15 Special Interests at the Gate: The ALI Corporate Governance Project, 1978–1992

Corporate law and corporate governance are not the same thing. They overlap at some points but not at others. Their relationship is complicated and evolves dynamically. No one-line statement can summarize it.

Corporate law is the cases and statutes pursuant to which all corporations are formed and operated. Corporate governance, which tends to matter only in larger corporations, starts with the cases and statutes and adds best practices enunciated by policy entrepreneurs and endorsed by constituent communities. Corporate law sets out a framework within which private actors can create and operate their own producing organizations. Corporate governance is a field of action on which managers, employees, financial interest holders, and other constituents allocate power in large producing corporations. Corporate law facilitates the imposition of management accountability when it sets out rights and duties pursuant to which litigants can hold those in charge of corporations responsible for their defalcations. Corporate governance imposes accountability as investors and managers go back and forth in the ongoing allocation of control. Where corporate law facilitates productive investment of capital, corporate governance wrestles with dollars and cents investment outcomes. Although some experts specialize in one or the other, many do both. Indeed, there is significant overlap not only as regards the cast of characters but the terms and dynamics of regulation. Within the area of overlap, however, lawyers and business people tend to emphasize different things. Where lawyers tend to connect governance to accountability, with an emphasis on legal accountability, business people associate it with productive efficiency, seeing no necessary tie to legal accountability.

So close are corporate law and corporate governance that a novice observer could be forgiven the assumption that the two have always travelled together as natural and inevitable concomitants of production in large firms. But such is not the case. Where corporate law has always been there, corporate governance appeared as a concept only in recent history. The concept coalesced during the early 1970s¹ in reaction to a perceived deficit in management performance.

Corporate governance quickly became a topic of general concern during those early years, even as its more particular contents were heavily contested. There was a politics. To the left stood progressives who saw corporate governance as an institutional vehicle with a potential to facilitate social reform. To the right stood corporate managers themselves, ever ready to suborn the new construct, rendering it innocuous and leaving intact their own privileges and prerogatives. The space between the left and the right was occupied by moderate voices looking for enhanced management accountability within the inherited institutional context.

In 1978, the American Law Institute (ALI) launched a Corporate Governance Project (the Project) intended to yield a focal point statement of the meaning and content of corporate governance, taking a middle ground perspective. The idea was to articulate extralegal governance principles along with restatements or revisions of the parts of corporate law that bear most directly on governance, integrating the two toward the end of enhanced management accountability. Unfortunately, a moderate perspective did not assure a moderate response as the Project went forward. Far from providing a focal point for general agreement respecting the content of corporate governance, the Project became a platform for the rearticulation of points of dispute, especially on the question whether legal accountability entailed a sacrifice of productive efficiency.

The goal of an enduring focal point statement would have proved elusive even in a more harmonious context, for the meaning and content of corporate governance has evolved dynamically. The 822-page Principles of Corporate Governance: Analysis and Recommendations (the Principles), finally approved by the ALI’s members in 1992,² very much reflects the political economic dispensation that prevailed at the time of the Project’s origin. Things look very different today. That said, the Project’s progenitors by no means wasted their time as they inched their way through a hostile environment to complete their task. The Principles stood (and continue to stand) head and shoulders above the rest of the literature as the best treatise ever produced on corporate law.³ The Principles also stood (and continue to stand) as the formal source of the monitoring model of the corporate board of directors, the model that continues to dominate thinking both in corporate law and corporate governance.

This chapter recounts the Project’s origins and evolution.

Although corporate governance was a new topic of concern at the time of the Project’s initiation in 1978, management accountability was not. Adolf Berle and Gardiner Means famously had problematized it in The Modern Corporation and Private Property,⁴ published in 1932. Berle and Means described a separation of ownership and control—the shareholders owned but could not control, due to dispersed holdings and resulting collective action problems. Managers accordingly wielded considerable power in the economy and the polity without the accountability that befalls a conventional property owner operating in a traditional product market.⁵

Berle and Means’s structural account would endure. But policy concerns about management accountability would ease, a least for a while. As economic expansion succeeded depression and war, corporate managers came to enjoy great prestige. They were seen as the successful planners behind the postwar boom.⁶ Their considerable power was thought to follow ineluctably from organizational expertise. Moreover, even as structural impediments had foreclosed the possibility of effective market control,⁷ the post–New Deal regulatory state was seen to have made up the deficit, adequately controlling the managers’ behavior and keeping them responsive to constituent demands.⁸ Berle, writing during the postwar period, came to see managers, constrained by the threat of regulation, as quasi-civil servants.⁹

All of this caused corporate law to fall back from the policy margin. Indeed, it came to be viewed as a backwater. In 1962, Bayless Manning, one of the era’s prominent corporate law academics, pronounced corporate law dead as a field of intellectual effort, a dry-as-dust doctrinal inheritance lacking in policy salience.¹⁰

The managerialist era ended during the 1970s. The first blow came with the demise of the once great Penn Central railroad in 1970. The company’s passive and inattentive board of directors figured prominently in the causal postmortem.¹¹ The bad news compounded when the economic bill for the Vietnam War came due in 1972 and 1973. The economy went into a severe recession aggravated by the Mideast oil crisis even as inflation increased.¹² The stock market collapsed with the economy and spent a long time in recovery—there would be no money to be made investing long term in equities for a decade. The appearance of international competition in manufactured goods added to the stock of chronic problems.¹³ The malaise undermined the economic assumptions of the managerialist era.¹⁴

The public service gloss also faded. The New Deal political coalition that created and maintained the strong regulatory state fell apart. Managers, formerly cooperative in the face of overwhelming state power, defected. No longer afraid of noncompliance, they skirted regulatory boundaries and played a hostile game against regulatory initiatives. Accountability concerns crystallized when corporate “questionable payments” were uncovered in the Watergate investigation. At company after company secret slush funds had been channeled into domestic political contributions and bribes of foreign officials.¹⁵ CEOs and board members consistently denied any knowledge. A governance gap needed to be filled accordingly. Legal compliance came to be seen as a part of top management’s job, right up there with business planning. And the job was not being done.¹⁶

The conceptual framework surrounding large corporations underwent a substantial change. The happy story of managers as capable technocrats who enhanced social welfare under the watchful eye of the big stick state no longer resonated. It had become difficult to associate management power with either productive efficiency or responsiveness to constituent needs. The separation of ownership and control came back to the forefront as a problem in need of solution.

Corporate governance was invented to tackle the job. The role of the board of directors, long seen as a moribund institution,¹⁷ was reconsidered. We should, it was thought, give the board a more focused job description, assigning it the task of monitoring management performance. If boards could be induced to monitor successfully, corporate performance would improve.¹⁸ The monitoring function in turn required independent directors and a committee structure keyed to monitoring functions.¹⁹ The approach, fully developed in Melvin Eisenberg’s The Structure of the Corporation,²⁰ which appeared in 1976, caught on quickly.

The burning question concerned implementation. Progressives backed a preemptive federal incorporation scheme, variously suggesting minimum standards of conduct and stepped-up liability,²¹ a universal and mandatory director independence requirement, and an expanded shareholder franchise.²² Bills were introduced in Congress and hearings held.²³

The progressives had become manifestly frustrated—they were dissatisfied with the level of new regulation and outraged by corporate noncooperation even as they despaired of marshaling political backing for new initiatives.²⁴ Policy entrepreneurs looked to governance institutions for reform platforms. For them, director “independence” meant putting like-minded types onto corporate boards with socially responsible results.²⁵ Federal incorporation was a wedge intended to open up this possibility.²⁶

The corporate establishment went on the defensive. It conceded the need for monitoring boards populated by independent directors, even as it vigorously opposed new federal governance mandates. Managers and their lawyers cleaned house.²⁷ To assist them, the corporate committee of the American Bar Association (ABA) put out a guidebook for effective board monitoring.²⁸ Even the Business Roundtable (BRT), the club comprised of the CEOs of the two hundred (or so) largest companies, pronounced in favor of independence and monitoring.²⁹ By the time the New York Stock Exchange, pressured by the Securities and Exchange Commission (SEC), in 1977 amended its rules to require an independent audit committee, 90 percent of public companies already had made the change.³⁰ The ALI Project, approved by the Council in May 1978, was viewed as part of this defensive response—a private legal organization would pursue a private solution to the governance problem, thereby defusing the threat of new regulation.³¹

The Project’s eventual Chief Reporter, Melvin A. (Mel) Eisenberg of Berkeley Law, and its chief public defender, the ALI’s President from 1980 to 1993, Roswell B. (Rod) Perkins, would later insist that the Project was indistinguishable from any other ALI undertaking. The ALI no longer limited itself to common law subjects, having successfully taken up securities and tax. Corporate law had long been one of the topics on its back burner.³² The Project, they said, should be seen as having risen to the top of the ALI’s agenda in the ordinary course.³³ But the conventional wisdom was otherwise, closely linking the Project with the politics of the day.³⁴

As it happened, federal incorporation stalled and faded on Capitol Hill, the Congress limiting itself to the insertion of a monitoring mandate within the Foreign Corrupt Practices Act of 1977.³⁵ The Project proceeded nonetheless, with Ray Garrett Jr., a prominent Chicago lawyer and former SEC chairman, as Chief Reporter and Harvey Goldschmid of the Columbia Law faculty as Deputy Chief Reporter. John C. (Jack) Coffee Jr., of Columbia Law, and Mel Eisenberg would join as Reporters.³⁶ Upon Garrett’s death in 1980, Stanley A. Kaplan of the Chicago Law faculty, a senior and much-revered member of the business law professoriate, succeeded as Chief Reporter. There also were forty-four Advisers, of which ten with particular expertise in the subject matter³⁷ were to take a leading role as “consultants.” A three-year timetable was projected.

The Reporters went forward, their output denominated “Principles of Corporate Governance and Structure: Restatement and Recommendations.” The pace was slower than anticipated. Tentative Draft No. 1³⁸ (TD No. 1) appeared in advance of the ALI’s 1982 Annual Meeting. Its sections were drafted in the mode of model legislation and tended to begin with a pronouncement that “corporate law should provide,” signaling mandates as the outcome in view.

TD No. 1’s recommended mandates included, inter alia, the following:

TD No. 1 promptly became the most controversial document in the history of American corporate law. The controversy had started even before TD No. 1 was published. In January 1982, Andrew Sigler, the CEO of Champion International and chair of the BRT’s corporate governance task force, circulated a letter to BRT members encouraging them to oppose the ALI’s proposals⁵⁰ with the objective of stopping the Project. The stated justification was political. The Project stemmed from the 1970s effort to deflect federal incorporation proposals. Since any such threat had dissipated, new tactics were called for. Cooperation should cease: the BRT should shelve its own previous pronouncements on the composition and structure of boards; the pronouncements were no longer needed and always could be pulled down and dusted off in case of a resurgence of anti-managerial activism.⁵¹ Sigler followed up the letter with a choice quote in a New York Times piece run in the wake of that year’s ALI Annual Meeting. The Project, he said, was “a ludicrous imposition of an unworkable method by a bunch of people who don’t know anything about it.”⁵² Walter Wriston, the CEO of Citibank, also had a zinger ready: “We don’t require four law professors to tell us how to run our business. They aren’t restating the law, they’re trying to change the way corporations operate. It’s not a Restatement, it’s a ‘prestatement’ of what they think the law should be, and it shows a complete misunderstanding of how the process operates.”⁵³

The BRT, having thus stated its ultimate objective in advance of TD No. 1, targeted TD No. 1 more specifically in a bill of particulars in February 1983.⁵⁴ This was a seventy-page takedown prepared by a team at the law firm of Weil, Gotshal & Manges under the leadership of the firm’s crack litigator, Dennis Block, and its high-level adviser to boards of directors, Ira M. Milstein.⁵⁵ The Weil team, following the BRT line, went for the jugular and recommended that the Project be abandoned in its present form.⁵⁶ Its BRT Statement was otherwise a kitchen sink document. But some leading themes were clear enough:

The preceding points and variations thereon would be repeated over and over by a range of opponents for the remainder of the Project’s gestation.

The BRT, in sum, did a volte face on corporate governance. This move, while sudden and audacious, could hardly have been thought surprising. The CEOs were only doing from the right what progressives already had been doing from the left with federal incorporation initiatives—trying to capture this new thing called corporate governance. (Indeed, from management’s point of view, the progressive federal incorporation push had been aimed at wresting away lawmaking territory—the drafting and enactment of state corporate codes—captured by management long before.⁶³) Once the progressives exited the policy stage after 1980, the managers had no further interest in cooperating with policy entrepreneurs interested in structural adjustments that constrained the managers’ freedom of action. Independent directors and audit, nominating, and compensation committees were here to stay. But so long as “independence” was loosely and congenially defined and numerical mandates were avoided, “independent” boards could be populated with fellow CEOs and other sympathetic types, denuding any threat to management autonomy.⁶⁴ The Project, as embodied in TD No. 1, manifestly sought to rouse corporate law to foreclose this tactic, mandating the structural standards devised during the 1970s to make boards independent in fact. Such an initiative threatened management’s control not only of board composition but of corporate lawmaking, a double-sided loss. The Project accordingly needed to be put down or, failing that, neutralized.

The BRT, as it went into opposition, followed the same take-no-prisoners strategic path its members’ companies had been taking when faced with new regulatory initiatives. And, just as they did with new regulation, the CEOs used corporate lawyers as their agents of opposition. Corporate lawyers who also happened to be ALI members were persons of particular interest. There were meetings, lobbying campaigns, and get-out-the-vote drives. Attendance grew at the ALI’s Annual Meeting, as did the number of corporate types on the membership roster. It was later even rumored that corporate clients were retaining ALI members to represent their views within the ALI, while law firms that supported the Project were losing corporate clients.⁶⁵ Rod Perkins, speaking at the 1991 Annual Meeting, urged the members to leave their clients at the door so as to “preserve our integrity as an organization.”⁶⁶

The ALI had initiated the Project on the assumption that corporate governance, like contract and tort law, was, as Rod Perkins put it, “a field in which rational and dispassionate analysis and clarification … could fruitfully be brought to bear by the ALI.”⁶⁷ Now the BRT and its agents were mooting just the opposite. To its credit, the ALI stuck to its guns and proceeded with the Project. Its resolve was signaled when Perkins took the lead in rebutting the BRT’s charges. He reached out to his fellow business lawyers, asking them to endorse the subject matter’s suitability and thereby confirm the Project’s legitimacy.⁶⁸ The initiative eventually proved successful—the Project came to enjoy widespread support among the members. Perkins would not, however, manage to tamp down interest group jockeying and insulate the Project in a cocoon of reason and probity—the BRT’s neutralization campaign would continue to the end. But he did manage to steer the ship in that direction and finally guide it to port in 1992.⁶⁹

High tension prevailed during the period 1982 to 1984, as those responsible for the Project retreated on substantive points and regrouped their forces. No vote was taken on TD No. 1 at the 1982 meeting and the Project was omitted entirely from the 1983 Annual Meeting agenda, reappearing with extensive revisions the following year. Final approval was (optimistically) set back to 1987, with Perkins assuring his corporate law constituents that all points were contingent until final votes were taken.⁷⁰ Meanwhile, a special subgroup of the Project’s Advisers who also held seats on the ALI Council was designated to work with the Reporters to “help shape issues for the consideration of the Council.”⁷¹ The subgroup’s membership imported an establishment imprimatur at the highest level—it included Judges Henry Friendly and Charles Breitel, Lloyd Cutler (a Dean of the Washington bar), two other partners from large law firms, and a former chair of the ABA’s business law section. Interestingly, this concessionary process refinement never really left the drawing board—the special subgroup never met with the Reporters.⁷²

Meanwhile, no corresponding concessions were made regarding the composition of the Project’s Advisers. That group would remain substantially the same from the Project’s inception to its conclusion. Not so with the Reporters. Kaplan stepped down as Chief Reporter in 1984 to be replaced by Mel Eisenberg. The post of Deputy Chief reporter was phased out even as Harvey Goldschmid stayed on as a Reporter. Two new Reporters were added, Marshall Small, who was just ending a term as the chair of Morrison & Foerster, joined in 1982, and Ronald (Ron) Gilson of the Stanford Law faculty joined in 1984.

These process concessions did not placate the Project’s opponents. They wanted more, for it was turning out that the ALI was an uncongenial territory for collateral attack. The opponents complained that there was no opportunity early in the drafting and approval process for intervenors to impose binding directives on or otherwise corner the Reporters.⁷³ Opponents could of course make motions at the Annual Meeting. But that was proving to be too late in the game. Time constraints at the meeting limited room for maneuver. And, in any event, the membership tended to be supportive of the Project,⁷⁴ a membership the overwhelming majority of which knew little or nothing about corporate law.⁷⁵

The opponents had a point, but not much of one, for a special input channel for the business bar already had been conceded, albeit a tightly institutionalized one. The council of the business law section of the ABA designated an Ad Hoc Committee on the ALI Corporate Governance Project, called CORPRO. CORPRO was granted access to the Reporters and the Council for the purpose of registering comments and criticisms.⁷⁶ CORPRO’s members put the grant to use, commenting on every draft and in the end exerting a stronger influence on the Project’s terms than did the Advisers and Consultants.⁷⁷ They assigned themselves the role of ameliorating the expertise deficit identified by the BRT, for, unlike most of the Reporters, they were experienced business lawyers privy to the inner workings of “real life” corporations.⁷⁸

CORPRO’s participation had a double-gestured aspect. On the one hand, it operated as an opposition party with an agenda. As such, its members did not bring their experience and skills to the Project in the spirit of dispassionate analysis and clarification. They instead pursued an agenda grounded in existing cases and statutes, protesting every departure therefrom. They wanted the Principles to be shorter, simpler, and as closely tracking the Model Business Corporation Act (MBCA) as possible.⁷⁹ They would eventually claim responsibility for a list of modifications in the Principles’ terms.⁸⁰ But they would never be satisfied, and at the final bell would formally register “disappointment” regarding the remaining distance between the Principles and the MBCA.⁸¹ On the other hand, CORPRO’s members, particularly those who also were ALI members, acted as a loyal opposition. As such, they engaged constructively with the Reporters, working out drafting compromises as a way of settling points of dispute.⁸² The more it worked in this mode, the more CORPRO brought the corporate bar inside the Project’s tent, enhancing the Project’s legitimacy.

The two years of retrenchment ended with the appearance of Tentative Draft No. 2 in April 1984 (TD No. 2). It contained revisions of TD No. 1’s provisions on corporate purpose, board structure, and the duty of care. The section on corporate purpose emerged more or less unscathed. Elsewhere there were high-profile concessions. The first of these appeared on the cover page, where the title of the Project had been changed to negate the claim to status as a statement of positive law. What had been a “Restatement and Recommendations” was downgraded a notch to an “Analysis and Recommendations.”⁸³ Downgrading continued in the sections on governance structure. The description of the board’s duties⁸⁴ and the audit committee requirement⁸⁵ now more closely tracked the terms of existing corporate codes and the stock exchange rules.⁸⁶ Moreover, the majority disinterested board was no longer something the law “should” provide. It was instead recommended as a matter of good corporate practice in a section no longer printed in the boldface type that signified a black-letter pronouncement.⁸⁷

The statements of the duty of care and business judgment rule also underwent modification. Where TD No. 1 had required that a director “make reasonable inquiry when acting upon corporate transactions” and “be reasonably concerned with the existence and effectiveness of monitoring programs, including law compliance programs,” TD No. 2 substituted a more vaguely phrased duty that the director be “informed with respect to the subject of the business judgment to the extent he reasonably believed to be appropriate under the circumstances.”⁸⁸ The board’s duty to monitor legal compliance—the great governance result of the questionable payments scandals—was consigned to the comments. The rational basis requirement remained, but only for a year. Tentative Draft No. 4 would substitute a more conditional and slightly subjective requirement that the director “rationally believes that his business judgment is in the best interests of the corporation.”⁸⁹ Thus phrased, the statement of the business judgment rule was approved at the 1985 Annual Meeting.

The concessions did not silence the Project’s opponents. But they did contain them. The Reporters, by stepping back from their preferred formulations and yielding to widely expressed concerns, concretely demonstrated openness and responsiveness to outside inputs. The Project’s legitimacy was thereby reconfirmed and the BRT accordingly frustrated in the achievement of its primary objective.

The 1984 Annual Meeting also occasioned the first appearance of the Principles’ provisions on the duty of loyalty, contained in Tentative Draft No. 3 (TD No. 3). These sections took hold of three sets of components: (1) the processes attending internal corporate approval—disinterested director approval, shareholder approval, and ex post ratification, (2) litigation burdens of pleading and proof, and (3) three variant standards of judicial review—business judgment, fairness, and waste. The sections combined the components into a complete and integrated sequence of instructions for adjudication of loyalty issues. Each of the field’s core fact patterns got a separate, tailored treatment—director and officer self-dealing transactions,⁹⁰ transactions between corporations with interlocking boards,⁹¹ compensation grants,⁹² use of corporate position, property and information,⁹³ corporate opportunities,⁹⁴ and competition with the corporation.⁹⁵

The assembled instructions were, simply, a tour de force. No one before had thought these matters through in this thoroughgoing way. Now, the sections did not restate the law. They could not have done so given a set of complete instructions as the end in view, for the law charitably could have been described as sketchy and more accurately would have to have been described as confused.⁹⁶ The Reporters, faced with a doctrine in disarray, took up the building blocks and did the job themselves, making explicit what was inchoate in the cases and statutes.

Nor would the sections become the law, putting aside the adoption of the corporate opportunity section by the Supreme Courts of Oregon⁹⁷ and Maine.⁹⁸ But that should not interfere with our appreciation of the Reporters’ accomplishment. Even if one did not concur with a particular result or treatment, the whole stood forth as invaluable resource—a compendium of the doctrinal choices and policy possibilities attending any and all cases in the field. This was ALI work product at its best. The duty of loyalty now had a conceptual framework and could never be the same again.

The core provision covered self-dealing transactions. It contained a trio of innovative terms:

Features (1) and (2) would survive into the Principles’ final version.¹⁰⁴ Feature (3) would be watered down, extending the quasi business judgment standard to ex post ratification on the condition the failure to obtain ex ante approval was excusable and had not resulted in injury to the corporation, and the corporation furthermore had had a representative on its side of the contract.¹⁰⁵ The sections’ original title also would be modified. TD No. 3 termed the sections “the Duty of Loyalty,” which was of course perfectly accurate. The title was later downgraded to the “Duty of Fair Dealing” at the behest of CORPRO.¹⁰⁶ In this case, it was the Reporters who stood on the side of the law and the ABA factotums who stood on the side of radical change. In 1984, even as the Reporters were rationalizing the terms of the duty of loyalty for the first time, the drafters of the MBCA were removing the term “fiduciary” from their code and commentary¹⁰⁷ on the ground that it unjustifiably heightened expectations about the character of management duties and encouraged plaintiffs.

One can see how the Reporters and the Council could be amenable to accepting this change, for innovation was what the Project was all about. One wishes they had resisted. Although only a change of denomination, it was not just rhetorical. It cut off today’s bundle of management duties from their historical antecedents, removing the notion of a selfless trustee from the conceptual baseline and substituting the standard of conduct appropriate for a self-interested contracting party. There comes a point where such a shift makes a difference.

In the event, the drafters of the MBCA went back to their own statute five years later¹⁰⁸ to make it crystal clear that disinterested director approval results in business judgment as the standard of review for a self-dealing transaction.¹⁰⁹ One wonders whether the earlier appearance of a stricter ALI treatment had causative role.

The sections on the duty of loyalty (by then termed the duty of fair dealing) came up for extended discussion at the 1986 Annual Meeting. Judge Frank Easterbrook took the floor to moot a conceptual expansion of Section 5.09. The section extended the standards of review applied to director and shareholder approval to advance directives in charters and bylaws that sanctioned self-dealing arrangements. The question, said Easterbrook, was this: “[T]o what extent is a corporation fundamentally a contract among a large number of sophisticated and commercial venturers, and to what extent is it a form imposed by external law.”¹¹⁰ Section 5.09 gave weight to the latter answer, for it allowed for modification of fiduciary duties by contract but not complete elimination. Easterbrook wanted to open a much wider door for modification in initial charter provisions and charter amendments inserted prior to initial public offerings.¹¹¹

With this intervention the Project directly encountered the nexus of contracts corporation, the deregulatory project of corporate law’s law and economics movement, and with it a different form of challenge. Easterbrook and his Chicago Law colleague Daniel R. Fischel had a corporate governance project of their own, a theoretical project grounded in Jensen and Meckling’s famous microeconomic model of corporate organization.¹¹² In the Jensen and Meckling model, private contracting and stock market pricing combined effectively to control management agency costs, but did so only given strict, unrealistic assumptions. Easterbrook and Fischel expanded the model to accommodate the real-world corporate governance framework. The field of private contracting grew accordingly, encompassing not only the face-to-face bargaining but also corporate law itself and internal corporate legislation enacted over time.¹¹³ Easterbrook and Fischel also expanded the set of market controls of agency costs. In addition to stock market pricing as employed in the model, they relied on the market for corporate control, the product markets, and executive labor markets. In the emerging “contractarian” picture, the four markets operate together to assure agency cost minimization on a multiperiod basis.¹¹⁴

Two claims about corporate law followed. First, there should be a presumption against having any more of it than already exists. Because rational actors arrange governance in contracts and markets price the contract terms, legal mandates are justifiable only in the unlikely event that “the terms chosen by firms are both unpriced and systematically perverse from investors’ standpoints.”¹¹⁵ Second, the inherited corporate law regime is economically rational,¹¹⁶ justifying a strong normative presumption in its favor. The two claims, taken together, ratified corporate law’s status quo, a natural result in a framework asserting the evolutionary dominance of maximizing arrangements.

A fundamental critique of the Project followed. Easterbrook (accurately) described it as an attempt finally to solve the problem of separated ownership and control described by Berle and Means by transferring power from unaccountable managers to better incented actors such as independent directors and judges.¹¹⁷ But, in Easterbrook’s view, Berle and Means had diagnosed incorrectly in the first place—there was no structural problem of misaligned incentives. Managers operated under competitive constraints and were accordingly accountable to the market; investors bought their interests at prices discounted for residual agency costs.¹¹⁸ Fischel added a retrospective look at the formative events of the 1970s. Since when, he asked, did a handful of bankruptcies and a slush fund scandal imply a productive crisis for corporate capitalism? Bankruptcies just meant that markets were working properly and the payments, while questionable from a public policy point of view, had been made for the benefit of the shareholders.¹¹⁹ Another law and economics scholar, Judge Ralph Winter, suggested that charter competition assured consonance between investor interests and the terms of corporate law.¹²⁰ He added that the Project was behind the times, academically speaking. It represented a single academic viewpoint, a viewpoint that had come in for serious challenge.¹²¹ Others opined similarly.¹²²

An alliance of convenience¹²³ emerged between the BRT and its agents and the contractarian academics, with the academics fleshing out the BRT’s points about the unsuitability of legal analysis,¹²⁴ costs and benefits,¹²⁵ and the need for empirical support.¹²⁶ There were differences in motivation, of course. Where the CEOs criticized the Project as part of a multifront fight to preserve their own insulation, the professors saw the Project as an ancillary front in the fight for paradigmatic dominance within the academy.

The contractarians did score academic successes, precipitating fundamental changes in the way academics view corporate law. Henceforth, policy discussions would proceed in a microeconomic framework importing a healthy skepticism about potential perverse effects from new regulation (if not a blanket presumption disfavoring new regulatory initiatives to control management). There also would be an openness to considering private contracting and market correction as solutions to governance problems (if not a blanket presumption favoring private contracting and market control). But things worked out differently for contractarianism as regarded the Project’s more particular concerns. Management accountability continued to take primary place as corporate law’s central policy concern. Furthermore, the blanket characterization of everything in corporate governance as contract would be deemed insufficiently robust to justify turning corporate law into a thoroughgoing default regime. In the consensus view, fiduciary duties would have to remain mandatory because proxy voting did not offer a process context suited to effective noncompetitive transacting.¹²⁷

The takeover wars of the 1980s raged in the background while the Project went through the drafting and approval process. They impacted corporate law and governance in novel and fundamental ways. The takeover boom denuded management of insulation from market pressure, demonstrating the power and transformative potential of capital market inputs for the first time since the early twentieth century. The takeovers also brought forward the shareholders as the primary corporate constituents, ushering in a new era of solicitude of their interests, an era that continues today.

Perhaps in recognition of the background turmoil, the Principles’ section on corporate control transactions, introduced in 1990 in Tentative Draft No. 10,¹²⁸ adjusted the drafting mode. The Council¹²⁹ and the Reporter, Ron Gilson, opted for principles over rules, erring on the side of general statement and eschewing sequences of precise instructions. The general statements, in turn, were minimal:

Some thought the corollary recognizing other constituent interests out of step with the law on the books, but that was arguable. More pointed opposition came from the management interest and the mergers and acquisitions bar, which variously worried about fine points of state law conformity, questioned how the sections impacted on practitioners advising parties to control transactions, or argued for language parroting that of the Delaware cases.¹³⁴ There was also a question whether the subject matter should be omitted entirely as unripe.¹³⁵ The sections were sent back to the Reporters, who presented them again in substantially the same form in 1991.¹³⁶ Approval followed in the ordinary course.¹³⁷

Why were takeovers relatively easy in comparison with the Project’s other topics? The principles-based drafting certainly helped. But one suspects that the interest group alignment also mattered. The alliance of convenience between the managers and the contractarians dissolved on this topic. Where the managers wanted hostile takeovers shut down, the contractarians saw a robust control market as an essential constraint in lowering agency costs. Business interests fragmented as well. Capital favored takeovers because it liked the premium payoffs they entailed. Only the managers opposed reasonableness review. But the law on the books no longer favored that position. Moreover, the Reporters’ concession regarding nonshareholder interests left the managers considerable running room.

The ALI saved the thorniest bit—the sections on shareholder derivative actions—for last. These implicated the day-to-day practices of more than a few of the ALI’s members, which included plaintiffs’ lawyers in addition to inside and outside corporate counsel. The sections also traversed one of the fault lines on which progressives and conservatives invariably differ—the use of litigation as a regulatory tool.

The Reporters had put their broad view of the matter on the table in TD No. 1: private enforcement and judicial review were essential parts of an effective duty of loyalty regime. They never wavered on the point. They also held to their view, expressed in section 7.03 in TD No. 1,¹³⁸ that dismissal of well-pleaded derivative actions by special committees of independent directors should be subject to substantive judicial review. The successor section maintained this position, doing a more nuanced job of drawing a line between business judgment constraint and direct review: if the action concerned a duty of care violation, the business judgment shield covered it; if the duty of loyalty or takeover defense were implicated, dismissal could be sustained only on a finding that the board “reasonably determined that dismissal was in the best interests of the corporation, based on grounds that the court deems to warrant reliance.”¹³⁹

This bifurcated approach was repeated on the other great issue of the day—the treatment of the “demand requirement.” This had originated as a sensible means of assuring that the board had notice and an opportunity to take over what was in the end the corporation’s cause of action. It had evolved into a backdoor (and jerrybuilt) way to slip board-level enforcement decisions concerning duty of loyalty defalcations into the business judgment zone.¹⁴⁰ Under the Project’s approach, the board’s refusal of the plaintiff’s demand ripens into a case for dismissal of the complaint only when the underlying transaction or conduct already lay in business judgment territory. With a complaint alleging a breach of the duty of loyalty, the board’s refusal of the demand is reviewed under the same intermediate standard applied to the board’s approval of the action or transaction in question.¹⁴¹ As it happened, the final version of the section in question was a compromise initiated by CORPRO with the cooperation of the Reporters.¹⁴²

One final blast from the BRT would follow,¹⁴³ once again drafted at the Weil Gotshal firm.¹⁴⁴ It objected to comments on the section added after the approving meeting by the Reporter, Jack Coffee, on the ground that they undercut the Black Letter. Those involved supported the Reporter¹⁴⁵ and the shot went wide. One wonders why it was taken.

Commentaries published at the time of the Project’s completion described failures. The pattern of attack and response was presented as evidence of a misstep: the ALI had strayed from its historical doctrinal role to enter the politicized world of public policymaking, a place where rational and dispassionate analysis and clarification are not the usual mode of proceeding. Unseemly interest group machinations came with the territory, so it was no good bemoaning their presence.¹⁴⁶ At the same time, the Project’s critics were said to have made fair points about methodological and process limitations.¹⁴⁷ Corporate governance was about efficient production as well as legal accountability. The Project had been short on expertise respecting the former and excessively weighted toward the latter.¹⁴⁸

These points were fair. They ring hollow today even so. The ALI, far from retreating to safe places, continues to enter politicized precincts, dealing with interest group inputs in the ordinary course. There is an inevitable sacrifice of authoritativeness,¹⁴⁹ but no apparent loss of legitimacy. The fact that such a project lacks the gravitas of a traditional restatement surprises no one, least of all its Reporters. Furthermore, in a world saturated with interest group machinations it matters more than ever to have an institution that provides protected space for rational and dispassionate analysis by accomplished members of the legal profession. The ALI may not be perfect when viewed through a public choice lens, but it still comes forth as the best we have in an imperfect world. Rod Perkins and the Reporters were right to stay the course, doing things the way they are done at the ALI.

The Principles, viewed with the benefit of hindsight, got a lot of things right. The duty of care, as enunciated by the Delaware courts, now has an emphatic and mandatory compliance component.¹⁵⁰ The distinction between standards of conduct and standards of review introduced in the Principles’ articulation of the duty of care and the business judgment rule also has entered the law. The Principles’ corporate purpose statement remains cogent even in light of a recent burst of scholarly commentary on the topic. For this author, no one yet has offered anything better. Finally, and most importantly, the monitoring model has triumphed, becoming mandatory early in this century through stock exchange rules backed up by provisions of the Securities Exchange Act of 1934.

But that very triumph also requires us to situate the Principles in their own time. Monitoring has won on the ground in part due to the appearance of investment institutions as empowered actors in corporate governance. They are nowhere to be seen in the Principles because they all followed a passive strategy at the time of the Project’s inception and had only recently become active at the time of its completion.¹⁵¹ The Reporters accordingly did not “miss” investment institutions, leaving a “gap” in the Project. It was just that they worked against a dynamic background which was changing materially even as they put down their pens.

The subsequent developments cast new light on the interest group machinations and policy conflicts surrounding the Project. There turn out to be winners and losers. On the loss side we find management. The BRT has lost its fight to preserve its own prerogatives, a loss that came at the hands of activist institutional shareholders rather than lawyers. The burden of persuasion at the policy table is now on the BRT. If it wants to retrieve the lost ground, it must show that insulation enhances long-term value, something it has not done. On the winning side we find the Reporters themselves. The Principles would look even better today had the Reporters’ original vision been respected and the round of concessions in TD No. 2 never been made. Ironically, the contractarians join them on the winning side, for it now is clear that market constraints substantially can reduce agency costs. Moreover, shareholders now pay so much attention to governance as to import tractability to the idea of universal opting out. This does not, however, mean that the contractarians were right at the time of the 1986 Annual Meeting. It would take a couple of decades before the institutional conditions necessary for shareholder intervention in business planning finally coalesced.

But coalesce they did. No sensible observer models shareholders as helpless anymore. Negative implications follow as regards representative litigation’s role in corporate governance. Not that anyone suggests that derivative litigation be abolished. It is just that few view the continued accretion of procedural barriers as a mighty policy problem.

One last change should be noted: the emergence of Delaware as a source of quality corporate law and of Delaware jurists as central figures in corporate governance discussions. Of course, Delaware played the same leading role as corporate charterer and fiduciary adjudicator back in 1978 that it plays today. But, back in 1978, Delaware also widely was viewed as having been captured by management. The progressives, with their federal incorporation drive, recently had sought (unsuccessfully) to put it out of business as a corporate lawgiver. Thus did Delaware present a problem for the Project, a problem the Reporters elided as they hewed to the middle of the road. Certainly, the Principles would privilege neither Delaware case law nor the Delaware code. But, at the same time, any structural attack on Delaware was avoided—the Reporters enunciated corporate law principles without focusing on the background of charter competition. At the same time, actors from Delaware got no special place at the Project’s process table. There was only one Delaware jurist¹⁵² and no Delaware lawyer among the Project’s Advisers.¹⁵³

If the Project had been initiated in 1992 rather than in 1978, this quiet exclusion of Delaware would have been inconceivable. By then Delaware’s Chancellor William T. Allen had emerged as the country’s leading corporate law judge. During the 1980s, he and his brethren had reinvented the Delaware fiduciary law applicable to mergers and hostile takeovers, taking it in a direction that balanced management and capital interests. The Delaware jurists simultaneously reached out and joined the national governance discussion, taking leading roles. Their successors continue the enterprise, keeping their own fiduciary law closely attuned to the interests and views of both management and capital.

They have at the same time taken it further and further away from the exhaustively articulated template in the Principles, accepting business judgment review of disinterested director approval¹⁵⁴ and moving to broad standards and case-by-case scrutiny on all the facts.¹⁵⁵ So far their experiment seems to be succeeding. No negative implications for the Principles follow, however. Recent innovations in Delaware case law presuppose a governance framework grounded in director independence and inclusive of active shareholders. They accordingly could not have been undertaken before the second decade of this century.

We shall see how these developments influence the Restatement of Law, Corporate Governance, a new ALI project which recently produced its first Tentative Draft.¹⁵⁶ The titular change is noteworthy. What was seen as practice four decades ago, triggering controversy respecting appropriateness as ALI subject matter, now has the status of law.