University of Pennsylvania Law School – Institute for Law and Economics
Qualivian Investment Partners performance update for the month ended July 31, 2022. Q2 2022 hedge fund letters, conferences and more Dear Friends of the Fund, Please find our July 2022 performance report below for your review. Qualivian reached its four year track record in December 2021. We are actively weighing investment proposals. Starting in November Read More
The financial crisis of 2008 focused increasing attention on corporate America and, in particular, the risk-taking behavior of large financial institutions. A growing appreciation of the “public” nature of the corporation resulted in a substantial number of high profile enforcement actions. In addition, demands for greater accountability led policymakers to attempt to harness the corporation’s internal decision-making structure, in the name of improved corporate governance, to further the interest of non-shareholder stakeholders. Dodd-Frank’s advisory vote on executive compensation is an example.
This essay argues that the effort to employ shareholders as agents of public values and, thereby, to inculcate corporate decisions with an increased public responsibility is misguided. The incorporation of publicness into corporate governance mistakenly assumes that shareholders’ interests are aligned with those of non-shareholder stakeholders. Because this alignment is imperfect, corporate governance is a poor tool for addressing the role of the corporation as a public actor.
The case of JPMorgan and the London whale offers an example. Although JPMorgan suffered a massive loss due to the whale’s risky trading decisions, JPMorgan shareholders benefited from this risk-taking. Accordingly, shareholders were poorly positioned to address the incentives that drove risky operational decisions. So-called “improved corporate governance” in the form of shareholder empowerment, rather than functioning as a solution, may have exacerbated the problem. In the end, the mess at Morgan demonstrates limitations on the value of shareholder empowerment in addressing the public impact of the corporation and suggests that, at least in some cases, regulatory approaches such as the Volcker rule may be warranted.
In April 2012, the financial media reported large derivatives trading by a JPMorgan trader known as the London whale. JPMorgan eventually reported a $6.2 billion loss stemming from the whale’s proprietary trading in derivatives. Over the course of the next several months, JPMorgan’s troubles multiplied such that the original whale began to seem more like a minnow. News reports revealed JP Morgan’s involvement in wide-ranging misconduct—from unfair credit card billing practices to misrepresentations in the sale of mortgage-related products to investors. Overall, in a two and a half year period from June of 2011 to January of 2014, JP Morgan paid almost $34 billion in fines and penalties.
The revelations were particularly notable in that, until early 2012, JPMorgan appeared to have escaped the widespread misfortunes associated with the financial crisis. Policymakers argued that the financial crisis was caused, in part, by excessive risk taking by Wall Street financial institutions. This risk-taking led to the collapse of many large banks including Bear Stearns, Lehman Brothers and Wachovia, and required an unprecedented government bailout. President Obama criticized the “fat cat bankers” for continuing to take large bonuses while the country and their stockholders suffered.
Yet, at the same time, commentators praised JPMorgan for adhering to a conservative investment strategy that enabled it to weather the storm. JPMorgan was the only large financial institution to post a profit during the financial crisis. JPMorgan was also the first bank to repay the funds it received from the government through the Troubled Asset Relief Program.
The reputational hit experienced by JPMorgan following the whale and the subsequent revelations solidified the demand—sparked by the financial crisis—for the increased accountability of corporate managers. This demand led to demands for increased shareholder empowerment premised on the view that the failures at the large banks were, at least in part, governance failures. Shareholder empowerment was a substantial component of the regulatory strategy of the Dodd Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank). One component of Dodd-Frank’s shareholder empowerment approach is its mandate that publicly-traded corporations provide shareholders with an advisory vote on executive compensation—Say on Pay.
The substantial impact that large public corporations have on a broad range of constituencies has long been recognized. Recent commentators have termed this phenomenon “publicness,” by which they mean the actions of the corporation that affect the economy and society generally rather than just shareholder interests.
One regulatory response to publicness is increased shareholder empowerment. Claiming that the widespread misconduct of the financial crisis reflected a failure of corporate governance, policymakers have begun to seek to harness the corporation’s internal decisionmaking structure to further the public interest.
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