I. Introduction

This Article builds upon existing literature on controlling shareholders, financial intermediation and creditor governance (Part II) to analyze the mirroring setup between controlling and noncontrolling shareholders on the equity side, and private and public lenders on the debt side (Part III). It studies the dynamic interaction of these characteristics across jurisdictions where different combinations of debt and equity exist (Part IV). Finally, it concludes that this framework can sometimes explain cross- and intra-jurisdictional variations in governance outcomes (Part V).

II. Literature Review

The traditional account of ownership concentration revolves around the distinction between controlling (“CS”) and noncontrolling shareholder (“NCS”) firms and jurisdictions.¹See Ronald J. Gilson, Controlling Shareholders and Corporate Governance: Complicating the Comparative Taxonomy, 113 Harv. L. Rev. 1642 (2006); see also John C. Coffee, Dispersed Ownership: the Theories, the Evidence, and the Enduring Tension Between ‘Lumpers’ and Splitters (European Corporate Governance Institute (ECGI), Working Article No. 144/2010), available at https://ssrn.com/abstract=1532922 (referring to this dichotomy as the “single most noticeable fact about corporate governance”). On the one hand, it is costlier for NCSs to supervise companies and coordinate their actions to influence corporate decisions.²Lucian A. Bebchuk & Assaf Hamdani, The Elusive Quest for Global Governance Standards, 157 U. Pa. L. Rev. 1263, 1282–83, 1290–91 (2008). NCSs also have a limited incentive to incur these costs given their relatively small stake in a given company.³Id. at 1281; Mariana Pargendler, The Corporate Governance Obsession, 42 J. Corp. L. 359, 371 (2016). On the other hand, CSs are better able to align managerial behavior with their preferences because they do not need to overcome the hurdle of coordination costs, and the large stakes that they hold make monitoring companies worth the costs.⁴John Armour, Luca Enriques, Henry Hansmann & Reinier Kraakman, The Basic Governance Structure: The Interests of Shareholders as a Class, in anatomy of corporate law: a comparative and functional approach 128 (Reinier Kraakman, John Armour, Paul Davies, Luca Enriques, Henry Hansmann, Gerard Hertig, Klaus Hopt, Hidekki Kanda, Mariana Pargendler, Wolf-Georg Ringe & Edward Rock, 3rd ed., 2017) (henceforth “The Anatomy”).

The public-private debt dichotomy mirrors the NCS-CS framework in many respects. Like CSs, private debt creditors generally have large individual stakes, incentivizing them to monitor their debtors. Furthermore, private debt creditors and CSs face different collective action problems than scattered public debt creditors and NCSs.  This mirror image is also reflected in the illiquidity of private debt⁵Douglas W. Diamond & Raghuram G. Rajan, Banks and Liquidity, 91(2) Am. Econ. Rev. 422, 422 (2001); Daniel K. Tarullo, Nomura Professor of International Financial Regulatory Practice, Harvard Law School, Lecture at Harvard Law School on the Regulation of Financial Institutions (2022); see also George A. Akerlof, The Market for “Lemons”: Quality Uncertainty and the Market Mechanism, 84 Q. J. Econ. 488 (1970). and large equity stakes on secondary markets, which contrasts with the relative ease in selling public debt and the small number of shares held by NCSs. It is helpful to study shareholder-creditor agency theory to elucidate the implications of this mirroring setup.

Creditors will typically fear shareholder behaviors that would reduce the value of their debt claims, such as raising additional senior or pari passu debt.⁶See, Michael C. Jensen & William H. Meckling, Theory of the Firm: Managerial Behavior, Agency Costs and Ownership Structure, 3 J. Fin. Econ. 305(1976); Mark J. Roe, David Berg Professor of Law, Harvard Law School, Lecture at Harvard Law School on Bankruptcy (2022). While they are deemed able to protect themselves via covenant clauses covering a wide array of corporate actions,⁷See David Christoph Ehmke, Bond Debt Governance: A Comparative Analysis Of Different Solutions To Financial Distress Of Corporate Bond Directors 151–57 (2018). these contractual levers are mostly relevant to private debt creditors. Indeed, the cost of negotiating, monitoring, and enforcing covenants is often prohibitively high for public debt creditors, who tend to obtain laxer and less extensive protection.⁸Yakov Amihud et al., A New Governance Structure for Corporate Bonds, 51 Stan. L. Rev. 447, 458 (1999); Douglas W. Diamond, Financial Intermediation and Delegated Monitoring, Rev. Econ. Stud. 393, 410 (1984) (“If there are m outside security holders in a firm and it costs K>0 to monitor, the total cost of direct monitoring is m.K. This will either imply a very large expenditure on monitoring or a free rider problem where no securityholder monitors because his share of the benefit is small”).

This distinction is fundamental because it undergirds a new strand of literature that questions the conventional wisdom that creditors only play a passive role in corporate governance.⁹See Frederick Tung, Leverage in the Board Room: The Unsung Influence of Private Lenders in Corporate Governance, 57 UCLA L. Rev. 115 (2009); see also Douglas G. Baird & Robert K. Rasmussen, Private Debt and the Missing Lever of Corporate Governance, 154 U. Pa. L. Rev. 1209 (2006); see also Greg Nini et al., Creditor Control Rights, Corporate Governance, and Firm Value, 25 Rev. Fin. Stud. 1713 (2012). Rather, according to these authors, creditors are actually able to influence corporate decisions when debtors violate covenants, giving creditors the right to declare an event of default.¹⁰See in general, Frederick Tung, supra note 10. This observation reflects how creditors actually hold significant negotiating leverage, as they can validly threaten to call the loan. Since debtors routinely breach their covenants, the interference of creditors in governance occurs much prior to acute financial distress.¹¹Id. at 115.

III. Research Design

A. The Problem

Like there are NCS and CS jurisdictions, there are jurisdictions in which corporate lending relies more heavily on private debt than public debt, and vice-versa. Therefore, to each jurisdiction corresponds a pairing which depends on where it stands on both the NCS-CS and the public debt-private debt axes (Table 1). Combining the insights from the three strands of literature mentioned above can help better understand the interaction of these two factors. In a (NCS; Private Debt) jurisdiction like the UK, one may hypothesize that the free space left out in corporate governance by scattered shareholders is filled by creditors rather than managerial slack. A (NCS; Public Debt) configuration like the US seems to be the most favorable to opportunist managers seeking to extract value from the firm, as both shareholders and creditors lack strong incentives and means to monitor them. France fits the (CS; Private Debt) category, which would seem prone to a balance of power between “strong owners” and “strong creditors”. The (CS; Public Debt) configuration would theoretically give the CS more latitude to control the company and extract value at the expense of the minority and creditors. However, no existing jurisdiction seems to fit this intersection.

Table 1: The Financial Intermediation-Ownership Concentration Matrix.

	Noncontrolling Shareholders	Controlling Shareholders
Public Debt	United States	[none]
Private Debt	United Kingdom	France

B. The Method

This Article assesses how this mirroring setup dynamically functions across these three jurisdictions by looking at appointment and dismissal rights, one of the levers of alignment presented in The Anatomy.¹²See, John Armour et al., Agency Problems and Legal Strategies, in Anatomy Of Corporate Law, supra note 5, at 32; on the functional approach, see David Christoph Ehmke, supra note 8, at 32 (“The question has to be whether the same, a similar or an apparently different rule performs the same function within the particular legal and extra-legal environment similarly effective”); see also, Konrad Zweigert & Heinz Kötz, Einführung in die Rechtsvergleichung, (3rd ed., 1996). This lever involves dynamics that crystalize the interaction between ownership concentration and financial intermediation. By focusing on appointment and dismissal rights, this Article seeks to understand whether creditors or shareholders have more control over what these methods seek to achieve (e.g., control of the functions of the board of directors).

IV. The Comparison

A. The Vicinity of Insolvency

When a firm nears insolvency, conventional expectations are that shareholders control the appointment and dismissal of directors. Since public debt indentures contain a restricted and looser set of covenants, US creditors can hardly influence such decisions. Dispersed shareholders will also have a limited reaction to the firm’s financial difficulties, as their monitoring is limited and intervening would be costly. However, when private creditors are faced with dispersed NCSs like in the UK, they are able to leverage their power to grant a waiver of default for “tripped” covenants. Although found in a US context, the case of Krispy Kreme exemplifies this setup. In 2005, bankers were able to obtain the dismissal of the CEO and chairman of the board after the firm failed to deliver financial statements under one of its covenants.¹³Douglas G. Baird & Robert K. Rasmussen, supra note 10, at 1211–12. However, in France, controlling shareholders are better able to resist the pressure of private creditors. This can once again be illustrated through a discrete US case. In 1976, the clothing company Farah was teetering on the edge of bankruptcy when it was granted an additional loan by its bank creditor. This new loan included a covenant meant to keep out the former CEO, thereby demonstrating the bank’s significant influence on the way the firm is run. Nevertheless, the family in control of the company eventually reinstated him despite the threat of an event of default. This example reflects how a private creditor can be partially tamed by a controlling family that possesses the capacity and incentive to control the board.

B. Insolvency

Once a firm has filed for bankruptcy, the default rule in the US is that the debtor stays in possession of the firm, and existing management can remain in charge.¹⁴Bankruptcy Code §1107 (the statute uses the term of art “Debtor-In-Possession” (or “DIP”)); see John Armour et al., Corporate Ownership Structure and the Evolution of Bankruptcy Law: Lessons from the United Kingdom, 55 Vand. L. Rev. 1745 (2002) (arguing that the rationale is the incumbent’s detailed knowledge of the firm). Should dispersed shareholders and public bondholders seek a change in management, they would have to actively seek its ousting, implying coordination costs. Despite a relatively lax statutory standard,¹⁵US Bankruptcy Code §1104. the appointment by the court of a trustee upon the creditors’ request is largely seen as an exceptional remedy.¹⁶Mark J. Roe, David Berg Professor of Law, Harvard Law School, Lecture at Harvard Law School on Bankruptcy (2022). This is consistent with the expectation that dispersed bondholders would not have the economic incentive to make use of their formal right to oust incumbents.  In contrast, in the UK, the default legal rule is that debtors must relinquish control of their companies when they enter the insolvency regime.¹⁷Vanessa Finch, Corporate insolvency law: perspectives and principles 280-281 (2nd ed., 2009). In administration, the court-appointed administrator thereby acts for creditors as a whole.¹⁸Insolvency Act 1986 Schedule B1 s. 3(1). While this provides protection from the shareholder abuses found in the US context, it leaves concentrated creditors with an opportunity to exert significant influence.¹⁹Finch, supra note 18, at 440-441. In contrast, the administrator in a French “redressement judiciaire” does not owe a duty of care to creditors. As the mission of the court-appointed judicial administrator is limited to “assistance,” CSs still preserve significant leeway over the firm leadership.²⁰French Commercial Code art. L631-12. Creditors, on the other hand, are hamstrung by the French legal framework since the judicial representative representing their interests has a limited role. This prevents them from leveraging their strength to appoint directors on their own. This (Private Debt; Controlling Shareholder) configuration, can be exemplified by the case of the Hunter family in the US.²¹Mark J. Roe & Frederick Tung, Bankruptcy and Corporate Reorganization, Legal and Financial Material 253 (4th ed. 2016). In line with the model’s prediction, the controlling family profited from the default rule that left them in control to undertake risky projects from which they would reap the benefits as shareholders. In case of failure, the bank creditors would have borne the losses on their claims. However, the fact that these private creditors did not move for the appointment of a trustee, even though they had both the means and an economic incentive to do so, left bankruptcy experts surprised.²²Id. at 294-305.

V. Conclusion

This mirroring setup thus explains how and why private creditors may exert significant influence over a firm out of formal bankruptcy proceedings, depending on the organizational capacity of the shareholders it faces. Conversely, it also sheds light on the extent to which CSs confronting private creditors may retain influence even after a bankruptcy filing. Moreover, it is easy to underestimate the central role played by the statutory framework of each jurisdiction as it may mitigate or magnify power imbalances between these constituencies. However, little scholarly attention has been so far dedicated to this interaction between debt and equity investors, which helps surpass monolithic views of corporate governance omitting the crucial role of creditors.²³In 2002, an article analyzed the US and UK bankruptcy regimes through this lens. Both statutes and the legal scholarship have since then evolved in significant ways but there has been no comparable work in the last two decades; See, John Armour et al., supra note 15.

In June of 2018, the California legislature passed the California Consumer Privacy Act of 2018, establishing a new system of privacy regulation that has never before been seen in the United States.  Specifically, the provisions of the CCPA allow consumers five rights: (1) the right to know what personal information a company has; (2) the right to know whether information is sold or disclosed; (3) the right to opt-out or say no to the sale of personal information; (4) the right to access the information; and (5) the right to equal pricing if these rights are exercised.¹Cal. Civ. Code  § 1798.175 The law provides for private action regarding privacy and personal data, providing for damages as detailed in the statute of $100 to $750 per incident.²Id.  The law has developed as new regulations have been put in place across the pond in Europe and is in part modeled after some of the legislative and judicial advancements in privacy that came with the establishment of GDPR³EU General Data Protection Regulation(GDPR): Regulation (EU) 2016/679 of the European Parliament and of the Council of 27 April 2016 on the protection of natural persons with regard to the processing of personal data and on the free movement of such data, and repealing Directive 95/46/EC (General Data Protection Regulation), OJ 2016 L 119/1. and the “right to be forgotten”⁴See generally Steven C. Bennett, The “Right to Be Forgotten”: Reconciling EU and US Perspectives, 30 Berkeley J. of Int’l L. 161 (2012) in the European Union.

While the CCPA has already been passed by the California legislature, the provisions of the law will not be enforced until 2020.  In preparation for the passage of this act, key definitions will be important to analyze to fully understand the scope of the law and the protections it provides. The current version of the law applies to residents of California and includes a broad definition of personal information with an enumerated list that includes geolocations, biometric information, and data regarding protected classifications.  As California continues to grow and advance the tech industry and companies continue to collect and store data, the CCPA’s application to private sector businesses grows in importance.  Updates and clarifications the CCPA may be announced by the California Attorney General closer to the date of enforcement implementation. Additional clarifications may provide more detailed information regarding the definition of “personal information,” the protected consumers, and the businesses that will ultimately have to comply with the CCPA’s provisions.

Planning for compliance with the CCPA may prove less cumbersome for larger organizations that have been forced to comply with privacy regulation across other jurisdictions.  Following the Google Spain v. Agencia Espanola de Proteccion de Datos and Mario Costeja Gonzalez⁵ECLI:EU:C:2014:317 case from the Court of Justice, Google Spain was required to respond to take down requests for storage of personal information on their website and servers.  Google convened an Advisory Council of professors, practitioners, and lawyers to analyze the implications of removal of information and the correct procedures to receive requests.⁶Advisory Council to Google on the Right to be Forgotten, “Final Report,” Jan 2015. While the rights triggered under this decision are not perfectly analogous and covered a very different rights regime where First Amendment implications did not exist, the groundwork to develop a compliance process has already been set in motion.  While early stage and emerging firms in the tech sector with access to consumer data may be more nimble to adapt to the CCPA, complying with the law may create new impacts to the sector that will continue to emerge as the law comes into effect and the Attorney General provides greater clarity on the provisions.

As California’s data privacy protections expand, key legal questions will continue to emerge regarding the applicability of California’s law on technology and data collection that can be “borderless.”  A state by state solution may ultimately lead to inconsistencies in the laws governing data collection and privacy and have an outsized effect on companies seeking to target markets across the United States.  For example, the Illinois Biometric Information Privacy Act,⁷740 ILCS 14/1. governing the collection, use, and storage of biometric data requires written consent for the use of biometric data, and the Illinois Supreme Court has recently ruled that no harm, other than a violation of a legal requirement of the statute is needed.⁸See Rosenbach v. Six Flags Entm’t Corp., 2019 IL 123186.  The Business Roundtable, a group of CEOs from leading American companies,⁹Business Roundtable, “About Us,” https://www.businessroundtable.org/about-us, (last visited Feb. 1, 2019). has issued a policy perspective calling for a national consumer privacy regime.  Their recommendations seek to create consistency and uniformity for consumers and businesses as the business of privacy continues to develop and expand.

Ever since Bitcoin’s electrifying launch in 2009, the crypto market has evolved into a new frontier of wealth, generating a boom of cryptocurrencies, elaborate exchanges, and even a whole new universe built upon the blockchain. The new industry seemed immune to the financial pressures caused by the COVID-19 pandemic in 2020; people don’t need to leave their homes to buy and invest crypto. Indeed, the crypto market hit an all-time high in January 2021, and then again in November of the same year. For investors and a niche subset of the public, there appeared to be no end in sight. Reddit and Discord became a breeding ground for a new generation of young adults seeking the rush of asset trading, with real-time advice and discussion on market trends and even informational videos for those who decided that the alluring modern market was an attractive entry into the world of trading.

Unfortunately, for every boom there must be a bust. On November 7, 2021, the second largest cryptocurrency exchange in the world—FTX—announced a liquidity crisis and sought a bailout by venture capitalists and Binance, its top market rival. In a run likened to that of 1929, spooked investors rushed to the site seeking $6 billion in withdrawals. Over the next seven days, a whirlwind of events would unfold: Binance’s announcement—and then abandonment of—a plan to acquire FTX after diligence revealed evidence of mishandled funds; FTX’s foreign assets were frozen; and reports surfaced that millions of dollars in customer deposits were funneled into hedge funds eerily acquainted with FTX founder Sam Bankman-Fried mere days before the crash.

So what went wrong? It turns out that the SEC was wrestling with a “will they or won’t they” regulation dilemma on cryptocurrency for months leading up to the FTX crash. The agency, in deciding whether to launch into a lengthy and complicated research period to find the right regulatory balance, found itself grappling with a fear of restricting a growing and potentially lucrative industry while remaining worried of illegal cryptocurrency payments and a black-market ecosystem rife with cybercrime.

In fact, about a month prior to the run on FTX, the SEC began to toss around the idea of seriously cracking down on the crypto market. There was only one problem: the agency could not decide whether cryptocurrency counted as a security. SEC Chairman Gensler certainly made his views clear over the past year, citing the Securities Act of 1933, the Securities Exchange Act of 1934, and the “Howey Test” as put forth by the Supreme Court in SEC v. W.J. Howey Co. Under the Howey Test, a transaction is considered a security if it meets the following four criteria:

• Money is invested.
• There is an expectation that the investor will earn a profit.
• The investment is in a common enterprise.
• Profits are generated via the efforts of others.

If deemed a security and registered with the SEC, crypto exchanges would be forced to adopt technology systems to make their order books audit-compliant. They would also face strict rules on order execution to prevent market manipulation. From Gensler’s perspective, crypto intermediaries that engage in the business of effecting transactions in security tokens are brokers. And those that buy, sell, or swap crypto security tokens for their own accounts are dealers. Because of this, crypto investors “should get the protections they receive from regulated broker-dealers,” Gensler said.

With FTX handling billions in consumer funds, it seems striking that the crypto exchange giant went wholly unregulated by the SEC for two years—and it’s not because FTX simply wasn’t on their radar. If the SEC was under the impression that it possessed authority to regulate crypto exchanges, it could have done so a long time ago. Chairman Gensler actually met with Mr. Bankman-Fried and FTX executives repeatedly in the months preceding FTX’s failure. Earlier that year, the SEC also inquired into documents and information on FTX’s practices related to its handling of customer assets—the heart of the alleged fraud—but evidently turned up with nothing. Whether this was just an unfortunate oversight, or the result of Bankman-Fried’s reputation on Capitol Hill as a friendly face with a deep wallet, remains to be seen.

Forging ahead, there continues to be pervasive uncertainty in the world of crypto. Many are wondering if the FTX scandal will result in a slew of legislation and regulation as did the last known financial scandal in recent history: Enron. It turns out the two are scarily linked in more ways than one. John Ray III, the leader in recouping billions for Enron’s creditors back in the early 2000s, has stepped in as CEO of FTX. Ray, however, seems to view the two on different levels, stating about the crypto exchange, “Never in my career have I seen such a complete failure of corporate controls and such a complete absence of trustworthy financial information as occurred here.” In fact, the parallels between the two companies continue to reveal themselves. Enron painted itself as an advanced tech pioneer through its energy trading platform Enron Online. That very guise of modernity actually acted to shield dodgy accounting practices and related-party self-dealing while capturing institutional and regulatory actors to keep the wheel spinning. Here, the glamour of a new market built entirely upon the shiny new technological advancements of the last two decades resulted in a regulatory failure that allowed the FTXs to flourish domestically and internationally.

It does at least seem as though the SEC has learned from its mistakes. In late January 2023, the agency charged two digital asset giants — Gemini Trust and Genesis Global Capital — with selling unregistered products to individual investors. Congress announced that it would raise the agency’s budget this fiscal year. And a late 2022 court victory has finally given the SEC the go-ahead to fully treat crypto tokens as securities subject to regulation whether or not they are sold through initial coin offerings. Unsurprisingly, crypto companies are poised to fight back. Armed with internet conspiracists and Twitter “trolls,” the millennial and gen-z crypto community’s resistance to the SEC is centered around a doubt that the agency, comprised of mostly middle-aged civil servants, possess the knowledge and authority to try and regulate the market. The SEC, meanwhile, is standing strong on its desire to bring crypto middlemen like FTX into the existing securities regulatory regime.

Over the next few weeks, months, and years, the SEC will have an opportunity to redeem itself as long as it continues to deliver on its threats to crack down on the crypto market (and whatever other shiny new financial development that is sure to come). Should the SEC choose to regard it as so, FTX and crypto’s flashy rise and fall could serve as a final wake-up call for its continued history of leaving financial markets largely unchecked. But this isn’t the first time that writing has been on the wall. From Bernie Madoff cheating rich, sophisticated investors, to Enron’s hidden accounting practices and now Sam Bankman-Fried’s transfer of customer assets to small subsidiary venture funds, one can’t help but notice a larger pattern. Post dramatic newsworthy implosion, the agency likes to go public with its retaliatory measures for a few weeks. However, once the press dies down and the ringleaders go through prosecution, all public statements and efforts to regulate financial markets seem to fade away. If the SEC is serious this time about cracking down on consumer-oriented regulations, I hope that their recent actions and inquiries into the crypto market don’t turn out to be hollow. Moving forward, the questions remain—can the cryptocurrency industry remain afloat? Can the SEC rebuild the public’s trust? And more importantly: what lessons will the agency glean to prevent the next generation’s financial scandal?

In a dramatic unfolding¹This paper was written on November 5, 2022, and changes to Twitter under Musk’s ownership have continued to develop since then but are not examined in this piece., Elon Musk has completed a $44 billion acquisition of Twitter, taking the company from public to private.²https://www.nytimes.com/2022/10/27/technology/elon-musk-twitter-deal-complete.html Musk closed the merger on the evening of October 27, 2022, introducing a new era where the ultra-wealthy can purchase entire companies in which they become interested.³Id. This closing came after Twitter filed suit against Elon Musk, as Musk tried to back out of the deal.⁴Musk’s buying of Twitter came under scrutiny by the U.S. Government for data-security issues due to Musk’s foreign investors, although no further developments of this inquiry have been reported. (https://www.bloomberg.com/news/articles/2022-11-17/musk-s-twitter-deal-remains-in-focus-for-us-data-security-review) Then, weeks before the trial was scheduled to begin in Delaware courts, Musk announced he would proceed with the deal.⁵https://www.nytimes.com/2022/07/08/technology/elon-musk-twitter.html The below sections provide a brief overview of the timeline of the deal, the legal arguments presented by Musk and Twitter, and examines possible motivations for Musk to pivot and close the deal as originally agreed upon with Twitter. …

From Public to Private: A Mogul’s Acquisition of TwitterRead More »

Technology has changed the way that we conduct business domestically and internationally, and legal departments have had to stretch to meet those repercussive demands. These demands are expansive but include automation and AI developments; corporate online presence and reputation; even larger-scale corporate transactions; and with the aftershocks of the COVID-19 pandemic, a shift in workplace norms as the boundaries between home and work continue to blur. The problem is, many legal departments are averse to structural change, and as a result, the majority are stuck in outdated governance structures that have been the norm for decades.¹https://www.americanbar.org/groups/business_law/publications/blt/2022/07/legal-tech-trends/ But are traditional conceptions of legal department structures, and the balance of powers and work division between the CLO and other in-house counsel, efficient enough to keep up with the changing legal and technological landscape? Across industries, legal departments are faced with a fundamental decision that could determine the future success of their legal practices and the businesses they serve. Rather than ignoring the new technologies that are permeating the business world, legal departments have the opportunity to integrate new automated technologies into daily activities to shift day-to-day work away from more tedious tasks, and to reconstruct governance structures in a way that allows for a more proactive department that embraces a future of business-first, strategic lawyering.

It’s no surprise that the world’s businesses and corporations have fundamentally changed over the past few decades. From what used to be simple proprietorships isolated from international pressures or distant consumer demands are now the corporate behemoths we know and (sometimes?) love. The growing complexity of these corporations, coupled with government attention to compliance control and increased transparency, has introduced a larger need for businesses to remain keenly aware of daily operations, regulatory compliance, internal oversight, and ethical conduct.²https://www.mckinsey.com/industries/financial-services/our-insights/four-imperatives-for-the-next-generation-legal-department Cue: the quintessential legal department, loaded with lawyers in charge of complicated contracts, compliance policies, and a changing landscape of laws and regulations domestically and in international markets.

The evolution of corporations has not slowed down—rather, with the explosion of Silicon Valley came even larger, robust, and complex tech companies in a relatively new industry that is ripe with government scrutiny and fast-paced regulatory changes. Businesses are steadily taking advantage of new technology to streamline day-to-day operations, meet new consumer demands, and continue to expand territory and profits. Unfortunately, legal departments have not followed the same trend. Despite digitization transforming the rest of the company, legal departments remain almost a relic of the past, keeping with rigid governance structures and choosing to not lighten the burden of tedious tasks by using new technologies.

As we exit the second year since the COVID-19 pandemic began, legal departments could find themselves perfectly positioned to take uncharacteristically large leaps to embrace the modern, flexible, and digitized practices of the 21^st century. The question is, will departments take the opportunity to do so? If they did take efforts to embrace modernity, it could be key in attracting and retaining young talent and best supporting their organization. Not only are these changes in legal departments’ best interest, but for many, an updated way of working is deemed necessary. Corporate legal departments are increasingly being asked to reduce costs, increase efficiency, and transform from something of an internal law firm to a blended legal/commercial arm that drives economic value for the business.³https://www2.deloitte.com/content/dam/Deloitte/us/Documents/finance/us-advisory-legal-department-of-the-future.pdf Gone are the days of rigid department silos and governance structure—to keep up with the growing business demand, lawyers and legal departments are going to have to become something of business partners, embedded and able to work across units and specializations.

So what can legal departments do to embrace the modern era? There are scores of emerging technology that can be employed to reduce the load of traditional, time-sinking tasks: artificial intelligence technology to perform highly detail-oriented tasks such as identifying patterns within volumes of text and voice conversations; cloud technology to lessen the need for in-house storage and simplify file-sharing; blockchain to ensure secure design and automation of contracts and disputes; automation to perform tedious research, document review, or e-discovery; and analytics to assist in business intelligence and operational strategy for easier compliance.

Of course, anytime there are discussions of implementing technology to automate certain detail-oriented and perhaps lower-level tasks, there is a fear of what the implications are for the lawyers whose jobs the robots seem to be replacing. Admittedly, the tedious tasks that artificial intelligence and automation can most easily take on are those of the first- and second-year associate. However, the impact on jobs need not be severe at all; first, because there is no tool that could replace the subjective elements that are core to a lawyer’s expertise—areas of nuance, motive, risk appetite, and emotion. Second, because the shift of more burdensome tasks to technology frees up crucial space for legal departments to take the most important step in shepherding in the modern era: a fundamental shift in legal department governance.

Even in the past decade, we’ve seen evolutions in globalization and internal legal professional needs due to new laws and regulations, social and political changes, and the substantial reach of many modern companies. There is no doubt that the future will bring even more pressure on corporate legal departments to shed their traditional siloed service structures and decentralized delivery model in exchange for a more centralized model to leverage the new blurred lines of global and business functions. This will mean an increased reliance on and investment in legal operations, perhaps, by dedicating a formal legal operations lead role.⁴Id. Traditionally, this role would be targeted at addressing the efficiency of the internal legal departments’ operations; however, there is also room for the role to go beyond its traditional purpose to serve more broadly as the “connector” between the legal department and the business operations, to help the legal department better understand the business and vice versa. The focus on developing a robust legal operations position coupled with the centralization of separate and siloed legal teams can help move legal departments away from the role of a completely reactive entity, and instead shift the department to become more proactive, strategic, and integrated members of their corporate community.

From a pure governance standpoint, there are also opportunities for legal departments to make internal organizational changes to better fit the delivery model of the organization they serve. For example, global conglomerates have different needs than not-for-profit organizations. A new tech start-up won’t need as rigid a corporate structure as a traditional retail seller. Despite the fundamental differences in the services that these companies may provide, many of them have the same traditional legal department structure that has permeated the corporate world for decades: a strict CLO position with separately functioning teams that hardly communicate and often function to react to any issue that arises. There is room for legal departments to shed this traditional model in favor of a more flexible team structure: sharing authority across two or three senior leaders to minimize concentration of decision-making power; breaking down traditional work silos to increase communication amongst teams; transitioning from a reactionary role to one that proactively identifies potential company risks; and integrating the legal department into the company itself to allow for more transparency and increased visibility.

Of course, these changes won’t be without resistance. Lawyers are famously risk- and change-averse. However, the time for acknowledging the changing needs of the modern corporate lawyer and legal department is now. Legal departments can’t be the outdated, traditional feature holding back their companies from continuing to evolve and grow into the modern era. There is an opportunity to embrace technology and move corporate lawyering away from tedious, time-sinking tasks, and instead transform legal departments into strategic, process-savvy, and proactive actors within the company. If there were ever a time for lawyers to shed their infatuation with the status quo, it’s now—embracing technology and integration could give legal departments the perfect edge needed to keep their businesses afloat in ever-advancing markets and uncertain future.

Introduction

Economic growth has been a dominant concern for senior global leaders and policy makers for the past century; understandably, the determinants of economic growth has preoccupied economists for the past several decades.

The figure above shows the share of world GDP by select countries and regions for the period, 1820-2008, based on data from the Maddison Project Database (2018).

Today, U.S. has the highest percentage of the world GDP compared to other countries. In 1820, the situation was quite different; China accounted for a third of the world GDP and the U.S. barely registered.

The figure above compares the GDP per capita in 1990 dollars (to account for inflation) for the U.S., Argentina, and Australia for the period 1900-2008, based on data from the Madison Project Database (2018).

These graphs above raise several practical questions. Why such different economic growth rates for U.S. and Argentina for the past century?¹One difference between these two countries is based on geography: U.S. is in the northern hemisphere, Argentina is in the southern hemisphere. However, Australia has also enjoyed significantly higher economic growth rates than Argentina in the past century; yet, both countries are in the southern hemisphere. Why such different economic growth rates for the U.S. and China during the past two centuries? Economists have studied three broad categories of determinants of economic growth: geography, history (including culture and religion), and . Douglass North provides a useful definition of economic institutions: “Institutions are the humanly devised constraints that structure political, economic and social interaction… Institutions provide the incentive structure of an economy; as that structure evolves, it shapes the direction of economic change towards growth, stagnation, or decline.” Economic institutions involve the rule of law, and respect for and enforcement of private property rights, since each of these have the ability to incentivize (or constrain) certain economic activities.

A previous paper by Rodrik et al focuses on the role of economic institutions on economic growth in 137 countries in 1995. They measure economic institutions as “Rule of Law” compiled by Kaufman et al for the World Bank. They explain: “the Rule of Law reflects perceptions of the extent to which agents have confidence in and abide by the rules of society, and in particular the quality of contract enforcement, property rights, the police, and the courts, as well as the likelihood of crime and violence.” Rodrik and colleagues consider Rule of Law, geography (distance from the equator), openness to trade, and colonial history as potential determinants of economic growth. They find that only Rule of Law explains economic growth. We consider 134 countries during the period 1984-2019 and find a significant positive relation between Rule of Law and GDP per capita. Notably, this positive relation is getting stronger with time. We consider an alternative measure of Rule of Law developed by a commercial vendor, the PRS Group’s International Country Risk Guide; Additionally, we document that lesser corruption in the political system is correlated with higher levels of GDP per capita.

Besides the size of the national pie, which is measured by GDP, senior policy makers and the media across the globe are increasingly concerned about how this pie is sliced, that is, about income inequality. We find that countries with greater adherence to Rule of Law are characterized by less income inequality. Additionally, we find that countries with greater GDP per capita are characterized by less income inequality; however, once we control for Rule of Law in the country, we do not observe this negative correlation between GDP per capita and income inequality. This further highlights that adherence to the Rule of Law relates to reducing income inequality.

Economic institutions and economic growth

Robert Solow suggested that an economy’s output growth is a positive function of physical and human capital growth. Under the twin assumptions of constant returns to scale and competitive markets, deviations of an economy’s actual output growth from the implied growth can be attributed to changes in technology and institutional change, such as, abrupt changes in law and order (and property rights) brought about by armed conflict and political upheavals.  Hence, economic institutions play an important role in promoting economic growth.²Adam Smith in Wealth of Nations provides an earlier characterization of this argument, “Commerce and manufactures can seldom flourish long in any state which does not enjoy a regular administration of justice, in which the people do not feel themselves secure in the possession of their property, in which the faith of contracts is not supported by law…”

Where do economic institutions come from? Some scholars propose a theory of political institutions. They argue that different individuals have distinct preferences over economic institutions since these institutions play a role in resource allocation. In general, people’s preferences over economic institutions do not converge, since different institutions benefit different people. Those who have political power have the ability to choose the economic institutions. Political power can be de jure (based on the constitution, law, and electoral rules) or de facto (based on the circumstances, such as the ability to generate non-violent and/or violent protests and demonstrations). Those with greater economic resources tend to wield more de facto political power. De jure and de facto political power jointly determine today’s economic institutions and future political institutions. In summary, political institutions lead to economic institutions.

As Solow has noted, economic growth has three primary factors: physical capital growth, human capital growth, and technological innovation. If individuals are less confident their private property rights will be enforced, they are less likely to invest in physical capital (business facilities, manufacturing plants and equipment) since physical capital can be expropriated. This expropriation can be led by the state if the country does not have a rule of law, or if the rule of law does not enforce respect for private property rights. If a country has rule of law but does not enforce respect for private property rights, then expropriation can occur in the form of looting by non-state individuals using physical force and threat of armed violence on the owners of the physical capital.

Human capital is more difficult to expropriate than physical capital. The primary reason most individuals invest in human capital (education, trade apprenticeship, professional training) is it enhances their ability to generate income and create wealth. Income and wealth can be expropriated almost as easily as physical capital. Hence, if individuals are less confident their private property rights over their income and wealth will be enforced, they are less likely to invest in human capital. The usual way most individuals use their human capital to generate income and create wealth is by starting businesses, selling to customers, employing workers, growing their busines, selling to more customers, hiring more employees; with this self-reinforcing positive impact on job and wealth creation. Hence, as individuals stop or decrease investing in their human capital, this has a negative multiplier effect on job creation and economic growth.

Technological innovation is a key driver of economic growth. Technological innovation is primarily driven by the intellectual and creative efforts of those with significant human capital.  Hence, as individuals stop or decrease investing in their human capital, this dampens technological innovation which has a negative multiplier effect on job creation and economic growth.

Data and empirical results

We use multiple sources of data to establish our analysis. We obtain GDP per capita (GDPPC) from the International Monetary Fund, World Economic Outlook Database, October 2019. To measure the effects of the rule of law on GDP and income inequality, we obtain data on Rule of Law (RuleOfLaw) and Control of Corruption (CC) from the Worldwide Governance Indicators, 2019 Update.³“The Worldwide Governance Indicators (WGI) are a research dataset summarizing the views on the quality of governance provided by a large number of enterprise, citizen and expert survey respondents in industrial and developing countries. These data are gathered from a number of survey institutes, think tanks, non-governmental organizations, international organizations, and private sector firms.” Kaufman, Kraay, and Mastruzzi (2010). RuleOfLaw reflects perceptions of the extent to which agents have confidence in and abide by the rules of society, and in particular the quality of contract enforcement, property rights, the police, and the courts, as well as the likelihood of crime and violence. CC reflects perceptions of the extent to which public power is exercised for private gain, including both petty and grand forms of corruption, as well as “capture” of the state by elites and private interests. We obtained an alternate set of data on country governance variables from the PRS Group’s International Country Risk Guide (ICRG). The PRS Group’s Law and Order (LAW) index is focused on their assessment of the strength and impartiality of the legal system, and the popular observance of the law. ICRG’s corruption index (CORRUPT) is its assessment of corruption within the political system – patronage, nepotism, favor-for-favor, secret party funding, and close ties between politics and business. Higher index values of LAW and RuleOfLaw indicate better adherence to and effectiveness of rule of law. Higher index values of CORRUPT and CC reflect less corruption. We obtain the MILITARY index from ICRG; a higher MILITARY index reflects a smaller degree of military participation in politics. We use the index constructed by the World Bank to measure income inequality. GINI index measures the extent to which the distribution of income among individuals or households within an economy deviates from a perfectly equal distribution. A GINI index of 0 represents perfect equality, while an index of 100 implies perfect inequality.

The figure above illustrates the correlation between GDP per capita and Law and Order for the 134 countries in our sample for each of the years between 1984 and 2019. Law and Order index is from the PRS Group’s International Country Risk Guide; this index is focused on their assessment of the strength and impartiality of the legal system, and the popular observance of the law. Higher index values of Law and Order indicate better adherence to and effectiveness of rule of law.

The correlation between GDPPC and Law and Order index (LAW) is significantly positive for each of the years during 1984-2019. Also, there is a strong increasing trend of the correlation between GDPPC and LAW in this period; from 0.40 in 1984 to 0.70 in 2019.

Here are some salient examples of how Law and Order and GDP per capita are related:

In 1990, India’s GDP per capita ranked it in the 15.0 percentile compared to the GDP per capita of the other countries in the world; its Law and Order index was at 1. (Recall higher Law and Order indices reflect better adherence to the rule of law.) In the early 1990s, India liberalized its international trade and deregulated its industries; by 2015 its Law and Order index was at 4.5, and its GDP per capita rank was at 26.1 percentile. Another view of the data shows that from 1990 to 2015, several hundred million Indians went from abject poverty to a quasi-middle class standard of living.

China’s case is even more dramatic. In 1984, its Law and Order index was at 3, and GDP per capita rank was in the 3.3 percentile. After extensive adoption of free market policies, its Law and Order index was at 4.5 in 2006 and its GDP per capita rank was in the 31.3 percentile. Again, a more relevant way of looking at the above data shows that from 1984 to 2006, almost a billion Chinese people went from subsistence living to a quasi-middle class standard of living.

Argentina enjoyed a GDP per capita rank in the 64.9 percentile and Law and Order index of 5 in 1999. Subsequently, with changes in their political regime, greater regulation and less free markets, their Law and Order index in 2017 stood at 2, and the GDP per capita rank in the 57.1 percentile.

Venezuela enjoyed a GDP per capita rank of in the 62.6 percentile and Law and Order index of 4 in 1999. Subsequently, Chavez and his successor Maduro nationalized major industries, and significantly increased government spending. As oil prices fell, they resorted to printing money. This led to hyperinflation. Venezuela imposed price controls which led to severe shortages and social unrest. In 2017, Venezuela’s Law and Order index was 1 and its GDP per capita rank was at the 37.6 percentile. While Venezuela’s decline in GDP per capita is significant, it should be viewed in the light of the shattered lives of the tens of millions of Venezuelans during the past two decades.

Similarly, another way to analyze the results is by using the RuleOfLaw metric:

The figure above illustrates the correlation between GDP per capita (GDPPC) and RuleOfLaw for the 134 countries in our sample for each of the years between 1996 and 2018. Data on RuleOfLaw are from the Worldwide Governance Indicators, 2019 Update.  RuleOfLaw reflects survey perceptions of the extent to which agents have confidence in, and abide by, the rules of society, and in particular the quality of contract enforcement, property rights, the police, and the courts, as well as the likelihood of crime and violence. Higher index values of RuleOfLaw indicate better adherence to and effectiveness of rule of law.

The correlation between GDPPC and RuleOfLaw is significantly positive for each of the years during 1996-2018. Also, similar to the earlier figure , there is a strong increasing trend of the correlation between GDPPC and RuleOfLaw in this period; from 0.62 in 1996 to 0.76 in 2018. Not surprisingly, both of the rule of law metrics, LAW and RuleOfLaw, are highly positively correlated for each of the years during 1996-2018. The average correlation between LAW and RuleOfLaw is 0.79.

This figure illustrates the correlation between GDP per capita (GDPPC) and CORRUPT for the 134 countries in our sample for each of the years between 1984 and 2019. CORRUPT is the corruption index of The PRS Group’s International Country Risk Guide; CORRUPT is their assessment of corruption within the political system – patronage, nepotism, favor-for-favor, secret party funding, and close ties between politics and business. Higher index values of CORRUPT reflect less corruption.

The correlation between GDPPC and CORRUPT is significantly positive for each of the years during 1984-2018. (As noted above, higher index values of CORRUPT reflect less corruption.)  Additionally, there is a strong increasing trend of the correlation between GDPPC and CORRUPT in this period; from 0.40 in 1984 to 0.73 in 2019.

This figure shows the correlation between GDP per capita (GDPPC) and control of corruption (CC) for the 134 countries in our sample for each of the years between 1996 and 2018. Data on CC is from The Worldwide Governance Indicators, 2019 Update. CC reflects perceptions of the extent to which public power is exercised for private gain, including both petty and grand forms of corruption, as well as “capture” of the state by elites and private interests. Higher index values of CC reflect less corruption.

The correlation between GDPPC and control of corruption is significantly positive for each of the years 1996-2018. (Recall, higher index values for CC reflect less corruption.) Also, similar to the relationship between CORRUPT and GDPPC, there is a strong increasing trend of the correlation between GDPPC and CC in this period; from 0.58 in 1996 to 0.77 in 2018. AS the above figures suggest, CORRUPT and CC are highly positively correlated for each of the years during 1996-2018; the average correlation between CORRUPT and CC is 0.87.

Before turning to the panel regression results, it would be instructive to observe the relationship between GDP per capita and the Law and Order (LAW) index for 2018 for 50 countries with the largest populations.

This figure shows GDP per capita as a function of Law and Order for the 50 most populous countries in our sample for 2018. Law and Order is from The PRS Group’s International Country Risk Guide; this index is focused on their assessment of the strength and impartiality of the legal system, and the popular observance of the law. Higher index values of Law and Order indicate better adherence to and effectiveness of rule of law. Countries are labeled with the three alphabet World Bank code.

Similar positive relation is observed for our full sample of 134 countries, and for every year in our sample period of 1984-2019.

Using panel regression, we document a significant positive relation between ICRG’s Law and Order index (LAW), and the log of GDP per capita.⁴chrome-extension://efaidnbmnnnibpcajpcglclefindmkaj/https://journals.law.harvard.edu/hblr/wp-content/uploads/sites/87/2020/11/Rule-of-Law-Appendix.pdf This relation is robust to alternative measures of law and order, and for the sample of countries with a population greater than 10 million in 1996. This means that the relationship between LAW and GDP per capita can handle variability and still remain accurate. Also, countries that are less corrupt and where the military is less involved in politics enjoy a significantly higher GDP per capita.

Furthermore, our regression analysis shows a significant negative relationship between GDP per capita and the GINI index. Moreover, we observe a significant negative relation between the law and order (LAW) index and the GINI index. However, when both GDP per capita and LAW are included as explanatory variables, only LAW is significant. This highlights the positive role of law and order in decreasing income inequality.⁵Chong and Gradstein thoroughly document the relationship between rule of law and income inequality for 130 countries during 1960-2000. They do not control for GDP per capita in their analysis. Conceptually, as law and order improves in a country, its citizens have greater confidence that they can enjoy the benefits of their investment in physical capital and human capital; increased incentive to invest in physical and human capital leads to more income for the broader citizenry resulting in less income inequality. The regressions also confirm the positive role of rule of law in decreasing income inequality by using an alternative measure of rule of law (namely, RuleOfLaw), an alternative measure of income inequality (ratio of income of highest quintile to lowest quintile), and for the sample of countries with 1996 population greater than 10 million.

Summary and conclusions

Economic growth has been a dominant concern for senior global leaders and policy makers for the past century; understandably, the determinants of economic growth has preoccupied economists for the past several decades. We consider 134 countries during the period 1984-2019 and find a significant positive relation between Rule of Law (law and order provided by police and courts, respect for private property rights) and GDP per capita. Notably, this positive relation has improved over time. We consider an alternative measure of Rule of Law; the earlier positive relation between Rule of Law and GDP per capita is robust to this alternative measurement. Additionally, we document that lesser corruption in the political system is correlated with higher levels of GDP per capita.

Besides the size of the national pie, which is measured by GDP, senior policy makers and the media across the globe are increasingly concerned about how this pie is sliced, that is, about income inequality. We find that countries with greater adherence to Rule of Law are characterized by less income inequality. We find this to be a very robust relation – robust to alternative measures of income inequality, alternative measures of Rule of Law, and for countries of different sizes. Moreover, we find that countries with greater GDP per capita are characterized by less income inequality; however, once we control for Rule of Law in the country, we do not observe this negative correlation between GDP per capita and income inequality. This further highlights the positive role of  Rule of Law in attenuating income inequality.

On the basis of the above empirical results we have the following policy recommendations. Political leaders in various countries around the globe ought to focus on ensuring respect for private property rights, an effective police force, and fair courts. The leadership of international organizations like the United Nations and World Bank should encourage the political leaders of the countries around the world, especially the developing countries, to prioritize ensuring respect for private property rights of their citizens, an effective police force, and fair courts; this will enhance economic prosperity for their citizens and diminish income inequality across the globe.