to the corporation as a whole, but if the corporation had a factory in a State, that operation would be subject to State regulation. If the factory was operated as a separate subsidiary corporation, the State could require it to be incorporated in that State; if it was simply a division of the national corporation, the State could require that division to be registered in the State and be subject to certain restrictions.

I think that's perfectly appropriate because there's no need for the Federal Government to regulate all of the local implications.

Senator HARTKE. What you run into frequently now in legislative procedures is the fact that when you move into the Federal level at all on any field there is a drive then by the organization affected to ask for a preemption, thereby to avoid the duplication; but in a way, this cynicism which is out there is something which is going to have to be dealt with very quickly in this American society or the whole fabric of this Government is going to collapse. There's just no question about that, and that is not an assumption. That's a fact of life. And there's always been a question in my mind whether or not a contributing factor of that cynicism has been the fact that there's not that flexibility to deal with the peculiar things which are solely within the jurisdiction of the State itself or the local community.

Mr. RATNER. What I would envision is that you would try to leave to the States the areas which the States can effectively regulate. The problem is the States can't effectively regulate the central management operation of a large corporation with plants in many different States. It simply picks up and moves and incorporates somewhere else.

As I said in my paper, a large corporation is like a 800-pound gorilla. Where does it sit? Anywhere it wants. And if it wants to sit in Delaware, it will sit in Delaware, and there's nothing other States can do to prevent it from operating under the Delaware standards.

Senator HARTKE. And become sort of a pawn in the operation because it does not want to in any way exclude any of the beneficial effects that would accrue from doing business in the State.

Mr. RATNER. That's right; what should be left to State regulation is the parts the States can effectively control. Whether the States can control such things as pollution effectively is something that you will have to consider. They may not always have the resources to deal with it. But certainly you would want to leave the local problems to them. Senator HARTKE. That's part of the difficulty. You say the States don't have the resources to deal with it. The States have the same resources the Federal Government has.

Mr. RATNER. I suppose in an area like pollution, in connection with testing to determine what standards there should be, it would be needless duplication for each State to conduct the tests. There should be some central way of determining what types of things produce the most pollution.

As I was saying, the reason for suggesting a Federal law governing corporations is that the States simply do not have the power. A State which wanted to impose strict controls on corporate management to prevent this type of misconduct simply couldn't do it because the corporation would reincorporate in another State where the laws are looser. Delaware, as Professor Schwartz and others have mentioned, has been the leader in a movement which, whether you think it's good

or bad, has been in the direction of giving corporate management maximum freedom to act without the consent of shareholders, without in many cases even a meeting of the board of directors. The management can simply get the individual written consent of each director without any opportunity for discussion of the matter.

One of the participants in the conference I attended yesterday said that he had been lecturing in Europe and that the thing he found most difficult to explain to the Europeans is why we have State corporation laws governing these large national corporations. They simply can't understand why a single State writes the laws governing corporations which have no connection with that State except to maintain a post office box and to pay a nominal franchise tax every year. I suppose the answer is largely historical, because corporations came in at a time when most enterprises were largely local and the enterprises simply outgrew the form.

Turning to the arguments against Federal corporation law, the first argument is that it's an infringement of States rights. I don't think there's really any substance to that. In the first place, there's no need to displace State chartering of corporations. The Federal corporation law could be written as a set of restrictions applicable to any corporation above a certain size or with certain criteria, leaving the basic incorporation documents and filing fees in the States, but with Federal law prevailing where it imposed additional restrictions.

While the people of Delaware certainly have the right to regulate activities within their borders-a right which the Federal Government should not interfere with unnecessarily-what they have in effect been doing is using that power to create entities which can then dominate the lives of people in the other 49 States, which hardly falls within the traditional idea of "States rights" of Delaware or the other incorporating States.

The second argument, pressed by the NAM and others, is that this is a bureaucratic interference with the free enterprise system or with the freedom of corporations. I think this position results largely from a confusion of management with the corporation. The management, of course, has the prime innovative role, the role of initiating new developments and putting them through. But this doesn't mean that, in order for corporations to operate, management must be given a complete carte blanche to ignore any considerations other than what the particular manager happens to think at the moment is best suited for the corporation-which he tends to identify in many cases with his own personal well-being.

Unfortunately, when the courts had to deal with the corporation as an entity, they decided the only thing that it was like was a person, and so the corporation became a person for the purposes of the Constitution anl the laws. This is a useful idea in certain respects. A corporation can enter into contracts and relations as a person can. But when you come to the internal workings of the corporations, the person analogy gets you into problems because the corporation is not a person. There are a lot of different interests that have to be taken into account, and if you simply treat it as a person it inhibits you in dealing with those internal problems.

I think that a Federal corporation law could establish orderly procedures to make the management decisions more closely correspond to what the original model was, that management would propose

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 suggest 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 corpora tions 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 ourselves. 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.