governmental agency coming up with a workable formula for effective interest group representation across the board. What we are instead likely to achieve is the re-creation of American industry in the image of the U.S. Postal Service.

The fault, to paraphrase Shakespeare, is not in our corporations, but in our. selves. Or, as Pogo put it more succinctly: "We have met the enemy and he is us." If we, as a people, indeed had a firm commitment to a clean environment, or to racial equality, corporate management would fall into line pretty quickly. The truth of the matter is that most people's commitment to the environment evaporates when it comes up against their desire for a job and for the personal comforts and mobility that their money can buy. And their commitment to racial equality ends when it threatens their jobs, the stability of their neighborhoods, or their hopes for their children.

There is a sense, however, in which the corporation is responsible for one dilemma in which we find ourselves. The business corporation is a type of institution which is particularly well-suited to the organization of large numbers of people and large aggregations of capital for the exploitation and manipulation of natural resources. Indeed, this presumed “social utility" of corporations is the only reason for freeing corporate managers from the democratic controls that we place on other officials who exercise power under a grant of authority from the state.

Corporations are not particular about what they produce. They will produce either buses or bombers, depending on whether our national policy favors mass transportation or mass destruction. But they are biased in favor of some sort of production, exchange and consumption of material goods. If we decide that national policy should favor less energy consumption, a stable population, and people doing more things for themselves, we can count on corporate managers to oppose that policy, because it lessens their role and importance in the society. We may therefore wish to impose additional controls on corporate managers simply because the things that they do best, and have been rewarded for doing, become counter-productive to the goals of the society as a whole.

CORRUPTION

This brings me to the third indictment of our large corporations-corruption. I am not referring simply to the recent exposures of bribery of foreign and domestic government officials, but to the flagrant and widespread departures from fair and decent commercial practices-deceptive advertising, faking of test results, manipulated financial statements, and the myriad of ways in which corporate managers strengthen their position by misleading customers, shareholders, government agencies and others with whom they deal. Here I think reform of the corporation laws can make a major contribution to reform of corporate behavior. Power does corrupt, as the old cliche tells us, and the corruption of corporate management is directly traceable to the almost unlimited powers over vast aggregations of assets which corporate managers enjoy under present "law.”

How can this be changed? I believe there are three general areas in which corporation law could be changed which would result in more effective monitoring of management and more responsible management conduct:

1. Better access to corporate information.
2. Greater shareholder participation in decisionmaking.
3. More effective remedies against management misconduct.

Information.—The "trade secret” idea and Fourth Amendment privacy concepts have been extended far beyond their intended scope to shield corporate records from scrutiny by anyone not connected with corporate management itself. Corporation law should be changed to assure that corporate records are available to directors, shareholders, employee and customer groups, and other interested parties, subject to appropriate exceptions for such things as personnel records, and legitimate "trade secrets." At the same time, the role of the independent auditors should be strengthened; they should be given the authority to decide on the accounting principles to be followed in presenting the company's financial statements, and the appointment and dismissal of auditors should rest not with management but with an outside audit committee of the board of directors.

Shareholder Participation.—It is popular to suppose that shareholdings in our largest corporations are so scattered that shareholders can no longer exercise any effective voice in corporate decision-making. However, recent studies have shown that increasing concentration of stock holdings in institutions, particularly pension funds, has created a potentially effective agency for review of major policy decisions. Large individual shareholders may also be roused to action under particularly egregious circumstances, as indicated by the recent actions of Mellon family representatives on the board of Gulf Oil Corporation. Corporation laws should be revised to require shareholder approval, after full disclosure, for major expansions, for acquisitions of other businesses, for issuance of large amounts of new securities, for repurchase of outstanding securities, and similar actions. At the same time, proxy voting procedures should be revised to make it easier for significant shareholder groups to submit proposals for shareholders' action and to nominate and elect representatives to the board of directors.

Remedies for Management Misconduct.-Current remedies against management misconduct are inadequate. Criminal procedures and sanctions designed for robbers and murderers are generally ill-suited to corporate wrongdoing, and prosecutors, courts and juries are reluctant to apply them. Private class and derivative actions against corporate managers have been hobbled by procedural obstacles. Corporation law should be amended to provide for sanctions by a federal administrative agency against corporate managers and directors, including dismissal from office and disqualification from association with any large corporation in a managerial capacity. Provision should also be made for agency approval of new directors where pervasive corruption is demonstrated, as the SEC has required in a number of recent instances. Substantive and procedural obstacles to class and derivative suits should be removed, so that corporate managers and their associates can be held financially responsible for profits obtained through breach of their fiduciary responsibilities.

The changes I have suggested all fall within what has generally been considered the domain of state corporation law What then is the need for a federal corporation law? Can't these changes, if they are desirable, be made by the states? The answer is that they can, but they haven't, and they won't. The reason lies in the relationship between the giant corporations and the states. An eight billion dollar corporation is like an eight hundred pound gorilla. "Where does an eight hundred pound gorilla sit?" We all know the answer: “Anywhere it wants."

Most of the large corporations want to establish their corporate seats in Delaware, which in recent years has proved most imaginative in eliminating from its corporation law any restrictions which corporate management found burdensome and inserting any safeguard which management desired for its own protection. Typical of the former are the elimination of shareholder' voting or appraisal rights for many kinds of transactions, and even elimination of requirements for a formal meeting of the board of directors to approve management actions. Examples of the latter are the generous provisions for indemnifying corporate officers against civil liabilities and their expenses incurred in defending themselves in civil and criminal proceedings, and, most recently, a requirement that management receive 20 days prior notice of any tender offers for the company's stock so that it can more easily defend itself against a takeover bid. While Delaware has been the "leader" in this movement, other states (as well as the American Bar Association, in its "Model" Business Corporation Act) have supinely followed, for obvious reasons. While a state can effectively regulate an entity which conducts business largely within its borders, no state can effectively regulate the internal decision-making process of an entity incorporated in another state and conducting its business in many different states and even foreign countries. The only result of a state's enacting a “strict" corporation law is that the large corporations domiciled there will pick up and reincorporate in Delaware, as many of them have done.

What are the objections to a federal corporation law? The argument that a federal corporation law would infringe on "states' rights" is totally without substance. Whatever theoretical right the states have to regulate the giant corporations that do business within their borders, they have no practical power to do so. And whatever rights the people of Delaware may have, it does not include the right to launch a juggernaut with power to crush people in 49 other states, when its only connection with Delaware is the maintenance of a post office box and the payment of a nominal amount of franchise tax.

The argument that federal corporation law would be an “invasion of the free enterprise system” is equally baseless. It results from confusion of management with the corporation. A recent editorial in the Wall Street Journal referred to the modest proposal for outside audit committees of the board of directors, with power to blow the whistle on management misconduct, as the creation of "corporate commissars.” The irony of this characterization is that it is the present allocation of power within the corporation that most resembles Soviet-style government. One man or a small group runs the entire enterprise, with succession to power based on the internal intrigues rather than a public elective process. Management decisions are ratified (or occasionally criticized) at regular meetings of a politburo (board of directors) and in annual plebiscites in which management controls the voting process and there is usually one slate of candidates which is returned to office with more than 99 percent of the votes.

I am not suggesting that we recreate our corporate government in the image of our national government, with three coequal branches and the elaborate system of checks and balances built into our federal Constitution. But some of the ideas of due process and public accountability that apply to our governmental organizations could well be adapted for corporate use. For more than a century now, our government, federal and state, has given corporate managers a blank check in return for the "growth” which their unrestricted activities promised us. On the whole, it has not been a bad bargain. But growth is no longer the be-all and end-all, and we must search for ways to get the genie back in the bottle.

The final objection is that a federal corporation law would create a vast new bureaucracy, creating greater inefficiency in our economic system. But a carefully drafted law could provide for internal controls on management behavior, without creating an unwieldy new bureaucracy. The rules could be enforced within the corporate structure, through existing agencies, and by actions in the courts. The need now is for an authoritative study, under Congressional auspices, that could produce a draft of a federal corporation law for consideration by the Congress early in 1977.

[Whereupon, at 12:40 p.m., the hearing was recessed.]

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