When voting on proxy access proposals, shareholders need to understand that proxy access is a fundamentally flawed tool of accountability. That is, it is a very inefficient means to promote good corporate governance in a public company. As argued in this article, it is expected that proxy access will lead to increased error in the nomination of directors as decision-making is moved from the board of directors to shareholders who will make their nominations based on significantly less information and a shifting of the potential for certain opportunistic behavior, such as the extracting of private benefits from the corporation, from an independent board and nominating committee to certain shareholders who, unlike directors, are not subject to fiduciary duties. Such an argument also makes the case for the SEC not to waste its resources on revisiting the idea of mandatory proxy access.

However, the approach taken in the Act to reduce systemic risk is incomplete. The problem is that it is backward-looking. The Act does not take into consideration that, if history is any guide, financial innovation will lead to the development of new financial sector business models that are potentially unsustainable. While these business models are not necessarily bad if there is no viable alternative, policy makers and regulators need to make sure the financial sector is not overinvesting in such models as they may create unnecessary nodes of systemic risk.

To implement this approach, policy makers and regulators must focus on and regulate practices that encourage financial sector participants to be indifferent to the use of unsustainable business models. One possible practice originates from the large, front-loaded bonus arrangements provided Wall Street employees. These arrangements provide incentives for employees to focus on maximizing their personal short-term returns at the expense of their employers’ long-term interests.

For a solution to the problems created by these compensation arrangements, this essay recommends limiting the tax deductibility of financial sector compensation at the entity level, a new tax similar to Internal Revenue Code section 162(m), but with a much greater reach as it would apply to all Wall Street employees who work for financial sector firms. This new law would be supplemented by a provision that would restrict payouts of current and deferred bonuses at those times when a firm’s performance measures indicate excessive firm-specific risk.

Yet, how can that argument be reconciled with the behavior of Wall Street firms in regard to the large bonus payments it made to its employees in the years just prior to and during the financial crisis, a time when financial and economic conditions were clearly deteriorating? A better argument, at least for Wall Street firms such as Bear Stearns, Merrill Lynch and Lehman Brothers and other financial sector firms where asset management, trading and investment banking was a significant source of firm profitability, is that it was not an overzealous desire to meet the short-term demands of shareholders that was at work in the corporate governance of these firms, but the need to accommodate strongly positioned non-shareholder parties such as traders, investment bankers and asset managers (Wall Street employees), parties who acquired their strong negotiating position by possessing the critical assets needed by their respective firms, who did not need to make firm-specific investments and whose skills were highly valued by competing firms.

The implications of this argument are significant for Wall Street firms and other financial firms where Wall Street employees provide a significant source of firm profitability. First, the gap filling role of shareholder primacy can be understood as being crowded out by the economic terms demanded by those employees who have strong bargaining power. Second, shareholder empowerment proposals implemented to enhance board accountability such as say-on-pay, annual election of directors and shareholder nomination of directors may result in negatively affecting shareholder wealth. Finally, shareholder lawsuits seeking compensation from directors and executive management for wrongs perceived to have resulted from a lack of attention to shareholder interests may be unwarranted.

However, identifying whether or not a board is truly independent is just the first step in evaluating the quality of corporate governance at a controlled corporation. After all, a controlling shareholder still has the power to dominate an independent board through his direct voting power and by threats of removal. Therefore, a proper evaluation requires knowledge of those corporate governance practices that a controlled company uses to monitor and manage the decision-making influence of the controlling shareholder. Furthermore, to make sure these practices are optimal, a subjective analysis of just how the controlling shareholder interacts with the board is required. In addition, the focus of such a subjective analysis must go primarily to an evaluation of the character of the controlling shareholder and his/her motivations regarding the welfare of the company.

This paper explores how the personality of the controlling shareholder will also play a role in determining the most optimal corporate governance practices. In doing so, this paper takes the perspective of an institutional investor who is a current or prospective shareholder of a controlled corporation and is trying to evaluate the company’s corporate governance practices or determine what changes may be necessary at the controlled company to increase value to all shareholders. An institutional investor will often find it necessary to do so because a significant number of public companies worldwide have controlling shareholders.

It is now understood that board approval of compensation policies that are heavily weighted toward large bonuses can encourage the pursuit of fake alpha and that the decisions to pay out huge amounts of company capital in the form of bonuses may primarily be the result of fake alpha being successfully achieved. In terms of corporate governance, these decisions reveal how opportunistic rent seeking stakeholders can pressure the corporate board into excessively risky decisions that can jeopardize the financial health of the corporation. The question then becomes whether corporate law needs to be modified to deal with this weakness in corporate governance and if so, how should it be done. In this essay, it is argued that the courts should require a public company’s board, a board composed presumably of a majority of independent and disinterested members, to fulfill an enhanced duty in the process of deciding to approve policies or make decisions that on their face implicate both opportunistic rent seeking behavior on the part of one or more company stakeholders and the financial health of the firm. Such board decisions would necessarily include, among others, those decisions that involve moving massive amounts of cash out of the company and into the pockets of one or more stakeholders (huge company wide bonuses, large executive management team compensation, large dividend payouts, aggressive stock buybacks, etc).

The significance of these employment policy decisions cannot be overstated. By comparison, what was at stake in the much publicized litigation involving the Walt Disney Company was almost trivial, since the facts of the Disney litigation did not involve a threat to the company’s existence or billions of dollars of capital outflows.

The elevation of company-wide compensation policies to the fore of corporate governance issues facing Wall Street firms requires both a change in perspective on how these policies should be implemented as well as a reconsideration of whether the protections of the business judgment rule as applied to corporate board decisions under corporate law need to be adjusted accordingly.

The criterion for selecting outside board members is to choose members who enhance the efficiency of board decision-making. For that to occur, we must have an understanding of how the corporate board of a public corporation is to operate in an efficient manner. As proposed by Professors Margaret Blair & Lynn Stout, in order for the corporate board of a public corporation to operate efficiently, it must operate as a mediating hierarchy, consistent with a team production approach to corporate law and governance. Given this approach, a board composed of members that can best understand how the corporation operates as a mediating hierarchy should be the board that operates the most efficiently.

For guidance on how we should select board members using a team production approach, we rely on the work of Kaufman & Englander.

Obviously, something was amiss at the top of the Enron pyramid and we think it had something very much to do with the composition of the Enron board, no matter how impressive the backgrounds of its individual members. We, of course, are not alone in this opinion as the Enron debacle led to enhanced independence requirements for board members.

As a response to the facts of the Enron scandal, we certainly endorse the board member independence requirements of the stock exchanges and the enhanced independence guidelines as recommended by proxy advisory companies, but it is our position that corporate boards of publicly held firms would be better off and less prone to error if other rules or guidance were in place that required or strongly encouraged corporate board nominating committees to select members who were prominent and respected, but less prone to what we refer to as "dysfunctional deference."

The challenge for teachers of Van Gorkom is to explain why shareholders were correct in approving exculpation clauses even as our thinking about corporate law evolves and corporate scandals (Enron, Tyco, Parmalat, etc.) continue to influence our perspective on the correct level of corporate accountability. As this paper tries to demonstrate, applying the creative approaches taken by legal scholars such as Michael P. Dooley, who introduced Kenneth Arrow's understanding of the value of centralized authority into the study of corporate law, and Stephen M. Bainbridge who has so aptly applied Professor Dooley’s work in the development of his director primacy model, and Margaret M. Blair and Lynn A. Stout, who introduced the concept of the board of directors as a mediating hierarchy gives Van Gorkom new and greater meaning and reaffirms the correctness of insulating directors from duty of care liability.

The basic premise underlying this article is that the real value of the corporate form is its hierarchical nature as reflected in the centralized authority of the corporate board. This value is manifested by the corporate board’s ability to: 1) efficiently filter information in its decision-making process; and 2) act as a mediating hierarchy. Such organizational efficiencies create a strong presumption that the laws of corporate governance should not interfere with the corporate board’s decision making process.

In contrast to the approach taken by both Dooley and Bainbridge, this article does not utilize a contractarian framework. More importantly, this article does not require that shareholder wealth maximization be a norm underlying the laws of corporate governance. By relaxing this standard assumption, we can, for the first time, utilize the efficiency arguments of Dooley and Bainbridge on one hand and those of Blair and Stout on the other, as two complementary, instead of competing, approaches supporting the position that corporate board decisions need to be protected from judicial review.

This paper reflects my continuing interest in Van Gorkom and was heavily influenced by my previous work, Being Informed Does Matter: Fine Tuning Gross Negligence Twenty Plus Years after Van Gorkom, The Business Lawyer, Vol. 62, No. 1, pp. 135-160 (November 2006).