August 24, 2009

Treasury Inc.: Bailout Reshapes Corporate Theory & Practice

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Corporate law theory and practice considers shareholder relations with companies and the implications of ownership separated from control.  Yet through the TARP bailout and the government's resultant shareholding, ownership and control at many companies has merged, leaving corporate theory and practice for the financial and automotive sectors in chaos.  The government's $700 billion bailout is a unique historical event; not merely because of its size, but because of a resulting ripple through corporate scholarship and practice.  This article builds on the author's four testimonies before Congress during the financial crisis and implementation of the TARP bailout and his consultation for the Inspector General for TARP.  It updates the six central theories of corporate law to reveal that none function adequately when considered with a controlling government shareholder that enjoys sovereign immunity from corporate and securities law.  From agency theory and nexus-of-contracts thought to the shareholder/director primacy debate, even to notions of progressive corporate law, existing theory breaks down when a government shareholder is present.  The article also develops an economic model of incentives facing political decisionmakers in exercise of their shareholder power.  After considering corporate theory, the article offers predictions for how Treasury's stock ownership reshapes the practice of corporate law.  In short, TARP will result in a tectonic shift for current understanding about insider trading, securities class actions, share voting, and state corporate law fiduciary duties.  The article closes with three recommendations.  First, that Treasury take frozen options, an invention explained in the text, rather than equity.  Second, that Congress pass legislation establishing a fiduciary duty for Treasury to maximize the value of its investment, a suggestion that has resulted in Sens. Warner and Corker introducing implementing legislation based on the author's suggestion.  Third, that Treasury adopt a sales plan for closing out its TARP holdings.