I've posted the following at The
Conglomerate for their inaugural masters forum on Jones v. Harris. Several
good guest bloggers have already posted on the case, and more will do so over
the next few days, so head over there to check out all the fun.
The teacher’s manual to Klein,
Ramseyer, & Bainbridge opens discussion of Jones v. Harris in
typically Ramseyeresque fashion:
This case deviates from our usual practice. In
general, we pick cases for the facts. This case has no facts of
interest. We include it instead for the reasoning – for Frank
Easterbrook’s in-your-face explanation for why compensation is best left for
the market.
Judging from the outpouring of interest in the case, many
law professors appear to disagree with Ramseyer that Jones v. Harris has
no interesting facts. (Or, alternatively, we share Klein,
Ramseyer, and Baindridge’s fascination with Easterbrook’s “in your face” market
defense). But Ramseyer is certainly correct that executive compensation
(and compensation issues more generally) is
“hot” at the moment.
I expected, prior to reading Easterbrook's opinion (Download
Easterbrook), to disagree with the 7th Circuit ruling. In
the end, however, I did not. Easterbrook’s basic argument that the
appropriate reference point for the court’s decision should be the fees that
other funds of similar size and investment goals pay their advisers, rather
than the fees charged to unaffiliated institutional clients seems correct to
me, at least based on the information we currently have available. And,
according to the 7th Circuit, it is undisputed inJones v. Harris that
the fees Oakmark paid Harris Associates are roughly equal in both level and
breakpoints to those paid by similar funds. (I’ll leave aside, for
present purposes, the extent to which Easterbrook’s opinion abandons Gartenberg and
replaces it with a disclosure standard, as that question is addressed at length
elsewhere, including in today’s
oral argument).
Why did I expect to disagree with the 7th Circuit
ruling? Posner’s dissent from rehearing en banc (Download Posner
dissent) resonates in some fairly basic ways. Chief among
them is his discussion of the incentuousness of the mutual fund industry. As
Posner notes on page 5:
“connections among agents in [the mutual fund industry]
foster favoritism, to the detriment of investors. Fund directors and advisory
firms that manage the funds hire each other preferentially based on past
interactions. When directors and the management are more connected, advisors
capture more rents and are monitored by the board less intensely.”
Quoting Camelia M. Kuhnen, “Social Networks, Corporate
Governance and Contracting in the Mutual Fund Industry” (Mar. 1, 2007),
http://ssrn.com/abstract=849705 (visited July 28, 2008).
This is a reality that should resound with even casual
students of board life. In my own research on
boards of directors (designed to study questions of race and gender
diversity on boards but, in fact, revealing a trove of information about the
daily workings of boards, management, and their corporate constituent
relations) narratives of board interconnectedness and “it’s all about who you
know” recur.
Yet Easterbrook anticipates such objections well. As
he notes, there are thousands of mutual funds, and investors can (and
apparently do) shift money at will, creating competition. True,
funds may not explicitly compete on management fees, but mutual funds’ total
expenses as a percentage of assets are a widely publicized benchmark and even
lazy investors seek maximum returns net of expenses.
Very few observers of today’s financial and corporate
landscape believe that the market perfectly sets compensation to align
management incentives with shareholder welfare. Concluding that
courts can systematically do better, however, requires more evidence than what
I’ve seen so far in Jones v. Harris.
Elaborating on Easterbrook’s university president
hypothetical, my boss, Duke University president Richard Brodhead, may be
overpaid (for the record, I do not believe this to be the case, but you get the
picture). If Brodhead receives “$50 million a year, when no other
president of a comparable institution receives more than $2 million,” then a
court might reasonably conclude that the compensation is so unreasonable that
deceit must have occurred or the trustees abdicated their responsibilities in
approving the compensation. But should the court inquire whether a
salary normal among similar institutions is, nonetheless, excessive, because
all university trustee-president relationships are insular? Absent a
clearer statutory mandate than §36(b), or more evidence of market failure
than was presented in Jones v. Harris, I think not. In
Easterbrook’s words, “a fiduciary duty differs from rate regulation.”
Cross-posted at The Glom