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Fact and Fiction in Corporate Law and Governance

This paper evaluates the fidelity of corporate law and governance scholarship to institutional facts. It evaluates the legal literature’s “contractarian” theory of corporate governance in light of the past three decades of empirical work, and concludes that the facts do not support the theory — not with respect to the IPO stage, the supposed “race to the top,” or the ongoing governance of public companies. Market forces alone do not promote innovative or customized governance arrangements as the theory posits, and there is no basis on which to conclude that market forces yield socially optimal governance arrangements. The design and widespread use of corporate governance indices in the empirical literature is another point of divergence between academic work and institutional fact. Many elements of commonly used governance indices have no potential to entrench management or otherwise reduce firm value. For example, among the common misconceptions embodied in governance indices is the idea that more takeover defenses means greater insulation against the takeover threat. This is not true. Once a company has a staggered board, additional defenses provide no protection at the margin, and even in companies without staggered boards multiple defenses are generally redundant.