AFTER ENRON At the end of the twentieth century, it was thought by many that the Anglo-American system of corporate governance was performing effec - tively and some observers claimed to see an international trend towards convergence around this model. There can be no denying that the recent corporate governance crisis in the US has caused many to question their faith in this view. This collection of essays provides a comprehensive attempt to answer the following questions: first, what went wrong—when and why do markets misprice the value of firms, and what was wrong with the incentives set by Enron? Secondly, what has been done in response, and how well will it work—including essays on the Sarbanes-Oxley Act in the US, UK company law reform and European company law and auditor liability reform, along with a consideration of corporate governance reforms in historical perspective. Three approaches emerge. The first two share the premise that the system is fundamentally sound, but part ways over whether a regulatory response is required. The third view, in contrast, argues that the various scandals demonstrate fun- damental weaknesses in the Anglo-American system itself, which cannot hope to be repaired by the sort of reforms that have taken place. After Enron Improving Corporate Law and Modernising Securities Regulation in Europe and the US Edited by John Armour and Joseph A McCahery Oxford and Portland, Oregon 2006 Published in North America (US and Canada) by Hart Publishing c/o International Specialized Book Services 920 NE 58th Avenue, Suite 300 Portland, OR 97213-3786 USA Tel: +1 503 287 3093 or toll-free: (1) 800 944 6190 Fax: +1 503 280 8832 Email: orders@isbs.com Website: www.isbs.com © The editors and contributors jointly and severally, 2006 The editors and contributors have asserted their rights under the Copyright, Designs and Patents Act 1988, to be identified as the authors of this work. All rights reserved. No part of this publication may be reproduced, stored in a retrieval system, or transmitted, in any form or by any means, without the prior permission of Hart Publishing, or as expressly permitted by law or under the terms agreed with the appropriate reprographic rights organisation. Enquiries concerning reproduction which may not be covered by the above should be addressed to Hart Publishing at the address below. Hart Publishing, 16C Worcester Place, Oxford, OX1 2JW Telephone: +44 (0)1865 517530 Fax: +44 (0) 1865 510710 Email: mail@hartpub.co.uk Website: http://www.hartpub.co.uk British Library Cataloguing in Publication Data Data Available ISBN 13: 978-1-84113-531-1 ISBN 10: 1-84113-531-3 Typeset by Forewords, Oxford Printed and bound in Great Britain by TJ International, Padstow, Cornwall Acknowledgements We are grateful to the authors for agreeing to contribute their material to this collection. Several of the chapters have previously been published as articles, and where the copyright is not held by the authors, we are also grateful to the publishers for permitting us to reproduce their material. In particular, we acknowledge the permission of the American Bar Associa - tion (Chapters 3 and 7); Sage Publications (Chapter 4); Oxford University Press (Chapters 6 and 14); the Asser Press (Chapters 9 and 15); Blackwell Publishing (Chapter 10); Theoretical Inquiries in Law (Chapter 11); Cam - bridge University Press (Chapter 16) and the University of Pennsylvania Journal of International Economic Law (Chapter 17). We gratefully acknowledge financial support from the Anton Phillips Fund. We owe a large debt of gratitude to James Risser and Mel Hamill for their excellent work in editing the chapters, and are most grateful to Richard Hart and his colleagues at Hart Publishing for their patience in responding to the inevitable delays in a project of this sort. CONTENTSCONTENTS Contents Acknowledgements v List of Contributors ix Introduction After Enron: Improving Corporate Law and Modernising Securities Regulation in Europe and the US JOHN ARMOUR and JOSEPH A McCAHERY 1 Part I: Stock Markets and Information 27 1 The Mechanisms Of Market Efficiency Twenty Years Later: The Hindsight Bias RONALD J GILSON and REINIER KRAAKMAN 29 2 Taming the Animal Spirits of the Stock Markets: A Behavioural Approach to Securities Regulation DONALD C LANGEVOORT 65 Part II: Corporate Scandals in Historical and Comparative Context 127 3 Icarus and American Corporate Regulation DAVID A SKEEL, JR 129 4 Corporate Governance after Enron: An Age of Enlightenment SIMON DEAKIN and SUZANNE J KONZELMANN 155 5 Financial Scandals and the Role of Private Enforcement: The Parmalat Case GUIDO FERRARINI and PAOLO GIUDICI 159 6 A Theory of Corporate Scandals: Why the US and Europe Differ JOHN C COFFEE, JR 215 Part III: Evaluating Regulatory Responses: The US and UK 235 7 The Case for Shareholder Access to the Ballot LUCIAN ARYE BEBCHUK 237 8 Rules, Principles, and the Accounting Crisis in the United States WILLIAM W BRATTON 265 9 The Oligopolistic Gatekeeper: The US Accounting Profession JAMES D COX 295 10 The Liability Risk for Outside Directors: A Cross-Border Analysis BERNARD BLACK, BRIAN CHEFFINS and MICHAEL KLAUSNER 343 11 The Legal Control of Directors’ Conflicts of Interest in the United Kingdom: Non-Executive Directors Following the Higgs Report RICHARD C NOLAN 367 Part IV: Reforming EU Company Law and Securities Regulation 413 12 Enron and Corporate Governance Reform in the UK and the European Community PAUL DAVIES 415 13 Modern Company and Capital Market Problems: Improving European Corporate Governance After Enron KLAUS J HOPT 445 14 Who Should Make Corporate Law? EC Legislation versus Regulatory Competition JOHN ARMOUR 497 15 Company and Takeover Law Reforms in Europe: Misguided Harmonization Efforts or Regulatory Competition? GÉRARD HERTIG and JOSEPH A McCAHERY 545 16 The Regulatory Process for Securities Law-Making in the EU EILÍS FERRAN 575 17 EC Company Law Directives and Regulations: How Trivial Are They? LUCA ENRIQUES 641 Index 701 viii Contents LIST OF CONTRIBUTORSLIST OF CONTRIBUTORS List of Contributors JOHN ARMOUR is a Senior Lecturer in the Faculty of Law, and Research Associate in the Centre for Business Research, at the University of Cambridge. LUCIAN ARYE BEBCHUK is William J. Friedman and Alicia Townsend Friedman Professor of Law, Economics, and Finance, Harvard Law School. BERNARD BLACK is Haydn W. Head Regents Chair for Faculty Excellence and Professor of Law at the University of Texas Law School and Professor of Finance at the Red McCombs School of Business, University of Texas. WILLIAM W. BRATTON is Professor of Law at the Georgetown University Law Center. BRIAN CHEFFINS is S.J. Berwin Professor of Corporate Law in the Faculty of Law at the University of Cambridge. JOHN C. COFFEE, JR. is Adolf A. Berle Professor of Law at Columbia University and Director of the Center on Corporate Governance at Columbia University Law School. JAMES D. COX is Brainerd Currie Professor of Law at the Duke University School of Law. PAUL DAVIES is Cassel Professor of Commercial Law at the London School of Economics. SIMON DEAKIN is Robert Monks Professor of Corporate Governance in the Judge Business School, Acting Director of the Centre for Business Research, and Yorke Professorial Fellow in the Faculty of Law at Cambridge University. LUCA ENRIQUES is Professor of Business Law at the University of Bologna, Faculty of Law, and ECGI Research Associate. GUIDO FERRARINI is Professor of Law at the University of Genoa and the Centre for Law and Finance. EILÍS FERRAN is Professor of Law in the Faculty of Law at the University of Cambridge. RONALD J. GILSON is Meyers Professor of Law and Business at Stanford Law School and Stern Professor of Law and Business at Columbia Law School. PAOLO GIUDICI is Professor of Law at the Free University of Bozen and Centre for Law and Finance. GÉRARD HERTIG is Professor of Law and Economics, Eidgenössische Technische Hochschule Zürich. KLAUS J. HOPT is Professor of Law and Director of the Max Planck Institute for Foreign Private and Private International Law in Hamburg. MICHAEL KLAUSNER is Professor of Law at Stanford Law School. SUZANNE J. KONZELMANN is Reader in Management at Birkbeck College, University of London and Research Associate at the Centre for Business Research, University of Cambridge. REINIER KRAAKMAN is Ezra Ripley Thayer Professor of Law at Harvard Law School. DONALD C. LANGEVOORT is Professor of Law at Georgetown University Law Center. JOSEPH A. MCCAHERY is Professor of Corporate Governance at the University of Amsterdam Center for Law and Economics. RICHARD C. NOLAN is a Fellow of St. John’s College and Senior Lecturer in Law at the University of Cambridge; he is also a Barrister at Erskine Chambers, Lincoln’s Inn, London. DAVID A. SKEEL, JR. is S. Samuel Arsht Professor of Corporate Law at the University of Pennsylvania Law School. x List of Contributors [...]...J OHN ARMOUR AND J OS EPH A MCCAHERY I NTRODUCTI ON Introduction After Enron: Improving Corporate Law and Modernising Securities Regulation in Europe and the US J O H N A R M O U R * a n d J O S E P H A M c CA H E RY * * D URING THE 1990s, US stocks led the world in the greatest bull market in history On 24 March 2000, the S&P 500 Index peaked at a record high of 1,527.47, up a dizzying 500 per... not be repeated: the cessation of federal subsidies to railways in the 1870s; the Securities Acts of 1933 and 1934, and the Sarbanes-Oxley Act in 2002 Skeel then reflects on the link between interest group politics and the regulation of corporate behaviour in the US For most of the history of the corporate form, managers have been the dominant interest group: they have at their disposal corporate resources... and the like and weaker corporate performance In the US, most of corporate law is formulated at the state, rather than the federal, level The Sarbanes-Oxley Act, being federal, is an important exception US corporations are free to select their state-level governing law by changing their state of incorporation, something which SarbanesOxley did nothing to change ILucian Bebchuk has argued that because... futures, and part of the probable future, of European company and securities law- making They stand in stark contrast to the attempts at harmonization which were in vogue in previous decades In Chapter 17, Luca Enriques examines the weaknesses of this mode of law- making, arguing that it has tended to fall foul of political opposition on all significant issues This meant that, even in the early days of the European... rather than principles, in US accounting practice, and the oligopolistic structure of the US accounting industry 3 Recently, the trend in the UK has been away from self -regulation, as with the Financial Services Authority taking control of the Listing Rules from the London Stock Exchange in 2000 John Armour and Joseph A McCahery 15 It has been argued by some that one of the factors that facilitated... (Chapter 12), argues that the use of ‘soft law has been useful to the UK government in overcoming managerial lobbying, because the government retains thinly-veiled bargaining power from the (unexercised) threat to resort to legislation Such techniques have also been used in the US: for example, in response to Enron, both the New York Stock Exchange and NASDAQ have recently introduced new rules 2 UK... regarding auditor liability in Italy were, at the time the misdeeds occurred at Parmalat, actually more stringent than the post Sarbanes-Oxley regime in the US Yet these rules nevertheless failed to prevent large-scale auditor failure Ferrarini and Giudici argue that this was because of weaknesses in the rules’ enforcement In Italy, as in much of continental Europe, the regulation of corporate governance... Cadbury Code in 1992, following scandals in the early 1990s Post-Enron, the UK’s Higgs Review (Higgs, 2003) has seen a further, ‘incremental’, strengthening of the rules relating to non-executives, (Davies, Chapter 12, this collection) The thinking behind these reforms is that independent non-executive directors may be able to act as champions of shareholders’ interests, and a check on egregious fraud,... suggest that non-executives should be viewed as capable of playing an active part in the formulation of business strategy, by bringing outside experience to strengthen the John Armour and Joseph A McCahery 17 board’s capabilities, and a valuable network of contacts Others see non-executives as performing a role akin to board-level auditors of decision-making processes—asking questions, and putting a check... between the UK’s ‘outsider’ share ownership and the ‘insider’ share ownership of continental Europe, with a corresponding difference in the emphasis of regulation between rendering management accountable and keeping blockholders under control Member states also differ systematically in the way in which their regulation is designed and enforced Furthermore, following enlargement in 2004, the EU now contains . ix Introduction After Enron: Improving Corporate Law and Modernising Securities Regulation in Europe and the US JOHN ARMOUR and JOSEPH A McCAHERY 1 Part I: Stock Markets and Information 27 1 The. place. After Enron Improving Corporate Law and Modernising Securities Regulation in Europe and the US Edited by John Armour and Joseph A McCahery Oxford and Portland, Oregon 2006 Published in North. Regulation in Europe and the US JOHN ARMOUR * and JOSEPH A McCAHERY ** D URING THE 1990s, US stocks led the world in the greatest bull market in history. On 24 March 2000, the S&P 500 Index peaked