VOLUME 168, ISSUE 1 JANUARY 2020

Articles

In his final years, United States Supreme Court Justice Robert H. Jackson worked on a number of autobiographical writing projects. The previously unknown Jackson text that follows this Introduction is one such writing. Justice Jackson wrote this essay in longhand on thirteen yellow legal pad pages in the early 1950s. It is Jackson’s writing about religion in his life.

Passive investors—ETFs and index funds—are the most important development in modern‐day capital markets, dictating trillions of dollars in capital flows and increasingly owning much of corporate America. Neither the business model of passive funds, nor the way that they engage with their portfolio companies, however, is well understood, and misperceptions of both have led some commentators to call for passive investors to be subject to increased regulation and even disenfranchisement. Specifically, this literature takes a narrow view both of the market in which passive investors compete to manage customer funds and of passive investors’ participation in the capital markets.

We respond to this failure by providing the first comprehensive theoretical framework for passive investment and its implications for corporate governance. To start, we explain that to understand passive funds, it is necessary to understand the institutional context in which they operate. Two key insights follow. First, because passive funds are simply a pool of assets, their incentives are a product of the overall business operations of fund sponsors. Second, although passive funds are locked into their investments, their shareholders are not. Like all mutual fund investors, shareholders in index funds can exit at any time by selling their shares and receiving the net asset value of their ownership interest. Consequently, the sponsors of passive funds compete on both price and performance with other investment options—including other passive funds as well as actively managed funds—for investor dollars. As we explain, this competition provides passive fund sponsors with a variety of incentives to engage with the companies in their portfolios. Furthermore, the size of the major fund sponsors and the breadth of their holdings affords them economies of scale that not only justify engagement economically but also enable them to engage effectively.

An examination of passive investor engagement in corporate governance demonstrates that passive investors behave in accordance with this theory. Passive investors are devoting greater sophistication and resources to engagement with their portfolio companies and are exploiting their comparative advantages—their size, breadth of portfolio, and resulting economies of scale—to focus on issues with a broad market impact, such as potential corporate governance reforms, that have the potential to reduce the underperformance and mispricing of portfolio companies. Passive investors use these tools, as opposed to analyzing firm‐specific operational issues, to reduce the relative advantage that active funds gain through their ability to trade.

We conclude by exploring the overall implications of the rise of passive investment for corporate law and financial regulation. We argue that, although existing critiques of passive investors are unfounded, the rise of passive investing raises new concerns about ownership concentration, conflicts of interest, and common ownership. We evaluate these concerns and the extent to which they warrant changes to existing regulation and practice.

An injunction against libel, backed by the threat of prosecution for criminal contempt, is like a miniature criminal libel law—just for this defendant, and just for statements about this plaintiff. That is its virtue. That is its danger. And that is the key to identifying how the First Amendment and equitable principles should constrain such injunctions.

Although previously considered rare, over three hundred startups have reached valuations over a billion dollars. Thousands of smaller startups aim to follow in their paths. Despite the enormous social and economic impact of venture‐backed startups, their internal governance receives scant scholarly attention. Longstanding theories of corporate ownership and governance do not capture the special features of startups. They can grow large with ownership shared by diverse participants, and they face issues that do not fit the dominant principal‐agent paradigm of public corporations or the classic narrative of controlling shareholders in closely held corporations.

This Article offers an original, comprehensive framework for understanding the unique combination of governance issues in startup companies over their life cycles. It shows that venture‐backed startups involve heterogeneous shareholders in overlapping governance roles that give rise to vertical and horizontal tensions between founders, investors, executives, and employees. These tensions tend to multiply as the company matures and increases the number of participants with varied interests and claims. This framework of startup governance offers new insight into issues of current debate, including monitoring failures by startup boards and late‐stage governance complexity, and suggests that more attention should be paid to how corporate law principles apply in the startup context.

Comments

Let’s make a deal. You pay me $200,000 for a four-year experience with no guarantee you will enjoy it or profit from it. During those four years, you are bound by the rules I write—and I may change them unilaterally and without notice. This deal must be accepted as is; there shall be no negotiating terms. If you don’t make this deal, you will likely be consigned to minimum wage work. Should you challenge in court any action I take, a judge will apply existing caselaw that instructs him or her to defer to my specialized judgment and my interpretation of the agreement. Do we have a deal?

Most death row inmates today face execution by lethal injection through a series of compounded lethal drugs. Compounded lethal drugs are mixed by individuals at local shops according to their own specifications and are widely regarded to be less safe than manufactured drugs. These drugs receive little government oversight in their production. Although the Food and Drug Administration (FDA) has statutory authority to regulate compounded lethal drugs, it has consistently refused to do so. Non‐regulation of compounded lethal drugs has contributed to a disturbing series of botched executions. Non‐regulation of compounded lethal drugs also poses profound dangers to the public.

The FDA can refuse to regulate these drugs because the law insulates its inaction from judicial review. While courts regularly conduct arbitrary and capricious review of agency enforcement actions, they are far more reluctant to review agency inaction. In fact, the Supreme Court has created a presumption against judicial review of agency inaction.

The presumption against judicial review seems unreasonable when the stakes are so high for death row inmates and the public at large. Although the presumption against judicial review may be a sound principle generally, the FDA’s refusal to regulate compounded lethal drugs is the kind of agency inaction that one might think necessitates at least some judicial scrutiny.

I therefore propose creating a narrow avenue of judicial review for cases like these. My rule, what I will call “discrete look,” identifies opportunities for judicial review that are sensible and manageable for the courts to engage in, while also keeping these avenues sufficiently narrow to respect the underlying policy rationales of the existing doctrine. Under discrete look, when death row inmates sue the FDA for its failure to regulate compounded lethal drugs, courts can no longer treat the FDA’s inaction as an exercise of unreviewable enforcement discretion.

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