III. Critical Junctures Theory: A Synopsis
Given that the crash-then-law and punctuated equilibrium accounts of corporate law change each suffer from limitations, it is appropriate for another batter to step up to the plate. A critical junctures model stands out as a contender worth considering. “The goal of the critical juncture framework is to address . . . questions of when, why, and what,” which are points where current models of corporate law change come up short to varying degrees.
A. The Critical Junctures Model Comes to the Fore
Critical junctures theory’s academic pedigree can be traced back at least to the early 1990s. Nevertheless, a 2007 article by Giovanni Capoccia and Daniel Kelemen stands out as a particularly “important . . . contribution” that “offered valuable conceptual and terminological clarity.” Following its publication “[t]he critical junctures conceptual literature . . . flourished,” taking “a deeper analytical turn.”
The critical junctures model has now gained a firm foothold in the social sciences. Topics canvassed have included the development of regional institutions in East Asia, the promotion of industrialization policy in mid-twentieth century Latin America, the formulation of Mexico’s macroeconomic policy, and the Eurozone crisis afflicting the European Union in the wake of the 2008 financial crisis. Much has been done in the process “to make the critical juncture a more rigorous concept.” The critical juncture has in turn emerged in the social sciences as “an important analytical concept to explain incidences of institutional change,” fostering in the process a “better understanding derived from a deeper appreciation of the nature of change.”
In contrast with the social sciences, the critical junctures model’s impact on legal scholarship has been negligible. Law professors frequently use the term “critical juncture” informally as a synonym for a turning point, as Gelter and Puaschunder did when they suggested that COVID-19 could bring big changes to corporate governance. However, legal academics have referred to the critical junctures model itself only sparingly and in passing. Given that the “framework has been highly productive—for many scholars over several decades,” critical junctures merits consideration as a theory for explaining change with respect to corporate law. The next two sub-parts of the paper provide necessary context by summarizing the model’s key features, initially by defining critical junctures and then by rounding out the framework by canvassing key points relating to it.
B. Defining Critical Junctures
In order to think through changes to corporate law in terms of critical junctures it is necessary to define what constitutes a critical juncture. Capoccia and Kelemen noted in their influential 2007 article that “[m]any scholars define critical junctures on the basis of their outcome, namely, change.” They argued it was necessary to go further and emphasized in so doing the “structural fluidity and heightened contingency” involved with critical junctures. Capoccia and Kelemen correspondingly defined “critical junctures as relatively short periods of time during which there is a substantially heightened probability that agents’ choices will affect the outcome of interest.”
Subsequent definitional efforts similarly associate a critical juncture with a window of opportunity when substantial change comes on to the agenda. Political scientist Hillel Soifer, in a 2012 article that “formalized the causal logic of critical junctures,” said “[c]ritical junctures are marked by heightened contingency, or increased causal possibility.” Capoccia, in a 2016 chapter on critical junctures, spoke of “moments of openness for radical institutional change.”
Capoccia’s “moments of openness” terminology draws attention to another feature of definitions of critical junctures. This is duration—the length of the time period where change is in the cards. The emphasis has been on brevity. In a 2017 article that sought to map out a methodology for studying critical junctures, David Collier and Gerardo Munck describe one element of a critical juncture as “a major episode of institutional innovation.” Others defining critical junctures have referred to “concentrated periods,” “trigger events,” and “episodes or events.”
A legacy of change also features with some regularity in definitions of critical junctures. While critical junctures themselves should be relatively brief, there should also be a meaningful outcome that stands the test of time. The point has been made in various ways. Collier and Munck say a critical juncture generates “an enduring legacy.” Others have suggested there should be a “paradigm shift in policy.” Or critical junctures should “set an institution’s development onto a certain path, which then ensures, through self-reinforcing feedback, its own reproduction over time.” In other words, what makes junctures “critical” is that “they generate path dependence.” Certainly the effects of the change should last longer than the critical juncture that prompted the change in the first place. Capoccia and Kelemen say on this “the duration of the critical juncture must be brief relative to the duration of the path-dependent process that it initiates.”
In the legal context, the most obvious type of “enduring legacy” will be substantial legislative reform. A legislature will typically be much better positioned to recast the law substantially than the judiciary. Judges can only act after litigants have commenced court proceedings and operate within the confines of case law precedent in a way legislators do not.
Normally a legislative legacy will be associated with increased regulation, but substantial change can run in the opposite deregulatory direction. Which direction will change go? The famous neoliberal economist Milton Friedman suggested “[o]nly a crisis—actual or perceived—produces real change. When that crisis occurs, the actions that are taken depend on the ideas that are lying around.” It follows that if the ideas “lying around” are market-friendly when a critical juncture occurs, the legacy could well be deregulatory. Indeed, social activist Naomi Klein has suggested: “Friedmanites stock-pile free market ideas” they try to foist quickly upon crisis-racked polities before there can be a reversion to the status quo. Whatever the merits of this “shock doctrine” thesis, a major shift to market-oriented neoliberalism in Mexico in the early 1980s marked by privatization and deregulation is thought of as being the product of a critical juncture in that country.
C. Rounding Out the Critical Junctures Framework
Teasing out a definition of critical junctures yields important insights regarding the formulation of a critical junctures framework that can be deployed to analyze changes to corporate law. There is a set of issues, however, associated with critical junctures that merit elaboration to round out the critical junctures framework before we turn to corporate law. These relate to the frequency of critical junctures, the chronological proximity between a putative critical juncture and the change of interest, and the relationship between critical junctures on the one hand and external shocks and the prospects for transformative change on the other.
1. How Common Are Critical Junctures?
Critical junctures are a departure from the norm, occurring outside the ordinary course of events. As Capoccia and Kelemen have said, “the critical juncture constitutes a situation that is qualitatively different from the ‘normal’ historical development of the institutional setting of interest.” Capoccia, writing on his own, has suggested a critical junctures perspective is not applicable “if institutions are constantly vulnerable to piecemeal modification and reinterpretation and their shape changes continuously in accordance with shifts in power and influence among the relevant actors.” In short, critical junctures analysis does not account for routine change.
2. How Soon Does the Change Have to Occur?
A critical juncture need not be simultaneous with the change of interest. As sociologist Taylor Boas has suggested, “[t]he emergence of the legacy may also be temporally removed from the critical juncture itself.” However, if whatever change occurs is not roughly proximate in time with the catalyst for change then it is unlikely that a critical juncture will be involved. Under such circumstances, there will not be the short-term cause that should be present. As Capoccia and Kelemen note, if an explanation for change “relies on a cause that has a relatively long-term time horizon, then it is highly unlikely that a critical juncture framework will be applicable.”
3. Will a Major Shock Always Yield a Critical Juncture?
Potent external events such as an economic crisis or a natural disaster increase the likelihood that critical juncture-style change will occur, whether in the legal realm or more broadly. Indeed, theories of institutional change often put exogenous shocks (“focusing events”) center stage. But will a shock necessarily amount to a critical juncture? Law professor Steven Ramirez has suggested “yes,” at least in relation to financial crises, saying they “invariably lead to federal intervention.” In fact, shocks do not always yield the enduring legacy associated with critical junctures. Instead, substantial “institutional change is obviously not a necessary response to such events.” Indeed, possibly “[m]ost crises are followed either by policy continuity or by incremental change, not critical junctures.” Circumstances where a shock or crisis occurs and a critical juncture does not follow on “may be seen as analogous to a missed opportunity.” But there will be no critical juncture.
4. Is a Critical Juncture Necessary for Transformational Change?
“Causally important events” do not have to be associated with a critical juncture. According to political scientists John Hogan and David Doyle, “[s]ometimes there are no wars, or other great events . . . that can be held to account for dramatic policy and/or structural changes.” Substantial policy innovation thus can occur as part of a “concentrated” or an “extended” episode. Only the former, however, can be part of a critical juncture. A critical juncture will not be involved if substantial change occurs over a prolonged period, featuring “smaller steps that eventually add up to a major transformation.”
IV. Corporate Law’s Critical Junctures—The Big Three
Academics who have analyzed changes to U.S. corporate law by reference to crash-then-law and punctuated equilibrium patterns have focused on three episodes of federally oriented legislative change: the introduction of federal securities law, SOX, and Dodd-Frank. What explains the occurrence of these bouts of regulatory reform, this corporate and securities law “big three”? A sharp drop in share prices has been implicated, but there have been other bear markets. As we will see now, the critical junctures framework fills in the gaps.
A reader familiar with the basic jurisdictional terrain for corporate law might wonder how federal reforms come into play at all. Corporate law is a state-based affair, with companies incorporating under the laws of one of the fifty states rather than under a federal statute. The U.S. Supreme Court said in 1987 in CTS Corp. v. Dynamics Corp. of America “[i]t thus is an accepted part of the business landscape in this country for States to create corporations, to prescribe their powers, and to define the rights that are acquired by purchasing their shares.” From this departure point law professor Mark Roe has observed:
If one were only to skim the doctrinal surface, one might think there was a sharp divide between state and federal corporate authority: states govern internal corporate affairs, while the federal robemakers, via the SEC, govern the external trading of the firm's securities.
Despite “the doctrinal surface,” as Roe and various other legal academics have argued, federal authorities can make corporate law and quite often do so. The corporate and securities law “big three” stand out in this regard.
Again, a critical juncture involves a relatively short period of “structural fluidity” that yields significant change with lasting consequences. With each of the big three, there was a shock that created the necessary “moment of openness” followed in reasonably short order by substantial legislative changes that endured. Hence, each was a corporate law critical juncture episode. The nature of the critical juncture was similar moreover in each instance. There was a prolonged stock market slump associated with allegations of corporate misconduct that fostered the belief that reform was necessary and weakened otherwise potentially influential opponents of substantial change. A succinct summary of each of the big three corporate law critical junctures demonstrates these points.
A. The Introduction of Federal Securities Law
The introduction of federal securities law in the mid-1930s was the first of the big three, and on various counts the biggest. The enactment of the Securities Act of 1933 and the Securities Exchange Act of 1934 underpinned the most extensive corporate governance-related reform wave ever in the United States. From a corporate law perspective, the 1933 and 1934 Acts marked “the starting point” with “federal law developments that have replaced or supplemented areas traditionally within the purview of the states.”
It is doubtful whether Congress intended when enacting the 1933 and 1934 Acts to authorize federal securities regulators to interfere in the management of companies. Nevertheless, the potential significance of federal securities law from a corporate law perspective has been recognized for decades. In a 1961 SEC opinion in an administrative broker-dealer disciplinary proceeding that “set in motion the modem law of insider trading,” SEC chair William Cary said the federal securities laws had created “a wholly new and far-reaching body of Federal corporation law.” And this potential subsequently was amply fulfilled. Mark Roe argues “[m]uch securities regulation impinges on or overturns state corporate governance rules” and cites as a key example shareholder voting, saying it is “perhaps the core ‘internal affair.’ Lawyers who work on corporate voting and proxy solicitations operate primarily not under state law but under the 1934 Securities and Exchange Act's federal proxy law, which transformed most voting rules into federal rules.”
The most dramatic bear market in American history and the traumatic onset of the Great Depression set the scene for the 1930s enactment of federal securities legislation. In 2020 Morningstar, an American financial services firm, released a report on seventeen instances occurring over the previous 150 years where share prices had declined by 20 percent or more. Morningstar graded the downturns in accordance with a “pain index” that measured “the severity of each market crash in a way that takes into account both the degree of the decline and how long it took to get back to the prior level of cumulative value.” Morningstar said amongst this cohort of bear markets “[t]he 79 per cent loss due to the crash of 1929, which led to the Great Depression,” was “the worst drop on the chart.” That decline took place over a period of nearly three years, running from the market peak in August 1929 to May 1932. The downward spiral began in earnest in September 1929, followed by a 13.5 percent decline on October 28 of that year (“Black Thursday”) that was the largest single day loss ever until “Black Monday” in October 1987.
And the pain endured. Only in the mid-1950s did stock prices recover fully from losses inflicted between 1929 and 1932. Not surprisingly, according to Morningstar, the 1929–32 crash was the worst occurring over the 150 years it canvassed. Accordingly, this crash was assigned 100 percent on Morningstar’s “pain index,” with other bear markets’ percentages representing how closely they matched its level of severity.
“Mainstream” corporate law enacted at the state level was largely unaffected by the 1929–32 crash and the associated market turmoil. There was a movement at the time to reform state corporation laws but the priority was to keep locally based businesses incorporated in-state. Substantially bolstering protection of investors side-swiped by the market calamity was not a realistic option for a reform-minded state because if its laws were thought to be insufficiently manager-friendly local corporations would simply reincorporate in Delaware or another hospitable state.
While the stock market devastation occurring between 1929 and 1932 did not markedly affect state corporate law, at the federal level the trauma did much to create the structural fluidity associated with critical junctures. When Franklin Roosevelt took office after winning the 1932 presidential election, it was, according to Joel Seligman’s history of the SEC, “that rare time when money talked and nobody listened.” The highly distressed economic conditions played a key part in setting the scene for the introduction of federal securities law. Reports of business wrongdoing also played a significant role, however.
Congressional hearings on the operation of securities markets that ran from 1932 to 1934 with lead counsel Ferdinand Pecora playing a starring role did much to create the narrative in favor of federal regulation by discrediting Wall Street. According to Seligman, by the time of the enactment of the 1933 Act “Wall Street and business in general were on the defensive, daily embarrassed by the Pecora investigation’s revelations.” The charges Pecora leveled may have been exaggerated in material respects. Moreover, there were more obvious culprits for the 1929 crash and the ensuing economic turmoil than Wall Street chicanery, such as acute late 1920s investor overconfidence, imprudent lending by commercial banks, and missteps by the Federal Reserve. Nevertheless, in contrast with numerous attempts earlier in the twentieth century to regulate corporations at the federal level that failed, the Pecora hearings’ tales of corporate and financial skulduggery combined with the harsh market conditions to create the “increased causal possibility” associated with critical junctures. Quoting Seligman again: “[I]n spite of the severity of the stock market crash, effective securities legislation might not have been enacted had Pecora’s revelations not galvanized broad public support for direct federal regulation of the stock markets.”
The Securities Act of 1933 focused on securities being sold to the public for the first time and in relation to these required the submission of prescribed financial information, prohibited material misstatements, and created a number of private remedies for aggrieved purchasers. The 1933 Act contemplated Federal Trade Commission (FTC) oversight of securities markets. The Securities and Exchange Act of 1934 relieved the FTC of this regulatory responsibility by creating the SEC. The 1934 Act also broadened the regulatory net considerably. With respect to investor protection, the 1934 Act went beyond the issuance of securities and imposed periodic reporting requirements on companies with securities traded on a national stock exchange and barred fraud and market manipulation with respect to the purchase and sale of securities of such firms. The legislation also provided for oversight of the marketplace for securities—stock exchanges—including giving the SEC authority to approve stock exchange listing rules.
With respect to corporate law, the enactment of the 1933 and 1934 Acts threw into sharp relief the potential for federal intervention into the states’ traditional corporate law space. That potential was only partially fulfilled for the remainder of the twentieth century. The post-1934 regulatory pattern was generally assumed to be one where Congress focused on correcting public markets for shares and bonds by way of disclosure and anti-fraud rules (“securities law”) and left “corporate law” relating to the internal affairs of companies to the states. Hence, with some notable exceptions—proxy voting, insider dealing, and takeover regulation—“corporate law” relating to the internal affairs of companies was a state matter. SOX, discussed next, would be a game-changer in this regard, demonstrating an unprecedented federal willingness to regulate corporate internal affairs.
Alan Greenspan, chair of the Federal Reserve from 1987 to 2006, said of the stock market in the second half of the 1990s: “[H]i-tech excitement brought extra sizzle to what was already a hot market for stocks.” The 2000s would be a much different proposition, amounting to a “decade from hell” for the public company. The gloom set in promptly as the decade got underway. The 1990s stock market frenzy ended in the first half of 2000 and the economy fell into recession for much of 2001. The Dow Jones Industrial Average accordingly declined 36 percent between January 2000 and September 2002 and the S&P 500 dropped 48 percent between March 2000 and September 2002. The S&P 500 only made up the lost ground fully eighty-six months later, at the end of May 2007.
The bear market of the early 2000s would, in combination with scandals involving Enron, WorldCom, and a number of other high-profile public companies, set the scene for regulatory change. Leo Strine, then Vice Chancellor of the Delaware Court of Chancery, said state policymakers would “not block their ears” to calls for reform but ultimately his influential corporate law state would “stand pat.” Change would instead occur at the federal level, in the form of the second of the corporate and securities law “big three,” the Sarbanes-Oxley Act of 2002.
Law professor Robert Thompson suggested in 2004 that with SOX and associated revisions to the listing rules of the New York Stock Exchange and its rival NASDAQ corporate America had “experienced . . . something like a hundred-year flood of reform.” Key reform topics SOX addressed included boards and executive conduct. With boards, SOX mandated listing rule changes that required a listed company to have an audit committee composed entirely of independent directors, prescribed the formal duties of audit committees, and obliged a listed company to offer an explanation if its audit committee lacked a member who was a financial expert.
As for executive conduct, SOX prohibited public corporations from giving loans to their top managers. The legislation also required the chief executive officer (CEO) and chief financial officer of a publicly traded corporation to attest together with the corporation’s auditor that the corporation had a robust internal financial control system and to certify personally the accuracy and completeness of quarterly and annual financial reports filed with the SEC. Knowingly false certifications were deemed punishable by criminal penalties. Executives could also be required to give back bonuses received after the filing of inaccurate financial reports that failed to comply with securities law requirements.
Despite imposing various new requirements on public companies and their executives and directors, SOX did not constitute a radical departure from past practice. Instead, it built on existing federal regulations, state laws, and corporate governance conventions. On the other hand, SOX marked a substantial change in approach for the federal government in the corporate context.
The federal securities laws enacted in the mid-1930s amounted to the first meaningful federal foray into the corporate law realm but this was a tentative jurisdictional intrusion. Hence, despite periodic twentieth century federal incursions into corporate law territory, SOX stood out. The nature and depth of SOX’s corporate law content “upset settled expectations.” According to Mark Roe,
With Sarbanes-Oxley in 2002, Congress did not even pretend to stay on the disclosure-and-trading side of the rhetorically traditional federal-state division of power, not even offering perfunctory respect for state rules governing the corporation’s internal affairs.
Hence, with respect to the division of labor between the states and the federal government with the making of corporate law there was a paradigm shift that would have the sort of lasting consequences associated with critical junctures.
SOX also fit within the critical junctures framework because reform occurred promptly following a concentrated episode that set the scene for change. Corporate scandals were important in this context. The bear market that began in 2000 could be blamed on flaky internet start-ups and a subset of excitable investors getting ahead of themselves. Hence, as David Skeel has pointed out, purely in relation to the dot.com bust “there were no calls for dramatic reform of American business.” Enron’s scandal-ridden collapse in the second half of 2001 implied, however, all was not well in corporate America and the scandal put downward pressure on the stock market as investors shunned companies known for Enron-like opacity. A reform bandwagon grew accordingly but, as the shock of Enron’s collapse began to fade, inertia began to undermine the prospects for meaningful reform.
WorldCom’s sudden collapse in mid-2002 would provide the decisive final push in favor of reform. The fraud’s brazen nature and WorldCom’s notoriety—it was better-known pre-scandal than any other scandal-afflicted company—put opponents of reform squarely on the back foot. As Skeel has said, “[t]he WorldCom collapse changed everything.” President George W. Bush in turn forsook previous calls for regulatory caution, hailing when signing SOX “the most far-reaching reforms of American business practices since the time of Franklin D. Roosevelt.”
The impact corporate wrongdoing such as WorldCom’s had on the reform equation in the early 2000s has been widely acknowledged. Law professor Robert Hamilton wrote in 2003 that “a steady drumbeat of embarrassing disclosures . . . contributed to a sudden and sharp decline in stock prices and to a significant decline in consumer confidence in the honesty and efficiency of . . . American business” and “an unexpected result of these developments” was that SOX “suddenly acquired legs.” Roberta Romano suggested similarly in 2005 “the window of opportunity for advocates of the corporate governance provisions included in SOX” opened because of “a shift in public mood regarding big business, coinciding with the high profile corporate scandals causing significant displacement and financial distress, as well as a sharp decline in the stock market.”
While SOX emerged as a result of the opening chapter of “the decade from hell” for the public company, the Dodd-Frank Act was the product of the jarring final chapter in the 2000s—the financial crisis of 2008. In critical juncture terms, there can be little doubt that the economic trauma associated with the financial crisis gave rise to “heightened contingency, or increased causal possibility.” As such, the crisis “sowed the seeds of ” Dodd-Frank, one of the most complex laws Congress has ever enacted. What is less clear is whether in the area of corporate law Dodd-Frank fostered the sort of transformational change associated with critical junctures. This is because the legislation was concerned primarily with overhauling financial regulation, particularly with respect to banking. In combination, however, with provisions in the 2012 JOBS Act that relaxed for smaller business enterprises various securities law requirements associated with issuing securities to the public, the legislative legacy of the financial crisis of 2008 pretty clearly is sufficient to qualify for corporate law critical juncture status.
Following on from a “credit crunch” in 2007, the financial crisis hit with dizzying strength in the fall of 2008. Numerous prominent banks either collapsed outright or had to be saved by a “rescue merger” at distress prices. Economic activity declined 8.4 percent in the fourth quarter of 2008. 2008 would end up the worst year for the S&P 500 since 1937 and the worst for the Dow Jones Industrial Average since 1931. The ensuing recession likely was the most severe since the late 1930s. The S&P 500 did not recover fully until March 2013.
The financial crisis constituted a significant reputational setback for corporate America. There was some criticism of non-financial firms, particularly automobile manufacturers the federal government had bailed out. Financial services companies were, however, the primary target of opprobrium. They were unpopular in part because of aggressive lending that fostered the cratering of the American residential mortgage market, which in turn set off the 2007 credit crunch that set the scene for the financial crisis. Efforts to rescue crisis-afflicted banks with government financial support exacerbated public misgivings. It appeared as if Wall Street was being bailed out while there was scant relief for Americans suffering the consequences of banker irresponsibility.
The public antipathy toward business played a key role in opening the window for post-financial crisis reform. Stephen Bainbridge wrote in 2011 “populist outrage motivated Congress to pass” Dodd-Frank. Fellow law professor Jack Coffee, having observed that the financial crisis offered “abundant evidence of financial chicanery and fraud that outraged and repulsed the public,” said the enactment of Dodd-Frank “showed hints of the public’s desire for retribution.” Christopher Bruner echoed the same sentiment in a corporate governance-specific context, saying “the emergence of so thoroughly shareholder centric a set of proposals in the wake of the crisis is best understood as one reflection of a much broader populist backlash against managers.”
While the 2008 financial crisis “sowed the seeds” of Dodd-Frank, enactment was hardly a straightforward affair. Economist Alan Blinder, in a 2013 study of the financial crisis and its aftermath, noted that although “[t]he electorate is normally a somnolent body” “the intense public anger over the financial crisis” “was a potent political force to be reckoned with.” Nevertheless, “[a]long the arduous road to passage, reformers had to fight off hordes of bank lobbyists.”
With Dodd-Frank it seems that a specific allegation of corporate malfeasance which David Skeel has christened “the Goldman moment” tipped the balance in favor of enactment. As of April 2010, the fate of the legislation that would become Dodd-Frank had been uncertain for several months. That month the SEC sued investment bank Goldman Sachs, “a principal villain of the financial crisis,” alleging the firm had engaged in securities fraud when in 2007, at the behest of hedge fund titan Paulson & Co., it structured and marketed a synthetic collateralized debt obligation relating to residential mortgages. According to Skeel, “[t]he securities fraud allegations transformed the political landscape, shifting the momentum decisively in favor of the legislation.” In July 2010, President Barack Obama signed the Dodd-Frank Act into law.
Dodd-Frank, taken in its entirety, clearly meets the “significant change” threshold associated with critical junctures. It was described, for instance, as “groundbreaking legislation” that marked “a new epoch in financial regulation.” Dodd-Frank’s status as an agent of change in the corporate law realm is less obvious.
Bainbridge notes that “[c]ompared to some of the proposals floated in Congress following the 2007–2008 financial crisis, Dodd-Frank’s corporate governance provisions were relatively modest.” By his count, only seven sections of the Act specifically addressed corporate governance in publicly traded firms. Even with these, their impact sometimes was tempered. A 2011 judicial ruling against the SEC rendered at least temporarily moot section 971 of the Dodd-Frank Act, which vests the Commission with authority to promulgate a “proxy access” rule giving dissident stockholders seeking board representation the opportunity to communicate to fellow shareholders using proxy documentation their corporations circulate. Moreover, a Dodd-Frank measure obliging stock exchanges to require listed companies to have a board-level compensation committee in place to deal with executive pay was largely superfluous because the New York Stock Exchange and its rival NASDAQ had mandated this since 2003.
While Dodd-Frank’s corporate governance reforms were less impactful than they might have been, the legacy likely was substantial enough for the combination of the 2008 financial crisis and Dodd-Frank’s enactment to qualify as a corporate law critical juncture. Though Dodd-Frank’s treatment of compensation committees was of limited practical importance, its other executive pay reforms were considerably more consequential. The legislation, for instance, bolstered disclosure requirements regarding managerial compensation by instructing the SEC to require an issuer to disclose the annual total compensation of the issuer’s CEO, “the median of the annual total compensation of all employees of the issuer” except the issuer’s CEO, and the ratio of the two amounts. A politically fraught seven-year rule-making process ensued that elicited a level of public engagement virtually unprecedented in the long history of the SEC disclosure regime. It is still too early to say if requiring companies to divulge the CEO/rank-and-file pay ratio will alter compensation practices materially, but the change was significant on its own terms because companies were required for the first time to disclose under securities law information about how they pay their workers.
Another noteworthy Dodd-Frank executive pay innovation was the introduction of a “say on pay” regime giving shareholders of publicly traded companies the right to vote on executive pay policy on an advisory basis at least once every three years. With such resolutions shareholder dissent has been rare. This, however, has partly been due to boards making adjustments to keep investors onside. Shareholders, moreover, are choosy when they dissent, targeting companies delivering poor returns and executive compensation arrangements that seem blatantly over-generous and do little to align pay with performance. More broadly, by introducing say on pay as well as seeking to facilitate proxy access for shareholders, Dodd-Frank moved into largely uncharted territory for Congress—directly empowering shareholders. As law professor Jill Fisch has argued, “Dodd-Frank is different, however. For the first time, Congress has determined that shareholders’ governance rights are insufficient and attempted to increase shareholder power relative to management.”
Given that with respect to empowering shareholders “the Dodd-Frank intrusions, although small, reflect a difference in kind,” and given the attention the CEO/employee pay ratio disclosure initiative elicited, there likely was sufficient change on the corporate and securities law front for the 2008 financial crisis to qualify as a critical juncture with respect to corporate law. The enactment of the JOBS Act in 2012, however, likely resolves any doubts that the crisis and the associated stock market downturn constituted a corporate law critical juncture.
The JOBS Act was deregulatory in orientation. For instance, it expanded the number of institutional shareholders a company could have before needing to register with the SEC as a publicly traded company and gave smaller companies seeking to raise capital scope, as compared with standard federal securities law requirements, to provide less historical accounting data and to disseminate more impressionistic information (e.g., research reports and promotional materials). Law professor Usha Rodrigues maintains that because of the JOBS Act’s deregulatory nature it was not enacted in response to the 2008 financial crisis. The deregulatory nature of the JOBS Act is unproblematic from a critical junctures perspective; the enduring policy legacy of a critical juncture clearly can be market friendly. Somewhat less clear is the connection between the JOBS Act and the financial crisis of 2008, given that outcomes with critical junctures need to be proximate in time with the precipitating event. Still, the consensus appears to be that despite a four-year gap the JOBS Act was a product of the 2008 financial crisis, with the legislation constituting an attempt to improve increase access to equity capital with banks having retrenched after the meltdown.
V. Identifying Potential Additional Market-Driven Critical Junctures
We have now seen that the introduction of federal securities law in the mid-1930s, SOX, and Dodd-Frank were all associated with corporate law critical junctures. We will now assess whether there are other critical junctures to add to the list. This will be done by deploying two filters: (1) identifying economic traumas occurring since 1900 akin to those that served as critical junctures for the “big three” to ascertain whether the financial turmoil was associated with major changes to corporate law; and (2) canvassing corporate law developments at the state level to see if there were additional instances of rapid, substantial change akin to the “big three.” We deploy the first filter in this part of the article and the second in Part VI.
To anticipate, there are no additional fully fledged corporate law critical junctures. With the economic traumas this part canvasses, none elicited major changes to corporate law. This was either because the market conditions were not as severe as with the “big three” or because corporate misbehavior did not feature prominently. Correspondingly, the public indignation and investor dissatisfaction that created momentum in favor of reform with the “big three” and put entrenched interests on the back foot were absent. As for corporate law developments at state level, Part VI indicates that the changes either took place too slowly or were insufficiently broadly based to amount to fully fledged critical junctures.
In October 1907 a failed attempt to “corner” the shares of the United Copper Company triggered a Wall Street panic which prompted uncertainty amongst investors, drove various well-known brokerage houses, banks, and trust houses to the wall, and stoked concerns about the soundness of the banking system. A rescue operation investment banker J.P. Morgan famously orchestrated stemmed the chaos. Was the panic of 1907 severe enough to create regulatory possibilities? While historian Robert Wiebe says it “acted as a catalyst in the political ferment,” the 1907 panic was not sufficiently traumatic to be a corporate and securities law game-changer. Instead, the financial system promptly returned “to a remarkably stable condition until the commencement of World War I.” The nature of the stock market downturn had much to do with this.
Unlike the 1929 stock market crash and the 2008 financial crisis, the panic of October 1907 marked the end, not the beginning, of the bear market with which it was associated. The decline that culminated in the October 1907 panic began in mid-1906. As measured by the Dow Jones Industrial Average, the market sustained losses of 9.7 percent in March 1907 and 8.2 percent in August 1907, coinciding with an economic slowdown the United States experienced. The market hit bottom in November of that year before beginning to recover. All of the lost ground was recaptured by August 1909. According to Morningstar’s stock market “pain index,” which again measures bear markets by reference to the size and duration of the share price decline, the panic of 1907 only ranked eighth in severity over the past 150 years.
With the panic of 1907 winding down quickly, the statutory legacy was fairly meager. Congress, aware of “the crude expectation” there would be a law passed that “would prevent the possibility of future panics,” enacted the Aldrich-Vreeland Act in 1908. This “product of a few days struggle at the end of the session” introduced a scheme that eased the issuance of currency in financial emergencies and created the National Monetary Commission, which generated in 1912 recommendations that led to the enactment of the Federal Reserve Act of 1913.
Even the modest progress made with regulating the financial system ultimately would be substantial compared to corporate law. A plea that President Theodore Roosevelt made to Congress as the panic of 1907 abated to provide for national chartering of corporations fell on deaf ears. A bill introduced to the Senate in late 1907 governing the incorporation and regulation of companies engaged in interstate commerce fell by the wayside, as did a similar bill introduced in early 1908. A 1910 bill that would have provided for voluntary federal incorporation met the same fate.
Again, the stock market crash of 1929 scores no. 1 on the “pain index” Morningstar constructed in 2020 to rank stock market declines of 20 percent or more occurring over the previous 150 years. Number 2 on the list was a stock market decline Morningstar deemed to begin in June 1911 and end in December 1920, with the peak-to-trough decline being nearly 51 percent. Morningstar, mindful of the COVID-19 pandemic, said “[t]his market downturn . . . may be most relevant to today’s situation, since it included the influenza pandemic of 1918.” Share prices of firms traded on the New York Stock Exchange indeed were negatively correlated with the death rate of the “Spanish Flu” that would persist until early 1920.
While the 1918 influenza pandemic apparently did put downward pressure on share prices, the stock market generally performed well. The Dow Jones Industrial Average increased 10.5 percent in 1918 and 30.5 percent in 1919, meaning 1919 was its ninth best year between 1915 and 2020. As Robert Shiller, a leading expert on share prices, said at the outset of the COVID-19 pandemic, based on analysis of a historical dataset of his:
the stock market in the United States did not crater when, in September–October 1918, the news media first started covering the Spanish flu pandemic that eventually claimed 675,000 US lives (and over fifty million worldwide). Instead, monthly prices in the US market were on an uptrend from September 1918 to July 1919.
Why did stock prices hold up well despite share prices being negatively correlated with the influenza epidemic death toll? Part of the explanation is that “a lot of other stuff was happening then—namely, World War I.” In particular, the good news associated with the ending of the conflict in late 1918 likely helped to cancel out the bad news associated with the pandemic. Moreover, with the 1918–19 flu pandemic, “the economic impact was surprisingly mild.” Many people could work largely uninterrupted in jobs that did not involve close social contact, such as farming, fishing, and forestry. Also, while most major cities imposed bans on large public gatherings,
it was exceedingly difficult to get an urban population to stay at home. People needed to work so they could eat; parents wanted their children to go to school; businesses dependent on customers, whether department stores or movie theater operators, did not want to close down.
Investors were similarly phlegmatic in their approach to the influenza pandemic. While there was downward pressure on share prices, not once did stock prices move up or down 2.5 percent or more in a day due to influenza outbreaks or policy responses to such outbreaks.
Stocks did fall dramatically on either side of the 1918–19 flu pandemic. In 1917, share prices dropped substantially due to the imposition of restrictions on the economy associated with America’s entry into World War I. Stock prices also fell in 1920 and much of 1921, with the Dow Jones Industrial Average declining by nearly one-third in 1920 alone. This bear market aligned with trends in the real economy, which experienced perhaps the most severe bout of deflation in American economic history. The stock market did not rally as promptly as it did following the panic of 1907. It would take until the end of 1924 to recover fully from the decline occurring from November 1919 through to August 1921.
The 1920–21 downturn was severe enough to set the scene for some regulatory change at the federal level on the corporate front. The Revenue Act of 1921 substantially relaxed tax rules governing mergers and acquisitions as part of an effort to stimulate corporate reorganizations and thereby foster business activity amidst the economic slump. There also were legislative proposals that foreshadowed the enactment of securities legislation in the 1930s. A 1921 bill introduced to the Senate would have required corporations launching public offerings of securities to register with the FTC and to disclose prescribed information before going public. A 1922 House measure would have fortified state “blue sky” laws governing securities offerings by prohibiting the use of the facilities of interstate commerce to sell securities in a state unless there had been compliance with that state’s blue sky law. It turned out, though, “the climate . . . was not yet amenable to widespread support for these laws,” so no legislation was enacted. Ultimately, then the regulatory legacy was far too modest for a critical juncture to be involved.
Why? The 1920–21 bear market clearly was painful. It was not associated, however, in any meaningful way with business misconduct. The severe economic contraction—some say depression—arose instead due to a surge in agricultural production that drove down commodity prices and fiscal and monetary retrenchment following World War I-driven growth in government spending and borrowing. “[It would be . . . folly to portray business in the 1920s as the knight in shining armor,” given that in 1922 the Teapot Dome scandal broke that would ultimately lead to the conviction of the then Secretary of the Department of Interior for bribery in relation to the granting of lucrative rights to federal oil reserves. Nevertheless, the United States would have to endure the 1929–32 stock market trauma before the political equation changed sufficiently to open the way for the enactment of federal securities legislation.
C. The 1970s
With the stock market crash pain index Morningstar compiled in 2020, 2000–09 was no. 3 on the list following 1929–32 and 1911–20, with Morningstar treating the 2000s as being one long bear market with a peak in 2000 and a bottoming out in early 2009. Number 4 was a precipitous stock market decline of 52 percent occurring between 1972 and 1974 compounded by a gradual recovery that meant stock prices did not reach 1972 levels until 1983. The stock market fell steeply when wage and price controls failed to stem inflation elicited by the 1971 dismantling of the Bretton Woods system of international monetary management and by oil price havoc engendered by a 1973 embargo by Arab oil producers. Coinciding with the bear market, the economy moved into a recession that lasted until March 1975. Time Magazine was asking its readers on the cover of a July 1975 issue “Can Capitalism Survive?” Productivity growth, measured in terms of output per hour, was dismal for the remainder of the decade and as the 1970s ended the economy was stuck in a “great stagflation swamp.”
While the 1929 stock market crash, the early 2000s dot.com meltdown, and the 2008 financial crisis each had a corporate law reform legacy benefiting a critical juncture, this was not the case with the economic misery of the 1970s. Mainstream corporate law reform did come on to the federal agenda in the latter part of the decade. In 1977 the SEC held multi-city hearings on corporate accountability that amounted to its most far-reaching study of corporate conduct up to that point in time. The following year a blue-ribbon congressional advisory committee on corporate governance was struck to consider legislative possibilities, with members including the chair of the board of telecommunications colossus AT&T and the chair/CEO of chemicals giant DuPont.
Despite such corporate law reform initiatives and despite the economic tumult, the legislative output was meager. In 1978 the SEC adopted rules requiring issuers to disclose the existence of board level auditing, nomination, and compensation committees (if any) and the composition of any such committees. Also, while the Foreign Corrupt Practices Act (FCPA) of 1977 would achieve notoriety primarily as an anti-bribery statute, it amended federal securities law to require publicly traded companies to keep accurate books and records and to have a suitable system of internal accounting controls in place. Broader corporate law initiatives fell by the wayside, however.
Corporate America, accustomed to being grudgingly conciliatory when responding to federal regulatory proposals as the 1970s got underway because business was “a four letter word” in Washington, pushed back forcefully as an anti-government mood started to develop as the decade drew to a close. The SEC, for its part, “put on the back burner most of the fundamental issues” its 1977 hearings raised. Bills introduced to Congress in 1980 that would have mandated an independent director majority on boards of large companies and would have required corporate boards to establish audit and nomination committees comprised entirely of independent directors went nowhere.
Why did the travails of the 1970s not yield a more substantial regulatory legacy? The economic news was clearly bad enough; certainly worse than the early 2000s and perhaps the late 2000s as well. What appears to have been lacking was the blameworthy conduct on the part of business that helped to foster the “big three” corporate law critical junctures. To be sure, there were mid-decade revelations of illicit corporate political donations and questionable foreign payments that ultimately prompted the enactment of the FCPA. Public outrage, however, rarely featured. As the New York Times said in 1975, “the most curious upshot of the recent disclosures has been the public’s ambivalent reaction to them.”
Why did business escape blame for the woeful economic conditions prevailing during the 1970s? As the decade opened corporate executives found themselves in the cross-hairs of considerable social ferment. Moreover, subsequent criticism of managerial quality was harsh. For instance, according to a 2004 history of “management hooey” in Fortune “[b]y 1980 American management hadn’t had a good idea in years.” By the end of the 1970s serious concerns about the quality of management of American public companies were beginning to emerge. Up to that point in time, however, the economic malaise was blamed on the 1973 oil crisis and government mismanagement of the economy rather than corporate failings. Indeed, growing skepticism of government would foster a deregulatory movement that flourished in the 1980s. As a result, the FCPA aside, the momentum in favor of regulation did not build in the 1970s in the same way as it did in the 1930s, early 2000s, or late 2000s.
On the thirtieth anniversary of a stock trading day that became known as “Black Monday,” Robert Shiller described October 19, 1987, as “one of the worst days in stock market history.” In the seven weeks prior to Black Monday, the Dow Jones Industrial Average had fallen 17.5 percent from its then record high. On Black Monday itself the Dow dropped a further 508 points, or almost 23 percent, the largest one day decline in history up to that point. Newspaper headlines blared “Crash,” “Bedlam,” and “Panic.” Many wondered whether the same kind of economic depression that followed the 1929 stock market crash was in the offing, fueled by a sense that a day of reckoning was due given supposed excesses of the 1980s.
The New York Stock Exchange responded to Black Monday by amending its rules to put in “circuit breakers” authorizing it to halt trading in response to sharp stock price declines. In general terms, though, “Black Monday didn’t lead to any meaningful reforms.” The immediate market aftermath does much to explain why. The day after Black Monday, Federal Reserve chair Alan Greenspan affirmed the Fed’s readiness to serve as a source of liquidity to support the economic and financial system and the Fed followed up by encouraging banks to lend on normal terms. The markets reacted favorably, with the Dow gaining back 57 percent of the Black Monday losses in two trading sessions. Neither a banking crisis nor an economic recession ensued.
While Black Monday was a shock, by the following year markets were back on a sufficiently even keel for a presidential task force investigating matters to characterize October 19, 1987, as a “market break” rather than a crash or collapse. Less than two years after Black Monday, U.S. stock markets had rallied fully and were hitting new highs. Due in substantial part to this prompt rebound, Morningstar only ranked Black Monday tenth in its 2020 ranking of bear market “pain.” This transitory market disruption in turn proved to be insufficiently traumatic to serve as a critical juncture for corporate and securities law. As we will see in the next part of the article, there were some important state-level changes to U.S. corporate law in the 1980s. They were unrelated, however, to Black Monday.
VI. State Corporate Law and the Critical Junctures Model
Our analysis of corporate law critical junctures has focused thus far on federal reforms. This might seem surprising, given that firms incorporate under state law. We begin this part of the article, which focuses on the state law angle, by explaining why the states do not provide a promising context for the sort of sudden, substantial reform associated with critical junctures. We then consider two instances where change did occur rapidly at the state law level unrelated to a stock market crash but maintain that because of their narrow focus these were no more than “mini” critical junctures. We consider in this context the statutory authorization of inclusion of provisions in corporate charters displacing directors’ personal liability for negligence and the promulgation of state anti-takeover laws.
A. Delaware General Corporation Law/Model Business Corporations Act
Again, a critical juncture involves “structural fluidity” and “an enduring legacy” with the changes being proximate in time to the trigger for “heightened contingency.” It is possible for major change to occur as part of “concentrated” or “extended” episodes but only the former can involve a critical juncture. With state corporate law, change seems destined to be too piecemeal and incremental for full-scale critical junctures to occur. Roberta Romano’s research on the adoption of six statutory measures thought to be hallmarks of modern state corporate law illustrates the prevalence of gradual, interstitial adjustment in this context. She reports that the interval over which these key provisions spread throughout the states after initial adoption ranged from fourteen to ninety-six years.
The incremental pattern is evident with the two most obvious potential agents of critical juncture-style change in the state corporate law universe, namely the Model Business Corporations Act (MBCA) and the Delaware General Corporation Law (DGCL). The MBCA is a model statute promulgated by the Committee on Corporate Laws of the Business Law Section of the American Bar Association that states can adopt substantially or in its entirety. The DGCL is Delaware’s corporate law statute.
The MBCA and the DGCL are the two most influential corporate law statutes in the United States. The MBCA is crucial because more than thirty states have a corporations statute that implements the MBCA in substantial measure, meaning it is “the backbone of U.S. statutory corporate law.” In contrast, only three states (Kansas, Nevada, and Oklahoma) have a statute clearly modeled on the DGCL. The DGCL, however, is by far the most popular corporate legislation amongst America’s largest companies, with Delaware being the home of over 60 percent of Fortune 500 companies.
The MBCA is poorly suited to operate as a transmission mechanism for corporate law critical junctures. Leo Strine, former Chief Justice of the Delaware Supreme Court, has characterized the MBCA as a “refiner” and cited the MBCA’s protracted amendment protocol in a 2011 co-authored article in making the point:
The MBCA’s drawn-out, formal process (three formal “readings” and publication of an exposure draft following the second reading) is not conducive to nimble adaptation, but promotes the clarity of drafting and internal coherence suitable to a model statute.
The MBCA’s history accords with the present-day emphasis on patience and deliberation. The ABA’s Committee on Business Corporations began preparing the first MBCA, issued in 1950, a decade beforehand, and drew heavily on a statute that was nearly a decade old (the Illinois Business Corporation Act of 1933) in so doing. Moreover, the MBCA hardly turned the world of corporate law statutes upside down in the manner that would be expected if a critical juncture were involved. While over thirty states currently have corporate laws modeled after the MBCA, only four states had adopted the MBCA as of 1952, increasing to a modest total of fifteen by 1961.
The DGCL similarly has not served as the medium for wholesale, sudden change on the corporate law front. Strine, in his 2011 co-authored article, cited nine DGCL amendments occurring between 1983 and 2009 that were subsequently introduced to the MBCA to make the point that Delaware was “a more prolific source of innovation in statutory corporate law” than the ABA’s Committee on Corporate Laws. A streamlined amendment process involving substantial delegation to experts helps to explain the pattern. Delaware’s state legislature relies heavily on the Corporate Law Section of the Delaware Bar Association to recommend, review, and draft amendments to Delaware’s corporate statute and amendments proposed in this way typically pass overwhelmingly without debate or adjustment.
While statutory tweaking can happen readily in Delaware, the sort of sweeping alterations associated with critical junctures have never been a hallmark of Delaware’s approach to corporate law. This is by design. Delaware has dominated the state-oriented market for incorporations in part by having reliably manager-friendly corporate law. Delaware’s state constitution mandates that revisions of the state’s corporation code be supported by a two-thirds supermajority vote of both houses of the state legislature. Romano has said “this provision makes it extraordinarily difficult to refashion fundamentally the corporation code's flexible posture—only a critical election that revolutionized state politics could do so.” No such “critical election” has happened. When the Delaware legislature passed an act in 1963 to create a committee to review Delaware’s corporations statute, the legislative preamble specifically acknowledged that there had “been no comprehensive revision of the Delaware Corporation Law since its enactment in 1898.” That review resulted in the enactment of a new statute in 1967, but there has not been a wholesale revision since then.
What about the 1967 revision? The preamble for the 1963 legislation identified the catalyst for the review Delaware wanted to undertake, namely a concern that “many States have enacted new corporation laws in recent years in an effort to compete with Delaware for corporation business.” So, there was no dramatic motivating event of the type associated with critical junctures. Moreover, the Delaware General Corporation Law of 1967 was not meant to be a game-changer. Ernest Folk, whose report to the committee tasked with reviewing Delaware’s corporation law did much to shape the 1967 statute, said the new legislation “was not the wholesale rewriting of the statute that some may think it was.” Instead, according to Folk, the committee to which he reported “made an early decision to change only where necessary, and also to keep as much of the original language as possible, especially where it had a heavy gloss of case-law. The policy of the pre-1967 and the 1967 statutes is identical.” Hence, the sort of sweeping change and lasting consequences associated with critical junctures have been absent in Delaware, at least in relation to its corporate statute.
B. Smith v. Van Gorkom
Even if statutory reforms in Delaware have not risen to the level of a corporate critical juncture, perhaps such a change could have occurred in the Delaware courts. Legislatures are generally much better positioned to execute sweeping change than the judiciary. On the other hand, Jill Fisch has suggested that “the process by which Delaware courts make corporate law resembles legislation in some ways.” Given this, a specific episode in Delaware corporate law history involving a 1985 Delaware Supreme Court decision that elicited substantial change to the personal liability of directors merits analysis as a possible critical juncture.
The Delaware Supreme Court held in Smith v. Van Gorkom that outside directors of a public company were liable to the corporation for breaching duties they owed because they failed to scrutinize sufficiently diligently a merger proposal the company’s CEO had negotiated. Up to that point, instances where directors of business corporations had been held personally accountable for breach of duty without engaging in self-dealing had been “few and far between.” As a result, Smith v. Van Gorkom “exploded a bomb” that “shook the foundations of the corporate world.” The case fostered an immediate re-evaluation of the personal risks of board service and reports of directors resigning and individuals declining invitations to serve on boards abounded. The decision also reinforced uncertainty in a D&O insurance market where premiums were already increasing rapidly, coverage on offer was shrinking, and policy deductibles were on the rise.
Indiana responded to the growing concerns about director liability Smith v. Van Gorkom fostered by amending its corporate law statute in April 1986 to lower the standard of care for directors from negligence to wilful misconduct or recklessness. Delaware went next in July. It took a different approach, authorizing corporations to include a provision in their charters precluding director liability for monetary damages for breaches of duty not involving the duty of loyalty, a failure to act in good faith, intentional misconduct, or a transaction involving an improper personal benefit. By the end of 1987, twenty-nine states had followed Delaware in permitting charter amendments eliminating or limiting directors’ personal liability risk for negligence. The MBCA followed suit in 1990, by which point thirty-six states had adopted Delaware’s approach. As of the early 2000s, the number had increased to forty-five states; all others had followed Indiana’s approach.
Delaware’s response to the perceived director liability crisis was not merely widely imitated by other states. It also proved popular with corporations. Virtually every public company incorporated in Delaware quickly adopted an exculpatory provision in its charter and the pattern was similar with large companies incorporated elsewhere.
With respect to directorial liability, Smith v. Van Gorkom likely qualifies as a “mini” critical juncture. The Delaware Supreme Court’s decision caught most observers off guard, thereby creating the sort of “moment of openness” associated with critical junctures. According to a motion for a rehearing by the defendant directors the decision “shocked the corporate world in its unprecedented holding that knowledgeable directors . . . may be exposed to catastrophic liability . . . where there were no charges or proof of fraud, bad faith or self-dealing.” In turn, the rapid promulgation of statutory measures authorizing the adoption of exculpatory provisions was the sort of concentrated episode of change associated with critical junctures. And reform was consequential. Giving corporations the option to circumscribe monetary liability for breach of duty by directors “was a very big change” that arguably ameliorated materially liability risk directors faced.
While Smith v. Van Gorkom fostered significant changes to directors’ duties, the case does not qualify as a fully fledged corporate law critical juncture. Director liability obviously is an important aspect of corporate law. However, it is just one facet of a much larger legal tapestry. The changes that followed on from Smith v. Van Gorkom correspondingly are not of sufficient general relevance to add the case to the big three of 1930s federal securities law, SOX, and Dodd-Frank. As we will see next, the same pattern arose at the same time when there was “an epidemic-like character to the spread of state anti-takeover legislation.”
C. CTS Corp. v. Dynamics Corp. of America
In corporate America, the 1980s was “the Deal Decade.” Takeover-related activities preoccupied executives, commentators, and the public to an unprecedented extent. The hostile takeover, involving an uninvited and at least initially unwelcome approach, was at the center of discussion. “[F]ear and anxiety” were “lurking in executive suites all over the U.S.” At least with Delaware companies, by virtue of a series of landmark 1985 Delaware Supreme Court decisions, unless the sale of a target company was inevitable, board adoption of defensive measures was protected from judicial review by the business judgment rule if the directors showed there were reasonable grounds for believing that there was a danger to corporate policy and effectiveness and the defensive tactic was reasonable in relation to the threat posed. Nevertheless, corporate executives sought legislative assistance, lobbying states to enact measures designed to curb hostile takeovers. This approach yielded substantial dividends following the Supreme Court’s 1987 ruling in CTS Corp. v. Dynamics Corp. of America. The case correspondingly merits consideration as a possible corporate law critical juncture.
A 1982 Supreme Court decision that struck down an Illinois anti-takeover law discouraged states from enacting statutory measures designed to restrict bids for in-state companies, despite an ongoing flurry of controversial takeover offers. Indiana was an exception. In 1986, it enacted a law providing that when an entity acquired “control shares” by purchasing a large equity stake in an Indiana-incorporated public company that entity could not vote its shares unless the corporation’s pre-existing disinterested shareholders approved.
In CTS Corp. v. Dynamics Corp. of America the Supreme Court upheld Indiana’s new anti-takeover law. The “change of heart” as compared with the court’s 1982 ruling was “a surprise.” According to law professor Dale Oesterle, “[i]t appears that no one, nary a lower federal court nor a commentator, was even close to foreseeing the result in the CTS case.” States wasted little time accepting the Supreme Court’s unexpected CTS invitation to promulgate an antitakeover statute that would survive constitutional challenge. Before 1987 drew to a close, thirteen had amended or enacted anti-takeover laws, often responding to lobbying from local companies facing takeover threats in so doing. Within two years of the CTS ruling, that number had increased to thirty-seven. Delaware fell into line in 1988.
Many felt the new anti-takeover laws “dramatically shifted the balance of power between corporate hunters and their prey.” The new measures in fact were not “absolute show-stoppers” with a hostile takeover bid but they did help to bring the Deal Decade to a close. The Delaware case law that afforded incumbent management substantial latitude to fend off unwelcome takeover bids and “a sudden disappearance of money” due to debt markets tightening also contributed to the demise of the Deal Decade.
With respect to takeovers, CTS Corp. v. Dynamics Corp. of America plausibly qualifies as a “mini” critical juncture akin to Smith v. Van Gorkom with directorial liability. The unanticipated change of direction by the Supreme Court created the structural fluidity that features with critical junctures. Also, the ensuing “epidemic-like” enactment of state anti-takeover legislation fits the critical junctures pattern. Nevertheless, CTS was not a critical juncture for corporate law generally. As with the statutory provisions that reduced liability risk for directors in the wake of Smith v. Van Gorkom, the anti-takeover measures enacted as the 1980s drew to a close were only one cog in a much larger corporate law wheel. The changes 1930s federal securities law, SOX, and Dodd-Frank made, in contrast, took effect across a sufficiently wide range of topics to mean they qualified as fully fledged corporate law critical junctures.
VII. The COVID-19 Pandemic as a Critical Juncture
Up to this point, we have relied on history to explore the extent to which a critical junctures framework provides insights regarding the evolution of corporate law. We have seen that critical junctures analysis builds productively on previous efforts to explain major changes to corporate law by reference to a crash-then-law account and the notion of punctuated equilibrium. In this part of the paper we switch to the present day, drawing on the analysis and evidence Parts IV to VI have canvassed to consider whether the COVID-19 pandemic is likely to provide the catalyst for a corporate law critical juncture.
A. Is It Too Early to Use Critical Junctures Analysis to Evaluate COVID-19?
COVID-19, perhaps the biggest news story ever, has been cited as a historical turning point. USA Today has said “this global crisis has mushroomed into a national defining moment with as yet untallied cultural and economic repercussions. No one questions whether we will be talking about this for generations. If there is debate, it is over the proper historical comparison.” Larry Summers, a Harvard economist, concurs, saying “the coronavirus crisis will still be considered a seminal event generations from now. . . . We are living through not just dramatic events but what may be well be a hinge in history.” Legislative reform could be one legacy. The Economist suggested in the spring of 2020 as pandemic-driven job losses mounted that the trend “will surely facilitate more change than America’s choked political system would otherwise have allowed.” Corporate governance changes could be another; it has been predicted “that COVID-19 will have a lasting effect on corporate governance around the world.”
Given that critical junctures analysis focuses on turning points and given its academic prominence, it might have been anticipated that the critical junctures framework would have been deployed with some regularity to assess the implications of the COVID-19 pandemic. In fact, there has been little reliance on critical junctures theory thus far. A possible explanation is uncertain predictive capabilities.
The fact that lasting consequences help to define a critical juncture is the primary reason why using a critical junctures framework to look forward is potentially problematic. Collier and Munck said in the 2017 article where they mapped out a methodology for studying critical junctures “[a] key claim in the critical juncture framework is that this major episode of institutional innovation generates an enduring legacy. In short: no legacy, no critical juncture.” Correspondingly, they maintained, critical juncture scholars must “focus on factors that yield a self-reinforcing outcome over a longer time horizon.” This implies critical junctures analysis is “entirely postdictive,” available only to scrutinize “formative moments . . . retrospectively.”
Other critical juncture scholars are prepared to deploy the framework more liberally than Collier and Munck, such as in the midst of a turning-point-type of event. Hogan and Doyle maintain a critical junctures model can incorporate a predictive element, thereby broadening the applicability of the critical juncture concept and contributing “to a better understanding of policy change.” Taylor Boas suggests similarly that “even without a strong basis for arguing that a definitive legacy has emerged, there are still productive ways of using the critical juncture framework.” He argues that critical junctures analysis can be deployed “even before the ‘dust had settled’. . . rather than waiting one or more decades to justify delving into questions of a ‘new critical juncture.’” Boas suggests it should be possible in the short to medium term “to debate alternative explanations about antecedent conditions and constant causes, and to look for evidence of both reactive and self-reinforcing sequences.” Such work, he reasons, “will surely lay the groundwork for subsequent, more conclusive research on critical junctures and their legacies.” It is in this spirit that we consider whether we are in the midst of a COVID-19-driven corporate law critical juncture. Corporate governance, after all, appears to be an area where “one way to forecast the future is to analyze the past.”
B. Corporate Law Critical Junctures Patterns
To assess whether the COVID-19 pandemic is likely to foster a corporate law critical juncture, it is instructive to recall the insights this article has provided thus far. The crash-then-law account that Stuart Banner and Frank Partnoy advanced nearly a quarter-century ago treated a sharp decline in share prices as the most obvious explanation for the occurrence of substantial reform. This article’s critical juncture-oriented analysis of corporate law tallies with this insight. Part IV indicates that with the introduction of federal securities law in the 1930s and with the enactment of SOX in 2002 and Dodd-Frank in 2010 a harsh bear market acted as a catalyst for regulatory reform substantial enough to mean a corporate law critical juncture was involved. Part VI makes the point that change on the scale of the bear market-driven “big three” critical junctures has been absent at state level, regardless of market conditions.
Why is a substantial stock market downturn so crucial for a full-blown corporate law critical juncture? Due to an amendment process inimical to major, sudden change state law can be set to one side off the bat. At the federal level, in the absence of market turmoil, neither investors nor the public at large have an obvious reason to press for major change. Moreover, incumbent financial and business interests should be sufficiently well-positioned to fend off unwelcome proposals for thoroughgoing reform.
While a substantial bear market may be a necessary condition for a corporate law reform wave it is not a sufficient one. Part V canvassed a series of noteworthy stock market declines that failed to yield a meaningful corporate and securities law legacy. These instances suggest two elements in addition to a sharp drop in stock prices need to be present for there to be a critical junctures-style turning point. First, the downward pressure on stocks will need to endure over a sustained period. A quick rally likely will undercut whatever regulatory momentum the initial market shock might have created. With the introduction of federal securities law, SOX, and Dodd-Frank, the pain with each of the bear markets that served as the catalyst for reform was lengthy.
Second, the market turmoil will need to be intertwined with a sense of public outrage arising from perceived corporate misconduct. Under such circumstances, reform becomes thought of as essential to correct the market’s faults and discredited vested interests will be deprived of at least some of the political clout that otherwise might thwart reform. The “moment of openness” that paves the way for substantial regulatory change therefore comes into being. The necessary discontent was prevalent in the early 1930s, fueled by the Pecora hearings, in 2001–02 as a result of corporate scandals (e.g., Enron and WorldCom), and in 2008 due to alleged banker malfeasance.
Part V drew attention to three instances where short-lived bear markets failed to yield a meaningful corporate law reform legacy: 1907, 1917, and 1987. In 1907 and 1987 Wall Street was badly shaken by market turmoil. In both cases, however, the stock market immediately began to recover and lost ground was recovered promptly. The 1917 stock market swoon was cancelled out by a rally that occurred despite the 1918–19 influenza pandemic.
This leaves two stock market crashes unaccounted for, 1920–21 and 1972–74. On both occasions, there was an appreciable delay before the market recovered fully. Indeed, the entire 1970s was dismal. In both cases, though, the crash-related public outrage toward business that appears to be necessary for corporate law critical junctures was absent. The 1920–21 bear market was twinned with a harsh recession where the downturn was associated with the dismantling of the wartime economy, fiscal and monetary retrenchment, and declining agricultural prices rather than problematic business behavior. Similarly, with economic woes the United States endured during the 1970s governmental mismanagement and a sharp increase in oil prices overshadowed whatever corporate misfeasance that was occurring.
An alternative way of distinguishing between bear markets as regulatory catalysts that merits consideration is to separate out those where a stock price bubble has “burst” from market downturns where this has not happened. Law professor Stephen Bainbridge subscribes to this logic, as he treats the existence of such a bubble as a pre-condition for substantial regulatory interventions in the corporate realm. The 2008 financial crisis cannot be squared readily with this reasoning, however. While there was a substantial stock price crash in the fall of 2008, no bubble was evident. That summer stock prices were below record levels and markets seemed to be “stable and almost seemed to be neutral.”
More generally, emphasizing the policymaking significance of bubbles is problematic because it is difficult, if not impossible, to identify a bubble in real time. For instance, according to Bainbridge’s reasoning the absence of a significant regulatory legacy following on from Black Monday in October 1987 implies there was no bursting of a stock market bubble. Various contemporaries, however, suggested that this was exactly what had happened. Hence, while it is clear that not all stock market crashes set the scene for a corporate law critical juncture, a prolonged bear market is a better predictor than a putative stock price bubble.
The pattern underlying America’s past corporate law critical junctures suggests that a repeat is unlikely with the COVID-19 pandemic. To reiterate, the hallmarks of past critical junctures in this area have been (1) a stock market decline occurring over a sustained period and (2) blameworthy business conduct. Both elements thus far are lacking with COVID-19.
In early 2020, a bear market of the sort associated with corporate law critical junctures became a very real possibility. Between February 19 and March 23, the S&P 500 fell nearly 34 percent, the fastest ever 30 plus percent decline from all-time highs in stock market history. Although the stock market rallied quickly after hitting bottom, increasing 18 percent in just three days, it still seemed a fraught time for investors. Robert Shiller wrote in the New York Times in early April 2020:
But the world has never seen an event quite like this before—a new pandemic that is being aggressively throttled by draconian shutdowns of whole industries, and by confining millions of people to their homes. The tools of statistical analysis and machine learning, powerful as they are, can’t adequately assess what the world is experiencing. There isn’t any stock market experience that is entirely analogous . . . .
Despite the COVID-19 related apprehension, the news for investors would soon get better and better. The sharp drop in share prices turned out to be a “‘blink and you will miss it’ bear market.” April 2020 was the best month for the stock market in decades, despite unemployment rates hitting a post-World War II high of 14.7 percent. As a result, the COVID-19 bear market only lasted thirty-three days, the shortest on record. Share prices continued to rally even though the United States experienced its steepest quarterly drop in economic output on record—9.1 percent—in the second quarter of 2020. When in 2021 Morningstar issued a revised version of the bear market “pain index” it initially generated in 2020 and added the COVID-19 stock market decline to its previous list of seventeen bear markets, it noted that the COVID-19 bear market was by some distance the least painful due to the rapid rebound.
“The most remarkable bull run in financial history” continued throughout 2020. A year after the COVID-19 stock market swoon, there was even talk of a stock market bubble. For present purposes, the key point is that, if history is any guide, the 2020 bear market was reversed far too quickly to act as the catalyst for a corporate law critical juncture.
Even if the COVID-19 stock market turmoil had proved to be more enduring, a corporate law critical juncture was unlikely to ensue. Again, a crash will probably not suffice in isolation. Instead, blameworthy business conduct probably must accompany the falling share prices. That has been lacking with COVID-19, thus far at least.
While perceptions of corporate and financial skulduggery helped to set the scene for the enactment of federal securities legislation in the mid-1930s, SOX, and Dodd-Frank, thus far circumstances are much different with the current pandemic. COVID-19, as a natural phenomenon, was an exogenous shock for the corporate sector unrelated to business behavior. As the chief economist at a large bank said as the pandemic first spread globally “[w]hat we’re seeing is caused by something external to the economy.” Former Rep. Barney Frank, co-sponsor of the Dodd-Frank Act, made the same point when contrasting COVID-19 with the 2008 financial crisis. He said: “This one is scarier to me, because we knew how to handle the other one . . . . The other one was a result of human error and bad decisions. This is different.” Or as a CNBC contributor indicated when engaging in the same exercise; “In 2008, the banks were the source of the problem for financial markets. . . . . Banks weren’t the culprit in this latest downturn.”
While the economic havoc COVID-19 initially wrought could not be blamed on America’s corporate sector, problematic business conduct could yet emerge akin to that associated with corporate law critical junctures. For instance, the pandemic could be a catalyst for dubious financial engineering. As The Economist has said, “[w]hen economic survival is threatened, the line separating what is acceptable and unacceptable when booking revenues or making market disclosures can be blurred.” Executive pay could become another flash point. Employee Benefit News said of the pandemic in spring 2020: “[A]s the pain grows for ordinary workers, executive pay—a divisive issue in an age of extraordinary inequality—has come to the fore once again.” Given that CEO pay hit record levels in 2020 as many companies adjusted incentive plans in response to COVID-19 in ways that yielded higher executive pay, not surprisingly there is some evidence of dissatisfaction. Still, while the possibility that corporate America will ultimately suffer a reputational black eye due to the COVID-19 pandemic cannot be discounted, as matters stand the culpability that has accompanied previous corporate law critical junctures is absent.
What prompts significant changes in corporate law? The intellectual tools available to engage with this important question are currently rudimentary. Major changes to corporate law have been explained primarily in terms of a crash-then-law logic and the related notion of punctuated equilibrium. These analytical approaches do provide insights, as they account plausibly for three key reform episodes—the introduction of federal securities law in the 1930s, SOX, and Dodd-Frank. However, the crash-then-law and punctuated equilibrium accounts leave open as many questions as they answer. For instance, can major changes to corporate law occur in short order without a stock market crash? Is a substantial bear market both a necessary and sufficient condition for significant reform? If not all crashes prompt a major legislative overhaul, what kind of crashes are most likely to do so?
This article has engaged with these important questions. It has done so by drawing upon an analytical framework that has gained a firm intellectual foothold in the social sciences but has yet to make a meaningful mark on legal scholarship, namely critical junctures. We have deployed the critical junctures framework to identify factors likely to yield major changes to corporate law. In so doing, we have extended our investigation beyond the “big three” of 1930s federal securities law, SOX, and Dodd-Frank. We have examined the regulatory legacy of other instances of market turmoil, such as the Wall Street panic of 1907, the flu pandemic of 1918–19, and 1987’s “Black Monday.” We have also taken into account state law, drawing attention to barriers to change that preclude quickly executed multi-themed alterations. We conclude that the federally oriented “big three” continue to stand out as the only true corporate law “critical junctures” and that future such episodes are unlikely to occur without a combination of a prolonged stock market slump and public outrage toward business.
The COVID-19 pandemic understandably is preoccupying everyone right now. Correspondingly, while we are aware that prediction is a hazardous game, we have relied on critical junctures analysis to assess whether the pandemic is likely to elicit major regulatory change. We suggest that, as matters stand, the corporate law “big three” will remain the “big three.” This exercise in prediction, however, ultimately is a sideshow in a larger project. We have turned to an intellectual framework legal scholars have yet to deploy systematically—critical junctures—to build fruitfully on existing theorizing about corporate law reform. We provide in so doing a historically oriented analysis that can be drawn on productively by those who follow corporate law developments as well as those interested generally in how law evolves.